Climate change is leading to increasingly severe and frequent risks, such as heatwaves, wildfires, droughts, and floods. At the same time, these risks are driving up spending in areas like disaster relief, healthcare, and insurance programs. It is also likely that climate change will reduce net revenues by affecting productivity, work hours, and the overall labor force. When these factors are combined, they will result in a significant loss to the U.S. federal budget.
However, these losses are not currently adequately represented in the methodology used to determine the costs and benefits of climate policy. In this context, a report titled “The Effects of Climate Change on the Budget and Their Potential Impact on Legislation,” published by the RAND Corporation in 2023, highlights the main ways in which climate change impacts the U.S. federal budget and how these effects can be mitigated through improved modeling and legislative development.
Scope of the Challenge:
While the risks associated with climate change have been theorized and predicted for decades, we are increasingly witnessing real-world consequences. Unprecedented heatwaves, droughts, and floods that affect tens of millions of Americans each year are costing the federal government billions of dollars. Moreover, the federal government spends billions annually on protection, prevention, and mitigation efforts related to climate risks. Similarly, efforts to decarbonize sectors such as energy, transportation, construction, and agriculture will require significant federal spending, amounting to trillions of dollars.
However, budget analysis currently only assesses the costs borne by the federal budget based on implemented policies, focusing on how policy affects discretionary and mandatory spending and revenues without incorporating potential non-financial benefits, such as reduced mortality from cleaner air. While most federal agencies conduct cost-benefit analyses of proposed policies, the basic assumption of budget analysis is that lawmakers will identify the potential benefits of policies, while costs are quantified and reported as outcomes.
This methodology provides an incomplete picture of policy impacts and can be biased against phenomena that operate outside the traditional budget horizon of 10 or 30 years, such as climate change. Agencies like the Congressional Budget Office (CBO) and the Office of Management and Budget (OMB) have shown strong commitment to understanding the impacts of climate change in their budget estimates. However, both agencies are constrained by the time, resources, and mandates provided by Congress.
The Dilemma of Misunderstanding:
The relationships between the economy, climate change, and federal mitigation and adaptation policies are extremely complex and only partially understood. Additionally, experts and stakeholders may not be aware of or agree on many of the conceptual models that describe the system of interest (such as the climate) or how to estimate and evaluate alternative outcomes, like comparing the costs of mitigation to the damages avoided for future generations. Since the consequences of climate change and the responses to it will unfold over decades or even millennia, assumptions about how to evaluate future costs can alter the results of the analysis. For this reason, commonly used methods, such as cost-benefit analyses, are insufficient to address climate change.
Given the complexity, uncertainty, and growing importance of the relationships between climate change and the economy, it is critical for policymakers to have access to strong policy analysis tools. In this report, the researchers outline key considerations for developing an appropriate model, which include: (1) embodying key interrelationships between climate change, the economy, and policy, (2) exploring the range of potential pathways for major climate risks, and (3) testing different assumptions regarding beliefs about key policy parameters, such as other countries’ responses or technological advancements in efficiency. These considerations then provide a roadmap for developing a model that can appropriately represent the costs and benefits of climate change policies, and outline suitable methods for using the model to guide budget analyses through dynamic scoring.
Climate Change and the Budget:
Since the Congressional Budget Office (CBO) and the Office of Management and Budget (OMB) are two key federal agencies responsible for studying and modeling fiscal policy, understanding their current work on the interactions between climate change and the budget is important. However, it is also essential to recognize that both agencies have limitations in their mandates, which restrict the scope of their analyses. In recent years, the CBO has added the effects of climate change to its long-term budget forecasts through reductions in overall labor productivity. This involves a five-step process.
First, the CBO uses various standard economic estimates of the economic impact of changes in temperature and precipitation, alongside different climate projections, to produce a series of economic impact estimates for the year 2050. Second, the CBO combines these estimates with a single climate projection and a weighted average of the economic impacts of climate change. Third, the CBO estimates the damages from increasing hurricane frequency and severity based on its previous estimates. Fourth, the impacts of hurricane damages and hydrological climate variables are combined.
In the fifth and final step, the CBO ensures that the impacts of climate change are not double-counted by adjusting damage estimates based on climate effects already included in the baseline. Additionally, the CBO has modified its long-term baseline to include climate change-related damages and has evaluated the impact of wildfires on the budget and the estimated deficit reductions from a $25 per ton carbon tax on greenhouse gas emissions.
Recently, the OMB has also formally begun examining the impact of climate change on the federal budget. In April 2022, the OMB released a white paper that quantifies the damages from climate change on crop insurance, wildfire suppression, health, and coastal disasters. The OMB also included a climate risk scenario based on the 95th percentile scenario developed by the Network for Greening the Financial System (NGFS), which forecasts a 4.5% loss in GDP over the next 25 years.
In April 2022, the OMB, in collaboration with the Council of Economic Advisers, released a white paper discussing the need for the federal government to analyze the macroeconomic effects of climate change. The paper provided an overview of prior work that incorporated the physical risks of climate change on the economy alongside the risks associated with transitioning to a greener economy and cataloged available datasets and models for use in climate and macroeconomic analyses. Both agencies are tasked with providing the federal government with the capabilities to conduct climate and macroeconomic simulations under Executive Order 14030 (2021). To assist the Council of Economic Advisers and OMB in their analyses, the National Academy of Sciences established an Interagency Technical Working Group (ITWG) on Climate and the Macroeconomy.
Both the CBO and OMB have demonstrated a strong commitment to understanding the impacts of climate change on their budgetary projections. However, both agencies are constrained by the mandates set forth by Congress and the Executive Branch, respectively, and must complete their requirements within the available time and resources. For example, the CBO is tasked with scoring every piece of legislation that passes through Congressional committees, meaning it must complete hundreds of estimates each year.
Despite the five-step process for estimating the effects of climate change on the federal budget, the CBO notes that it lacks the basis to estimate future savings from investments in climate change adaptation and mitigation (i.e., community organizations lack the necessary inputs and information to complete this task). This means that many proposed bills do not account for the damages that could be avoided through climate policies. Instead, only direct monetary costs are included.
As part of its ongoing efforts to evaluate methods for incorporating climate risks into macroeconomic budget planning, the OMB has recommended using models with the following features: output of relevant macroeconomic variables, representation of U.S. climate policies, inclusion of additional information on climate damages, operation at a subnational level, representation of capital and labor frictions, and openness to peer review.
Key Findings:
The report identifies several key findings, including that climate change will have a significant impact on federal spending and revenue. For example, increases in extreme temperatures will lead to higher rates of illness and death. This will affect work hours, productivity, and the workforce as a whole, increasing healthcare spending while simultaneously reducing revenue, resulting in greater net losses overall.
Climate change mitigation policies will present both opportunities and risks for various sectors. For example, a policy supporting renewable energy could create new jobs in the renewable energy sector but lead to job losses in the fossil fuel industry. Depending on the timing and intensity of implementation, such a policy could result in asset losses and overall economic losses. The environmental and economic impacts of climate change mitigation policies will also depend heavily on characteristics that vary across populations, such as income and risk, as well as technological factors.
The environmental and economic effects of climate change differ from many other economic and physical systems because extreme events are more likely and larger in magnitude than other naturally occurring events. The economic impacts of climate change are typically modeled using equilibrium models, but these models are not well-suited to represent these characteristics. Using a fat-tailed distribution for impacts may inadequately represent both the risks and opportunities involved in climate policy.
Source: Flannery Dolan, Carter C. Price, Robert J. Lempert, Karishma V. Patel, Tobias Sytsma, Hye Min Park, Felipe De Leon, Craig A. Bond, Michelle E. Miro, and Andrew Lauland, “The Budgetary Effects of Climate Change and Their Potential Influence on Legislation… Recommendations for a Model of the Federal Budget”, RAND Corporation, 2023.
