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Letter January 30, 2004:

The Honorable Ernest F. Hollings: 
Ranking Minority Member: 
Committee on Commerce, Science and Transportation: 
United States Senate:

The Honorable John F. Kerry: 
Ranking Minority Member: 
Subcommittee on Oceans, Fisheries and Coast Guard: 
Committee on Commerce, Science and Transportation: 
United States Senate:

Subject: Climate Change: Analysis of Two Studies of Estimated Costs of 
Implementing the Kyoto Protocol:

In 1992 the United States ratified the United Nations Framework 
Convention on Climate Change, which was intended to stabilize the 
buildup of greenhouse gases in the earth's atmosphere but did not 
impose binding limits on emissions. In July 1997, when preliminary 
negotiations on a new climate agreement were under way, the Senate 
passed a resolution expressing the sense of the Senate that the Clinton 
administration should not agree to limits on U.S. greenhouse gas 
emissions if such an agreement did not include economically developing 
nations or if it could seriously harm the U.S. economy. In December 
1997 the United States participated in drafting the Kyoto Protocol, an 
international agreement to specifically limit greenhouse gas emissions. 
The Protocol did not impose limits on developing nations' emissions, 
and its possible effect on the U.S. economy was the subject of numerous 
studies during that period, including the two studies that are the 
subject of this report. Although the U.S. government signed the 
Protocol in 1998, the Clinton administration did not submit it to the 
Senate for advice and consent, which are necessary for ratification. In 
March 2001, President Bush announced that he opposed the Protocol.

A participating nation's compliance with the Kyoto Protocol will be 
determined by first calculating its average emissions of the six 
covered gases--carbon dioxide, methane, nitrous oxide, and three 
synthetic gases[Footnote 1]--for the 5-year period 2008 through 2012. 
Reductions can then be made for, among other things, the purchase of 
emissions reductions from certain other nations; this feature, called 
emissions trading, allows a nation that has reduced its emissions more 
than the required amount to sell its unused emissions reductions to 
other nations. In addition, developing nations can generate emissions 
reductions for developed countries by participating in certain 
projects.

Although the United States is not participating in the Kyoto Protocol, 
climate change remains a topic of congressional and public concern, and 
there is continuing interest in estimating how reducing greenhouse gas 
emissions could affect the U.S. economy and quality of life. To make 
such estimates, economists typically rely on economic models--
computerized sets of mathematical equations that represent the economy 
in a simplified way to project future conditions. Models can vary in 
terms of size, structure, complexity, and other features. Any such 
model's results can be significantly affected by changing its 
assumptions about economic growth, energy prices, and other key 
variables. For example, the estimated costs of implementing the Kyoto 
Protocol could be significantly higher or lower, depending on the 
modelers' assumptions about the future values of such variables. In 
addition, a model's results can be significantly affected by changing 
its assumptions about how a policy, like the Protocol, is implemented.

At a July 2002 hearing on the administration's climate initiative, the 
Chairman of the Council on Environmental Quality (CEQ) testified that 
implementing the Kyoto Protocol would reduce U.S. economic output by 
"up to $400 billion" in 2010.[Footnote 2] This estimate is similar to a 
$397 billion estimate that appeared in a 1998 report by the Energy 
Information Administration (EIA), an independent statistical and 
analytical agency within the U.S. Department of Energy.[Footnote 3] The 
EIA estimate differed from another, well-publicized estimate prepared 
the same year by the Council of Economic Advisers (CEA), which found 
that the costs of implementing the Protocol could be as little as $7 
billion to $12 billion a year in economic output, depending on the 
extent of international emissions trading allowed and the participation 
of developing countries.[Footnote 4] You asked us to identify likely 
reasons for the differences between the two cited cost estimates ($397 
billion from EIA and $7 billion to $12 billion by CEA), based on (1) 
the economic models used to prepare these estimates and (2) the 
assumptions incorporated into these models, including economic 
assumptions and assumptions about how the Protocol would be 
implemented. You also asked us to determine the basis for the cost 
estimate cited by the CEQ Chairman.

To address these objectives, we reviewed the CEA and EIA reports, the 
CEQ testimony, and related literature. We did not perform any 
independent economic modeling. In addition, we did not attempt to track 
the continuing international negotiations on the details of the 
Protocol or to determine whether CEA's and EIA's assumptions about the 
Protocol's operations turned out to be accurate.

Results in Brief:

Two likely reasons why the cost estimates differed based on the 
economic models are that (1) the models focus on different time 
periods, with different assumptions about how the economy adjusts to 
new policies, and (2) they measure costs differently. CEA used a type 
of model that typically focuses on longer time periods and generally 
assumes that the economy adjusts smoothly to new policies over the 
longer-term, while EIA used a type of model that typically focuses on a 
more immediate time period and highlights the near-term costs of 
economic adjustments (such as unemployment). The different types of 
models produce different types of cost estimates; EIA's model used a 
more comprehensive cost measure than CEA's model and was thus able to 
capture certain costs that CEA's model could not capture.

It was likely that EIA's cited cost estimate would be higher than CEA's 
estimate because of two assumptions the agencies made about the U.S. 
economy and about the Protocol's operations. First, the cited EIA 
estimate assumed that all reductions would be achieved domestically, 
while the cited CEA estimate allowed for the purchase of emissions 
reductions from other nations. Second, the economic growth rate assumed 
by EIA (2.3 percent a year for 1995 through 2010) was higher than the 
growth rate assumed by CEA (2.1 percent for the same time period). A 
higher growth rate results in more growth in emissions and would 
require larger reductions to reach an emissions target.

In testifying that implementing the Kyoto Protocol "would have cost our 
economy up to $400 billion" in 2010, the CEQ Chairman was relying on 
the highest of six cost estimates prepared by EIA. This scenario would 
have required reductions in U.S. greenhouse gas emissions to 7 percent 
below the 1990 level--the most restrictive of the six EIA estimates. 
Following the hearing, the Chairman noted that certain provisions in 
the Kyoto Protocol could require smaller reductions (specifically, to 4 
percent below the 1990 level), but he did not cite a cost estimate 
corresponding to this smaller reduction.

We received written comments on a draft of this report from the Council 
of Economic Advisers and Council on Environmental Quality, jointly, and 
from the Energy Information Administration. The Councils characterized 
our draft as, among other things, "incorrect, incomplete, and lacking 
in analytical rigor in several significant areas." We strongly disagree 
with this characterization and do not believe that the points in their 
comment letter provide adequate substantiation for such a broad 
assertion. However, we did enhance our report to provide additional 
information on developments prior to the negotiation of the Protocol, 
better specified the report's objectives, and clarified the importance 
of assumptions about how the Protocol might be implemented and the 
effect of these assumptions on the cost estimates. In addition, the 
Councils provided one technical comment, which we incorporated. EIA 
suggested that we include additional material on its approach to 
modeling, and we did so. EIA also provided technical comments, which we 
incorporated where appropriate.

Background:

Carbon dioxide and certain other gases trap some of the sun's heat in 
the earth's atmosphere and prevent it from returning to space. The 
trapped heat warms the earth's climate, much like glass in a 
greenhouse. Hence, the gases that cause this effect are often referred 
to as greenhouse gases. The most prevalent of the six greenhouse gases 
covered by the Protocol is carbon dioxide, which results from 
combustion of coal and oil in power plants and industrial boilers, the 
burning of gasoline in vehicles, and other sources. The six gases 
covered by the Protocol differ in their effects on the atmosphere and 
their expected lifetimes.

In recent decades, concentrations of greenhouse gases have built up in 
the atmosphere, giving rise to concern that continuing increases might 
interfere with the earth's climate system, for example, by increasing 
temperatures or changing precipitation patterns. In 1992, the United 
States joined with other nations in developing the United Nations 
Framework Convention on Climate Change, which does not impose specific 
binding targets or timetables for emissions reductions. In contrast, in 
the Kyoto Protocol, a follow-on to the Convention signed by the United 
States and about three dozen other nations--most of them economically 
developed--emissions were limited by specific amounts over a specified 
time frame. To help achieve the required reductions, the Protocol 
allows countries to purchase emissions reductions from other countries 
or to offset their emissions through the use of sinks, such as trees, 
which capture and store carbon dioxide.

Over the past decade or longer, there have been many efforts to 
estimate the cost to the U.S. economy of implementing various regimes 
for regulating greenhouse gas emissions. In the area of climate policy, 
two basic types of models, often referred to as top-down and bottom-up, 
are frequently used in assessing potential costs and benefits of 
reducing emissions. The two model types are based on fundamentally 
different perspectives, although in recent years the distinctions 
between the two model types have narrowed as modelers have begun to 
integrate features of the two types.

* Top-down models are economywide models that describe, among other 
things, the relationships between energy and the rest of the economy, 
based on observations of past experience, to project future policy-
induced changes. One type of top-down model, a macroeconomic model, 
starts from a view of how the economy as a whole functions and how 
macroeconomic variables, such as economic output (known as gross 
domestic product, or GDP), consumption, and aggregate savings and 
investment, are determined and interrelated. Another type of top-down 
model, a computable general equilibrium model, draws from microeconomic 
theory and assumes that markets adjust efficiently in the long run as 
consumers and producers adapt to changing prices in response to, for 
example, a new policy regulating greenhouse gas emissions.

* Bottom-up models generally contain a great deal of technological 
detail, but less detail on the rest of the economy. Their projections 
are based on, among other things, calculations of future technological 
possibilities under different economic or policy conditions. In 
contrast to top-down models, bottom-up models used for analyzing 
climate policy focus primarily on the energy sector of the economy, 
with less detail on the economy as a whole. They contain extensive 
information about specific energy technologies, identifying the least 
expensive technology options available for energy savings and fuel-
switching to reach a specific emissions target. Unlike top-down models 
that project possibilities for technological substitution based on 
trends observed in the past, bottom-up models allow for the 
substitution of new technologies at various prices, if, for example, 
the price of energy increases in response to a new carbon policy. 
Because they lack detail about the general economy, they are sometimes 
linked to top-down models, which can provide such detail.

Even among models of the same type (e.g., macroeconomic or computable 
general equilibrium models) results can vary because each model is 
designed with different features and may include different input 
assumptions.

CEA and EIA posed the same basic question about the potential costs to 
the U.S. economy of implementing the Kyoto Protocol but took different 
approaches to modeling these costs and produced different results.

CEA's study. CEA's 1998 study sought to estimate the costs to the U.S. 
economy of complying with the Kyoto Protocol by 2010. CEA modeled 10 
scenarios of how the Protocol might be implemented, which differed in 
the extent to which they allowed international emissions trading and 
the purchase of emissions credits in developing countries.[Footnote 5] 
Among these were scenarios in which the United States traded emissions 
only with certain other industrialized countries (i.e., other nations 
signing Annex I of the 1992 Framework Convention on Climate 
Change[Footnote 6]); with Annex I countries and certain developing 
countries; and with certain Annex I countries, as well as the countries 
of Eastern Europe and certain developing countries. Under the last 
scenario--the least restrictive--the cost to the U.S. economy in 2010 
was estimated to be 0.07 percent of GDP, or about $7 billion a year in 
total resource costs, which are defined by CEA as the direct costs to 
the U.S. economy of meeting its Kyoto target, including both the cost 
of abating emissions domestically and the cost of purchasing emissions 
reductions from abroad. CEA estimated that under this scenario the 
corresponding cost of reducing emissions would be $14 a ton in 
2010.[Footnote 7] At the other extreme, the CEA report implied that if 
the United States made all its reductions domestically, the cost would 
be $192 to $200 a ton.[Footnote 8]

Table 1 shows selected results for four of CEA's scenarios, from the 
least restrictive to the most restrictive. For each scenario, cost is 
represented both as the percentage by which GDP would decrease and the 
incremental cost of reducing emissions by one ton. As the scenarios 
become increasingly restrictive, total resource costs and the 
incremental cost of reducing emissions by one ton increase. (The costs 
shown do not include short-term adjustment costs, such as the temporary 
unemployment of workers due to high energy prices, which is discussed 
in more detail on pp. 7 and 8.):

Table 1: CEA's Cost Estimates under Four Scenarios:

Sources of emissions reductions from other nations: Certain Annex I 
nations, Eastern Europe, and key developing nations; 
Decrease in GDP in 2010; Total resource costs (1992 dollars in 
billions): $7; 
Decrease in GDP in 2010; Percentage of GDP: 0.07; 
Incremental cost to reduce emissions (dollars per ton)[A]: $14.

Sources of emissions reductions from other nations: Annex I and key 
developing nations; 
Decrease in GDP in 2010; Total resource costs (1992 dollars in 
billions): 12; 
Decrease in GDP in 2010; Percentage of GDP: 0.11; 
Incremental cost to reduce emissions (dollars per ton)[A]: 23.

Sources of emissions reductions from other nations: Annex I 
nations[B]; 
Decrease in GDP in 2010; Total resource costs (1992 dollars in 
billions): 23-26; 
Decrease in GDP in 2010; Percentage of GDP: 0.23- 0.24; 
Incremental cost to reduce emissions (dollars per ton)[A]: 54-56.

Sources of emissions reductions from other nations: No international 
trading (domestic reductions only)[B]; 
Decrease in GDP in 2010; Total resource costs (1992 dollars in 
billions): 54-60; 
Decrease in GDP in 2010; Percentage of GDP: 0.54-0.55; 
Incremental cost to reduce emissions (dollars per ton)[A]: 192-200. 

Source: GAO analysis of CEA data.

[A] We estimated these figures on the basis of information provided for 
other scenarios. The estimates were derived based on information 
provided by CEA for the $14-per-ton and $23-per-ton carbon price 
scenarios.

[B] The cost to reduce emissions is referred to by CEA as the permit 
price. We refer to the permit price as the incremental (marginal) cost 
of reducing emissions.

[End of table]

EIA's study. EIA's 1998 study estimated the costs[Footnote 9] in 2010 
of reducing carbon dioxide under six scenarios showing how the Protocol 
might be implemented. Because the exact rules that would govern final 
implementation of the Kyoto Protocol were not fully determined at the 
time of its analysis, EIA did not know the specific reduction in 
energy-related emissions that would be required. Therefore, EIA created 
six scenarios that assume a range of emission reductions levels. For 
example, the 1990 level minus 7 percent scenario was chosen to resemble 
the Kyoto Protocol target requiring the United States to reduce its 
emissions 7 percent below its 1990 baseline, without allowances for 
sinks, other greenhouse gases, or international activities; the 1990 
level minus 3 percent scenario was chosen to represent a case where 
sinks and offsets from other gases produce a 4 percentage point 
contribution toward meeting the 7 percent target.[Footnote 10] EIA 
modeled four other scenarios: no change in emissions and emissions 
increases of 9 percent, 14 percent, and 24 percent above the 1990 
level. Under these scenarios, it was assumed that the United States 
would purchase varying amounts of its required reductions abroad, with 
the most international purchases occurring under the 1990 level plus 24 
percent scenario.

EIA estimated that the costs would be between 1.0 and 4.2 percent of 
U.S. GDP in 2010, depending on the scenario, and that the corresponding 
incremental cost of reducing carbon emissions would be between $67 and 
$348 a ton. The lowest cost estimate was based on the scenario in which 
emissions in 2010 would be 24 percent above the 1990 level. The highest 
cost estimate was based on the scenario in which emissions in 2010 
would be 7 percent below the 1990 level.

Table 2 shows selected results for the six EIA scenarios, from the 
least restrictive to the most restrictive. Under each scenario, cost is 
represented both as the percentage by which GDP would be reduced and 
the incremental cost of reducing emissions by one metric ton. As the 
scenarios become increasingly restrictive, the cost to the overall 
economy and the incremental cost of reducing emissions by one metric 
ton increase.

Table 2: EIA's Cost Estimates under Six Scenarios:

Scenario: 1990 level + 24 percent; 
Decrease in economic output in 2010: 1992 dollars in billions: $96; 
Decrease in economic output in 2010: Percentage of GDP: 1.0; 
Incremental cost to reduce emissions (1996 dollars per metric ton): 
$67.

Scenario: 1990 level + 14 percent; 
Decrease in economic output in 2010: 1992 dollars in billions: 161; 
Decrease in economic output in 2010: Percentage of GDP: 1.7; 
Incremental cost to reduce emissions (1996 dollars per metric ton): 
129.

Scenario: 1990 level + 9 percent; 
Decrease in economic output in 2010: 1992 dollars in billions: 188; 
Decrease in economic output in 2010: Percentage of GDP: 2.0; 
Incremental cost to reduce emissions (1996 dollars per metric ton): 
163.

Scenario: 1990 level; 
Decrease in economic output in 2010: 1992 dollars in billions: 292; 
Decrease in economic output in 2010: Percentage of GDP: 3.1; 
Incremental cost to reduce emissions (1996 dollars per metric ton): 
254.

Scenario: 1990 level - 3 percent; 
Decrease in economic output in 2010: 1992 dollars in billions: 327; 
Decrease in economic output in 2010: Percentage of GDP: 3.5; 
Incremental cost to reduce emissions (1996 dollars per metric ton): 
294.

Scenario: 1990 level - 7 percent; 
Decrease in economic output in 2010: 1992 dollars in billions: 397; 
Decrease in economic output in 2010: Percentage of GDP: 4.2; 
Incremental cost to reduce emissions (1996 dollars per metric ton): 
348. 

Source: GAO analysis of EIA data.

Note: The decrease in GDP and the cost to reduce emissions in EIA's 
model include short-term adjustment costs, such as temporary 
unemployment of workers resulting from higher energy prices. The 
incremental costs represent the carbon prices resulting from each 
scenario. These carbon prices result in higher energy prices and lower 
GDP.

[End of table]

Using Different Types of Economic Models Likely Contributed to Higher 
Cost Estimates from EIA than from CEA:

In estimating the costs to the U.S. economy of implementing the 
Protocol, CEA and EIA used economic models that differ in the way they 
represent how the economy functions. The models focus on different time 
periods and measure costs differently. These differences likely 
contributed to higher cost estimates from EIA than from CEA.

CEA used a top-down computable general equilibrium model that describes 
the economy's path over the long term. Such models generally represent 
markets as adjusting smoothly in the long run to price changes 
resulting from, for example, new regulations for greenhouse gas 
emissions. Because they are generally not as well suited as 
macroeconomic models to represent the near-term effects of government 
policies, computable general equilibrium models may tend to 
underestimate the short-term costs of adjustments to a policy change. 
In contrast, EIA used a bottom-up energy sector model linked to a top-
down macroeconomic model. Macroeconomic models often yield higher cost 
estimates than computable general equilibrium models because they are 
better able to capture short-term economic adjustment costs, such as 
those that might be caused by limiting greenhouse gas emissions.

Because of differences in how they represent the economy, the models 
include different measures of costs. The total loss in GDP attributable 
to emissions reduction policies has two components:

* Loss of potential GDP measures the loss of productive capacity of the 
economy. This loss is directly attributable to the reduction in energy 
resources available to the economy. (Polices to reduce greenhouse gas 
emissions raise the price of energy, leading to reduced use.):

* Adjustment costs reflect frictions to the economy that result from 
the policies to reduce emissions. These frictions would include the 
temporary unemployment of workers and other resources resulting from 
higher energy prices.

The model used by CEA assumes that the economy makes a smooth 
transition to a new path over the long term, losing some productive 
capacity as a result of higher energy prices. Thus, CEA's cost estimate 
includes only the loss in potential GDP, or the loss in GDP if 
employment were full. In contrast, EIA's model captures both types of 
costs. EIA's approach to modeling energy markets explicitly 
incorporates, on an annual basis, such as factors as technological 
change and costs, consumer choice behavior, and changes to energy 
infrastructure. Thus, in addition to the loss in potential GDP, the EIA 
model also estimates the adjustment costs, and the estimates shown in 
table 2 include both types of losses.[Footnote 11] Compared to CEA, 
therefore, EIA's estimate of economic loss is a broader measure of the 
costs of implementing the Protocol.

EIA separately estimated economic losses in potential GDP, which is 
similar to the measure used by CEA. These estimates are shown in table 
3. In all of these scenarios, the losses in potential GDP are smaller 
than the corresponding losses in total GDP shown in table 2. For 
example, for the most restrictive scenario--achieving emissions 7 
percent less than the 1990 level--the estimated reduction in potential 
GDP was $72 billion, while the estimated reduction in total GDP was 
$397 billion.

Table 3: EIA's Cost Estimates (in terms of potential GDP) under Six 
Scenarios:

Scenario: 1990 level + 24 percent; 
Decrease in economic output in 2010: 1992 dollars in billions: $13; 
Decrease in economic output in 2010: Percentage of GDP: 0.1; 
Incremental cost to reduce emissions (1996 dollars per metric ton): 
$67.

Scenario: 1990 level + 14 percent; 
Decrease in economic output in 2010: 1992 dollars in billions: 27; 
Decrease in economic output in 2010: Percentage of GDP: 0.3; 
Incremental cost to reduce emissions (1996 dollars per metric ton): 
129.

Scenario: 1990 level + 9 percent; 
Decrease in economic output in 2010: 1992 dollars in billions: 34; 
Decrease in economic output in 2010: Percentage of GDP: 0.4; 
Incremental cost to reduce emissions (1996 dollars per metric ton):
163.

Scenario: 1990 level; 
Decrease in economic output in 2010: 1992 dollars in billions: 53; 
Decrease in economic output in 2010: Percentage of GDP: 0.6; 
Incremental cost to reduce emissions (1996 dollars per metric ton): 
254.

Scenario: 1990 level - 3 percent; 
Decrease in economic output in 2010: 1992 dollars in billions: 62; 
Decrease in economic output in 2010: Percentage of GDP: 0.7; 
Incremental cost to reduce emissions (1996 dollars per metric ton): 
294.

Scenario: 1990 level - 7 percent; 
Decrease in economic output in 2010: 1992 dollars in billions: 72; 
Decrease in economic output in 2010: Percentage of GDP: 0.8; 
Incremental cost to reduce emissions (1996 dollars per metric ton): 
348. 

Source: GAO analysis of EIA data.

Note: Like the CEA results in table 1, the decrease in GDP and costs to 
reduce emissions in this table do not include short-term adjustment 
costs, such as temporary unemployment of workers resulting from higher 
energy prices. The incremental costs represent the carbon prices 
resulting from each scenario. These carbon prices result in higher 
energy prices and lower GDP.

[End of table]

Using Different Assumptions Also Likely Contributed to Higher Cost 
Estimates from EIA Than from CEA:

Of the many assumptions incorporated into the two modeling efforts, we 
identified two used by CEA and EIA that likely contributed to their 
different results. One of these relates to how the Protocol would 
operate, while the other relates to the economy's growth rate. Both 
assumptions would likely yield higher cost estimates from EIA than from 
CEA in the scenarios we examined.

International trade in emissions reductions. A scenario that does not 
allow the United States to purchase emissions reductions from other 
nations will likely yield higher estimated costs than a scenario that 
does allow such purchases, because the United States' cost of reducing 
its emissions is likely to be higher than many other nations' costs. 
The most restrictive of the scenarios modeled by EIA did not allow for 
international trade in emissions reductions, while the least 
restrictive of the CEA scenarios did allow for such trade.[Footnote 12] 
In fact, according to the CEA study, an effective international market 
for emissions trading among industrialized countries would potentially 
reduce the resource costs to the United States by more than half 
relative to a scenario in which all emissions reductions occur 
domestically. Moreover, if the United States were allowed to purchase 
emissions from developing countries, the costs could be reduced even 
further. Thus, as would be expected, EIA's no-trading scenario cost 
estimate was higher than CEA's full-trading scenario estimate.

Economic growth rates. The rate at which an economy's GDP grows is 
important in determining the costs to limit emissions. A slower-growing 
economy uses less energy and produces fewer emissions; therefore, 
smaller emissions reductions are needed to meet a given target. 
Conversely, a faster-growing economy uses more energy and produces more 
emissions; therefore, larger reductions are needed to meet a given 
target. In its analysis, CEA assumed that the economy would grow by 2.1 
percent between 1995 and 2010, while EIA assumed that the economy would 
grow by 2.3 percent during the same time period, a difference of 0.2 
percentage points. This difference increases in significance when 
compounded over many years. In this case, CEA assumed that the economy 
would grow about 37 percent between 1995 and 2010, while EIA assumed it 
would grow about 41 percent. In the context of a roughly $10 trillion 
economy, this difference can be significant.

CEQ's Chairman Cited a Cost Estimate Based on EIA's Most Restrictive 
and Expensive Scenario:

In prepared testimony in support of the administration's 2002 climate 
change strategy, the Chairman of CEQ stated that implementing the Kyoto 
Protocol would cost the U.S. economy "up to $400 billion" in 2010. By 
citing this estimate, the CEQ Chairman focused on the most restrictive 
of the six scenarios modeled by EIA. This scenario required the deepest 
reduction in U.S. emissions (to 7 percent below the 1990 emissions 
level) and did not allow for, among other things, emissions trading 
with other nations. Under this scenario, EIA estimated that the cost to 
the U.S. economy (in terms of reduced GDP) would be $397 billion in 
2010.

In answering follow-up questions after the hearing, the Chairman 
recognized that the United States might not be required to reduce its 
emissions to 7 percent below the 1990 level. Specifically, he stated 
that "the inclusion of sinks provides a 3 percent offset to the most 
stringent case."[Footnote 13] He did not provide an estimate for the 
cost of reaching that less stringent level.

Agency Comments:

We provided a draft of this report to the Secretary of Energy; the 
Chairman, CEA; and the Chairman, CEQ, for review and comment. We 
received written comments jointly from the Chairman, CEA, and the 
Chairman, CEQ (see enc. I), and from the Administrator, EIA (see enc. 
II). The Councils characterized our draft as, among other things, 
"incorrect, incomplete, and lacking in analytical rigor in several 
significant areas." We disagree with this characterization and do not 
find that it is substantiated in the Councils' letter. However, we have 
provided additional information on developments prior to the 
negotiation of the Protocol, better specified the report's objectives, 
and clarified the importance of assumptions about how the Protocol 
might be implemented and the effect of these assumptions on the 
estimated costs to the economy. Our objective was to explain the 
differences in the results of the 1998 economic modeling studies by CEA 
and EIA. In addition, we addressed the technical comment made by the 
Councils.

EIA suggested that we include additional material on its approach to 
modeling, and we did so. EIA also provided technical comments, which we 
incorporated where appropriate.

Scope and Methodology:

To answer the first and second objectives, we reviewed the CEA and EIA 
studies and literature on economic modeling. To answer the third 
objective, we reviewed the CEQ Chairman's July 2002 testimony and his 
responses to follow-up questions. We did not independently assess the 
validity of the CEA and EIA models in this report. (In addition, we did 
not attempt to track the continuing international negotiations on the 
details of the Protocol or to determine whether the CEA's and EIA's 
assumptions about the Protocol's operation turned out to be accurate.) 
We performed our work from July through December 2003 in accordance 
with generally accepted government auditing standards.

As arranged with your offices, unless you publicly announce the 
contents of this report earlier, we plan no further distribution until 
30 days from the date of this report. At that time, we will send copies 
to the appropriate congressional committees; the Secretary of Energy; 
the Chairman, CEA; and the Chairman, CEQ. In addition, the report will 
be available at no charge on the GAO Web site at [Hyperlink, http://
www.gao.gov].

Should you or your staff need further information, please contact me or 
David Marwick at (202) 512-3841. Chuck Bausell and Anne K. Johnson made 
key contributions to this report. Karen Keegan, Cynthia Norris, and 
Anne Stevens also made important contributions.

Signed by:

John B. Stephenson: 
Director, Natural Resources and Environment:

Enclosures:

[End of section]

Enclosure I: Comments from the Council of Economic Advisers and Council 
on Environmental Quality:

EXECUTIVE OFFICE OF THE PRESIDENT:  
COUNCIL OF ECONOMIC ADVISERS: 
WASHINGTON, DC 20503: 

EXECUTIVE OFFICE OF THE PRESIDENT: 
COUNCIL ON ENVIRONMENTAL QUALITY:
WASHINGTON, DC 20503: 

December 10, 2003:

Mr. John Stephenson:

Director, Natural Resources and Environment: 
General Accounting Office:

Dear Mr. Stephenson,

Thank you for the opportunity to respond to your request for comments 
on the GAO report, Climate Change: Analysis of Two Studies of Estimated 
Costs of Implementing the Kyoto Protocol. Our staffs have reviewed the 
report, and their joint comments are enclosed.

Sincerely,

Signed by: 

N. Gregory Mankiw: 
Chairman:
Council of Economic Advisers:

Signed by: 

James L. Connaughton: 
Chairman: 
Council on Environmental Quality:

Enclosure:

Subject: Joint CEA/CEQ Staff Comments on GAO's Proposed Report, Climate 
Change: Analysis of Two Studies of Estimated Costs of Implementing the 
Kyoto Protocol:

The CEA and CEQ staffs have reviewed the proposed report and find it to 
be incorrect, incomplete, and lacking in analytical rigor in several 
significant areas. The report has questionable intentions and its 
inferences are not grounded in sound analysis.

First, the Report analyzes an Agreement that the Senate-including the 
two Senators who requested the Report-rejected. The report states that 
its goal is to compare the models and assumptions of two different 
analyses: the Energy Information Agency's (EIA) 1998 analysis of the 
costs of Kyoto to the Council of Economic Advisers' (CEA) 1998 analysis 
of the costs of Kyoto. According to the report, this examination of 
five-year-old models is done because "there is continuing interest in 
estimating how reducing greenhouse gas emissions could affect the U.S. 
economy." While there may be an interest in estimating the cost of 
greenhouse gas (GHG) reductions, it appears highly unlikely that 
today's Congress is interested in a comparison of the 1998-estimated 
costs of reductions that would be achieved by the Kyoto Protocol. 
Indeed, 95 Senators-including the two Senators who requested this 
report from the GAO-voted for a July 1997 resolution (with no votes in 
opposition) that the Senate would not support any international climate 
change agreement that did not mandate commitments from developing 
countries. The previous Administration's position was that "The 
President has made it clear that he does not intend to send the Kyoto 
Protocol to the Senate for ratification until we have achieved 
meaningful participation by key developing countries" (February 4, 
1998, Congressional testimony of Kathleen A. McGinty, CEQ Chair). The 
Kyoto Protocol has never mandated such commitments from developing 
countries. Two different Administrations and an overwhelming majority 
of the Senate (with no dissents) are thus on record as opposing the 
Kyoto Protocol assessed in this GAO analysis. These facts, which were 
previously noted to GAO staff, should have been included in the Report. 
Instead, the GAO report concludes incompletely and misleadingly that 
"In March 2001, the President announced he opposed the Protocol.":

Second, GAO fails to take into account that the CEA modeling effort 
wrongly assumed that developing countries would have greenhouse gas 
caps under the Kyoto Protocol, and further would participate in an 
efficient global emissions trading system, In fact, the Kyoto Protocol 
did not impose emissions reduction obligations on developing country 
Parties. Given that the CEA analysis is five years old, GAO should have 
included a section on the Kyoto negotiations between 1998 and the 
present. The report frequently cites the least-restrictive assumptions 
of CEA's 1998 analysis, but does not note that these assumptions for 
increased operational flexibility were never realized in subsequent 
negotiations and thus are now demonstrably incorrect. Indeed, in 
addition to omitting that developing countries do not face firm caps 
under the Kyoto Protocol, GAO's proposed report misleadingly states 
that under the Protocol, "developing nations can generate emissions 
reductions for developed countries by participating in certain 
projects." GAO fails to mention that, to date, only a handful of these 
projects (known as Clean Development Mechanism projects) have been 
approved. The 1998 CEA analysis also assumed the existence of an 
effective global market for trading of emission allowances. This 
assumption was also incorrect, as evidenced by the difficulty the 
European Union alone is currently having establishing their emissions 
trading scheme (ETS). In fact, according to a recent Deutsche Bank 
report, the ETS faces unresolved problems with deciding on the number 
of emissions credits to issue, measuring emissions, choosing an 
appropriate base year, determining criteria as proof of reductions, and 
harmonizing emissions trading with other environmentally-motivated 
policy measures of individual Member States ("EU trade in CO2 
Emissions: 2005 Launch Deadline at Risk," Deutsche Bank Research, 
December 2, 2003). The GAO report should therefore mention that all of 
the least-restrictive assumptions behind the 1998 CEA report have 
proven to be incorrect. From this, one can only conclude that the 1998 
CEA model is therefore not an accurate prediction of the costs of 
Kyoto.

By comparison, the EIA analysis case cited by Chairman Connaughton in 
his July 2002 testimony assumed that the U.S. target in the Kyoto 
Protocol would be met entirely by reducing energy-related carbon 
emissions. This assumption more nearly reflects the actual outcomes of 
the Kyoto negotiations, especially with respect to the status of 
developing countries' participation, credits for carbon sinks, the 
efficacy of the Clean Development Mechanism and emissions trading. Any 
defensible analysis of the validity of economic model cost estimates 
must include a discussion of these assumptions. CEA Chairman Yellen, in 
her testimony on this topic to the House Commerce Committee on March 4, 
1998, noted that "(e)ven within a given model, answers depend 
critically on the precise nature of the question asked. For example, 
the costs of emissions reductions depend critically on the extent of 
global participation and international trading that a treaty is assumed 
to feature." Openly reconciling the assumptions of five years ago with 
the realities of what has transpired subsequently in international 
negotiations is a fair expectation of the GAO, but unfortunately it is 
absent in this report.

Accordingly, in the "Results in Brief' section, GAO should have made it 
clear that there are three reasons why the cost estimates differed 
between EIA and CEA, the third (and most obvious) being that the 
underlying assumptions about the Kyoto Protocol differed. These 
differences in modeling approach were extensively documented in a 
hearing before the House Commerce Committee on March 4, 1998, as well 
as in another hearing before the Senate Energy and Natural Resources 
Committee on March 25, 1998. The report also presents inconsistent 
estimates implied from the 1998 CEA analysis. Table 1 presents CEA's 
cost estimates under four scenarios where the "no international trading 
scenario" is reported to have a total resource cost of $54-$60 billion. 
Footnote number 10, however, states that the inferred cost of a no-
trading CEA scenario is about $100 billion a year.

Third, it is misleading for GAO to rely on the 1998 State Department 
"analysis," because it ignores later developments on the role of carbon 
sinks in the Kyoto Protocol. The GAO report cites a 1998 State 
Department "analysis" on "how the Protocol would likely function," to 
claim that the United States' burden would be lower than implied by the 
7 percent target cited by Chairman Connaughton in his 2001 testimony. 
It is misleading to call this State Department document an "analysis," 
since it is actually a "Fact Sheet" that makes claims about the 
effective targets under the Kyoto Protocol. The GAO report cites this 
1998 advocacy document as evidence that the Kyoto Protocol promises to 
provide emissions reduction credits for sinks, but the report fails to 
mention that Article 3.4 of the Protocol is vague on the specifics 
concerning credits for sinks: the critical details were to be worked 
out after 1998. Indeed, a State Department Fact Sheet of August 1, 
2000, reports that the Kyoto Protocol "leaves open the exact ways that 
sinks will count." It goes on to say that, "One of the central issues 
at the next Conference of the Parties [COP] to the Framework Convention 
(scheduled for November 13-24, [2000,] in The Hague) will be to 
elaborate the Protocol's carbon sinks provisions. Currently, the 
Protocol addresses only a few limited land-use change activities such 
as reforestation and deforestation. The inclusion of other land-use 
activities such as forest, cropland and grazing land management will 
require a decision of the Parties." 

Finally, in support of broad allowance of carbon sinks, this 2000 State 
Department Fact Sheet states that "The United States believes that a 
comprehensive approach would best account for the full range of natural 
and human activities that could affect the global climate system." The 
GAO report also does not mention that the 2000 Sixth Conference of the 
Parties in The Hague broke down largely because the United States 
argued unsuccessfully for wide access to credits for sinks whereas the 
European Union insisted on more restrictive credits for sinks. The GAO 
report points out that the EIA-estimated economic cost of a 3 percent 
reduction is $327 billion, $70 billion less than the most restrictive 
scenario. Since the implementation of sinks in the Protocol had not 
been finalized in 1998, however, the implication that the 3 percent 
reduction is the more realistic scenario is wrong. Given the failure to 
include wide access to credits for sinks within the Protocol, the 7 
percent reduction target is indeed the more accurate one (this is the 
reduction level explicitly assigned to the United States in the 
Protocol), and GAO is incorrect to assert (based on an outdated State 
Department Fact Sheet) that the 3 percent reduction target is more 
realistic.

In conclusion, by selectively relying on a flawed CEA economic modeling 
effort based on inaccurate assumptions and evidence from the previous 
Administration's advocacy documents to assess Chairman Connaughton's 
2002 testimony, the GAO report is incomplete and misleading.

The following are GAO's comments on the joint Council of Economic 
Advisers/Council on Environmental Quality letter dated December 10, 
2003.

GAO's Comments:

1. We prepared this report in response to a request from the Ranking 
Minority Members of the Senate Committee on Commerce, Science and 
Transportation and its Subcommittee on Oceans, Fisheries and Coast 
Guard.

2. We added information on developments prior to the negotiation of the 
Protocol.

3. We stated that developing nations can generate emissions reductions, 
which CEA/CEQ does not dispute. As noted earlier, we did not attempt to 
track developments since 1998, such as how many such projects have been 
approved.

4. We believe that the first two paragraphs of our Results in Brief 
section appropriately summarize the results of our work on the likely 
reasons for the differences between the two cited cost estimates based 
on (1) the economic models used to prepare these estimates and (2) the 
economic and other assumptions incorporated into these models. However, 
in the body of the report, we have clarified in several places the 
importance of assumptions about how the Protocol might be implemented 
and the effect of these assumptions on the estimated costs to the 
economy.

5. We revised the report as suggested.

6. We deleted a comparison of the basis of the cost estimate cited by 
the CEQ chairman to a 1998 State Department fact sheet. However, we 
cite the fact sheet in the section dealing with EIA's cost estimates, 
because--according to EIA officials--one of EIA's six scenarios (a 
target of 3 percent below the 1990 emissions level) is based on the 
fact sheet.

[End of section]

Enclosure II: Comments from the Energy Information Administration:

Department of Energy 
Washington, DC 20585:

DEC 10 2003:

Mr. John Stephenson:

Director, Natural Resources and Environment 
General Accounting Office:
441 G Street, N.W. 
Washington, D.C. 20548:

Dear Mr. Stephenson:

The Energy Information Administration (EIA) appreciates the opportunity 
to comment on the General Accounting Office (GAO) draft report "Climate 
Change: Analysis of Two Studies of Estimated Costs of Implementing the 
Kyoto Protocol," Report No. GAO-04-144R. The report largely explains 
the reasons for differences in cost estimates between EIA's 1998 study 
of the Kyoto Protocol and an estimate prepared by the Council of 
Economic Advisors (CEA) that same year. We had the opportunity to 
provide informal comments on an earlier draft as well. To a great 
extent, the latest draft report addresses our previous comments.

The following comments suggest areas for improvement or elaboration:

The first paragraph of "Results in Brief' (page 3) identifies two 
likely reasons why the cost estimates differ. Another reason that is 
also addressed in your draft report, differences in international 
emissions trading assumptions in the cases compared, is arguably more 
important than either of the cited reasons in explaining the divergence 
in results. Therefore, we recommend that this section prominently note 
that the difference GAO was asked to examine is between EIA's most 
restrictive case (no emissions trading) and CEA's least restrictive 
case (frictionless global emissions trading), that both studies provide 
a range of relevant cases, and that estimates provided for comparable 
cases are in much closer accord. The second sentence of the second 
paragraph of "Results in Brief' which suggests that the difference in 
trading assumptions across cases being compared reflects modeler 
choices; rather than the selection of scenarios made by users of the 
modeling results, does not properly capture the main point and should 
be deleted.

Beyond the change recommended above, the two reasons cited in the 
current version of the first paragraph of the draft report do not 
adequately summarize the findings and seem to address only one of the 
reasons for the differences: the type of macroeconomic modeling 
methodology used. Another reason that should be included relates to the 
distinction between actual and potential GDP impacts.

While EIA estimated both impacts, the estimated costs cited from EIA's 
report are those for actual GDP. Actual GDP impacts include 
transitional impacts not reflected in potential GDP, or GDP under 
assumptions of full employment, as is assumed in the CEA estimates of 
the Kyoto impact. Since this issue is not merely a difference in 
modeling approaches, but a key source of differences, it should be 
highlighted up front as a third key difference.

The GAO report correctly cites the macroeconomic modeling differences 
as a key source of differences in the cost estimates (pages 3 and 9/
10). Equally important, though, is the difference in the EIA and CEA 
approaches to modeling energy markets, per se. While the GAO report has 
a section (page 5) to describe modeling approaches as either "bottom-
up" or "top-down" the report does not at that point identify which 
approaches EIA and CEA used. Later, on page 9, only the macroeconomic 
modeling differences used are discussed. The section on pages 9 and 10 
should be expanded to address the differences between EIA's and CEA's 
modeling of energy markets. EIA's study included a chapter comparing 
cost estimates for the Kyoto Protocol, and addresses some of these 
modeling differences, including the approach used by the CEA (based on 
a model developed by the Pacific Northwest National Laboratory).

EIA simulates U.S. energy markets with explicit regional, 
technological, and sectoral detail on an annual basis. EIA's energy 
modeling approach incorporates explicit assumptions and modeling 
structures to address such factors as technological change and costs, 
consumer choice behavior, changes to energy infrastructure, and energy/
environmental regulation. As a result, EIA's approach estimates higher 
emission reductions costs than models which assume energy use and 
substitution are more responsive to energy prices.

The CEA's report was based upon a model developed by the Pacific 
Northwest National Laboratory (PNNL). Their approach modeled energy 
markets and the economy on a national basis at five year intervals. The 
approach is based on aggregate assumptions about consumer price-
responsiveness (demand elasticities and capital/energy substitution 
elasticities) over a long term time frame (50-to-100 years). Applying 
the long-term elasticities to the short-term and mid-term period can 
overstate the extent consumers can reduce energy-related carbon dioxide 
emissions in response to energy-based carbon prices.

While the GAO study identifies the issue of "different time periods" as 
critical to the assessment process, this view needs to be broadened. 
The report appropriately addresses the differences regarding the 
modeling of a long-run equilibrium and assessing the short-run 
adjustment cost (on page 9 of the draft). Omitted, however, is the 
issue of how the economy's response to the Kyoto Protocol was assumed 
to be phased-in prior to the actual commitment period. The CEA analysis 
implicitly assumed a start date of 2000 and a ten-year adjustment 
period to meet a target reduction in 2010. The EIA analysis, however, 
assumed market-based controls on emissions begin in 2005 and are 
phased-in over three years in 
advance of the 2008 reduction target, the first year of five-year 
commitment period. This three-year phase-in of the market controls on 
emissions results in a larger peak impact than the longer run-up 
implied by the CEA analysis, independent of the model selected. The 
issue of the length-of-time to full implementation was addressed in a 
subsequent EIA analysis in July 1999 (Analysis of the Impacts of an 
Early Start for Compliance with the Kyoto Protocol.), which considered 
a case where the market controls on emissions began in 2000. Compared 
with the earlier EIA study, the macroeconomic impacts start earlier in 
the 1999 analysis, but the peak impact is less severe.

On page 6, the last sentence of footnote 5 should be corrected to 
indicate that the results for the CEA's scenario with no international 
trading, while not presented explicitly, are readily derived from the 
other information presented in the report, as is reflected later in 
Table 1:

The point made as a footnote to Table 1, that the decrease in GDP and 
costs to reduce emissions in CEA's model do not include short-term 
adjustment costs, is an important one and a key source of the 
differences. This point should be made directly in the paragraph that 
discusses Table 1.

On page 11, the section on International Trade in emissions reductions 
makes a confusing comparison between EIA and CEA's results for two 
different scenarios: "The most restrictive scenario modeled by EIA did 
not allow for international trade in emissions reductions, while the 
least restrictive CEA scenario did allow such trade." The point should 
be made that both organizations analyzed cost impacts from scenarios 
with and without trading, and both organizations found trading 
scenarios to be substantially lower in costs. Then, the point that the 
scenario cited from EIA's report was one without trading (the most 
costly), while the scenario cited from CEA was with trading can be made 
in the proper context.

On page 3, the economic growth rates cited should provide the year 
range explicitly.

The units for emission costs should be identified as dollars per metric 
ton of carbon.

Thank you for the opportunity to comment on this report.

Sincerely,

Signed by: 

Guy F. Caruso: 
Administrator: 
Energy Information Administration: 

The following are GAO's comments on the Energy Information 
Administration's letter dated December 10, 2003.

GAO's Comments:

1. We believe that the first two paragraphs of our Results in Brief 
section appropriately summarize the results of our work on the likely 
reasons for the differences between the two cited cost estimates based 
on (1) the economic models used to prepare these estimates and (2) the 
economic and other assumptions incorporated into these models.

2. We expanded our discussion of its approach to modeling energy 
markets. See page 8.

3. EIA notes that we did not discuss the difference between CEA and 
EIA's approaches for estimating the economy's response as the Kyoto 
Protocol was phased in over time. We recognize that this assumption 
could have affected the agencies' respective cost estimates. Whereas 
EIA notes that CEA "implicitly" assumed a particular phase-in period, 
we did not find explicit documentation in the CEA study for its 
assumption in this regard and, therefore, did not report on this issue.

4. We clarified our discussion, as suggested.

360394:

FOOTNOTES

[1] Hydrofluorocarbons, perfluorocarbons, and sulfur hexafluoride.

[2] Statement of James L. Connaughton, Chairman, White House Council on 
Environmental Quality, on United States Global Climate Change Strategy, 
before the Senate Committee on Commerce, Science and Transportation, 
July 11, 2002.

[3] Energy Information Administration, Impacts of the Kyoto Protocol on 
U.S. Energy Markets and Economic Activity. Report No. SR/OIAF/98-03, 
October 1998.

[4] President's Council of Economic Advisers, The Kyoto Protocol and 
the President's Policies to Address Climate Change: Administration 
Economic Analysis, July 1998.

[5] CEA's report presents the results of nine scenarios that 
incorporated international emissions trading. It also refers to a tenth 
scenario, involving no emissions trading, assuming rather that all 
reductions occurred domestically. Although CEA did not present the 
results for that scenario, the inferred cost is $54 billion to $60 
billion.

[6] Thirty-six developed countries are listed in Annex I. These 
countries include all the countries belonging to the Organization of 
Economic Cooperation and Development in 1990, plus most of the central 
and eastern European economies-in-transition.

[7] Costs per ton refer to costs per metric ton of carbon.

[8] We estimated this range on the basis of information provided in the 
CEA report on the trading scenarios. 

[9] EIA estimated incremental costs in 1996 dollars per metric ton of 
carbon. 

[10] According to the EIA study, a January 1998 fact sheet by the 
Department of State noted that the provisions of the Protocol would 
yield this 4 percentage-point difference--3 percentage points due to 
the counting of sinks and 1 percentage point due to the use of 1995, 
rather than 1990, as the base year for the three synthetic greenhouse 
gases.

[11] EIA refers to the sum of loss in potential GDP and economic 
adjustment costs as "actual GDP."

[12] As noted above, CEA modeled a range of scenarios with different 
levels of trading. The inferred cost of the no-trading CEA scenario is 
about $54 billion to $60 billion a year, while the estimated cost of 
the no-trading EIA scenario of 7 percent below the 1990 level is $72 
billion in terms of potential GDP. The comparable EIA estimate in terms 
of actual GDP is $397 billion.

[13] Response of the Honorable James Connaughton, Chairman, Council on 
Environmental Quality, to questions posed by Senators after the July 
2002 hearing.