The social cost of carbon and optimal carbon pricing: Economic impacts in a dynamic decentralized market model

Freiberger, M., Kuhn, M., & Wrzaczek, S. (2026). The social cost of carbon and optimal carbon pricing: Economic impacts in a dynamic decentralized market model. Economic Modelling 165 e107836. 10.1016/j.econmod.2026.107836.

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Abstract

Carbon taxation is widely regarded as a key instrument for addressing climate change, with the Social Cost of Carbon (SCC) often proposed as the benchmark for optimal policy design. Despite the widespread use of the SCC as a policy benchmark, it remains an open question under which conditions alternative carbon pricing concepts, in particular the Social Marginal Abatement Cost (SMAC), implement the socially optimal allocation in dynamic decentralized economies. This paper develops a dynamic decentralized market framework based on a DICE-type integrated assessment model to study the implementation of optimal carbon pricing. We show that while both the SCC and the SMAC can induce efficient abatement by firms under certain conditions, only the SCC generally ensures socially optimal household behavior through its effects on wages and interest rates. In contrast, the SMAC is sufficient only under restrictive conditions, such as interior abatement solutions. Overall, our results clarify the conditions under which different carbon pricing concepts implement the first-best allocation and highlight the broader welfare relevance of the SCC in dynamic decentralized economies.

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