Abstract

In project analysis, the rate at which future benefits and costs are discounted often determines whether a project passes the benefit-cost test. This is especially true of projects with long horizons, such as projects to reduce greenhouse gas (GHG) emissions. The benefits of reduced GHG emissions last for centuries, but mitigation costs are borne today. Whether such projects pass the benefit-cost test is especially sensitive to the rate at which future benefits are discounted. In evaluating public projects, France and the United Kingdom use discount rate schedules in which the discount rate applied today to benefits and costs occurring in future years declines with maturity: the rate used today to discount benefits from year 200 to year 100 is lower than the rate used to discount benefits in year 100 to the present In the United States, the Office of Management and Budget (OMB) recommends that project costs and benefits be discounted at a constant exponential rate, although this rate may be lower for projects that affect future generations. This raises a familiar, but difficult, question: how should governments discount the costs and benefits of public projects, especially projects that affect future generations? In this paper we ask what principles should be used to determine the rates at which to discount the costs and benefits of regulatory programs. Specifically, we ask whether these principles suggest that a declining discount rate (DDR) schedule should be used in project evaluation—similar to the approach followed in the UK and France—or whether benefits and costs should be discounted at a constant exponential rate. We conclude that the arguments in favor of a DDR are compelling, and merit serious consideration by regulatory agencies in the United States.

Reference

Kenneth J. Arrow, Maureen Cropper, Christian Gollier, Ben Groom, Geoffrey Heal, R. Newell, William D. Nordhaus, R. Pindyck, W. Pizer, P. Portney, Thomas Sterner, R. Tol, and Martin L. Weitzman, Should a Declining Discount Rate Be Used in Project Analysis?, September 12, 2013.

See also

Published in

September 12, 2013