Valuing the future: the social discount rate in cost benefit analysis

Abstract

Governments face a bewildering array of policy choices, ranging from regulatory interventions with little direct cost to government and potentially quick payoffs (such as regulating product safety), through to complex investments in social and economic infrastructure costing billions and taking years to implement and decades to deliver their full benefits. Some policies have extremely long-term effects: for example, the costs and benefits of policies to address the uncertainties of climate change span centuries. Cost-benefit analysis is a powerful tool to inform this range of decisions. People generally expect more than a dollar in the future to compensate them for forgoing a dollar today. The selection of discount rates is important to bring the estimated dollar impacts over time to a common point so as to establish whether a particular project has a present value of benefits greater than its costs, and to rank viable alternatives. In August 2007, the Office of Best Practice Regulation (then part of the Productivity Commission) published its Best Practice Regulation Handbook, containing guidelines including use of a social discount rate of 7 percent real, with sensitivity testing over the range of 3 to 11 per cent (OBPR 2007, pp 129-132). This Visiting Researcher Paper was initiated, as foreshadowed in the Handbook, to examine further the evidence on the parameters influencing the choice of discount rate. It was prepared by Dr Mark Harrison when a visiting researcher at the Commission. The paper reviews conflicting views on the issues influencing discount rate selection, and examines recent evidence of possible market benchmarks for discount rate derivation.

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