![]() This article seeks to answer this question, focusing in particular on the principles that should be used to determine the rates at which to discount the costs and benefits of regulatory programs. 1 These conflicting government approaches to discounting raise a familiar, but difficult, question: How should governments discount the costs and benefits of public projects, especially those that affect future generations? In the United States, however, the Office of Management and Budget (OMB) recommends that project costs and benefits be discounted at a constant exponential rate (which, other things equal, assigns a lower weight to future benefits and costs than a declining rate), although a lower constant rate may be used for projects that affect future generations. That is, 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 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 the future declines over time ( HM Treasury 2003 Lebègue 2005). This means that the ability of such projects to pass the benefit-cost test is especially sensitive to the rate at which future benefits are discounted. In the case of GHG emissions projects, the benefits of reduced GHG emissions last for centuries, but the mitigation costs are borne today and in the near future. This is especially true of projects that have long time horizons, such as those aimed at reducing greenhouse gas (GHG) emissions. In project analysis, the rate at which future benefits and costs are discounted often determines whether a project passes the benefit-cost test. We conclude that the arguments in favor of a DDR are compelling and thus merit serious consideration by regulatory agencies in the United States. With simplifying assumptions, this leads to the Ramsey discounting formula, which results in a declining certainty-equivalent discount rate if the rate of growth in consumption is uncertain and if shocks to consumption are correlated over time. ![]() In benefit-cost analysis, the net benefits of a project in year t (in consumption units) are discounted to the present at the rate at which society would trade consumption in year t for consumption in the present. However, this literature has been criticized because it lacks a connection to the theory of project evaluation. There is a growing empirical literature that estimates models of long-term interest rates and uses them to forecast the DDR schedule. Should governments use a discount rate that declines over time when evaluating the future benefits and costs of public projects? The argument for using a declining discount rate (DDR) is simple: if the discount rates that will be applied in the future are uncertain but positively correlated, and if the analyst can assign probabilities to these discount rates, then the result will be a declining schedule of certainty-equivalent discount rates. ![]()
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