The most appropriate discount rate

See Long et al. (2013). It is also challenging to identify individual’s valuations of a project (whether they are expected to be alive or dead in year t). Since this challenge already exists for traditional benefit-cost analysis, we do not further discuss these empirical challenges, despite their importance.

See also Anderson and Gugerty (2009).

They note: “[Table 1] reveals spectacular disagreement among dozens of studies that all purport to be measuring time preference. This lack of agreement likely reflects the fact that the various elicitation procedures used to measure time preference consistently fail to isolate time preference, and instead reflect, to varying degrees, a blend of both pure time preference and other theoretically distinct considerations, including: (a) intertemporal arbitrage, when tradable rewards are used; (b) concave utility; (c) uncertainty that the future reward or penalty will actually obtain; (d) inflation, when nominal monetary amounts are used; (e) expectations of changing utility; and (f) considerations of habit formation, anticipatory utility, and visceral influences” (p. 389).

Subsequent studies by Chapman (2003) and Groom, Hepburn, Koundouri and Pearce (2005) provide compilations of recent literature on time preference and discounting, yet do not suggest a method for identifying a social discount rate.

For a broader (but still partial) review of findings on time preference heterogeneity, see the many references Frederick (2003) and in, Anderson and Gugerty (2009).

For further details see Burgess (2013b).

It should also be mentioned that the financial data that Moore et al use to estimate the marginal rate of return of 6.79% depends upon assumptions about the aggregate debt/equity ratio, the inflation rate etc., and it is highly sensitive to business cycle swings (because capital is valued at market prices rather than at replacement cost). It is also less comprehensive than desired, i.e., it does not reflect the historical average performance of capital in the economy as a whole. A better estimate of the real rate of return to capital in the private sector uses national income accounts data. See Jenkins and Kuo (2010).

The authors do not list these interested economists. They cite Cole, a lawyer, inappropriately as an authority as follows: “Indeed, Cole (2010, personal communication), originally a member of the Scientific Committee reviewing these principles and standards notes that “not one of those three [commissioned white papers] supports the high discount rates recommended in Professor Zerbe’s report.” This is incorrect. Only one paper was commissioned to address directly the issue of the discount rate and this was the Burgess paper. Other papers briefly addressed this issue in the context of broader issues but simply cited other literature. Cole resigned from both the Scientific Committee and indeed from the Benefit-Cost Society reportedly (telephone call between Zerbe and Cole) as a result of our acceptance of the Burgess view. Cole’s reaction was that of an advocate committed to low discount rates, not a scientist; such an approach is ascientific.

The Burgess and Zerbe view has been presented more formally by Burgess (2013a).

An income tax is assumed to be equivalent to a lump sum tax in the STP approach because there is no accounting for the efficiency cost of the tax.

Bradford (1975) and Lind (1982) rule out the rate of return in the private sector as the relevant opportunity cost for public investment whenever direct government investment in the economy is not feasible on political or other grounds, but they neglect the ability of the government to induce additional private investment through debt redemption.

Moore et al. do not regard debt reduction as an alternative use of tax dollars. Debt problems are presumably solved by economic growth, not by diverting taxes to debt reduction. But debt problems arise because project expenditures exceed tax revenue. Since the cost of debt is the SOC rate and debt results because spending exceeds tax revenue, spending going forward should only be approved if it satisfies the SOC criterion.

Government debt displaces private capital one for one only if the rate of return to capital in the private sector is exogenous. In the general (closed economy) case government debt will displace both private investment and consumption so the appropriate SOC rate is a weighted average of ρ and r.