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

29 Apr 2010
Description

A key element of the cost-benefit analysis framework is the use of a discount rate to compare costs and benefits received at different points in time. Yet there is little agreement about the appropriate discount rate

Cost-benefit analysis is used to improve decision making by systematically comparing the social costs and benefits of government policies, with the emphasis on valuing them (to the extent possible) in monetary terms. It provides decisionmakers with quantitative information about the policy’s likely effects and encourages them to take account of all the positive and negative effects and the linkages between them. Quantifying the impact of government policies in a standard manner promotes comparability, the assessment of relative priorities, and consistent decision making.

Moreover, the process of trying to describe and measure costs and benefits is valuable in itself. By examining what determines the costs and benefits and how they are likely to vary, policy makers are encouraged to consider different approaches and determine the best way to achieve objectives. Identifying and measuring costs and benefits encourages close examination of the factors that influence them and assists in minimising costs and maximizing benefit, helping decision makers increase net benefits to society.

Cost-benefit analysis can be used to analyse and strengthen a wide range of government choices, including whether to undertake an infrastructure project, provide a service, pass a regulation, produce a public good, change a social welfare programme or adjust a tax.

Most government policies or projects give rise to a stream of costs and benefits over time. A key element of the cost-benefit analysis framework is the use of a discount rate to compare costs and benefits received at different points in time. Yet there is little agreement about the appropriate discount rate, with cost-benefit guides, academics and textbooks giving conflicting advice. A wide range of discount rates has been recommended, with the average and the bottom of that range falling over recent years. The choice of discount rate can make a significant difference to whether the present value of a project is positive, and to the relative desirability of alternative projects, especially when costs and benefits accrue at different times and over long periods.

This paper is about discount rate choice: how to discount estimated cost and benefit flows. It is not about whether cost-benefit analysis should be used, or how well costs and benefits can be quantified. These are separate debates.

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2010
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