December 6, 2018

The Unsettled Matter of Discounting the Future

This paper reviews complications associated with the two most popular discounting frameworks for benefit-cost analysis, and presents an alternative approach based on a social discount rate of zero. The first method, known as the social opportunity cost of capital approach, is problematic in that it assumes all benefits are just like cash, thereby giving too much weight to consumption relative to investment. The second method, the social rate of time preference approach, applies distributive weights to benefits and costs in a manner inconsistent with economic efficiency, and it assumes a social welfare function that is unlikely to correspond with society’s actual preferences. This paper suggests modifying the social rate of time preference approach so that it relies on a social welfare function consistent with efficiency. This would seem to be equitable as well as wealth maximizing. But even if the approach recommended here is not preferred by economists, a reexamination of the standard approaches is long overdue.