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The Appropriate Measure of the Social Discount Rate and Its Role in the Analysis of Policies with Long-Run Consequences
The appropriate measure of the social discount rate is the social opportunity cost of borrowed funds (a weighted average of the rates of return on displaced investment, postponed consumption, and incremental foreign funding), which ensures that a proposed policy produces a potential Pareto improvement. The approach yields a discount rate in the order of 7 percent per annum for the United States using national income accounts data, with no evidence of any secular decline in the rate over the past half century. Using a lower discount rate equal to the social rate of time preference requires either (1) abandoning a basic tenet of benefit-cost analysis that worthy projects must improve allocative efficiency, or (2) assuming that the government must balance the budget each period (no debt financing at the margin), debt reduction is not an option, and the marginal tax instrument is a nondistortionary tax that impacts only consumption. Neither option seems reasonable.