The Appropriate Measure of the Social Discount Rate and Its Role in the Analysis of Policies with Long-Run Consequences

16 Pages Posted: 6 Dec 2018

See all articles by David Burgess

David Burgess

University of Western Ontario

Date Written: December 6, 2018

Abstract

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.

Keywords: social discount rate, social opportunity cost of borrowed funds

JEL Classification: D61, H43

Suggested Citation

Burgess, David, The Appropriate Measure of the Social Discount Rate and Its Role in the Analysis of Policies with Long-Run Consequences (December 6, 2018). Mercatus Research Paper, December 2018. Available at SSRN: https://ssrn.com/abstract=3297256 or http://dx.doi.org/10.2139/ssrn.3297256

David Burgess (Contact Author)

University of Western Ontario ( email )

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London, Ontario N6A 5B8
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