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Determining the Discount Rate for Government Projects

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Abstract

Discount rates are widely used in the public sector to assess policy proposals where costs and benefits accrue over long time periods. Socially optimal policy choices require an appropriate choice of discount rate. This paper assesses the applicability of the two key theoretical approaches to selecting discount rates in the public sector. The two key theoretical approaches considered are the social rate of time preference and the social opportunity cost. Estimation issues in determining the rate using these two approaches are reviewed. The social rate of time preference is considered to be the appropriate approach. When estimates of the social rate of time preference are unavailable or clearly unreliable and the Government is considering financing a project, the social opportunity cost should be used. The social opportunity cost can be used as a proxy for the social rate of time preference. The paper presents an example using the capital asset pricing model in a weighted average cost of capital formula to determine a social opportunity cost.

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  • Louise Young, 2002. "Determining the Discount Rate for Government Projects," Treasury Working Paper Series 02/21, New Zealand Treasury.
    • Handle: RePEc:nzt:nztwps:02/21
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    File URL: https://treasury.govt.nz/sites/default/files/2007-09/twp02-21.pdf
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    1. Sandmo, Agnar & Dreze, Jacques H, 1971. "Discount Rates for Public Investment in Closed and Open Economies," Economica, London School of Economics and Political Science, vol. 38(152), pages 395-412, November.
    2. Michael Parsonage & Henry Neuburger, 1992. "Discounting and health benefits," Health Economics, John Wiley & Sons, Ltd., vol. 1(1), pages 71-76, April.
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    Cited by:

    1. Daniel Cohen & Pierre Jacquet & Helmut Reisen, 2007. "Loans or Grants?," Review of World Economics (Weltwirtschaftliches Archiv), Springer;Institut für Weltwirtschaft (Kiel Institute for the World Economy), vol. 143(4), pages 764-782, December.
    2. Horna, Daniela & Zambrano, Patricia & Falck-Zepeda, Jose Benjamin (ed.), 2013. "Socioeconomic considerations in biosafety decisionmaking: Methods and implementation," IFPRI books, International Food Policy Research Institute (IFPRI), number 978-0-89629-207-9, June.
    3. Jay-Hyung Kim & Jonas Arp Fallov & Simon Groom, 2020. "Public Investment Management Reference Guide," World Bank Publications - Books, The World Bank Group, number 33368, December.
    4. Abeer Al Yaqoobi & Marcel Ausloos, 2022. "An Intergenerational Issue: The Equity Issues due to Public-Private Partnerships. The Critical Aspect of the Social Discount Rate Choice for Future Generations," Papers 2201.09064, arXiv.org.
    5. Claude Montmarquette & Iain Scott, 2007. "Taux d'actualisation pour l'évaluation des investissements publics au Québec," CIRANO Project Reports 2007rp-02, CIRANO.
    6. Andrew Coleman, 2019. "Liquidity, the government balance sheet, and the public sector discount rate," Working Papers 19_13, Motu Economic and Public Policy Research.
    7. Arthur Grimes, 2010. "The Economics of Infrastructure Investment: Beyond Simple Cost Benefit Analysis," Working Papers 10_05, Motu Economic and Public Policy Research.
    8. Sun, Shanshan & Wong, Yiik Diew & Rau, Andreas, 2020. "Economic assessment of a Dynamic Autonomous Road Transit system for Singapore," Research in Transportation Economics, Elsevier, vol. 83(C).

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    More about this item

    Keywords

    Discount rate; Social opportunity cost; Social rate of time preference;
    All these keywords.

    JEL classification:

    • H4 - Public Economics - - Publicly Provided Goods
    • H43 - Public Economics - - Publicly Provided Goods - - - Project Evaluation; Social Discount Rate

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