Circular A-4: Practical Advances in Discounting for Policy Decisions

This article provides an overview of the recently updated federal guidance on discounting methods to be used in benefit–cost analysis by US government agencies. These updated recommendations include a lower central real discount rate of 2 percent (relative to the previous value of 3 percent). They also replace the use of a discount rate reflecting the return to capital (estimated at 7 percent) with the shadow price of capital approach. Finally, they provide alternative approaches for accounting for risk. We discuss the empirical and conceptual bases underlying these updates, which reflect the decline in prevailing market interest rates and advances in the discounting literature since this guidance was last modified in 2003. These updates to discounting guidance have major implications for the evaluation of long-lived impacts such as climate change. A lower discount rate means that more emphasis is placed on the future, including the future impacts of climate change. For example, moving from a discount rate of 3 to 2 percent can itself more than double the social cost of carbon, which represents the monetized damage to society of an incremental ton of carbon dioxide emissions.