Social discount rates for the European Union: an overview

Time discounting in the public sector remains a source of confusion and some academic controversy. The very concept of a ”social” discount rate, not revealed by the market, is rejected by mainstream financial economics. Elsewhere the setting of public sector discount rates equal to the commercial return on private investment continues to have wide appeal. Both these approaches are flawed. More widely favoured by experts in the field today is a rate derived as the sum of pure time preference for marginal utility and a factor reflecting the decline in marginal utility of income as per capita income increases. However controversy continues about pure time preference, especially in the absence of any empirical data on people’s social (as opposed to individual) preferences. There is empirical evidence from several sources on the income elasticity of marginal utility, but it is very thin, although informed opinion, for developed economies, generally lies today on the range of -1 to -2. The discount rate is also often seen by ministers and officials as an instrument to promote their own national or departmental policy objectives. Further problems arise from confusions between discounting, the government cost of capital, and the rate of return for a public body trading in competitive markets. Within the EU there is much to be said for each Member State establishing its own standard government discount rate for general use, which might in most cases be in the region of 4% to 5% in real terms. However the application of discounting to the very long term is at best contentious. And discounting should not be allowed to divert attention from other, often much more important appraisal assumptions