The Derivation of Discount Rates with an Augmented Measure of Income

Most developed economies invest in public goods such as national defense, education, infrastructure, and the environment. Expenditures on public projects entail a diversion of funds away from investments in private capital. Discount rates used to evaluate such projects should reflect the rate of return on the current mix of investment opportunities. The present paper derives discount rates using an augmented measure of national income inclusive of non-market goods. The discount rate reflects three key factors: the productivity of private capital, the opportunity cost of direct expenditure on public projects, and the returns to public investment that accrete outside of the market boundary. The difference between this social rate and the market rate depends on the latter two factors. In the first empirical calculation of discount rates in this setting, the paper reports that, in the U.S. economy, the difference between augmented and market discount rates amounts to 1.24 percent from 1999 to 2002 and under 1 percent from 2002 to 2011.