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Removing Some Dissonance From the Social Discount Rate Debate

In an economy with a capital income tax distortion, the social discount rate (SDR) should reflect the social opportunity cost of capital rather than the social rate of time preference (consumption rate of interest) to ensure that public investments can produce Pareto improvements. The marginal cost of funds may exceed unity for a lump sum tax, but it is irrelevant for project evaluation. Even if a social welfare improvement is judged to be possible without passing the compensation test, the SDR should still reflect the social opportunity cost of capital to ensure that the project is the most efficient use of public funds.

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Paper provided by University of Western Ontario, Economic Policy Research Institute in its series University of Western Ontario, Economic Policy Research Institute Working Papers with number 20082.

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Date of creation: 2008
Date of revision:
Handle: RePEc:uwo:epuwoc:20082
Contact details of provider: Postal: Economic Policy Research Institute, Social Science Centre, University of Western Ontario, London, Ontario, Canada N6A 5C2
Phone: 519-661-2111 Ext.85244
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  1. Bradford, David F, 1975. "Constraints on Government Investment Opportunities and the Choice of Discount Rate," American Economic Review, American Economic Association, vol. 65(5), pages 887-99, December.
  2. Browning, Edgar K, 1987. "On the Marginal Welfare Cost of Taxation," American Economic Review, American Economic Association, vol. 77(1), pages 11-23, March.
  3. Sjaastad, Larry A & Wisecarver, Daniel L, 1977. "The Social Cost of Public Finance," Journal of Political Economy, University of Chicago Press, vol. 85(3), pages 513-47, June.
  4. Timothy J. Bartik, 2008. "Evaluating the Benefits of Non-marginal Reductions in Pollution Using Information on Defensive Expenditures," Book chapters authored by Upjohn Institute researchers, in: Joseph Herriges & Catherine L. Kling (ed.), Revealed Preference Approaches to Environmental Valuation, volume 0, pages 459-475 W.E. Upjohn Institute for Employment Research.
  5. 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.
  6. Courant, Paul N. & Porter, Richard C., 1981. "Averting expenditure and the cost of pollution," Journal of Environmental Economics and Management, Elsevier, vol. 8(4), pages 321-329, December.
  7. Wildasin, David E, 1984. "On Public Good Provision with Distortionary Taxation," Economic Inquiry, Western Economic Association International, vol. 22(2), pages 227-43, April.
  8. Dreze, Jacques H, 1974. "Discount Rates and Public Investment: A Post-Scriptum," Economica, London School of Economics and Political Science, vol. 41(161), pages 52-61, February.
  9. Burgess, David F, 1988. "Complementarity and the Discount Rate for Public Investment," The Quarterly Journal of Economics, MIT Press, vol. 103(3), pages 527-41, August.
  10. Charles L. Ballard & Don Fullerton, 1990. "Distortionary Taxes and the Provision of Public Goods," NBER Working Papers 3506, National Bureau of Economic Research, Inc.
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