The Elasticity of Marginal Utility of Income for Distributional Weighting and Social Discounting: A Meta-Analysis

Abstract

AbstractEstimates of the elasticity of the marginal utility of income are necessary for determining distributional weights to correct for diminishing marginal utility of income, which is particularly important in light of increasing concern about accounting for distributional impacts in regulatory review. The elasticity is also necessary for computing the social discount rate using the Ramsey formula. Despite many attempts to estimate the elasticity of the marginal utility of income, considerable uncertainty exists about the magnitude of this key parameter. In this paper, we use meta-analysis of estimates of the elasticity from the US and UK to shed light on the appropriate elasticity values to use for both distributional weighting and discounting. Relying on our findings, we tentatively conclude that it is reasonable to base the social discount rate and distributional weights on an elasticity of 1.6, with lower- and upper-bound sensitivity testing at 1.2 and 2.0. This estimate results in distributional weights which appear plausible, and which we believe can contribute to a consensus on how to conduct distributional weighting. Moreover, the resulting social discount rate is within the range typically recommended when the Ramsey formula is used.