Appropriate Discounting for Benefit-Cost Analysis

Abstract

In order to be sensible about what discount rate to use one must be clear about its purpose. We suggest that its purpose is to help select those projects that will contribute more net benefits than some other discount rate. This approach, which is after all the foundation for benefit-cost analysis, helps to reconcile different suggested procedures for determining the discount rate. We suggest that the social opportunity cost of capital (SOC) is superior to other suggested approaches in its generality and its ease of use. We use the SOC to determine a range of real rates that vary between 6% and 8%. We suggest that approaches based on determination of preferences, which result in hyperbolic discounting, are less appropriate and less useful.