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Discount Rate

Discounting and Intergenerational Ethics

Discounting refers to the practice of devaluing money in the future by a percentage, typically 3-7%. At a discount rate of 5%, $5.92 today is worth $1000 100 years from now. Discounting is typically done because it is possible to invest money and expect a long-term return. However, it is also reasonable to value the well-being of a person in the far future equally to a person today.

Harmonizing these two concerns is a difficult problem for which there is no consensus on a solution 1. Discounting can make it difficult to deal with long-term environmental challenges, such as climate change.

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Discount rates can have a large effect on the current valuation of damages done by carbon dioxide, and hence on how much we should be willing to spend to mitigate CO2 emissions. Sources: 2, 3, 4. See also David Roberts' review of discount rates 5.

Recent work 6 finds that, using a 2% discount rate and some other modernized assumptions, that the social cost of carbon is $185/ton, significantly higher than most other estimates in widespread use.

Intergenerational ethics call for all policies, not just environmental policies, to be evaulated with low discount rates for the far future. This may mean, for instance, that a higher premium is called for on policies that raise the long-term rate of economic growth and scientific progress 1.

Suggested Rates

A survey of economists has found an average recommended social discount rate of 2.27%, and a median of 2%, when considering the far future 7.

References

  1. Cowen, T. "Caring about the Distant Future: Why It Matters and What It Means". The University of Chicago Law Review 74(5). 2007. ↩ ↩2

  2. Archer, D., Kite, E., Lusk, G. "The ultimate cost of carbon". Climatic Change 162, pp. 2069-2086. July 2020. ↩

  3. Nordhaus, W. "Economic Approaches to Greenhouse Warming". In Global warming: Economic policy approaches, ed. R. D. Dornbush and J. M. Poterba, 33-68. Cambridge, MA: MIT Press. 1991. ↩

  4. Stern, N. "The Economics of Climate Change". Cabinet Office - HM Treasury, Cambridge University Press. October 2006. ↩

  5. Roberts, D. "Discount rates: A boring thing you should know about (with otters!)". Grist. September 2012. ↩

  6. Rennert, K. et al. "Comprehensive evidence implies a higher social cost of CO2". Nature 610, pp. 687-692. September 2022. ↩

  7. Drupp, M. A., Freeman, M. C., Groom, B., and Nesje, F. "Discounting Disentangled". American Economic Journal: Economic Policy, 10(4):109-34. 2018. ↩