Geoscience Reference
In-Depth Information
ESTIMATES OF DISCOUNT RATES
In estimating the opportunity cost for the descriptive approach,
economists have looked at the rate of return on alternative investments.
Here are some examples. The posttax real returns on corporate capital
are estimated to be 6 percent per year for the United States over the past
four decades. Real rates of return on investments in human capital (edu-
cation) range from 4 to 20 percent per year depending upon the place,
time, and kind of education. Investments in real estate have typically
enjoyed real returns in the range of 6 to 10 percent per year, although
they have done poorly since the bursting of the housing price bubble
after 2006. Investments in energy savings (say through higher fuel ef-
fi ciency of cars or improvements in buildings) are often calculated to
have real returns of more than 10 and sometimes as high as 20 percent
per year.
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My own studies usually rely on the descriptive or opportunity cost
approach. Using a variety of estimates, I generally use a real rate of re-
turn on capital of around 4 percent per year for the United States, along
with a slightly higher rate of return on capital in the rest of the world.
I adopt the descriptive approach because it refl ects the reality that
capital is scarce, that societies have valuable alternative investments,
and that climate investments should compete with investments in other
areas.
Governments need to use discount rates in making their investment
decisions—on roads, dams, levees, and environmental regulations. In
its current regulations (OMB Circular A-94), the U.S. federal govern-
ment instructs agencies to use a real discount rate of 7 percent per year
in their base-case analysis. The rationale is basically the same as that for
the descriptive approach given above: “This rate approximates the mar-
ginal pretax rate of return on an average investment in the private
sector in recent years.” In addition, the federal government uses an al-
ternative approach that appears motivated by the prescriptive one. This
is described as follows: “When regulation primarily and directly affects
private consumption . . . , a lower discount rate is appropriate. The al-
