Fixing Our Public Discounting Systems

Frédéric Cherbonnier and Christian Gollier
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Frédéric Cherbonnier: TSE-R - Toulouse School of Economics - UT Capitole - Université Toulouse Capitole - UT - Université de Toulouse - EHESS - École des hautes études en sciences sociales - CNRS - Centre National de la Recherche Scientifique - INRAE - Institut National de Recherche pour l’Agriculture, l’Alimentation et l’Environnement, Institut d'Études Politiques [IEP] - Toulouse, UT Capitole - Université Toulouse Capitole - UT - Université de Toulouse
Christian Gollier: TSE-R - Toulouse School of Economics - UT Capitole - Université Toulouse Capitole - UT - Université de Toulouse - EHESS - École des hautes études en sciences sociales - CNRS - Centre National de la Recherche Scientifique - INRAE - Institut National de Recherche pour l’Agriculture, l’Alimentation et l’Environnement, UT Capitole - Université Toulouse Capitole - UT - Université de Toulouse

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Abstract: Most Western countries use a single discount rate to evaluate public investments and policies. This ignores the differential cost of risk, in a world where most risk markets exhibit surprisingly large prices of risk. The current discounting guidelines generate a misallocation of capital that entails a large welfare cost. We claim that the well-established asset pricing literature provides a strong normative justification in favor of risk-adjusting discount rates. More specifically, project-specific discount rates should be increasing in the income elasticity of the project's net benefit. This will favor projects whose net benefit materializes preferentially in low-income states, thereby recognizing their insurance benefit ex ante. The intuition is simple, the welfare benefit of the reform is large, and the methodology only requires evaluators to estimate an income elasticity on top of what is required in the current approach. It is time to fix our public discounting systems.

Keywords: Discounting; Risk adjustment; Carbon pricing; Cost-benefit analysis (search for similar items in EconPapers)
Date: 2023-11
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Published in Annual Review of Financial Economics, 2023, 15, pp.147-164. ⟨10.1146/annurev-financial-102921-111749⟩

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Persistent link: https://EconPapers.repec.org/RePEc:hal:journl:hal-04512435

DOI: 10.1146/annurev-financial-102921-111749

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