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Last week, the Office of Management and Budget (OMB) — the White House office in charge of implementing the president’s vision — made a little-noticed policy move that could have huge implications.
In a circular that updated previous guidance on regulatory analysis, OMB lowered the “discount rate” for the future.
I know that’s a deeply wonky collection of words, so let me break it down.
The discount rate basically tells us how to value the future versus the present — and thus has tremendous implications for the policies we enact today. That’s essentially what OMB is saying with a lower discount rate: that we, the people of this moment, need to value future generations more when making policy.
Another way to think about it: Say that the government is choosing between two infrastructure policies. One will deliver benefits to the public sooner — it’s expected to be worth $50 to each taxpayer in two years. The other will deliver larger benefits, but take longer to pay out — it’s expected to be worth $100 to each taxpayer, but not for another 10 years.
Which of these is a “better” policy?
Discount rates, explained
Economists attempt to answer this question with the discount rate, which is basically a factor for how to calculate the value of future money in the present day.
If you would rather have $100 now than $110 next year, that money is worth 10 percent more to you in the future, because you’ll take a 10 percent discount rate to have it now.
If it’s generally true of you that you’d pay $100 now for no less than $110 next year, then you’ll prefer the project with the public benefits that will be worth $50 to each taxpayer in two years over the project that’ll be worth $100 to each taxpayer in 10 years.
But if your discount rate is much lower — say, if you would be willing to pay $100 now for $102 next year — then you’d probably prefer the policy that delivers larger benefits in the longer term.
High discount rates mean that we, as a society, are willing to trade off the future for the present: that we’ll generally prefer policies that benefit us now over policies with long-term benefits that won’t be realized immediately. Low discount rates mean that we, as a society, are willing to make investments that won’t be realized for a long time.
So what discount rate to use in public policy analysis is a fairly important question.
Using interest rates to decide how much we care about the future
Financial markets need to answer the question, “How much is money later worth right now?” all the time, because they buy and sell government and corporate bonds with payouts at various points in the future, and which are bought and sold on the open market.
Discount rates aren’t the same thing as market interest rates, but there’s reason to think of market interest rates as the best way we have of answering what would otherwise be a bit of an unanswerable philosophical question.
Buying a 10-year government bond is a way of getting more money in the future in exchange for having less money now, so the interest that people demand on those bonds approximates how much they need to be paid later to give up money right now.
“Discount rates should be based on market prices, specifically interest rates, because those reflect the alternative choices that agents have for moving resources between the present and future,” Harvard economist Jason Furman, former chair of the Council of Economic Advisers under President Obama, argued recently.
Interest rates (that is, the inflation-adjusted return on a 10-year Treasury bond) fluctuate. But a 30-year average of interest rates shows that they’re steadily falling. In 2010, a 30-year average of real interest rates was at about 4 percent. Now, that average is 1.7 percent, and projected to fall further.
When regulators make decisions that require a cost-benefit analysis, they use a discount rate that’s based on these interest rates — a rate that OMB sets. The discount rate they currently use is 3 percent, which was selected 20 years ago, based on a 30-year average of the inflation-adjusted return on a 10-year Treasury at the time.
This week, the White House announced an update that, if finalized after a public comment period, will set the figure at 1.7 percent.
Technicalities that really matter
This may all seem fairly in the weeds. But these small decisions affect how huge amounts of money get spent. Projects get approved, or die, on the basis of cost-benefit analyses that have for the last two decades used a 3 percent interest rate.
There are potentially a lot of future-oriented projects that pass a cost-benefit analysis at a 1.7 percent interest rate and not at a 3 percent interest rate. Three percent might not sound steep, but it adds up.
To take one example of how incremental changes to the discount rate can be hugely consequential: The social cost of carbon is the number policymakers use to estimate the damage caused to the future by carbon emissions today. Under a discount rate of 5 percent, the social cost of one metric ton of emission in 2025 is $17; under a 3 percent discount rate, it’s $56; under a 2.5 percent discount rate, it’s $83. Just a small shift to a lower discount rate significantly changes what trade-offs we are willing to make — because with a lower discount rate, we care more about the effects of carbon on the world our grandchildren live in.
Beyond the discount rate discussion, there’s some really good stuff in the analysis published by the OMB. For the first time, its discussion of how to set discount rates includes a discussion of catastrophic risks — that is, risks that imperil our whole civilization, like a devastating pandemic or nuclear war — and allows regulators to take the effects of disaster on future generations into account while setting policy.
It also allows for regulators to take into account the effects of their policies on people in other countries — a low-key momentous shift. Meanwhile, in the discussion of long-term discounting, OMB cites moral philosopher Derek Parfit’s Reasons and Persons. It’s a degree of consideration of the ethical implications of these regulatory changes which I didn’t expect, and was pleasantly surprised by.
Overall, I think the changes proposed will make it much easier for regulators to consider the full scope, and full stakes, of their choices.
We all have an instinct that it’s worth, sometimes, investing now for a better future, planting trees whose shade we will never sit in, thinking harder about what world we’ll leave our grandchildren.
The details of implementing that can easily get intimidating. Most people don’t have any intuitions about whether to use a 10-year or a 30-year rolling average of real interest rates to set the government’s standards for a cost-benefit analysis.
But it’s in these government standards that many of our society’s real priorities get set — and this OMB’s move on the discount rate amounts to a declaration that we need to value the future even more when making policy today.
A version of this story was initially published in the Future Perfect newsletter. Sign up here to subscribe!
