8  Conclusions

The paper has examined the two main perspectives relating to the question of discounting, and the resulting approaches of the social rate of time preference and the social opportunity cost. The paper then considers each of these approaches and their estimation. An example is provided to detail some of the estimation issues to be considered.

Overall, the paper concludes that the social rate of time preference is appropriate (subject to estimation considerations) when the government is considering new government activities or ceasing existing government activities[11], because society’s preferences are important. In a significant number of cases the results from using the social opportunity cost and the social rate of time preference are the same.[12] However, the rate is important in a number of circumstances such as when the net present value is close to zero.

The use of the social opportunity cost is a good proxy for the social rate of time preference in the majority of circumstances. This is because one of the methods of estimating the social rate of time preference is similar to the method for estimating the social opportunity cost. In addition, distortions mean that the social opportunity cost is likely to be higher than the underlying social rate of time preference. Hence any positive net present value achieved using a social opportunity cost discount rate, should lead to the same result when using a social rate of time preference discount rate.

Given difficulties in estimating the social rate of time preference, new or significant social projects should be assessed using the social opportunity cost. All public sector investment projects should be assessed using the social opportunity cost. The social opportunity cost can be estimated using the capital asset pricing model and the weighted average cost of capital formula. Where a reasonable estimate of the social rate of time preference is available this should be used as well. This approach would ensure the best allocation of resources as well as meeting society’s preferences.

The social opportunity cost is appropriate for determining how to undertake government activities once there is a decision to have an intervention. In addition, when there is no change in the social preference for undertaking an activity, and the government is revisiting how it is provided, the social opportunity cost is the appropriate discount rate.

In all cases, sensitivity analysis should be undertaken, as the “true underlying” social rate of time preference or social opportunity cost cannot be exactly determined.