Question:
US EPA has a tool called CO-Benefits Risk Assessment (COBRA) Health Impacts Screening and Mapping Tool. It is used to help estimate the economic value of the health benefits associated with clean energy policies and programs to compare against program costs. On the COBRA FAQs page, there was a recent change made in the discount rate relevant to adult mortality and non-fatal heart attacks occur over a 20-year period from 2% to 3% and 7%. See https://www.epa.gov/cobra/cobra-questions-and-answers#15. What is the implication of this change?Answer:
The discount rate is enormously important in benefit-cost analysis of environmental policy.
From what I can tell of the COBRA model, estimated health benefits from reduced exposure to pollution (e.g., closing a coal-fired power plant lowers airborne particulates) that occur in the future are discounted. This is standard practice: many environmental policies accrue benefits or impose costs years down the line — policy analysis requires discounting to reflect these differences in timing. We down-weight future values because people are impatient, they prefer benefits sooner rather than later. (There’s more nuance, beyond the scope of this answer, when considering long-term policies that affect future generations.)
What is the effect of the choice of a particular social discount rate? All else equal, as the discount rate rises, we place less value on policy effects that occur further in the future.
For example, imagine a hypothetical environmental policy that imposes $5 million in costs on industry today, and generates $10 million in certain benefits from avoided mortality 20 years from now. With a 7 percent discount rate, those benefits are present-valued at about $2.6 million; with a 2 percent discount rate, benefits are $6.7 million, nearly three times higher. In this example, the choice of discount rate flips our conclusion about whether the policy is benefit-cost justified. These numbers are illustrative, but the pattern holds: higher social discount rates make costly upfront investments to improve society’s future wellbeing less likely to pencil out. It’s a consequential choice for evaluating policies to address long-term challenges like climate change.
So, what discount rate should we use for policymaking? One way to answer this question is to ask experts. A 2018 study did just that, and arrived at a median value of 2 percent, with 90 percent of surveyed experts “comfortable” with a social discount rate in the 1–3 percent range. The Biden administration released updated guidance on this topic in 2024 and recommended 2 percent; the current administration has since reverted to regulatory guidance from 2003, which is where the 3 and 7 rates come from.
Further reading:
Drupp, Moritz A., Mark C. Freeman, Ben Groom, and Frikk Nesje. 2018. "Discounting Disentangled." American Economic Journal: Economic Policy 10 (4): 109–34.
OMB Circular A-4 (2003). https://www.federalregister.gov/documents/2003/10/09/03-25606/circular-a-4-regulatory-analysis
OMB Circular A-4 (2024). https://bidenwhitehouse.archives.gov/wp-content/uploads/2023/11/CircularA-4.pdf
