Would you rather pay your bills tomorrow or next year?  What about your paycheck?  Intuitively, most people want delayed costs and immediate benefits, and so want checks now and liability later.  This poses a challenge for policymakers when weighing the costs and benefits of a new policy: is reasonable to pay 90 cents today for a dollar tomorrow—and what if tomorrow’s dollar is a benefit other than money?  When federal agencies undergo notice-and-comment rulemaking, they have to make these calculations.  Immediate costs and benefits must be considered, while future factors are discounted to their present value to account for the intervening time.  Selecting the discount rate can have material implications for any economic analysis, and especially for environmental rules which tend to involve front-loaded compliance costs and primarily future benefits.

Since 2003, federal agencies have discounted future costs and benefits under the Office of Management and Budget’s (OMB) Circular A-4 which set applicable discount rates.  Recently, OMB proposed new changes that would revise the discount rate lower, taking into account the changes in the economy since 2003.  The revised discount analysis will subtly but materially alter the economic framework for federal agency rulemaking and will have substantial pro-regulatory impacts for rules where costs and benefits are temporally mismatched.

Federal agencies have long encountered this problem; they are obliged to consider the costs and benefits of their decisions when engaged in rulemaking, but rules may be in effect many decades, and the costs and benefits from them uncertain and distant.  Moreover, many of those costs and benefits are not monetary.  Money is fungible, and relatively easy to discount—at least mathematically—based on its time value.  But how does an agency consider and discount non-monetary benefits?  If a rule limits oil and gas drilling, does the value of an undisturbed park in 2040 get a higher or lower discount than the foregone royalties? 

In 2003, OMB’s Circular A-4 sought to answer those questions by providing two real discount rates of 3 and 7 percent.  The latter, the 7% discount rate, is the “default” assumption “that reflects the returns to real estate and small business capital as well as corporate capital.”  In other words, if you invested $50 today, you could reasonably expect to average a 7% annual return before taxes.  And conversely, to produce a $50 benefit in 2040, you could invest an amount that would, after the years of compounding at 7%, yield $50.  The 3 percent rate applies when the effects of the regulation affect private consumption rather than the allocation of capital, “the rate at which ‘society’ discounts future consumption flows to their present value,” the “social rate of time preference.”   

Under this rubric, an agency might use the 7% discount rate when considering a rule which makes certain investment vehicles more costly because that rule primarily affects the allocation of capital.  A rule which more directly impacts consumption, for example a rule that limits the chemicals used in consumer plastics, might use the 3% rate.  These are just examples, but the dividing line between the rules is not always so clear and selecting the discount rate can have dispositive effects on a rule.  Currently, EPA is considering a rule that would limit the use of methylene chloride under the Toxic Substances Control Act; its economic analysis states that the benefits outweigh the costs using a 3% discount, but not at a 7% discount.  The higher the discount rate, the smaller the present value of that future sum. 

The problem of front-loaded compliance costs with long-term benefits is particularly acute in environmental regulation and, as we can see, makes the discount rate extremely important.  And so sometimes agencies have developed hybrid models.  For example, the Environmental Protection Agency’s Science Advisory Board “recommends using a single central rate of 5 percent as intermediate between 3 percent and 7 percent rates” for costs and benefits of Clean Air Act regulation.  Even in circumstances where one discount rate clearly applies, much has changed since 2003 and the 3 and 7 percent rates have been criticized as outdated and inapposite.  In 2017, the Council of Economic Advisors issued a report calling for an “overdue” update to these figures; and it is difficult to deny that there have been structural changes to the economy in the intervening time, to say nothing of the difficulty in selecting between these two figures for the (many) edge cases presenting a mix of the two factors.

The Office of Management and Budget has published proposed revisions to Circular A-4 to address these issues.  The proposed revision calculates that the social rate, previously 3 percent, has “averaged around 1.7 percent in real terms on a pre-tax basis” in the past thirty years.  OMB therefore proposed “setting one default rate for social rate of time preference for all effects from the present through 30 years into the future” at this 1.7 percent figure. 

The substantial reduction of the discount rate will have a material impact on agencies’ economic analyses going forward, and will tend to have a significant pro-regulatory impact, particularly for environmental regulation.  To be clear, costs and benefits both get discounted using the same rate.  But for many regulations, there are startup and transition costs that accrue up front, and the annual compliance costs accrue each year from the near term; while many of the benefits often appear only later over time and may even grow over time.  Accounting for the economic effects of climate change, one of the driving factors behind the revision, will see the biggest change as tens, perhaps hundreds of billions of dollars of future benefit are recognized with the revised discount rate.  Rules which appear to be economically questionable under a 7% or 3% discount rate are prudent measures under a 1.7% rate.

The revisions to Circular A-4 are part of the Biden Administration’s efforts to promote economic and environmental justice and to fight climate change.  In his January 20, 2021 Memorandum that laid out the early priorities for the Administration in reforming rulemaking, President Biden emphasized the need to reform Circular A-4 to “ensure that the review process promotes policies that reflect new developments in scientific and economic understanding, fully accounts for regulatory benefits that are difficult or impossible to quantify, and does not have harmful anti-regulatory or deregulatory effects.”  The proposed revisions are pending, but would be a significant change in the way the federal government weighs future contingent benefits against near-term costs, and would reframe many economically significant rules in important ways.