A New Premium on Discount Rates.

• Author: Marlowe, Justin
• Position: PERSPECTIVE

Moments after his inauguration, President Biden signed a document titled, "Memorandum on Modernizing Regulatory Review." It's as technocratic, inconspicuous, and inside-the-beltway as the title suggests. But it could reshape the way we think about the costs and benefits of state and local government.

This memorandum set in motion a review of how the federal government evaluates the impact of proposed regulations. That review has several components, including a careful look at how to better incorporate perspectives from those who are affected by regulation but haven't traditionally had a voice in policymaking. But the component that could affect state and local finance the most is a rethinking of discount rates.

As a quick refresher, recall that a discount rate is a number used to adjust future benefits to today's terms. For instance, imagine that a friend owes you $1,000. They of f er to pay you back the full $1,000 in three years orpay you $500 today. They're also quite unreliable, so there's a good chance the future payment will be less than $1,000. You need to build that uncertainty into your decision.

We quantify that intuition through a discount rate. Discount rates are higher when a future outcome is less certain, when an outcome is simply more valuable to us today than in the future, and when we expect higher inflation, among other reasons. Discount rates and interest rates go hand in hand.

Aborrower who is less creditworthy will pay a higher interest rate for a loan precisely because the lender applies a higher discount rate to the repayment of that loan. This same thinking also applies to costs. In that case, a higher discount rate means future spending feels "less costly" in today's dollars.

Discount rates are everywhere in the federal government. Today approximately $50 billion of annual federal spending on certain state and local infrastructure projects, especially in areas like mass transit systems and levees, is subject to formal benefit-cost analysis. Federal agencies also conduct benefit-cost analysis of many proposed regulations. The Office of Management and Budget and the Congressional Budget Office use discount rates in their long-term projections of future federal revenues and spending. In all these cases, policymakers' views on whether a proposed project, regulation, or budget appropriation will generate more benefits than costs are tied to the discount rate in play.

Discount rates are hard-wired into state and local...