Discounting according to Output Type

Federal discount rate policies advocate both a high rate representing the marginal productivity of capital and a low rate representing the government borrowing rate. These differential discount rate policies could be inconsistent and biased in favor of projects on which the lower discount rate is applied. This paper shows that the coexistence of different discount rates may be appropriate, depending on the type of project output. When a project's outputs are perfect substitutes for private consumption, both its costs and benefits should be discounted using the marginal productivity of capital. However, if the project's outputs are separable in the utility function, the benefits should be discounted using the net (of tax) rate of return.