<p>OBE has to use 7% or 3% interest rate as that is mandated by their rules. The 7% discount rate is based on returns to private equity. As mentioned by <a href="https://obamawhitehouse.archives.gov/omb/circulars_a004_a-4/" rel="nofollow noreferrer">OBE</a>:</p>
<blockquote>
<p>As a default position, OMB Circular A-94 states that a real discount rate of 7 percent should be used as a base-case for regulatory analysis. The 7 percent rate is an estimate of the average before-tax rate of return to private capital in the U.S. economy. It is a broad measure that reflects the returns to real estate and small business capital as well as corporate capital.</p>
</blockquote>
<p>The 4.25% discount rate mentioned in that paper is likely derived from general data that do not include only private equity. He states that it is the average of US low discount rate and high discount-rate elsewhere:</p>
<blockquote>
<p>he discount rate is the global average of a lower figure for the United States and a higher figure for other countries and is consistent with estimates in other studies that use US data</p>
</blockquote>
<p>If you look at average real bond returns over large time span (i.e. since 1973) the discount rate in US is about 3% (so that is the lower figure for US), this is even mentioned by OBE and thats why they sometimes use 3% discount rate instead of 7%. When it comes to the rest of the world the discount rate for middle income and low income countries is often estimated to be around 4 and 5% respectively. See, for example, <a href="https://academic.oup.com/heapol/article/35/1/107/5591528" rel="nofollow noreferrer">Haacker et al (2020)</a> for estimation of discount rates in health context (although the same discount rates can be used for climate analysis). Also the same paper estimates discount rate for high income countries to be around 3%.</p>
<p>Hence saying the average world discount rate is somewhere in ballpark of 4% is justified. I am not sure how exactly he arrived at precise figure of 4.25%, maybe that was as a weighted average depending on number of countries or population or something like that, but as explained above its reasonable.</p>
<p>Also you should note that the OBE 7% discount rate is quite high. That is derived basically assuming that we care only about effect to private US business, and it is not very reasonable to do that. They should be more appropriately using the 3% discount rate they also mention in the report, but I guess they have to follow some regulation from that Circular A-94 rather than using some scientific judgement.</p>

CC BY-SA 4.0
2023-02-01T01:57:29.530Z
This same idea seems to be mentioned in that OMB A-4 document: "The effects of regulation do not always fall exclusively or primarily on the allocation of capital...." for consumer goods, like oil, they recommend using long-term return on government debt of 3%.
Philip Meyer
CC BY-SA 4.0
2023-02-01T12:50:20.900Z
@PhilipMeyer yes thats what I mention also in last paragraph
1muflon1
CC BY-SA 4.0
2023-02-07T17:41:04.700Z
But aren't bonds also counted as part of the rate of return to private capital? And would have been part of that 7% figure?
Philip Meyer
CC BY-SA 4.0
2023-02-07T18:33:38.603Z
@PhilipMeyer no, this is not about who owns the bonds but what the bonds are used to. A bond used to finance a public road would be considered public capital. Bonds itself actually are not capital at all in economics, but the road would be considered capital so people will often say that a bond represents public capital.
1muflon1
CC BY-SA 4.0
2023-01-31T18:38:06.820Z
2023-02-08T08:50:31.503Z
2023-02-08T08:50:31.503Z
1muflon1
<p>William Nordhaus, the designer of the DICE integrated climate and economic model, in the most recent estimate I can <a href="https://www.pnas.org/doi/full/10.1073/pnas.1609244114" rel="nofollow noreferrer">find</a>, suggests a discount rate of 4.25% per year:</p>
<blockquote>
<p>With the current calibration, the discount rate (or, equivalently, the real return on investment) averages 4¼% per year over the period to 2100. The discount rate is the global average of a lower figure for the United States and a higher figure for other countries and is consistent with estimates in other studies that use US data. (This specification is sometimes called the “descriptive approach” to discounting. The alternative approach, used in ref. 10 and elsewhere, is called the “prescriptive discount rate.” Under this second approach, the discount rate is assumed on a normative basis and determined largely independently of actual market returns on investments.)</p>
</blockquote>
<p>Meanwhile, a few conservatives <a href="https://www.heritage.org/environment/report/discounting-climate-costs" rel="nofollow noreferrer">thinktanks</a> have also argued for a discount rate based on past rates of return on investment, and that it should therefore match that listed by the <a href="https://obamawhitehouse.archives.gov/omb/circulars_a004_a-4/" rel="nofollow noreferrer">Office of Management and Budget</a>, 7%. They also point to historic returns from the NYSE and S&amp;P 500 being about 7% after adjusting for inflation and taxes.</p>
<p>Is Nordhaus' rate lower simply because he is using global, rather than just US, rates of return on investment? If so, why is this &quot;consistent with estimates in other studies that use US data?&quot; Do these other studies just use different assumptions to find a lower value? And are more recent estimates lower than the 2003 estimate? As he does not cite anything here I was struggling to find a solid justification.</p>

<discount-rate><climate-change>
Why does William Nordhaus' preferred discount rate differ from that of the Heritage Foundation and the 2003 OMB?
Philip Meyer
# Why does William Nordhaus' preferred discount rate differ from that of the Heritage Foundation and the 2003 OMB?

(Asked by: username_0 on 2023-01-31)

William Nordhaus, the designer of the DICE integrated climate and economic model, in the most recent estimate I can [find](https://www.pnas.org/doi/full/10.1073/pnas.1609244114), suggests a discount rate of 4.25% per year:

> With the current calibration, the discount rate (or, equivalently, the real return on investment) averages 4¼% per year over the period to 2100. The discount rate is the global average of a lower figure for the United States and a higher figure for other countries and is consistent with estimates in other studies that use US data. (This specification is sometimes called the “descriptive approach” to discounting. The alternative approach, used in ref. 10 and elsewhere, is called the “prescriptive discount rate.” Under this second approach, the discount rate is assumed on a normative basis and determined largely independently of actual market returns on investments.)

Meanwhile, a few conservatives [thinktanks](https://www.heritage.org/environment/report/discounting-climate-costs) have also argued for a discount rate based on past rates of return on investment, and that it should therefore match that listed by the [Office of Management and Budget](https://obamawhitehouse.archives.gov/omb/circulars_a004_a-4/), 7%. They also point to historic returns from the NYSE and S&P 500 being about 7% after adjusting for inflation and taxes.

Is Nordhaus' rate lower simply because he is using global, rather than just US, rates of return on investment? If so, why is this "consistent with estimates in other studies that use US data?" Do these other studies just use different assumptions to find a lower value? And are more recent estimates lower than the 2003 estimate? As he does not cite anything here I was struggling to find a solid justification.

**Tags:** discount-rate, climate-change


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## 1 answers

### Answer by username_1 on 2023-01-31. Score: 2 | Accepted answer

OBE has to use 7% or 3% interest rate as that is mandated by their rules. The 7% discount rate is based on returns to private equity. As mentioned by [OBE](https://obamawhitehouse.archives.gov/omb/circulars_a004_a-4/):

> As a default position, OMB Circular A-94 states that a real discount rate of 7 percent should be used as a base-case for regulatory analysis. The 7 percent rate is an estimate of the average before-tax rate of return to private capital in the U.S. economy. It is a broad measure that reflects the returns to real estate and small business capital as well as corporate capital.

The 4.25% discount rate mentioned in that paper is likely derived from general data that do not include only private equity. He states that it is the average of US low discount rate and high discount-rate elsewhere:

> he discount rate is the global average of a lower figure for the United States and a higher figure for other countries and is consistent with estimates in other studies that use US data

If you look at average real bond returns over large time span (i.e. since 1973) the discount rate in US is about 3% (so that is the lower figure for US), this is even mentioned by OBE and thats why they sometimes use 3% discount rate instead of 7%. When it comes to the rest of the world the discount rate for middle income and low income countries is often estimated to be around 4 and 5% respectively. See, for example, [Haacker et al (2020)](https://academic.oup.com/heapol/article/35/1/107/5591528) for estimation of discount rates in health context (although the same discount rates can be used for climate analysis). Also the same paper estimates discount rate for high income countries to be around 3%.

Hence saying the average world discount rate is somewhere in ballpark of 4% is justified. I am not sure how exactly he arrived at precise figure of 4.25%, maybe that was as a weighted average depending on number of countries or population or something like that, but as explained above its reasonable.

Also you should note that the OBE 7% discount rate is quite high. That is derived basically assuming that we care only about effect to private US business, and it is not very reasonable to do that. They should be more appropriately using the 3% discount rate they also mention in the report, but I guess they have to follow some regulation from that Circular A-94 rather than using some scientific judgement.

> **Comments:**
> **username_0**: This same idea seems to be mentioned in that OMB A-4 document: "The effects of regulation do not always fall exclusively or primarily on the allocation of capital...." for consumer goods, like oil, they recommend using long-term return on government debt of 3%.  
> **username_1**: @PhilipMeyer yes thats what I mention also in last paragraph  
> **username_0**: But aren't bonds also counted as part of the rate of return to private capital? And would have been part of that 7% figure?  
> **username_1**: @PhilipMeyer no, this is not about who owns the bonds but what the bonds are used to. A bond used to finance a public road would be considered public capital. Bonds itself actually are not capital at all in economics, but the road would be considered capital so people will often say that a bond represents public capital.  

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