Discounting Environmental Benefits to Future Generations: Implications of a Coordinating Debt Policy and Tax Distortions in the Capital Market

Abstract

Looking beyond today’s fiscal problems in the U.S., the debate about the how to best incorporate the well-being of subsequent generations in current public policy discussions continues. Authors Liqun Liu, Andrew J. Rettenmaier, and Thomas R. Saving discuss coordinating the evaluation of long-term environmental projects with debt reduction given that both benefit future generations. This paper establishes a cost-benefit rule used to assess whether long-term projects are Pareto improving with a focus on how the generational benefits and costs should be discounted. This paper goes beyond the existing analysis of intergenerational discounting by exploring the implications of tax distortions in the capital market that drives a wedge between the marginal productivity of capital (the gross rate) and the consumer’s interest rate (the net rate) which have historically been in the range of 7% and 3%, respectively. It concludes that while the lower net rate should be used for future benefits within generations, the higher gross rate is the relevant discount rate for future generations.