Bob reports in his testimony that for cost-benefit analyses by government agencies the OMB suggests using both a 3% and a 7% discount rate (along with whatever else the analyst might think is appropriate). These choices are not random. Bob writes:
"The Office of Management and Budget writes instructions for federal agencies in regulatory analysis. These are called “OMB Circulars.” OMB Circular A-44 (relying in turn on Circular A-94) states that “a real discount rate of 7 percent should be used as a base-case for regulatory analysis,” as this is the average before-tax rate of return to private capital investment. However, Circular A-4 acknowledges that in some cases, the displacement of consumption is more relevant, in which case a real discount rate of 3 percent should be used. Thus it states: “For regulatory analysis, you should provide estimates of net benefits using both 3 percent and 7 percent.”"I found the reasoning for the different rates interesting. I may be thinking about this wrong, but given the argument for each rate it seems more appropriate to use the 7% rather than the 3% rate (again - ignoring all those additional arguments for lower rates which would reduce it further from 7%).
The OMB is right that in the future a lot of what will be crowded out is consumption - but what is crowded out in the future doesn't really matter for discounting future values. What matters is the trade-off in the present.
Think about it this way - these regs and Pigovian taxes are put in place to adjust behavior, but an equivalent strategy would be to require carbon emitting firms to hold funds in trust for future generations that are hurt by climate change. The question is, what level of funding would be required to provide adequate compensation in the future? We would calculate that level of funding using the average before-tax rate of return to private capital investment, since after all the trust would be privately invested in the meantime.
This implies using the 7% rate rather than the 3% rate.
I don't think this is obviously and unequivocally the right answer, but there's a good case for it. An argument that could be made for using the 3% rate instead is that carbon emitting firms could pay the full cost of carbon to consumers today and then those consumers could save the money, earn a return on it, and compensate their descendants. But this requires much stronger assumptions about intergenerational altruism, dynastic families, and bequest motives than creating a trust does. So it's not obviously wrong, but it is weaker.
Of course to all this we have to add all the other debates about why super-low