Question

Some have argued that in use for Cost-Benefit Analysis, a higher discount rate is ‘unfair’ to future generations. Explain why this is not necessarily the case. Give an example to demonstrate.

Answer 1

A discount rate is used to identify the present value of cost and benefits involved with a project. A higher value of discount rate is required to incorporate the future uncertainties. It will not be unfair to the future generation if the higher discount rate is used because any wrong estimation of the future cash inflows and outflows will be burdened to the future generation and they will face the increased taxation, duties and deductions. So, to protect the future generation, it is important to correctly measure the present value of cost and benefits even if it requires higher discount rate. Besides, the higher discount rate in the beginning, will make the cost and benefits to be spread properly and adequately throughout the time period of the project and it will be borne by everyone including the future generation.

For example, a toll bridge of flyover project is evaluated on the basis of cost-benefit analysis. Using higher discount rate will ensure stringent evaluation of the success of the project. If it is profitable then everyone will get be benefitted from the project and future generation will not be burdened with additional toll tax. If the lower discount rate is used and economic conditions become poor, then to make the project to be viable, future generation will face the higher amount of toll tax, duties to make the operation of the toll bridge a successful venture. So, it will be more harmful to the future generation when the lower discount rate is used.