2.8.1 In appraisals, we generally need to compare options that will impact over a period of years into the future. This raises the question of how future cost and benefits should be valued in today's terms. Normally people prefer to receive cash sooner rather than later, and pay bills later rather than sooner. This is true even after allowing for inflation. For an individual this time preference may be indicated by the real interest rate on money lent or borrowed.
2.8.2 In the public sector, likewise, we reflect social time preference by giving more weight to earlier than to later costs and benefits. This is usually given effect by applying a "discount rate" to future costs and benefits. The discount rate defines how rapidly the value today of a future real pound declines through time, just as a real rate of interest determines how fast the value of a pound invested now will increase over time. Guidance on the practical application of the discount rate is given in Appendix 4.
2.8.3 The standard discount rate is 3.5% per annum in real terms. The new 3.5% rate is also to serve as the Resource Accounting and Budgeting Cost of Capital Charge. This rate should be applied in all cases.
2.8.4 The 3.5% rate should be applied to all costs and benefits up to and including the 30th year of an appraisal. However, there is good reason for discounting longer term impacts less heavily. This is explained in Annex 6 of the Green Book. The main rationale for declining long-term discount rates arises from uncertainty about the future. Thus, instead of applying 3.5% to all future years, the following schedule should be used:
Years | 0-30 | 31-75 | 76-125 | 126-200 | 201-300 | 300+ |
Discount Rate | 3.5% | 3.0% | 2.5% | 2.0% | 1.5% | 1.0% |