Because resources for social programs and public-sector investment projects come from private-sector consumption and/or investment, economists typically advocate the use of a social rate of discount that reflects this private-sector opportunity cost. A good estimate of the opportunity cost of funds diverted from private consumption is the rate of return on government securities that is available to individual investors. Similarly, the average rate of return on private investments can be taken as the opportunity cost of private-sector investment funds.
A. Should pretax or after-tax rates of return be used to estimate the opportunity cost of resources diverted from the private sector to fund social programs or public-sector investment projects? Why?
B. Assume that the rate of return on long-term government bonds is 8%, a typical after-tax return on investment in the private sector is 10%, the marginal corporate and individual tax rate is 30%, and consumption averages 95% of total income. Based on the information provided, calculate an economically appropriate social rate of discount.

  • CreatedFebruary 13, 2015
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