Many activities of the federal government have budgetary and other effects that can last far into the future . To produce estimates of those budgetary effects—and to help lawmakers compare different policies—the Congressional Budget Office often has to translate a flow of future income or payments into an equivalent lump-sum
Many activities of the federal government have budgetary and other effects that can last far into the future. To produce estimates of those budgetary effects—and to help lawmakers compare different policies—the Congressional Budget Office often has to translate a flow of future income or payments into an equivalent lump-sum value today. This report describes such present-value estimates, particularly how CBO selects and uses discount rates to calculate the value of future cash flows in its analyses.
- Discount Rates and Present Values. The present value of future cash flows depends on the rate used to convert those flows into a single equivalent value at a specific time, generally the present. Discount rates account for the time value of money: the fact that an amount received or paid today is more valuable than the same amount received or paid in the future. Discount rates can also incorporate factors such as risk, inflation, and other considerations that can affect the value of an asset to a person or business.
- Types of Estimates That Use Present Values. CBO uses discount rates for a wide variety of estimates. They include estimates of the budgetary cost of federal programs that make or guarantee loans, the financial position of the Social Security trust funds, and the long-term effects of spending for infrastructure or children’s health on federal spending and revenues. CBO also uses discount rates to estimate household wealth, the value of future retirement benefits, the lifetime costs of weapon systems, the likelihood that people will invest in energy-saving technologies, and the cost of future damage from flooding, among other topics.
- CBO’s Methods and Data for Choosing Discount Rates. The choice of discount rates can have large effects on estimates, especially for cash flows far in the future. To estimate discount rates that are consistent with market prices and rates of return, CBO uses data from an array of sources, including financial markets, the Bureau of Economic Analysis, the Federal Reserve, and academic studies. CBO’s discount rates may differ from those used by the Administration for various reasons, such as differences in economic assumptions, assessments of risk, and decisions about what factors discount rates should reflect.
