The Externality of Discounted Externalities

This article addresses an unexplored problem in the externalities literature: the present value of future externalities. The problem arises because externalized costs and benefits occur in the future, and therefore should be discounted, yet discount rates used by corporate decision-makers are typically higher than the appropriate social discount rate.In simple terms, corporations discount the future too much, and therefore underproduce potential future benefits and overproduce potential future costs. Our key insight is that the impact of high corporate discount rates, relative to the socially appropriate discount rate, is an additional externality. We refer to the additional costs that arise when corporations use higher-than-optimal discount rates as “the externality of discounted externalities.”Policy makers should take into account the difference between corporate and social discount rates. Regulators and courts that seek to incentivize corporations to make decisions about the future in socially optimal ways should not ignore the externality of discounted externalities.