Circular No. A-94
October 29, 1992
(Transmittal Memo No.
MEMORANDUM FOR HEADS OF EXECUTIVE DEPARTMENTS AND ESTABLISHMENTS
SUBJECT: Guidelines and Discount Rates for Benefit-Cost Analysis
of Federal Programs
Table of Contents
- General Principles
- Net Present Value and Related Outcome Measures
- Cost-Effectiveness Analysis
- Elements of Benefit-Cost or Cost-Effectiveness Analysis
- Identifying and Measuring Benefits and
- Identifying Benefits and Costs
- b. Measuring Benefits and Costs
- Treatment of Inflation
- Real or Nominal Values
- Recommended Inflation Assumption
- Discount Rate Policy
- Real versus Nominal Discount Rates
- Public Investment and Regulatory Analyses
- Cost-Effectiveness, Lease-Purchase,Internal Government Investment,
and Asset Sale Analyses
- Treatment of Uncertainty
- Characterizing Uncertainty
- Expected Values
- Sensitivity Analysis
- Other Adjustments for Uncertainty
- Incidence and Distributional Effects
- Alternative Classifications
- Economic Incidence
- Special Guidance for Public Investment
- Analysis of Excess Burdens
- Special Guidance for Regulatory Impact
- Special Guidance for Lease-Purchase
- Required Justification for Leases
- Analytical Requirements and Definitions
- Related Guidance
- Effective Date
Appendix A: Definitions of Terms
Appendix B: Additional Guidance for Discounting
Appendix C: Discount Rates for Cost-Effectiveness,
Lease-Purchase, and Related Analyses
Purpose. The goal of this Circular is to promote efficient resource
allocation through well-informed decision-making by the Federal Government. It
provides general guidance for conducting benefit-cost and cost-effectiveness
analyses. It also provides specific guidance on the discount rates to be used
in evaluating Federal programs whose benefits and costs are distributed over
time. The general guidance will serve as a checklist of whether an agency has
considered and properly dealt with all the elements for sound benefit-cost and
2. Rescission. This
Circular replaces and rescinds Office of Management and Budget (OMB) Circular
No. A-94, "Discount Rates to Be Used in Evaluating Time-Distributed Costs and
Benefits," dated March 27, 1972, and Circular No. A-104, "Evaluating Leases of
Capital Assets," dated June 1, 1986, which has been rescinded. Lease-purchase
analysis is only appropriate after a decision has been made to acquire the
services of an asset. Guidance for lease-purchase analysis is provided in
Section 8.c.(2) and Section 13.
3. Authority. This
Circular is issued under the authority of 31 U.S.C. Section 1111 and the Budget
and Accounting Act of 1921, as amended.
This Circular does not supersede agency practices which are prescribed by or
pursuant to law, Executive Order, or other relevant circulars. The Circular's
guidelines are suggested for use in the internal planning of Executive Branch
agencies. The guidelines must be followed in all analyses submitted to OMB in
support of legislative and budget-programs in compliance with OMB Circulars No.
A-11, "Preparation and Submission of Annual Budget Estimates," and No. A-19,
"Legislative Coordination and Clearance." These guidelines must also be
followed in providing estimates submitted to OMB in compliance with Executive
Order No. 12291, "Federal Regulation," and the President's April 29, 1992
memorandum requiring benefit-cost analysis for certain legislative proposals.
a. Aside from the exceptions listed below, the guidelines in this
Circular apply to any analysis used to support Government decisions to
initiate, renew, or expand programs or projects which would result in a series
of measurable benefits or costs extending for three or more years into the
future. The Circular applies specifically to:
- Benefit-cost or cost-effectiveness analysis of Federal programs or
- Regulatory impact analysis.
- Analysis of decisions whether to lease or purchase.
- Asset valuation and sale analysis.
b. Specifically exempted from the scope of this Circular are decisions
- Water resource projects (guidance for which is the approved
Economic and Environmental Principles and Guidelines for Water and Related
Land Resources Implementation Studies).
- The acquisition of commercial-type services by Government or
contractor operation (guidance for which is OMB Circular No. A-76).
- Federal energy management programs (guidance for which can be found
in the Federal Register of January 25, 1990, and November 20, 1990).
c. This Circular applies to all agencies of the Executive Branch of the
Federal Government. It does not apply to the Government of the District of
Columbia or to non-Federal recipients of loans, contracts or grants. Recipients
are encouraged, however, to follow the guidelines provided here when preparing
analyses in support of Federal activities.
d. For small projects which share similar characteristics, agencies are
encouraged to conduct generic studies and to avoid duplication of effort in
carrying out economic analysis.
Principles. Benefit-cost analysis is recommended as the technique to
use in a formal economic analysis of government programs or projects.
Cost-effectiveness analysis is a less comprehensive technique, but it
can be appropriate when the benefits from competing alternatives are the same
or where a policydecision has been made that the benefits must be provided.
(Appendix A provides a glossary of technical terms used in this Circular;
technical terms are italicized when they first appear.)
a. Net Present Value and Related Outcome Measures. The standard
criterion for deciding whether a government program can be justified on
economic principles is net present value -- the discounted monetized
value of expected net benefits (i.e., benefits minus costs). Net present value
is computed by assigning monetary values to benefits and costs, discounting
future benefits and costs using an appropriate discount rate, and subtracting
the sum total of discounted costs from the sum total of discounted benefits.
Discounting benefits and costs transforms gains and losses occurring in
different time periods to a common unit of measurement. Programs with positive
net present value increase social resources and are generally preferred.
Programs with negative net present value should generally be avoided. (Section
8 considers discounting issues in more detail.)
Although net present value is not always computable (and it does not
usually reflect effects on income distribution), efforts to measure it can
produce useful insights even when the monetary values of some benefits or costs
cannot be determined. In these cases:
- A comprehensive enumeration of the different types of benefits
and costs, monetized or not, can be helpful in identifying the full range of
- Quantifying benefits and costs is worthwhile, even when it is
not feasible to assign monetary values; physical measurements may
be possible and useful.
Other summary effectiveness measures can provide useful
supplementary information to net present value, and analysts are encouraged to
report them also. Examples include the number of injuries prevented per dollar
of cost (both measured in present value terms) or a project's internal rate of
b. Cost-Effectiveness Analysis. A program is cost-effective if,
on the basis of life cycle cost analysis of competing alternatives, it
is determined to have the lowest costs expressed in present value terms for a
given amount of benefits. Costeffectiveness analysis is appropriate whenever it
is unnecessary or impractical to consider the dollar value of the benefits
provided by the alternatives under consideration. This is the case whenever (i)
each alternative has the same annual benefits expressed in monetary terms; or
(ii) each alternative has the same annual affects, but dollar values cannot be
assigned to their benefits. Analysis of alternative defense systems often falls
in this category.
Cost-effectiveness analysis can also be used to compare programs with
identical costs but differing benefits. In this case, the decision criterion is
the discounted present value of benefits. The alternative program with the
largest benefits would normally be favored.
c. Elements of Benefit-Cost or Cost-Effectiveness Analysis.
- Policy Rationale. The rationale for the Government program
being examined should be clearly stated in the analysis. Programs may be
justified on efficiency grounds where they address market failure, such as
public goods and externalities. They may also be justified where they improve
the efficiency of the Government's internal operations, such as cost-saving
- Explicit Assumptions. Analyses should be explicit about the
underlying assumptions used to arrive at estimates of future benefits and
costs. In the case of public health programs, for example, it may be necessary
to make assumptions about the number of future beneficiaries, the intensity of
service, and the rate of increase in medical prices. The analysis should
include a statement of the assumptions, the rationale behind them, and a review
of their strengths and weaknesses. Key data and results, such as year-by-year
estimates of benefits and costs, should be reported to promote independent
analysis and review.
- Evaluation of Alternatives. Analyses should also consider
alternative means of achieving program objectives by examining different
program scales, different methods of provision, and different
degrees of government involvement. For example, in evaluating a decision
to acquire a capital asset, the analysis should generally consider: (i) doing
nothing; (ii) direct purchase; (iii) upgrading, renovating, sharing, or
converting existing government property; or (iv) leasing or contracting for
- Verification. Retrospective studies to determine whether
anticipated benefits and costs have been realized are potentially valuable.
Such studies can be used to determine necessary corrections in existing
programs, and to improve future estimates of benefits and costs in these
programs or related ones.
Agencies should have a plan for periodic, results-oriented
evaluation of program effectiveness. They should also discuss the results of
relevant evaluation studies when proposing reauthorizations or increased
6. Identifying and Measuring Benefits and
Costs. Analyses should include comprehensive estimates of the expected
benefits and costs to society based on established definitions and
practices for program and policy evaluation. Social net benefits, and not the
benefits and costs to the Federal Government, should be the basis for
evaluating government programs or policies that have effects on private
citizens or other levels of government. Social benefits and costs can differ
from private benefits and costs as measured in the marketplace because of
imperfections arising from: (i) external economies or diseconomies where
actions by one party impose benefits or costs on other groups that are not
compensated in the market place; (ii) monopoly power that distorts the
relationship between marginal costs and market prices; and (iii) taxes or
a. Identifying Benefits and Costs. Both intangible and tangible
benefits and costs should be recognized. The relevant cost concept is broader
than private-sector production and compliance costs or government cash
expenditures. Costs should reflect the opportunity cost of any resources used,
measured by the return to those resources in their most productive application
elsewhere. Below are some guidelines to consider when identifying benefits and
- Incremental Benefits and Costs. Calculation of net present
value should be based on incremental benefits and costs. Sunk costs and
realized benefits should be ignored. Past experience is relevant only in
helping to estimate what the value of future benefits and costs might be.
Analyses should take particular care to identify the extent to which a policy
such as a subsidy program promotes substitutes for activities of a similar
nature that would occur without the policy. Either displaced activities should
be explicitly recorded as costs or only incremental gains should be recorded as
benefits of the policy.
- Interactive Effects. Possible interactions between the
benefits and costs being analyzed and other government activities should be
considered. For example, policies affecting agricultural output should reflect
real economic values, as opposed to subsidized prices.
- International Effects. Analyses should focus on benefits and
costs accruing to the citizens of the United States in determining net present
value. Where programs or projects have effects outside the United States, these
effects should be reported separately.
- Transfers. There are no economic gains from a pure transfer
payment because the benefits to those who receive such a transfer are
matched by the costs borne by those who pay for it. Therefore, transfers should
be excluded from the calculation of net present value. Transfers that arise as
a result of the program or project being analyzed should be identified as such,
however, and their distributional effects discussed. It should also be
recognized that a transfer program may have benefits that are less than the
program's real economic costs due to inefficiencies that can arise in the
program's delivery of benefits and financing.
b. Measuring Benefits and Costs. The principle of
willingness-to-pay provides an aggregate measure of what individuals are
willing to forego to obtain a given benefit. Market prices provide an
invaluable starting point for measuring willingness-to-pay, but prices
sometimes do not adequately reflect the true value of a good to society.
Externalities, monopoly power, and taxes or subsidies can distort market
Taxes, for example, usually create an excess burden that
represents a net loss to society. (The appropriate method for recognizing this
excess burden in public investment analyses is discussed in Section 11.) In
other cases, market prices do not exist for a relevant benefit or cost. When
market prices are distorted or unavailable, other methods of valuing benefits
may have to be employed. Measures derived from actual market behavior are
preferred when they are available.
- Inframarginal Benefits and Costs. Consumers would generally be
willing to pay more than the market price rather than go entirely without a
good they consume. The economist's concept of consumer surplus measures
the extra value consumers derive from their consumption compared with the value
measured at market prices. When it can be determined, consumer surplus provides
the best measure of the total benefit to society from a government program or
project. Consumer surplus can sometimes be calculated by using econometric
methods to estimate consumer demand.
- Indirect Measures of Benefits and Costs. Willingness-to-pay
can sometimes be estimated indirectly through changes in land values,
variations in wage rates, or other methods. Such methods are most reliable when
they are based on actual market transactions. Measures should be consistent
with basic economic principles and should be replicable.
- Multiplier Effects. Generally, analyses should treat resources
as if they were likely to be fully employed. Employment or output multipliers
that purport to measure the secondary effects of government expenditures on
employment and output should not be included in measured social benefits or
7. Treatment of Inflation. Future
inflation is highly uncertain. Analysts should avoid having to make an
assumption about the general rate of inflation whenever possible.
a. Real or Nominal Values. Economic analyses are often most
readily accomplished using real or constant-dollar values, i.e.,
by measuring benefits and costs in units of stable purchasing power. (Such
estimates may reflect expected future changes in relative prices, however,
where there is a reasonable basis for estimating such changes.) Where future
benefits and costs are given in nominal terms, i.e., in terms of the
future purchasing power of the dollar, the analysis should use these values
rather than convert them to constant dollars as, for example, in the case of
Nominal and real values must not be combined in the same analysis.
Logical consistency requires that analysis be conducted either in constant
dollars or in terms of nominal values. This may require converting some nominal
values to real values, or vice versa.
b. Recommended Inflation Assumption. When a general inflation
assumption is needed, the rate of increase in the Gross Domestic Product
deflator from the Administration's economic assumptions for the period of the
analysis is recommended. For projects or programs that extend beyond the
six-year budget horizon, the inflation assumption can be extended by using the
inflation rate for the sixth year of the budget forecast. The Administration's
economic forecast is updated twice annually, at the time the budget is
published in January or February and at the time of the Mid-Session Review of
the Budget in July. Alternative inflation estimates, based on credible private
sector forecasts, may be used for sensitivity analysis.
8. Discount Rate Policy. In order to compute net present
value, it is necessary to discount future benefits and costs. This discounting
reflects the time value of money. Benefits and costs are worth more if they are
experienced sooner. All future benefits and costs, including nonmonetized
benefits and costs, should be discounted. The higher the discount rate, the
lower is the present value of future cash flows. For typical investments, with
costs concentrated in early periods and benefits following in later periods,
raising the discount rate tends to reduce the net present value. (Technical
guidance on discounting and a table of discount factors are provided in
a. Real versus Nominal Discount Rates. The proper discount rate
to use depends on whether the benefits and costs are measured in real or
- A real discount rate that has been adjusted to eliminate the effect
of expected inflation should be used to discount constant-dollar or real
benefits and costs. A real discount rate can be approximated by subtracting
expected inflation from a nominal interest rate.
- A nominal discount rate that reflects expected inflation should be
used to discount nominal benefits and costs. Market interest rates are nominal
interest rates in this sense.
b. Public Investment and Regulatory Analyses. The guidance in
this section applies to benefit-cost analyses of public investments and
regulatory programs that provide benefits and costs to the general public.
Guidance related to cost-effectiveness analysis of internal planning decisions
of the Federal Government is provided in Section 8.c.
In general, public investments and regulations displace both private
investment and consumption. To account for this displacement and to promote
efficient investment and regulatory policies, the following guidance should be
- Base-Case Analysis. Constant-dollar benefit-cost analyses of
proposed investments and regulations should report net present value and other
outcomes determined using a real discount rate of 7 percent. This rate
approximates the marginal pretax rate of return on an average investment in the
private sector in recent years. Significant changes in this rate will be
reflected in future updates of this Circular.
- Other Discount Rates. Analyses should show the sensitivity of
the discounted net present value and other outcomes to variations in the
discount rate. The importance of these alternative calculations will depend on
the specific economic characteristics of the program under analysis. For
example, in analyzing a regulatory proposal whose main cost is to reduce
business investment, net present value should also be calculated using a higher
discount rate than 7 percent.
Analyses may include among the reported outcomes the internal
rate of return implied by the stream of benefits and costs. The internal
rate of return is the discount rate that sets the net present value of the
program or project to zero. While the internal rate of return does not
generally provide an acceptable decision criterion, it does provide useful
information, particularly when budgets are constrained or there is uncertainty
about the appropriate discount rate.
- Using the shadow price of capital to value benefits and costs
is the analytically preferred means of capturing the effects of government
projects on resource allocation in the private sector. To use this method
accurately, the analyst must be able to compute how the benefits and costs of a
program or project affect the allocation of private consumption and investment.
OMB concurrence is required if this method is used in place of the base case
c. Cost-Effectiveness, Lease-Purchase, Internal Government
Investment, and Asset Sales Analyses. The Treasury's borrowing rates should
be used as discount rates in the following cases:
- Cost-Effectiveness Analysis. Analyses that involve
constant-dollar costs should use the real Treasury borrowing rate on marketable
securities of comparable maturity to the period of analysis. This rate is
computed using the Administration's economic assumptions for the budget, which
are published in January of each year. A table of discount rates based on the
expected interest rates for the first year of the budget forecast is presented
in Appendix C of this Circular. Appendix C is updated annually and is available
upon request from OMB. Real Treasury rates are obtained by removing expected
inflation over the period of analysis from nominal Treasury interest rates.
(Analyses that involve nominal costs should use nominal Treasury rates for
discounting, as described in the following paragraph.)
- Lease-Purchase Analysis. Analyses of nominal lease payments
should use the nominal Treasury borrowing rate on marketable securities of
comparable maturity to the period of analysis. Nominal Treasury borrowing rates
should be taken from the economic assumptions for the budget. A table of
discount rates based on these assumptions is presented in Appendix C of this
Circular, which is updated annually. (Constant dollar lease-purchase analyses
should use the real Treasury borrowing rate, described in the preceding
- Internal Government Investments. Some Federal investments
provide "internal" benefits which take the form of increased Federal revenues
or decreased Federal costs. An example would be an investment in an
energy-efficient building system that reduces Federal operating costs. Unlike
the case of a Federally funded highway (which provides "external" benefits to
society as a whole), it is appropriate to calculate such a project's net
present value using a comparable-maturity Treasury rate as a discount rate. The
rate used may be either nominal or real, depending on how benefits and costs
Some Federal activities provide a mix of both Federal cost savings
and external social benefits. For example, Federal investments in information
technology can produce Federal savings in the form of lower administrative
costs and external social benefits in the form of faster claims processing. The
net present value of such investments should be evaluated with the 7 percent
real discount rate discussed in Section 8.b. unless the analysis is able to
allocate the investment's costs between provision of Federal cost savings and
external social benefits. Where such an allocation is possible, Federal cost
savings and their associated investment costs may be discounted at the Treasury
rate, while the external social benefits and their associated investment costs
should be discounted at the 7 percent real rate.
- Asset Sale Analysis. Analysis of possible asset sales should
reflect the following:
- (a) The net present value to the Federal Government of holding an
asset is best measured by discounting its future earnings stream using a
Treasury rate. The rate used may be either nominal or real, depending on how
earnings are measured.
(b) Analyses of government asset values should explicitly deduct
the cost of expected defaults or delays in payment from projected cash flows,
along with government administrative costs. Such analyses should also consider
explicitly the probabilities of events that would cause the asset to become
nonfunctional, impaired or obsolete, as well as probabilities of events that
would increase asset value.
(c) Analyses of possible asset sales should assess the gain in
social efficiency that can result when a government asset is subject to market
discipline and private incentives. Even though a government asset may be used
more efficiently in the private sector, potential private-sector purchasers
will generally discount such an asset's earnings at a rate in excess of the
Treasury rate, in part, due to the cost of bearing risk. When there is evidence
that government assets can be used more efficiently in the private sector,
valuation analyses for these assets should include sensitivity comparisons that
discount the returns from such assets with the rate of interest earned by
assets of similar riskiness in the private sector.
9. Treatment of Uncertainty. Estimates of
benefits and costs are typically uncertain because of imprecision in both
underlying data and modeling assumptions. Because such uncertainty is basic to
many analyses, its effects should be analyzed and reported. Useful information
in such a report would include the key sources of uncertainty; expected value
estimates of outcomes; the sensitivity of results to important sources of
uncertainty; and where possible, the probability distributions of benefits,
costs, and net benefits.
a. Characterizing Uncertainty. Analyses should attempt to
characterize the sources and nature of uncertainty. Ideally, probability
distributions of potential benefits, costs, and net benefits should be
presented. It should be recognized that many phenomena that are treated as
deterministic or certain are, in fact, uncertain. In analyzing uncertain data,
objective estimates of probabilities should be used whenever possible. Market
data, such as private insurance payments or interest rate differentials, may be
useful in identifying and estimating relevant risks. Stochastic simulation
methods can be useful for analyzing such phenomena and developing insights into
the relevant probability distributions. In any case, the basis for the
probability distribution assumptions should be reported. Any limitations of the
analysis because of uncertainty or biases surrounding data or assumptions
should be discussed.
b. Expected Values. The expected values of the distributions of
benefits, costs and net benefits can be obtained by weighting each outcome by
its probability of occurrence, and then summing across all potential outcomes.
If estimated benefits, costs and net benefits are characterized by point
estimates rather than as probability distributions, the expected value (an
unbiased estimate) is the appropriate estimate for use.
Estimates that differ from expected values (such as worst-case
estimates) may be provided in addition to expected values, but the rationale
for such estimates must be clearly presented. For any such estimate, the
analysis should identify the nature and magnitude of any bias. For example,
studies of past activities have documented tendencies for cost growth beyond
initial expectations; analyses should consider whether past experience suggests
that initial estimates of benefits or costs are optimistic.
c. Sensitivity Analysis. Major assumptions should be varied and
net present value and other outcomes recomputed to determine how sensitive
outcomes are to changes in the assumptions. The assumptions that deserve the
most attention will depend on the dominant benefit and cost elements and the
areas of greatest uncertainty of the program being analyzed. For example, in
analyzing a retirement program, one would consider changes in the number of
beneficiaries, future wage growth, inflation, and the discount rate. In
general, sensitivity analysis should be considered for estimates of: (i)
benefits and costs; (ii) the discount rate; (iii) the general inflation rate;
and (iv) distributional assumptions. Models used in the analysis should be well
documented and, where possible, available to facilitate independent review.
d. Other Adjustments for Uncertainty. The absolute variability of
a risky outcome can be much less significant than its correlation with other
significant determinants of social welfare, such as real national income. In
general, variations in the discount rate are not the appropriate method of
adjusting net present value for the special risks of particular projects. In
some cases, it may be possible to estimate certainty-equivalents which
involve adjusting uncertain expected values to account for risk.
10. Incidence and Distributional Effects. The principle
of maximizing net present value of benefits is based on the premise that
gainers could fully compensate the losers and still be better off. The presence
or absence of such compensation should be indicated in the analysis. When
benefits and costs have significant distributional effects, these effects
should be analyzed and discussed, along with the analysis of net present value.
(This will not usually be the case for cost-effectiveness analysis where the
scope of government activity is not changing.)
a. Alternative Classification. Distributional effects may be
analyzed by grouping individuals or households according to income class (e.g.,
income quintiles), geographical region, or demographic group (e.g., age). Other
classifications, such as by industry or occupation, may be appropriate in some
Analysis should aim at identifying the relevant gainers and losers from
policy decisions. Effects on the preexisting assignment of property rights by
the program under analysis should be reported. Where a policy is intended to
benefit a specified subgroup of the population, such as the poor, the analysis
should consider how effective the policy is in reaching its targeted group.
b. Economic Incidence. Individuals or households are the ultimate
recipients of income; business enterprises are merely intermediaries. Analyses
of distribution should identify economic incidence, or how costs and benefits
are ultimately borne by households or individuals.
Determining economic incidence can be difficult because benefits and
costs are often redistributed in unintended and unexpected ways. For example, a
subsidy for the production of a commodity will usually raise the incomes of the
commodity's suppliers, but it can also benefit consumers of the commodity
through lower prices and reduce the incomes for suppliers of competing
products. A subsidy also raises the value of specialized resources used in the
production of the subsidized commodity. As the subsidy is incorporated in asset
values, its distributional effects can change.
Special Guidance for Public Investment. This guidance applies only to
public investments with social benefits apart from decreased Federal costs. It
is not required for cost-effectiveness or lease-purchase analyses. Because
taxes generally distort relative prices, they impose a burden in excess of the
revenues they raise. Recent studies of the U.S. tax system suggest a range of
values for the marginal excess burden, of which a reasonable estimate is 25
cents per dollar of revenue.
a. Analysis of Excess Burdens. The presentation of results for
public investments that are not justified on cost-saving grounds should include
a supplementary analysis with a 25 percent excess burden. Thus, in such
analyses, costs in the form of public expenditures should be multiplied by a
factor of 1.25 and net present value recomputed.
b. Exceptions. Where specific information clearly suggests that
the excess burden is lower (or higher) than 25 percent, analyses may use a
different figure. When a different figure is used, an explanation should be
provided for it. An example of such an exception is an investment funded by
user charges that function like market prices; in this case, the excess burden
would be zero. Another example would be a project that provides both cost
savings to the Federal Government and external social benefits. If it is
possible to make a quantitative determination of the portion of this project's
costs that give rise to Federal savings, that portion of the costs may be
exempted from multiplication by the factor of 1.25.
12. Special Guidance for Regulatory Impact Analysis.
Additional guidance for analysis of regulatory policies is provided in
Regulatory Program of the United States Government which is published
annually by OMB. (See "Regulatory Impact Analysis Guidance," Appendix V of
Regulatory Program of the United States Government for April 1, 1991 to
March 31, 1992.)
13. Special Guidance for Lease-Purchase
Analysis. The special guidance in this section does not apply to the
decision to acquire the use of an asset. In deciding that, the agency should
conduct a benefit-cost analysis, if possible. Only after the decision to
acquire the services of an asset has been made is there a need to analyze the
decision whether to lease or purchase.
a. Coverage. The Circular applies only when both of the following
tests of applicability are satisfied:
- The lease-purchase analysis concerns a capital asset, (including
durable goods, equipment, buildings, facilities, installations, or land) which:
- (a) Is leased to the Federal Government for a term of three or
more years; or,
(b) Is new, with an economic life of less than three years, and
leased to the Federal Government for a term of 75 percent or more of the
economic life of the asset; or,
(c) Is built for the express purpose of being leased to the
Federal Government; or,
(d) Is leased to the Federal Government and clearly has no
alternative commercial use (e.g., a special-purpose government
- The lease-purchase analysis concerns a capital asset or a group of
related assets whose total fair market value exceeds $1 million.
b. Required Justification for Leases. All leases of capital
assets must be justified as preferable to direct government purchase and
ownership. This can be done in one of three ways:
- By conducting a separate lease-purchase analysis. This is the only
acceptable method for major acquisitions. A lease represents a major
- By conducting periodic lease-purchase analyses of recurrent decisions
to lease similar assets used for the same general purpose. Such analyses would
apply to the entire class of assets. OMB approval should be sought in
determining the scope of any such generic analysis.
- By adopting a formal policy for smaller leases and submitting that
policy to the OMB for approval. Following such a policy should generally result
in the same lease-purchase decisions as would conducting separate
lease-purchase analyses. Before adopting the policy, it should be demonstrated
- (a) The leases in question would generally result in substantial
savings to the Government that could not be realized on a purchase;
(b) The leases are so small or so short-term as to make separate
lease-purchase analysis impractical; and
(c) Leases of different types are scored consistently with the
instructions in Appendices B and C of OMB Circular No. A-11.
c. Analytical Requirements and Definitions. Whenever a Federal
agency needs to acquire the use of a capital asset, it should do so in the way
that is least expensive for the Government as a whole.
- Life-Cycle Cost. Lease-purchase analyses should compare the
net discounted present value of the life-cycle cost of leasing with the full
costs of buying or constructing an identical asset. The full costs of buying
include the asset's purchase price plus the net discounted present value of any
relevant ancillary services connected with the purchase. (Guidance on the
discount rate to use for lease-purchase analysis is in Section 8.c.)
- Economic Life. For purposes of lease-purchase analysis, the
economic life of an asset is its remaining or productive lifetime. It begins
when the asset is acquired and ends when the asset is retired from service. The
economic life is frequently not the same as the useful life for tax purposes.
- Purchase Price. The purchase price of the asset for purposes
of lease-purchase analysis is its fair market value, defined as the price a
willing buyer could reasonably expect to pay a willing seller in a competitive
market to acquire the asset.
- (a) In the case of property that is already owned by the Federal
Government or that has been donated or acquired by condemnation, an imputed
purchase price should be estimated. (Guidance on making imputations is provided
in Section 13.c.(6).)
(b) If public land is used for the site of the asset, the
imputed market value of the land should be added to the purchase price.
(c) The asset's estimated residual value, as of the end of the
period of analysis, should be subtracted from its purchase price. (Guidance on
estimating residual value is provided in Section 13.c.(7).)
- Taxes. In analyzing the cost of a lease, the normal payment of
taxes on the lessor's income from the lease should not be subtracted from the
lease costs since the normal payment of taxes will also be reflected in the
purchase cost. The cost to the Treasury of special tax benefits, if any,
associated with the lease should be added to the cost of the lease. Examples of
such tax benefits might include highly accelerated depreciation allowances or
- Ancillary Services. If the terms of the lease include
ancillary services provided by the lessor, the present value of the cost of
obtaining these services separately should be added to the purchase price. Such
costs may be excluded if they are estimated to be the same for both lease and
purchase alternatives or too small to affect the comparison. Examples of
ancillary services include:
- (a) All costs associated with acquiring the property and
preparing it for use, including construction, installation, site, design, and
(b) Repair and improvement costs (if included in lease
(c) Operation and maintenance costs (if included in lease
(d) Imputed property taxes (excluding foreign property taxes on
overseas acquisitions except where actually paid). The imputed taxes
approximate the costs of providing municipal services such as water, sewage,
and police and fire protection. (See Section (6) below.)
(e) Imputed insurance premiums. (See Section (6) below.)
- Estimating Imputed Costs. Certain costs associated with the
Federal purchase of an asset may not involve a direct monetary payment. Some of
these imputed costs may be estimated as follows.
- (a) Purchase Price. An imputed purchase price for an asset
that is already owned by the Federal Government or which has been acquired by
donation or condemnation should be based on the fair market value of similar
properties that have been traded on commercial markets in the same or similar
localities. The same method should be followed in estimating the imputed value
of any Federal land used as a site for the asset.
(b) Property Taxes. Imputed property taxes may be
estimated in two ways.
- (i) Determine the property tax rate and assessed (taxable)
value for comparable property in the intended locality. If there is no basis on
which to estimate future changes in tax rates or assessed values, the first-
year tax rate and assessed value (inflation adjusted for each subsequent year)
can be applied to all years. Multiply the assessed value by the tax rate to
determine the annual imputation for property taxes.
(ii) As an alternative to step (i) above, obtain an estimate
of the current local effective property tax rate from the Building Owners and
Managers Association's Regional Exchange Reports. Multiply the fair market
value of the government-owned property (inflation adjusted for each year) by
the effective tax rate.
(c) Insurance Premiums. Determine local estimates of
standard commercial coverage for similar property from the Building Owners and
Managers Association's Regional Exchange Reports.
- Residual Value. A property's residual value is an estimate of
the price that the property could be sold for at the end of the period of the
lease-purchase analysis, measured in discounted present value terms.
- (a) The recommended way to estimate residual value is to
determine what similar, comparably aged property is currently selling for in
(b) Alternatively, book estimates of the resale value of used
property may be available from industry or government sources.
(c) Assessed values of similar, comparably aged properties
determined for property tax purposes may also be used.
- Renewal Options. In determining the term of a lease, all
renewal options shall be added to the initial lease period.
14. Related Guidance. a. OMB Circular
No. A-11,"Preparation and Submission of Annual Budget Estimates."
Circular No. A-19,"Legislative Coordination and Clearance."
c. OMB Circular
No. A-70,"Federal Credit Policy."
d. OMB Circular No. A-76,"Performance of
e. OMB Circular No. A-109,"Policies to Be Followed
in the Acquisition of Major Systems."
f. OMB Circular No. A-130,"Management
of Federal Information Resources."
g. "Joint OMB and Treasury Guidelines to
the Department of Defense Covering Lease or Charter Arrangements for Aircraft
and Naval Vessels."
h. Executive Order 12291, "Federal Regulation."
"Regulatory Impact Analysis Guidance," in Regulatory Program of the United
j. "Federal Energy Management and Planning Programs;
Life Cycle Cost Methodology and Procedures," Federal Register, Vol. 55,
No. 17, January 25, 1990, and Vol. 55, No. 224, November 20, 1990.
Presidential Memorandum of April 29, 1992, "Benefits and Costs of Legislative
15. Implementation. Economic analyses
submitted to OMB will be reviewed for conformity with Items 5 to 13 in this
Circular, through the Circular No. A-11 budget justification and submission
process, and Circular No. A-19,legislative review process.
16. Effective Date. This Circular is effective
17. Interpretation. Questions
concerning interpretation of this Circular should be addressed to the Office of
Economic Policy, Office of Management and Budget (202-395-5873) or, in the case
of regulatory issues and analysis, to the Office of Information and Regulatory
DEFINITION OF TERMSBenefit-Cost Analysis -- A
systematic quantitative method of assessing the desirability of government
projects or policies when it is important to take a long view of future effects
and a broad view of possible side-effects.
Capital Asset -- Tangible property, including durable goods,
equipment, buildings, installations, and land.
Certainty-Equivalent -- A certain (i.e., nonrandom) outcome that
an individual values equally to an uncertain outcome. For a risk-averse
individual, the certainty-equivalent for an uncertain set of benefits may be
less than the mathematical expectation of the outcome; for example, an
individual may value a 50-50 chance of winning $100 or $0 as only $45.
Analogously, a risk-averse individual may have a certainty-equivalent for an
uncertain set of costs that is larger in magnitude than the mathematical
expectation of costs.
Cost-Effectiveness -- A systematic quantitative method for
comparing the costs of alternative means of achieving the same stream of
benefits or a given objective.
Consumer Surplus -- The maximum sum of money a consumer would be
willing to pay to consume a given amount of a good, less the amount actually
paid. It is represented graphically by the area between the demand curve and
the price line in a diagram representing the consumer's demand for the good as
a function of its price.
Discount Rate -- The interest rate used in calculating the
present value of expected yearly benefits and costs.
Discount Factor -- The factor that translates expected benefits
or costs in any given future year into present value terms. The discount factor
is equal to 1/(1 + i)t where i is the interest rate and
t is the number of years from the date of initiation for the program or
policy until the given future year.
Excess Burden -- Unless a tax is imposed in the form of a lump
sum unrelated to economic activity, such as a head tax, it will affect economic
decisions on the margin. Departures from economic efficiency resulting from the
distorting effect of taxes are called excess burdens because they disadvantage
society without adding to Treasury receipts. This concept is also sometimes
referred to as deadweight loss.
External Economy or Diseconomy -- A direct effect, either
positive or negative, on someone's profit or welfare arising as a byproduct of
some other person's or firm's activity. Also referred to as neighborhood or
spillover effects, or externalities for short.
Incidence -- The ultimate distributional effect of a tax,
expenditure, or regulatory program.
Inflation -- The proportionate rate of change in the general
price level, as opposed to the proportionate increase in a specific price.
Inflation is usually measured by a broad-based price index, such as the
implicit deflator for Gross Domestic Product or the Consumer Price Index.
Internal Rate of Return -- The discount rate that sets the net
present value of the stream of net benefits equal to zero. The internal rate of
return may have multiple values when the stream of net benefits alternates from
negative to positive more than once.
Life Cycle Cost -- The overall estimated cost for a particular
program alternative over the time period corresponding to the life of the
program, including direct and indirect initial costs plus any periodic or
continuing costs of operation and maintenance.
Multiplier -- The ratio between the direct effect on output or
employment and the full effect, including the effects of second order rounds or
spending. Multiplier effects greater than 1.0 require the existence of
Net Present Value -- The difference between the discounted
present value of benefits and the discounted present value of costs.
Nominal Values -- Economic units measured in terms of purchasing
power of the date in question. A nominal value reflects the effects of general
Nominal Interest Rate -- An interest rate that is not adjusted to
remove the effects of actual or expected inflation. Market interest rates are
generally nominal interest rates.
Opportunity Cost -- The maximum worth of a good or input among
possible alternative uses.
Real or Constant Dollar Values -- Economic units measured in
terms of constant purchasing power. A real value is not affected by general
price inflation. Real values can be estimated by deflating nominal values with
a general price index, such as the implicit deflator for Gross Domestic Product
or the Consumer Price Index.
Real Interest Rate -- An interest rate that has been adjusted to
remove the effect of expected or actual inflation. Real interest rates can be
approximated by subtracting the expected or actual inflation rate from a
nominal interest rate. (A precise estimate can be obtained by dividing one plus
the nominal interest rate by one plus the expected or actual inflation rate,
and subtracting one from the resulting quotient.)
Relative Price -- A price ratio between two goods as, for
example, the ratio of the price of energy to the price of equipment.
Shadow Price -- An estimate of what the price of a good or input
would be in the absence of market distortions, such as externalities or taxes.
For example, the shadow price of capital is the present value of the social
returns to capital (before corporate income taxes) measured in units of
Sunk Cost -- A cost incurred in the past that will not be
affected by any present or future decision. Sunk costs should be ignored in
determining whether a new investment is worthwhile.
Transfer Payment -- A payment of money or goods. A pure transfer
is unrelated to the provision of any goods or services in exchange. Such
payments alter the distribution of income, but do not directly affect the
allocation of resources on the margin.
Treasury Rates -- Rates of interest on marketable Treasury debt.
Such debt is issued in maturities ranging from 91 days to 30 years.
Willingness to Pay -- The maximum amount an individual would be
willing to give up in order to secure a change in the provision of a good or
ADDITIONAL GUIDANCE FOR DISCOUNTING1. Sample Format
for Discounting Deferred Costs and Benefits
Assume a 10-year program which will commit the Government to the stream
of real (or constant-dollar) expenditures appearing in column (2) of the table
below and which will result in a series of real benefits appearing in column
(3). The discount factor for a 7 percent discount rate is shown in column (4).
The present value cost for each of the 10 years is calculated by multiplying
column (2) by column (4); the present value benefit for each of the 10 years is
calculated by multiplying column (3) by column (4). The present values of costs
and benefits are presented in columns (5) and (6) respectively.
|Year since initiation renewal or expansion
|Expected yearly cost
|Expected yearly benefit
|Discount factors for 7%
|Present value of costs Col. 2 x
|Present value of benefits Col. 3 x
NOTE: The discount factor is calculated as 1/(1 +
i)t where i is the interest rate (.07) and
t is the year.
The sum of column (5) is the total present value of costs and the sum of
column (6) is the total present value of benefits. Net present value is $36.01,
the difference between the sum of discounted benefits and the sum of discounted
2. End-of-Year and Mid-Year Discount Factors
The discount factors presented in the table above are calculated on the
implicit assumption that costs and benefits occur as lump sums at year-end.
When costs and benefits occur in a steady stream, applying mid-year discount
factors is more appropriate. For instance, the first cost in the table may be
estimated to occur after six months, rather than at the end of one year to
approximate better a steady stream of costs and benefits occurring over the
first year. Similarly, it may be assumed that all other costs and benefits are
advanced six months to approximate better a continuing steady flow.
The present values of costs and benefits computed from the table above
can be converted to a mid-year discounting basis by multiplying them by 1.0344
(the square root of 1.07). Thus, if the above example were converted to a
mid-year basis, the present value of costs would be $110.06, the present value
of benefits would be $147.31, and the net present value would be $37.25.
3. Illustrative Discount Factors for Discount Rate of 7 percent
Initiation, Renewal or Expansion
OMB Circular No. A-94
(Revised January 2000)
DISCOUNT RATES FOR COST-EFFECTIVENESS, LEASE PURCHASE,
Effective Dates. This appendix is updated annually around the
time of the President's budget submission to Congress. This version of the
appendix is valid through the end of January 2001. Copies of the updated
appendix and the Circular can be obtained in an electronic form through the OMB
home page, http://www.whitehouse.gov/OMB/circulars/index.html. Updates of this
appendix are also available upon request from OMB's Office of Economic Policy
(202-395-3381), as is a table of past years' rates.
Nominal Discount Rates. Nominal interest rates based on the
economic assumptions from the budget are presented below. These nominal rates
are to be used for discounting nominal flows, which are often encountered in
Nominal Interest Rates on Treasury Notes and Bonds
Maturities (in percent)
Real Discount Rates. Real interest rates based on the
economic assumptions from the budget are presented below. These real rates are
to be used for discounting real (constant-dollar) flows, as is often required
in cost-effectiveness analysis.
Real Interest Rates on Treasury Notes and Bonds
Maturities (in percent)
Analyses of programs with terms different from those presented
above may use a linear interpolation. For example, a four-year project can be
evaluated with a rate equal to the average of the three-year and five-year
rates. Programs with durations longer than 30 years may use the 30-year
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