The DOE’s proposal establishes energy efficiency standards for 10 separate product classes of furnace fans. It would save a total of 4.58 “quads” of energy (4.58 quadrillion BTUs) over the first 30 years of implementation (2019–2048), according to the government analysis. The primary benefit of that energy conservation is the savings in energy expenditures by residential consumers, which comprise about 73 percent of the rule’s total benefits. In exchange for reduced long-term energy expenditures, the rule would cause the price of furnace fans to increase by between $67 and $183 per unit, a price increase of 31–54 percent.
Discounting consumer savings / To determine whether the long-term benefits of energy savings outweigh consumers’ higher upfront equipment costs, the value of future savings must be discounted so that it can be compared with current costs. In its guidance to federal agencies on how to conduct regulatory analysis, the Office of Management and Budget explains:
Benefits and costs do not always take place in the same time period. When they do not, it is incorrect simply to add all of the expected net benefits or costs without taking account of when [they] actually occur. If benefits or costs are delayed or otherwise separated in time from each other, the difference in timing should be reflected in your analysis.
Because consumers will receive the benefit of reduced energy bills over the entire 22.6‑year expected lifetime of their furnace fans, the DOE must discount those benefits to make them comparable with the upfront costs resulting from the standards. Benefits expected in the future are diminished in this calculation because people generally prefer present consumption to future consumption; that is, they have positive time preference.
A lower discount rate implies that present consumption is valued relatively low compared to future consumption, whereas a higher discount rate implies future consumption has less value relative to present consumption. The appropriate rate by which to discount future benefits, however, is not certain. Assuming a discount rate that is too high or too low would effectively misallocate consumption over time. The benefits of the DOE’s proposed rule vary dramatically depending on the discount rate used to compare them to costs. Thus the economic justifiability of the proposal depends crucially on the discount rate.
OMB guidelines / Pursuant to OMB guidelines, the DOE discounts at 3 percent and 7 percent to calculate the present value of its energy efficiency benefits, with 3 percent used for the primary benefit estimate. Using the two different rates, the DOE estimates the annualized benefits of this rule would be between $1.45 billion and $2.17 billion, respectively—a range of $720 million. Clearly, the discount rate used in the assessment is important to the rule’s economic justification.
However, consumers’ actual discount rates are not homogenous, either across the population or across purchase types. There is greater variation in estimated benefits when we utilize actual consumer discount rates that are derived from field studies.
Conveniently, many studies of implicit consumer discount rates use the purchase of energy-using durables (such as air conditioners, dishwashers, and refrigerators) to measure consumer time preferences. These appliances have upfront costs that potentially can be offset by long-term energy savings, and there often are many available options with varying costs and levels of energy efficiency for consumers to choose. As noted in a 1979 Bell Journal of Economics paper by Jerry Hausman on how consumers discount home appliance purchases, home heating and cooling systems “provide important examples where tradeoffs between capital costs and operating costs are substantial,” making implicit discount rates more easily accessible. Because furnace fans are energy-using durables that provide consumers with “tradeoffs between capital costs and operating costs,” research on other energy-using home appliances is applicable to the DOE’s furnace fan rule.
Importantly, this examination shows that implicit discount rates are not stable, either over time or between purchase types. The variance is often so wide that the DOE’s use (and the OMB’s recommendation) of 3 and 7 percent rates seems inadequate to measure actual consumer benefits from energy efficiency standards.
Actual discount rates for consumer appliances also vary quite a bit by income. In his paper on individual discount rates in the purchase of energy-using durables, Hausman noted that individuals’ implicit discount rates ranged from 5.1 percent to 89 percent for air conditioner purchases, depending on household income. Existing field studies show that median-income consumers use discount rates of about 27 percent, with low-income consumers using discount rates of 39 percent when making those purchases. Other studies put discount rates for such appliances at as high as 102 percent. Households with higher incomes can afford to bear lower discount rates because they have more certain future streams of income; low-income households, on the other hand, do not benefit from the same certainty. This disparity means that “a result of [energy efficiency] standards is to place an implicit tax on those individuals who are thought to have the highest discount rates: the less well off. Thus efficiency standards can have an adverse income distribution effect.”
The only individuals with actual discount rates that were approximate to the rates used by the DOE were in households with incomes higher than $160,000 (in 2012 dollars), which were the highest-income households included in Hausman’s analysis. This implies that only high-income households are adequately represented by the DOE’s use of a 3 percent discount rate. Given Hausman’s findings (again, adjusted for inflation), even median-income U.S. households have significantly higher discount rates of 27 percent for the purchase of energy-using durables such as furnace fans.
In light of this information, let’s reconsider the DOE’s cost-benefit analysis using five different discount rates: the DOE’s 3 percent and 7 percent, and field studies–recommended rates of 27 percent, 39 percent, and 102 percent. Table 1 presents the net present value for the first 15 years of the DOE proposal’s implementation. All values are discounted to the first year of implementation and are measured in constant 2012 dollars. The four product classes used in the table were chosen because they are the most widely used residential furnace fans, comprising over 80 percent of projected furnace fan shipments through 2045.
Importantly, because of higher discount rates, median-income, low-income, and senior-only households are more likely to bear net costs as a result of this rule, while high-income households are more likely to benefit. In this way, implementation of the proposed standard may act as a transfer payment from lower-income households to higher-income households. The DOE also notes that “the increased total installed cost of more efficient products causes some customers to forego (sic) product purchases,” indicating that the higher-priced furnace fans resulting from this rule will be out of reach for some consumers. Those distributive impacts necessitate close scrutiny to determine whether the proposed standards will actually improve social welfare.
