Circular No. A-94
(Transmittal Memo No. 64)
October 29, 1992
HEADS OF EXECUTIVE DEPARTMENTS AND ESTABLISHMENTS
and Discount Rates for Benefit-Cost Analysis of Federal Programs
Table of Contents
- Net Present
Value and Related Outcome Measures
- Elements of
Benefit-Cost or Cost-Effectiveness Analysis
and Measuring Benefits and Costs
Benefits and Costs
Benefits and Costs
- Real or Nominal
- Real versus
Nominal Discount Rates
- Public Investment
and Regulatory Analyses
Lease-Purchase,Internal Government Investment, and Asset Sale Analyses
- Expected Values
- Other Adjustments
and Distributional Effects
- Economic Incidence
Guidance for Public Investment Analysis
- Analysis of
Guidance for Regulatory Impact Analysis
Guidance for Lease-Purchase Analysis
- Required Justification
- Analytical Requirements
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 cost-effectiveness analyses.
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which has been rescinded.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
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.
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 policies.
- Regulatory impact
- Analysis of decisions
whether to lease or purchase.
- Asset valuation
and sale analysis.
b. Specifically exempted
from the scope of this Circular are decisions concerning:
- Water resource
projects (guidance for which is the approved Economic and Environmental
Principles and Guidelines for Water and Related Land Resources Implementation
- 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
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 program effects.
benefits and costs is worthwhile, even when it is not feasible to assign
monetary values; physical measurements may be possible
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 return.
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.
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.
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 subsidies.
- 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 investments.
- 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.
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 services.
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.
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 program funding.
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
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.
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.
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.
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 prices.
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
of Inflation. Future inflation is highly uncertain. Analysts should
avoid having to make an assumption about the general rate of inflation whenever
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.
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 costs.
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 lease-purchase analysis.
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.
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 Appendix B.)
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 observed.
- 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.
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 discount rate.
Lease-Purchase, Internal Government Investment, and Asset Sales Analyses.
The Treasury's borrowing rates should be used as discount rates in the
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.
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
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
- 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 are
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
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.
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.
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
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.
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.
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.)
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 circumstances.
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.
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.
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.
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,
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
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;
(d) Is leased
to the Federal Government and clearly has no alternative commercial
use (e.g., a special-purpose government installation).
- 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
- By conducting
a separate lease-purchase analysis. This is the only acceptable method
for major acquisitions. A lease represents a major acquisition if:
(a) The acquisition
represents a separate line-item in the agency's budget;
(b) The agency
or OMB determines the acquisition is a major one; or
(c) The total
purchase price of the asset or group of assets to be leased would
exceed $500 million.
- 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 that:
(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
(c) Leases of
different types are scored consistently with the instructions in Appendices
B and C of OMB Circular No. A-11.
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.
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).)
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 tax-free financing.
- 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
(a) All costs
associated with acquiring the property and preparing it for use, including
construction, installation, site, design, and management costs.
(b) Repair and
improvement costs (if included in lease payments).
and maintenance costs (if included in lease payments).
(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.)
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.
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.
Taxes. Imputed property taxes may be estimated in two ways.
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.
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 commercial markets.
book estimates of the resale value of used property may be available
from industry or government sources.
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.
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
- OMB Circular No.
A-11,"Preparation and Submission of Annual Budget Estimates."
- OMB Circular No.
A-19,"Legislative Coordination and Clearance."
- OMB Circular No.
A-70,"Federal Credit Policy."
- OMB Circular No.
A-76,"Performance of Commercial Activities."
- OMB Circular No.
A-109,"Policies to Be Followed in the Acquisition of Major Systems."
- OMB Circular No.
A-130,"Management of Federal Information Resources."
- "Joint OMB and
Treasury Guidelines to the Department of Defense Covering Lease or Charter
Arrangements for Aircraft and Naval Vessels."
- Executive Order
12291, "Federal Regulation."
- "Regulatory Impact
Analysis Guidance," in Regulatory Program of the United States Government.
- "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,
- Presidential Memorandum
of April 29, 1992, "Benefits and Costs of Legislative Proposals."
Effective Date. This Circular is effective immediately.
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 Affairs (202-395-4852).
-- 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.
Asset -- Tangible property, including durable goods, equipment, buildings,
installations, and land.
-- 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.
-- A systematic quantitative method for comparing the costs of alternative
means of achieving the same stream of benefits or a given objective.
-- 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.
-- The interest rate used in calculating the present value of expected
yearly benefits and costs.
-- 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.
-- 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.
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.
-- The ultimate distributional effect of a tax, expenditure, or regulatory
-- 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.
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
-- 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 involuntary
Net Present Value
-- The difference between the discounted present value of benefits and
the discounted present value of costs.
-- Economic units measured in terms of purchasing power of the date in
question. A nominal value reflects the effects of general price inflation.
Rate -- An interest rate that is not adjusted to remove the effects
of actual or expected inflation. Market interest rates are generally nominal
-- 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
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.)
-- A price ratio between two goods as, for example, the ratio of the price
of energy to the price of equipment.
-- 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 consumption.
-- 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.
-- 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
-- Rates of interest on marketable Treasury debt. Such debt is issued
in maturities ranging from 91 days to 30 years.
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 service.
1. Sample Format
for Discounting Deferred Costs and Benefits
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.
since initiation renewal or expansion
factors for 7%
value of costs Col. 2 x Col. 4
value of benefits Col. 3 x Col. 4
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 costs.
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
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.
Discount Factors for Discount Rate of 7 percent
since Initiation, Renewal or Expansion
Discount Rates for Cost-Effectiveness, Lease-Purchase,
and Related Analyses for OMB Circular No. A-94