Mathematical Constraints on Financially Viable Public Policy

TL;DR

This paper derives mathematical constraints to design robust public policies like Social Security that remain financially stable despite forecasting errors, and provides methods to construct such policies.

Contribution

It introduces a framework for creating financially robust public policies that maintain zero balance under forecasting uncertainties.

Findings

Robust policies can be mathematically characterized.

Most existing policies are not robust to forecast errors.

The paper offers a method to extend non-robust policies to be robust.

Abstract

Social Security and other public policies can be viewed as a series of cash in and outflows that depend on parameters such as the age distribution of the population and the retirement age. Given forecasts of these parameters, policies can be designed to be financially stable, i.e., to terminate with a zero balance. If reality deviates from the forecasts, policies normally terminate with a surplus or a deficit. We derive constraints on the cash flows of robust policies that terminate with zero balance even in the presence of forecasting errors. Social Security and most similar policies are not robust. We show that non-trivial robust policies exist and provide a recipe for constructing robust extensions of non-robust policies. An example illustrates our results.