Is Social Security a Ponzi Scheme?

by on September 10, 2011 at 12:47 pm in Economics | Permalink

Matt Yglesias says anyone who thinks social security is a Ponzi scheme is nuts. So let’s take a look at some of these nuts. First up is Nobel prize winner Paul Samuelson who wrote:

Social Security is a Ponzi Scheme that Works

The beauty of social insurance is that it is actuarially unsound. Everyone who reaches retirement age is given benefit privileges that far exceed anything he has paid in — exceed his payments by more than ten times (or five times counting employer payments)!

How is it possible? It stems from the fact that the national product is growing at a compound interest rate and can be expected to do so for as far ahead as the eye cannot see. Always there are more youths than old folks in a growing population. More important, with real income going up at 3% per year, the taxable base on which benefits rest is always much greater than the taxes paid historically by the generation now retired.

…A growing nation is the greatest Ponzi game ever contrived.

Samuelson wrote that in 1967 riffing off his classic paper of 1958. By “as far as the eye cannot see” he apparently meant not very far because it soon became clear that the system could not count on waves of youths or rapid productivity growth to generate the actuarially unsound returns that made the program so popular in the early years.

Milton Friedman and Paul Samuelson rarely agreed on much but Friedman also called social security a Ponzi scheme. In fact, he called it The Biggest Ponzi Scheme on Earth but perhaps Yglesias puts Friedman in the nut category so let’s go for a third Nobel prize winner who recognizes the Ponzi like nature of social security, none other than…..Paul Krugman (writing in 1996):

Social Security is structured from the point of view of the recipients as if it were an ordinary retirement plan: what you get out depends on what you put in. So it does not look like a redistributionist scheme. In practice it has turned out to be strongly redistributionist, but only because of its Ponzi game aspect, in which each generation takes more out than it put in. Well, the Ponzi game will soon be over, thanks to changing demographics, so that the typical recipient henceforth will get only about as much as he or she put in (and today’s young may well get less than they put in). (ital added, AT)

Of these, I agree the most with Krugman. Social Security is not necessarily a Ponzi scheme but it only generated massive returns in the past because of its Ponzi-like aspects. The Ponzi-like aspects are now over and social security is turning into what is essentially a forced savings/welfare program with, as Krugman recognizes, crummy returns for average workers. Social security is thus a Ponzi scheme which has not gone bust but it has gone flat.

Tom September 11, 2011 at 7:55 pm

Brad DeLong has a good retort to this.

Yancey Ward September 11, 2011 at 8:02 pm

All you have to do is note what it would have taken for Madoff’s scheme to have not collapsed. All Madoff needed was the ability to force new “investors” to “invest”. Given the right to do that, his Ponzi also could continue indefinitely. Other than that right of coercion, there is no basic difference between Madoff and SS today- none. Now, what would it take to end SS? All that is needed is for that right to coercion to be given up. Nothing more, nothing less. It would collapse almost within the first month.

Also, ask yourself this- given the demographics, what would you choose to do if you were allowed to invest (not spend today, invest locked up until you reached the same retirement age) your own payroll taxes today? And, remember, this question is what would you do if everyone had this choice.

Robert September 12, 2011 at 1:32 am

Both parties want ME to get much less than I put in, even though I have been paying the MAX into the system since 1985.

They want to uncap the limit, and they want to means test the benefits. That means I, a frugal saver who may have some income when I retire (though with artificially lowbinterest rates that may not be possible) will get NOTHIING.

Meanwhile any woman who paid into the system for a month can go to the SSDI office and say ‘Boo Hoo I’m Depressed’ and collect disability for the rest of her life, while she pumps out kids and lives with her drug dealer boyfriend.

MP September 12, 2011 at 7:01 am

You’re all missing the obvious point that since Social Security isn’t being run by Charles Ponzi, it CAN’T be a Ponzi scheme.

Now maybe we can get past the semantics and think about the substantive issues. Is Social Security as currently structured sustainable? If not, is there a case for a universal, actuarially sound, public pension system?

I think the answer to the first is ‘clearly no’. I haven’t looked at it in any depth myself, but even Social Security’s biggest supporters talk about necessary changes like raising the retirement age (though generally while arguing they’re small).

The second is a completely different question and fundementally one of philosophy rather than fact.

Andrew' September 12, 2011 at 10:15 am

I think I see the problem. Matt Yglesias thinks SS is the same as owning company stocks in your 401(k). You can make similar algebraic equations for the two looking at streams of future cash flows. But the sources of those cash flows are completely different. Stocks don’t have value only because a bigger sucker is willing to buy them off your hands. That is only the source of the short-term price not the long-term value. This is the fallacy Yglesias falls for, and I don’t blame him much considering a lot of economists still believe that logic.

H. Skip Robinson September 13, 2011 at 6:57 am

I suggest that a Ponzi scheme is a system in which newly enrolled individuals pays for the benefits of those already enrolled. Bernard Madoff. With Social Security we have a minimum age at which you can recieve the benefits, but the current paying non-beneficiaries and new enrollies are required to keep the system solvent. The key is if the money is there without having to recieve money from enrolled non-beneiciaries and new individuals, then it is not a ponzi scheme. Another good way to determine if it is a ponzi scheme, is If you can run the retirement system in the private sector and not be arrested, it would not be a ponzi scheme. If it would be illegal to set up such a system in the private sector, then it would be a ponzi scheme. It is a government run ponzi scheme because there is not enough money in the trust account to pay current recipients without having to get money from existing paying non-benficiaries and bringing in new individuals.

Carly EngageAmerica September 15, 2011 at 1:14 pm

Currently Social Security and Medicare use 8.5% of nonentitlement revenues (federal revenues dedicated to all other programs besides the two). By 2020, the deficits will grow to almost 25% (http://eng.am/poetWU). This means that within 9 years, in order to pay projected benefits to retirees and the disabled, the federal government will have to stop doing about one out of every five things it does today.

Restructuring Social Security to make it sustainable would fix this dilemma and put an end to the argument of whether or not the program is a “Ponzi scheme.” Such things as raising the retirement age could help. This switch would eliminate less than a one-third of the projected deficit. However, this needs to be done because people are living longer; therefore more people are getting paid for longer periods of time while fewer people are paying into the system. It would help to reduce benefits. If Social Security payouts were reduced by 3% or 5% for new beneficiaries, about 18% or 30% (respectively) of the funding shortfall would be eliminated. Also, bigger contributions should be required from workers and employers. Right now they pay 6.2% of earnings up to $106,800, or as much as $6,622 per year, into the Social Security system. If the contribution rate were increased to 7.3% of earnings, Social Security’s projected deficit would be eliminated (http://eng.am/rtUMqX ).

Mitchel Schapira September 15, 2011 at 7:08 pm

A ponzi scheme is a fraud in which people are told a lie about the source of their profits. This in no way describes Social Security. Furthermore, with minor tweaks, it will be solvent for the indefinite future. Right wing scare tactics during the political silly season are not to be confused with informed economic discussion by academics, even if they occasionally employ the same words or metaphors.

Wayne October 2, 2011 at 1:15 pm

I agree that SS has more similarities than differences with the Ponzi scheme. An earlier comment hit the nail on the head when he said that the scheme is a functional structure, not a motive. That the government forces investment from new entrants to pay out old investors merely prevents the scheme from toppling over. It doesn’t change the fact that it is still a “Ponzi” structure.

For example, do you think most wealthy Americans would continue to pay into SS fully knowing their rate of return will be negative? No, they wouldn’t. Do you think that, barring the input from the wealthy American’s, SS could still pay out decent returns to existing investors with today’s increasing elderly population? No, it wouldn’t. So, in the absence of compulsory participation, SS would ALREADY be toppled over, just like the Ponzi scheme Madoff pulled recently.

So yes, SS is “Ponzi.” It would be disingenuous to say that it isn’t. The real argument I hear is that it may not actually be a “scheme” because everyone knows what it is (or should know, at the very least). Contrary to what Bill has been saying, insurance is not a Ponzi scheme. Insurance is risk-sharing among CURRENT investors. A person does not pay insurance for an amount of time, quit, and then expect to be covered by the premiums of later insured people. If SS was like insurance, underwriters would have to have done the actuarial calculations based on demographics to predict the growth of the elderly. Thus, they would have paid in MUCH more than they did. Insurance cannot be calculated beyond the scope of a person’s lifetime. It is a very contemporary calculation. SS and Ponzi do not require these sorts of calculation, only that new investors can be acquired.

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