David R. Henderson  

Good News for Social Security Taxpayers

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Among the guidelines the IRS issued yesterday was allowing investors to claim their losses from a Ponzi scheme as a theft loss rather than a capital loss, a personal casualty loss or a personal theft loss.
This is from here.

My friend Ross Levatter writes: "Does this also allow us to deduct from our federal income tax the 12.4% we pay into Social Security, the greatest Ponzi scheme of all?"

As I wrote about Social Security in The Joy of Freedom: An Economist's Odyssey:

MIT economist Paul Samuelson added some of the intellectual backing for these policies. "The beauty about social insurance is that it is actuarially [italics Samuelson's] unsound." Samuelson's point was that if real incomes were growing quickly, each generation could get more out of Social Security than it paid in. While its critics attacked Social Security as a Ponzi scheme, Samuelson beat them to the punch in 1967 by blessing it as one. "A growing nation," wrote Samuelson, "is the greatest Ponzi game ever contrived."
(Samuelson quote is from Newsweek, February 13, 1967.)

As I also wrote:

A private citizen who set up such a financial chain letter would go to prison. In fact, he did. His name was Charles Ponzi, and he was arrested in 1920 for promising investors that they could double their money in 90 days and using the proceeds from later participants to keep his commitments to earlier ones. Thus was born the term "Ponzi scheme."

There are two main differences between Ponzi's original scam and the Social Security system. The first difference is that Social Security is run by government and, whatever its constitutionality and its questionable ethics, is legal. The second difference follows from the first: Whereas Ponzi had to rely on suckers, the government can and does use force.



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CATEGORIES: Social Security



COMMENTS (18 to date)
Felix writes:

This "Ponzi scheme" meme has been repeated so much it must be true.

I don't get it. Perhaps we can fuss that social security is *sold* as a Ponzi scheme, but it appears to be no more a Ponzi scheme than human life itself.

People in their productive years support old folks. And kids. And anyone in between not supporting themselves. Human life has been like that for some time now. Social security is simply an institution involved in this process. In the social security system current workers pay for current old folks. That's not a Ponzi scheme. That's simply how the world works with or without social security.

Other systems may be more efficient, more fair, more fare, or even more glamorous.

But, in the end, *any* system relies on current workers to support the old folks. If you believe that your life savings make that untrue, consider this: The money you've saved (and what it represents) is worth exactly what the young'uns make it worth.

James writes:

Felix,

The characteristic that makes SS a Ponzi scheme (in English) is that the money flowing to earlier participants comes from the contributions of newer participants. This is not the case with my savings account.

If you want to insist on an idisyncratic definition for Ponzi scheme, that's your choice.

Felix writes:

James,

Words can mislead. That SS has *a* characteristic of a Ponzi Scheme doesn't make SS a PS - unless you just want to mislead yourself by attaching a handy, negative label to SS and moving on.

Is it idiosyncratic to say fraud is a necessary characteristic of a PS?

In SS no one expects to be paid right now. Unlike a PS. And everyone *should* know that they are being paid by the next guy - later. Unlike a PS. And, is it fraud when someone tells you the deal, up front?

I would agree that SS is sometimes *sold* as a PS. That is, people are led to believe that they are "saving for the future" when they pay SS taxes. But, golly, check the fine print, dude.

Heck, if you use the new-money-goes-to-old-investors characteristic as the only PS characteristic, you could call practically any enterprise a "PS". There are lots of ways that one can "invest" in an enterprise - buying its product, for instance. (Unless you buy from someone you don't care if they go out of biz the next minute.)

And, yes, it's the case with your savings account. Try this mental image for a second: You've been saving all your life, doing the right thing. Now your body's got a lot of miles on it and is breaking. You can't pull your weight any more. No problem. You got money in the bank. But, sadly, a space-virus hits earth and all the younger people keel over in a moment. Good luck with that savings account. Turns out, it's a token - a symbol of your deserving that operation more than the next guy. But it's worth nothing without the "investment" of the new guys.

David writes:

Felix,
you wrote that people in their productive years support the old folks, but for all the popular examination of income inequality, the wealth distribution as function of age receives little attention. In the US, mean household wealth AND income of people over 70 is many times that of those in their 20's and 30's. On this basis, I would say social security is a broken system that transfers wealth from the working age demographics to many who don't even require it (like my own parents for example). On the moral level, I recognize a responsibility to look after both my children and my parents. Why should this moral responsibility translate into a wealth transfer scheme mandated by the federal government?

Steve Roth writes:

No. You really must consider this basic fact before largely retracting your position:

A Ponzi scheme requires an exponentially growing number of participants. It's the very sine qua non of a ponzi scheme. Without it, it ain't one.

The whole (or great bulk) of the American populace was subscribed to this scheme from day one. There's no prospect of signing up 600 million more.

It's simply not the same thing, either quantitatively or qualitatively.

Yes, the population is growing steadily. (Thank god for immigration! Now if several illegals would just work using my social security number...) One might argue rather tenuously that in that sense it's a ponzi scheme, but...no.

As for the economic growth part--well, your whole economic belief system is based on the virtue of growth supporting ever greater and more widespread prosperity and security. Why not Social Security?

You can't very honestly opt out of that belief system whenever it's rhetorically convenient.

No, don't try rhetorical jiu jitsu and evasion, saying SS hurts growth. That's not what we're discussing here.

Be honest (with yourself): it's not a Ponzi scheme, is it?

Call it something else, if you will. Words have meanings.

Randy writes:

David makes the key point.

"Why should this moral responsibility translate into a wealth transfer scheme mandated by the federal government?"

Human beings seem to have managed quite well for many thousands of years before the progressives found a way to skim the process. So maybe Social Security isn't precisely a "Ponzi Scheme". So what? Its good counter propaganda and I'm going with it.

Mike writes:

Why on earth would a Ponzi scheme require an exponentially growing number of participants?? Methinks some people know much less than they think they do.

Maniel writes:

Like Medicare, Social Security is an investment by the very young (and their working parents) in the very old. Since I fall into the latter group, I say "bring it on." They have their youth.

Phil writes:

A Ponzi scheme requires an exponentially growing number of participants. It's the very sine qua non of a ponzi scheme. Without it, it ain't one.

A Ponzi scheme requires an exponentially growing number of participants in order to stay in business--actually, the more precise way to put it is that it requires "an ever-increasing flow of money from investors in order to keep the scheme going" (as the wikipedia entry puts it. As soon as the condition no longer holds (something that surely will come to pass eventually), the whole thing falls apart.

All this is very different from saying that in order for something to even count as a Ponzi scheme, it needs an exponentially growing number of participants.

Felix writes:

David: In the US, mean household wealth AND income of people over 70 is many times that of those in their 20's and 30's.

Well, sure. It stands to reason, doesn't it? The older generation has had a whole lifetime to accumulate wealth and skills. There have been no catastrophic economic events since WWII in the US. No events to wipe the slate clean, so to speak. And, that generation had a gob of kids. Unless their kids were slackers (they aren't) - well, you get the picture.

Gen X is now moving in to the traces. And there ain't many of 'em. They simply won't carry as big a load. Boo hoo for me, of the baby boom's leading edge. :)

David: Why should this moral responsibility translate into a wealth transfer scheme mandated by the federal government?

Personally, I would say it shouldn't. I'm not convinced that national government is the proper vehicle for supporting old folks (and young, and others who need it). In fact, I think the greatest long term danger to the United States is summed up in these words: "I gave at the office." When you're forced to be charitable, you're going to lose some of your essential human instinct to be charitable. And, this doesn't even address an insidious gimping of the system the clever can pull off: Live it up; don't have kids; let other peoples' kids support you in your old age. And be sanctimonious about your selfishness! You're "saving the Earth". :)

Jim Glass writes:

"A Ponzi scheme requires an exponentially growing number of participants. It's the very sine qua non of a ponzi scheme. Without it, it ain't one.

"The whole (or great bulk) of the American populace was subscribed to this scheme from day one."
~~~~~~~~~

This is not true. FDR's original SS system covered far fewer workers than you imagine, and was steadily expanded "laterally", to cover ever greater numbers of workers in different occupations and with different employers (such as state and local governments) for decades -- specifically to increase the number of "contributors" needed to pay promised benefits.

Three Nobel economists have used the word "Ponzi" to describe Social Security -- Samuelson in the start as praise, "a Ponzi scheme that works" ... Krugman (in his pre-NY Times incarnation) talking about the middle, to warn that the Ponzi element of SS will cause future workers to get less from it than they put in, compared to past workers who got much more than they put in ... and Friedman looking to the future, condemning it as the Greatest Ponzi Scheme on Earth.

Personally, three Nobelists are good enough for me -- I won't argue with their collective wisdom.

But more than that, FDR himself was stridently opposed to what SS has become, with its inter-generational inequity, $15 trillion loss dumped on young workers, and it's now charging the young more for benefits than they are actuarially worth.

One can learn this from FDR's veto of Congress's actions that converted SS from the funded program that he created -- which paid a sound, actuarially stable return on contributions equal to the bond rate, the same to all generations -- into the paygo system that paid early participants Samuelson's Ponzi-scheme "ten time what they contribute" but gives today's young a $15 trillion loss.

One also can see it the statements to Congress of of Arthur Altmeyer, FDR's head of Social Security, urging Congress to uphold the veto and *not* turn SS paygo ... as it did.

What would FDR think of today's Social Security?.

If one deems "fraud or misrepresentation" as necessary for a Ponzi scheme, then the constantly repeated refrain "Social Security has done great until now, so we should keep it as is!" certainly qualifies. SS has already been converted (in the 1983 amendments) from a scheme that gave past generations $15 trillion more than they put in, into one that gives today's and future participants $15 trillion less than they put in.

Not admitting this $30 trillion welfare swing to the worse for participants, and representing today's SS as being "FDR's Social Security", both easily pass the gross misrepresentation test.

As to a Ponzi scheme, when does "the whole thing fall apart"? Why, when the returns to contributors change from big positive to big negative, of course -- which happens with today's young workers, age 40 and under.

Hey, suppose that past generations had gotten $15 trillion less from SS than they put in, that it had made them $15 trillion poorer rather than richer on a lifetime basis (had given them $30 trillion less than it did!). Would they have deemed it such a great success? Ha! Would they have stood for that at all??

That is the political future of Social Security.

Of course, that's a lot better than Medicare's.

Daniel Shaviro, Wayne Perry Professor of Taxation of New York University, has notably said that if any used car salesman sold cars to the public the way the politicians have sold Medicare to it, that used car salesman would be in jail today.

"Don't you like it? Sure you do! Take it! Take it! It's free today, no money down! Enjoy it! Just a few payments later -- sign the contract but don't worry about them. You want it, so why worry about the cost that you won't owe until who knows when later ... (ahem, cough, only $40 trillion dollars) ..."

Felix writes:

Jim Glass: FDR himself was stridently opposed to what SS has become

Thanks, Jim! Fascinating historical information, this and the rest you've provided.

However SS may be labeled, for whatever reasons, it's scary that *any* pension system would be brittle enough to "fall apart" in the face of normal ups and downs (now we have a lot of workers, now we have a lot of old folks, now we have a lot of workers...).

So, that's a key question. Is SS that brittle? I'd gotten the impression (probably from numbers coming from econlog authors) that raising the retirement age a couple years "fixes" SS in the coming baby boom crunch. True?

Too, are non-SS pension systems also that brittle? If they both are brittle, then we'd need to find another criteria to judge which type of system is better, eh?

Brandon Berg writes:

Social Security is a Ponzi scheme because it requires ever greater contributions in order to provide the returns promised. The tax rate has been increased several times, and it's about to go into the red again. It's not as wildly unsustainable as small-scale Ponzi schemes, but this is a matter of degree. The basic principles are the same; only the parameters differ.

Randy writes:

Felix,

I don't think that raising the retirement age is going to work as planned. It may be actuarially sound, but it isn't psychologically or politically sound. People are still going to retire as soon as they rationalize their ability to do so, and then they will rationalize the use of political power to make up the difference.

peco writes:

Brandon: What prevents the government from raising the tax as much as it needs to make SS sustainable?

Randy writes:

Brandon,

The Laffer curve. Eventually, people will simply refuse to pay and/or work. If you think about it, the government is already being forced to borrow and print to make ends meet.

Randy writes:

Oops... that should have been addressed to Peco.

himaginary writes:

I wonder why Social Security payment is not deductible in the U.S. in the first place. In Japan, it is.

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