David R. Henderson  

More on Social Security and Ponzi

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In his comment on my previous post on Paul Krugman and whether Social Security is a Ponzi scheme, "wintercow20" writes:

Would it not have made sense from the outset to argue something like, "Professor Krugman also recognizes the problems with Social Security?"

Good point. What Krugman did not disown was this part of his article 15 years ago:
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).

In other words, Krugman does recognize a key problem with Social Security.

In his comment on my post, Bob Murphy highlights the item linked to by Krugman in which the Social Security Administration thought it important to clarify what Ponzi's scheme was vs. what the Social Security system is. The whole thing is worth reading. The Social Security historian, Larry DeWitt, ends with this:

The first modern social insurance program began in Germany in 1889 and has been in continuous operation for more than 100 years. The American Social Security system has been in continuous successful operation since 1935. Charles Ponzi's scheme lasted barely 200 days.

In about 2000, when I was writing my chapter on Social Security in The Joy of Freedom: An Economist's Odyssey, I was in touch with Mr. DeWitt on the phone. He told me that he had written the Ponzi analysis for the Social Security Administration's web site and that it had been up for a while but then the higher-ups decided to take it down. He and I were both disappointed. I'm glad they have relented and put it back up.

I've had feedback off-line from someone suggesting that I clarify whether Social Security is a Ponzi scheme. Here's what I wrote in The Joy of Freedom:

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. It's true that the government refers to the Social Security payroll taxes--a hefty 10.6 percent (an extra 1.8 percent is for disability insurance and a further 2.9 percent, levied on all income from work, is for Medicare) of every worker's earnings up to $80,400 in 2001--as "contributions." But just try not "contributing." That's what Valentine Byler, an Amish farmer in New Wilmington, Pennsylvania, did in 1961. His religion taught that its members should care for each other and he tried to act on his religious beliefs by not paying Social Security taxes. The Internal Revenue Service responded by seizing three of his horses and selling them to collect $308.96 in unpaid taxes.

The use of force is the key to why Social Security has lasted so much longer than Ponzi's scheme.


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CATEGORIES: Social Security , Taxation



COMMENTS (14 to date)
Paul writes:

This discussion is silly. If you classify SS as a Ponzi scheme then essentially every private sector pension, every government activity and every form of investment or insurance is a Ponzi scheme.

But more importantly a Ponzi scheme is a fraud designed to engineer a financial windfall to the creators at the expense of everyone else. Considering that SS finances are a matter of public record and that current contributors essentially get as much money out as they put in I do not find this a convincing argument.

Todd Moodey writes:

To Paul:

It's of course not true that essentially every form of pension or investment program is a Ponzi scheme if you accept David's argument. In a true and legitimate investment program, the promoter attempts to generate return on the capital entrusted to him by investors. In a Ponzi scheme, the "return" is in actuality comprised of contributions made by subsequent unwitting investors sold the same phony scheme.

If you accept this, consider the following:

Ida Fuller was the first Social Security recipient. She and her employer contributed all of $25 each to the program before she began receiving checks. Over the course of her very long retired life (she lived to 100), she received about $23,000 in benefits. Do you think $50 could have generated this return? If not, where did the dollars come from?

Paul writes:

Your point about the original recipient is irrelevant. The question is not whether it WAS a Ponzi scheme, but rather if it IS one now (We could argue about some other issues with regards to the original recipients, but I won't bother). The average beneficiary is not receiving more money than they put in in taxes meaning there is no "return" that people are being falsely promised meaning it is not a Ponzi scheme under your own definition.

Todd Moodey writes:

To Paul:

The original recipient is not irrelevant, because her payout reflects the structure of the program: once it begins to operate that way (i.e., paying out funds received by current system contributors to current system recipients), the logic of the system requires that it be continued, absent some sort of "owning up" to the unsound structure and fixing it via a one-time tax or some other measure.

The average recipient is now, and has in the past received much more in benefits than he contributed in taxes. That gap has shrunk drmatically, and will continue to shrink until it reverses, so that the average recipient at some future date receives far less than his tax contributions: a classic Ponzi scheme, enforced at the point of a gun, as David rightly points out.

PrometheeFeu writes:

I think fundamentally this whole argument has become a silly definitional argument: What does or does not constitute a Ponzi scheme? At the very least, that definitional argument has started to hide the real arguments:

1) Is Social Security sustainable in its present form? If no, what does that mean?
2) Is Social Security a good investment? If not what does it mean?
3) Are we better off with it existing in its current form?
4) ...

I would tend to say that Social Security is not fundamentally sustainable in its current form, but it is also not unsustainable. The actual way it works is not pay-as-you-go, it's put everything in the general fund and beg Congress to pay the benefits. So ultimately, the question of sustainability is not the same as in the original Ponzi scheme. In the original Ponzi scheme, there was a clear promise (Pay X in Y days) and a clear price. Social Security on the other hand has no such promise. So Congress could tomorrow, double, triple, half, eliminate, withhold or whatever benefits and nobody would have the slightest recourse. Furthermore, Congress could do the same with the "contributions", print money to pay benefits cut the defense budget to pay the benefits or whatever they want. As such, the "sustainability" of Social Security is not a meaningful question.

TomO writes:

@ PrometheeFeu:

1) Is Social Security sustainable in its present form? If no, what does that mean?
2) Is Social Security a good investment? If not what does it mean?
3) Are we better off with it existing in its current form?
4) ...

I think this is the right way to think about it, but my answers differ:
1) SS is sustainable ish; ignoring the trust fund SS can pay out 78% of expected benefits even at the height of demographic mismatch. A 22% cut in SS would suck, but it doesn't go bust.
2) SS is not as bad an investment as you would think; this is hidden because parts of your SS payment aren't really investment - parts are pure welfare transfers to people who are too poor to save for what society deems to be a sufficient minimum retirement income, and another part is insurance payments against the possibility that the investment portion goes bad. Its still probably a bad investment net for high earners.
3) The basic structure of SS is probably fine; we should be more honest about the transfer/insurance portions and be willing to change the benefit schedule to cut benefits at the high end so that it is less of an investment program and more of a pure transfer/insurance program. Taxes could then be cut as well. I think I am probably fine with a little bit of paternalism in mandatory savings (although purer libertarians would not be) - at minimum its not a big cost. Also, long term I would want to phase out the employer portion as its just hidden tax/salary.

fundamentalist writes:

SS certainly shares the main trait of a Madoff scheme: it depends upon a growing base of contributors to maintain the recipients.

People are offended by the comparison because they have bought into the lie that SS is a fund. People supposedly take out what they have paid in plus a small return on investment.

But that always was a lie. From day one current workers paid for current retirees. It was a direct transfer of wealth from younger workers to older ones and that’s why the ratio of younger to older workers matters.

If SS were not a Madoff scheme, then the number of people paying into it would not matter at all, but that is all that matters for SS.

The fact that the state forces people to join SS and the fact that the state can create money out of thin air or force people to lend to them keeps SS from going bankrupt. Madoff schemes don’t enjoy those privileges so they tend to fail faster.

andy writes:

How long did Madoff's ponzi scheme last?

frankcross writes:

A Ponzi scheme by nature implies deception. If someone openly announced, I'm starting an investment plan where early investors are paid by later ones, it would be perfectly legal. Ponzi schemes are by nature deceptive.

SS uses force (democratically approved) in lieu of deception. You can argue that's bad, but it's a very different beast.

fundamentalist writes:

Madoff's mistake was in not partnering with the mafia. The mafia could force new members to join and counterfeit money, just as the state does.

The mafia has survived for centuries, too, btw.

fundamentalist writes:

frankcross, SS used deception from the very beginning. Its supporters told people it was a retirement fund and that they would get out of it what they put in. That was a lie from day one.

PaulByrne writes:

SS is like a ponzi scheme in an important sense. The contributions of "new" investments are used to pay artificially high "returns" to old investors. The pay-as-you-go retirement system is not destined to fail even if Ida May did get in incredible return. And the existence of the baby boom generation did not automatically turn it into a Ponzi scheme. It was a conscious decision by Congress to use the young baby boomers contributions to create artificially high returns to then current retirees. That it was made SS a Ponzi scheme, because doing so meant that baby boomers could not get the returns that previous generations got...unless Congress used Gen X contributions to fund baby boomers' returns...but then Gen X gets nothing...unless Congress takes even more money from Gen Y...

Ponzi Scheme.

Unless there is a constitutional guarantee of intergenerational equity, or if we become governed by angels IS most definitely profitable for politicians to create the ponzi scheme.

twv writes:

I think we're getting somewhere. The key feature of Social Security is that it morphed into a Ponzi scheme - or "more" into one - with the Baby Boom generation bulge in population. And is morphing into the unraveling period of the scheme with the retirement of Baby Boomers.

That is, the potential for Social Security to work as a Ponzi scheme was there from the start, but demographic changes and increases in benefits made these elements predominate.

It's also worth remembering that Social Security has been "saved before." This was done by changing the terms of the pyramid scheme. If Ponzi could have successfully managed such a change, his would have lasted longer.

Government can more easily manage such 'deal changers" than can private-enterprise fraudsters. After all, the greatest such switch occurs when a government turns credit money into fiat money.

It seems to me that by changing the terms, changing the nature of the deal, Social Security has demonstrated its own pyramid scheme nature, and, in each reshuffle so far, set up a new scheme, to follow a new course with its long-term cycle of early retirees getting better deals than later retirees in otherwise similar circumstances.

That's how Social Security survives.

Of course, Social Security was also set up to mimic elements of the tontine. These two aspects of the system confuse analysts. The squaring of the death rate for the elderly crippled the American system by destroying its "tontine" functionality.

kyle8 writes:

The truth is that it is actually far worse and more immoral than a Ponzi scheme. Ponzi used people's greed to defraud them.

Congress defrauded people with promises it could not keep and then used coercion to keep the program running. Then further lied in the 1980's and said they had fixed the problem.

We have long since passed the time in which the returns from "investment" are worse than the opportunity costs of just putting your money in some low yield safe instruments and compounding the interest.

In that respect it is worse than mere fraud and is now just outright theft.

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