Is Social Security a Ponzi scheme?

Repub­li­cans pri­mary pol­i­tics are mov­ing front and cen­ter, and claims made by var­i­ous can­di­dates are being heav­ily scru­ti­nized for their accu­racy. Hope­fully, most are fac­tu­ally cor­rect while some are patently absurd, such as Michele Bachman’s claim that she can bring back $2 per gal­lon gaso­line. Still oth­ers are of ques­tion­able accu­racy, such as Texas Gov­er­nor Rick Perry’s claim that Social Secu­rity is a Ponzi scheme and an out­right lie to this nation’s young peo­ple, that is, the sys­tem will not pro­vide them the ben­e­fits guar­an­teed under cur­rent law. Some other Repub­li­can pres­i­den­tial wannabes have stated this is totally untrue — par­tic­u­larly Mitt Rom­ney — while oth­ers seem to waf­fle on the issue. So, who seems to be cor­rect on this issue as it relates to Social Security?

First, it seems fit­ting to define pre­cisely what serves as a “Ponzi scheme.” Accord­ing to Merriam-Webster’s on-line dic­tio­nary, it is an ille­gal “… invest­ment scheme in which some early investors are paid off with money put up by later ones in order to encour­aged more and big­ger risk.” Also often men­tioned by other sources as char­ac­ter­is­tics of a Ponzi scheme are the efforts to cre­ate the illu­sion of prof­itabil­ity (so monies con­tinue to flow into the oper­a­tion and allow it to pros­per over time), and the abil­ity of the Ponzi-scheme orig­i­na­tors to skim funds from the unwary “investors” to pro­mote their own extrav­a­gant lifestyles.

So, does Social Secu­rity seem to meet the def­i­n­i­tion and char­ac­ter­is­tics of a Ponzi scheme?

On one issue the answer is clearly no, since the Social Secu­rity sys­tem is a legally enacted effort to pro­vide (in most instances) sup­ple­men­tal income for eli­gi­ble — and gen­er­ally retired — senior cit­i­zens. Chalk one up for those bash­ing Rick Perry.

Beyond this one issue, Social Secu­rity does a pretty good imi­ta­tion of a Ponzi scheme. Given its pay-as-you-go nature, it is cer­tainly true that indi­vid­u­als presently pay­ing into Social Secu­rity are being used to pay off ear­lier “investors.” Of course, all of this is being done through what amounts to an inter­gen­er­a­tional trans­fer, which does pro­vide a dis­tinc­tion with a tra­di­tional Ponzi scheme, which often have a very short life to them given the inabil­ity to keep the swin­dling oper­a­tions unde­tected over time. But this is not always true, as with Bernie Madoff’s scam.

As to the issues of giv­ing the appear­ance of prof­itabil­ity and pro­vid­ing for a lav­ish lifestyle for the originator(s) of the scheme, Social Secu­rity could still rea­son­ably be con­sid­ered a Ponzi scheme. How so?

Con­sider the issue of a prof­itabil­ity appear­ance. Since changes made in the early 1980s, excess funds paid in the sys­tem go into a “Trust Fund” to insure future sol­vency. But such funds are, in fact, spent by the U.S. gov­ern­ment as they “bor­row” the funds from the Social Secu­rity sys­tem, and replace the bor­rowed funds with non-marketable Trea­sury secu­ri­ties. This pro­vides the appear­ance of a finan­cially sound (prof­itable?) sys­tem. But as retired Amer­i­cans dis­cov­ered dur­ing the recent debt ceil­ing impasse, should the gov­ern­ment be unable to expand its bor­row­ing capa­bil­i­ties, Social Secu­rity pay­ments could be dis­rupted or even halted alto­gether. Since the non-marketable Trea­suries held in the Trust Fund can only be pur­chased by the issuer — the fed­eral gov­ern­ment via the U.S. Trea­sury — should access to finan­cial mar­kets be impaired, the “finan­cially sound” Trust Fund would default on its oblig­a­tions. Sounds a lot like a Ponzi scheme, right?

Also, con­sider the issue of the orig­i­na­tor liv­ing the good life at the expense of the investors in the scheme. In this case the orig­i­na­tor is the U.S. gov­ern­ment and the politi­cians attempt­ing to keep the sys­tem from going belly up. As noted above, the monies “bor­rowed” from the Trust Fund allow the gov­ern­ment to pay for its cur­rent (extrav­a­gant) spend­ing with­out rais­ing rev­enues from cur­rent tax­pay­ers. Such an oper­a­tion allows politi­cians (and the gov­ern­ment) to appear more fis­cally respon­si­ble than they really are and pro­motes long/prosperous leg­isla­tive careers for politicians.

By the late 2030s, the Trust Fund is depleted and future Amer­i­cans (Rick Perry’s “young peo­ple”) will get no more than 70–75 cents per dol­lar of promised Social Secu­rity ben­e­fits under present law. While 70–75 cents per dol­lar of guar­an­tees may be good by Bernie Mad­off stan­dards, one would hope for some­thing bet­ter from the U.S. government.

In the final analy­sis, Rick Perry is prob­a­bly wrong to call Social Secu­rity a Ponzi scheme, but arguably accu­rate if he changes just slightly and clas­si­fies it as a “Ponzi-like” scheme.

Dr. James New­ton serves as chief eco­nomic advi­sor to Com­merce National Bank and is an aux­il­iary fac­ulty mem­ber in eco­nom­ics and sta­tis­tics at OSU-Marion and OSU-Newark. Dr. Newton’s views do not nec­es­sar­ily reflect those of Com­merce National Bank or OSU-Marion/Newark.

Posted by Jim Newton on Sep 20 2011. You can follow any responses to this entry through the RSS Feed. Comments can be made below.