Tuesday, September 13, 2011

Is Social Security a Ponzi Scheme?

Thanks to the Republican debates, the idea the Social Security is a Ponzi scheme is back in the news! I thought I would repost a comment I published on this notion the last time it turned up, during the furor about the Madoff case. Also see my comment on the complexities of this idea here.

Carlo Ponzi had a brilliant idea -- brilliant at any rate by the standards appropriate to judging the intelligence of criminals: Invite people to invest their money in your scheme, and pay them surprisingly large returns. But these payments are merely taken out of the deposits of new customers, who will be payed from deposits of still newer customers. But there really are no investments involved, and they rest of the money isn't going anywhere but into the conman's pockets.

Now that the economic downturn has exposed Bernie Madoff's truly despicable crime, the largest Ponzi in history, such schemes are in the news again, and some libertarians are making the familiar claim that the Social Security Administration is itself a Ponzi pyramid, far larger even than Madoff's . If so, the notion that Madoff's is the biggest such scam ever are in fact wrong. His is merely the largest private one. No one does it like the state.

Is it true that Social Security is a Ponzi scheme? I don't think it is (nor is the related idea true that SS is "insolvent"). I think the comparison does bring out features of the SSA that are ethically problematic, but the ethical problems are rather different from those that consigned Mr. Ponzi to prison (and, were there only such a place, to Hell).

The SSA pays Grampa Jones with money extracted from Jones Jr., who will eventually be paid with money extracted from Jones III. There is that much resemblance to a Ponzi.* The difference of course is that everyone knows from the outset that this is what Social Security is like.

As Nat pointed out to me recently, one of the important features of a Ponzi scheme, very often, is that the swindler sometimes avoids making payments to his victims. "Wow that's a huge dividend! Why don't you just reinvest it for me? I'll make even more!" Why sure, I'll reinvest it for ya. Heh heh. With SS, no beneficiary would ever do that because no one is under the illusion that this is an investment plan.

Social Security is nothing but a conduit by which wealth is extracted from those who produced it and transferred to those who did not. Of course, that is also true of a Ponzi scheme. But the difference is that Pozis do it with fraud, while SS does it with force. Social Security is to a Ponzi scheme as coercion is to deceit.

That is not a morally trivial difference. The people who received dividends from Madoff were benefiting from acts that violated the rights of others. But they were unwitting and innocent beneficiaries. What is Grampa Jones? He may be innocent, but not because he is unwitting. The ethics of his position are more complex and murky than those of Madoff's victims.

There is a particularly vicious sort of coercion involved in the SS system that many others have noticed. Suppose that we the people decide that we want to liquidate the system. What do we do with Grampa? All his working life he has been paying money into this growing, spreading system. Can we abandon him? And where will the money to support him come from? And how will we refund the money that the still-productive who have paid, usually enormous amounts,** into the system? They would have put part of that money into private retirement accounts, but now they can't do so, because the SSA took it from them.

That is why the economic sterility of the system is ethically problematic: not because it is fraudulent, but because it makes it all the more coercive. There is no fund of capital that might have enabled us to liquidate it. The generation that voted SS into being were handcuffing us to a monster. In this way, what they did was profoundly anti-democratic.

Update: Also, see this.
* Interestingly enough, when Junior pays more that Gramps needs, a trust fund accumulates, but by law this money must be spent on government bonds. In other words, it goes into the pockets of the perpetrator of the scheme. Again, like a Ponzi snow job.

** In 77% of cases, the employee's contribution plus that of the employer (which ultimately comes out of the employee's hide as well) is greater than the entire federal income tax paid by the worker.


Miss Catwalker said...

u are right.Iam tired of paying ss and dont know where the corrupted politicians invest it!

Mark M said...

I agree with your thoughts on how SS creates a vicious cycle. In advocating the dismantling of SS, I believe it should be done in some tiered way. For example, people who are now 55 get 100% of their promised benefit, but people my age (20's) get 0% (but have to keep paying in). People in the middle would be somewhere between 0 and 100%, on an increasing scale with age (the older you are, the less time you have to adjust your behavior.)

Yes, it bothers me that I'll need to keep paying in with the understanding I'll receive no benefit at the end, but I think it's worth it if that's what it takes to dismantle this thing.

The perverse incentives created by a government guaranteed retirement are incredible.

Lester Hunt said...


Yes, that may be the only way to do it. Here too, as you point out, someone will be hurt.

Rich Rostrom said...

"when Junior pays more that Gramps needs, a trust fund accumulates, but by law this money must be spent on government bonds. In other words, it goes into the pockets of the perpetrator of the scheme. Again, like a Ponzi snow job."

Wrong. The "SS trust fund" is lent to the Treasury, with explicit repayment obligation. Thus the Federal government does not gain anything.

However - SS as Ponzi scheme.

A Ponzi scheme induces new investors to put money in by paying generous returns to old investors out of the new investors' contributions.

SS, it could be said, induces the American people to keep paying into SS by paying generous benefits to retirees out of current contributions.

The people choose to keep paying by electing legislators that vote for sustaining and increasing SS taxes.

I don't know what would happen if a political faction actually proposed to end payroll taxation and cut SS to match. The elderly would be outraged, but would the non-elderly be significantly attracted? Or would they too be worried about losing expected benefits?

I think the latter would happen to a substantial degree, and it's interesting that voters could be so affected by a long-term expectation.

Lester Hunt said...


I was thinking that buying gov't bonds is (a form of) loaning it money. The issue you go on to raise sounds a lot like the one I talk about in my next post on this subject.