Is Social Security a Ponzi Scheme?

By on September 1, 2014 in ArticlesEntertainment

The other day, we posted an article listing the 10 biggest Ponzi schemes in history. But in compiling that list, it felt like we left the biggest one of all off: The American Social Security system. Many people like to joke that Social Security is the biggest Ponzi scheme of all time, but is it, really?  Sure it may look like and feel like and smell like a Ponzi scheme. Investors (tax paying Americans) pay into an investment that pays out to a separate group of investors. Add to that the feeling that Social Security will run out before Gen X retires because of all the baby boomers in the system depleting the "trust fund" month by month until there isn't anything left for those who will not retire for another 20 to 30 or more years. Fun stuff, right?

However, as much as Social Security may resemble a traditional Ponzi scheme, it really isn't. To understand why, let's take a look at what the phrase Ponzi scheme actually means.  Back in the Roaring (19)20s, a fellow by the name of Charles Ponzi figured out a way to make money off an inconsistency between the American and Italian postal systems.  Or so he thought. It turned out his assumptions about those international postal coupons was flawed. But nevermind! Ponzi found a way around that, he just recruited new investors to cover the gap and pay back those original investors.  Ponzi promised his investors that they'd see a 50% return on their money in 45 short days. If they could hang on for 90 days, they'd double their original investment.  Ponzi became a millionaire in six months, earning $15 million. He continued to use his extraordinary sales skills to recruit more investors to pay off the previous batch and so on until he ran out of new investors and it all fell apart after a year. Ponzi was charged with 86 counts of mail fraud and sentenced to five years in federal prison.

So, in other words, a Ponzi scheme is a system whereby investors invest in something that they think is real, like real estate, but which their investments are actually being used to pay other investors back on their investment. When the scheme runs out of new investors, it collapses. Hmmmm. That does sound like the Social Security Administration in a way, except for the collapse part (at least yet).

At one time The Social Security Administration actually had a page on its own website that amusingly described how it was not a Ponzi scheme.  The page said:

"It would be most accurate to describe Social Security as a transfer payment–transferring income from the generation of workers to the generation of retirees–with the promise that when current workers retire, there will be another generation of workers behind them who will be the source of their Social Security retirement payments."

Um. OK. Still sounds pretty Ponzi-esque to me. The similarity to it is how Social Security has different sets of investors that must rely on other future investors in order to get paid back, or in this case, their Social Security benefits.  This is the broadest possible definition of a Ponzi scheme. In order for a  Ponzi scheme to b a Ponzi scheme there must be the presence of fraud.  Giant, unbelievable, malicious fraud. For instance, people think they are investing in electronics, but their money is not being invested in anything, it is being used by the originator of the Ponzi scheme.

With Social Security, it is completely clear what's going on. Every year, the Social Security Administration releases a very detailed report on the system's finances, payments, potential problems it could face down the road, etc.  In a Ponzi scheme, the finances are a big secret and that is integral to the operation.  Social Security's finances are public as a matter of law.

In fact, Social Security has a more transparent funding and financing structure than almost anything else in the government. Take the Pentagon for instance. It has no dedicated funding to call its own. No one has any idea how it will be paid for 25 years from now. Every year there is a budget and that budget calls for more spending than the government takes in in taxes, so they borrow that money.

In contrast, Social Security has its own dedicated funding source. At the moment it is running surpluses, but that won't be the case for much longer. The surpluses are invested in U.S. Treasuries, largely though to be the safest investment in the world.  No one will argue that largely due to the large influx of retired baby boomers, the system needs tweaking to remain solvent for future generations, but compared to the rest of the federal government, Social Security is solid.

The other hallmark of a Ponzi scheme is that they almost always are dependent on big increases in the number of investors in order to keep operating.

The Social Security Administration explains it this way:

"To pay a 100% profit to the first 1,000 investors you need the money from 1,000 new investors. Now there are 2000 'investors' in the scheme, and in the second round of payouts to pay the same return to these 2,000 investors in the next round, you need the money from 2,000 new investors–bringing the number of participants to 4,000. And to pay these 4,000, you will end up with 8,000 'investors,' then 16,000–and so on."

Sometimes, Ponzi schemes are called pyramid schemes.

Social Security, on the other hand, is not a pyramid. It is actually the opposite. The current funding shortfall is a direct result of large numbers of baby boomers retiring and birth rates that have been on the decline for decades, resulting in more people receiving benefits but less people paying into the system than when the boomers were working and their parents were retiring.  Right now Social Security has a funding gap of less than one percent for the next 75 years. That gap could be eliminated by lifting the payroll tax cap—it currently only applies to the first $107,000 of income – or by adjusting benefits downward—which could present a real problem with rising housing and cost of living expenses. But once that is done, it is done and the system is stable again. A Ponzi scheme is never stable.

That distinction – the stability of Social Security – is the most obvious argument against Social Security being a Ponzi scheme. The Social Security Administration has been in continuous successful operation since 1935.  Charles Ponzi's scheme barely lasted 200 days.

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