Social Security as a Ponzi Scheme

Social Security is like a Ponzi scheme in one way but not in other, more important ones.

Jonathan Bernstein is annoyed at the “Social Security is a Ponzi scheme” meme.

After all, a Ponzi scheme is a deliberate fraud. Saying that Social Security is financed like a Ponzi scheme is factually wrong, but saying that Social Security is a Ponzi scheme or is like a Ponzi scheme is basically a false accusation of fraud against the US government and the politicians who have supported Social Security over the years.

The Ponzi scheme meme is overwrought but, as I understand it, just means that both promise big payouts on the theory that there will always be more investors to fund it and collapse if there aren’t. Social Security is a Ponzi scheme in the limited sense that, if there aren’t enough young folks to pay for the burgeoning population of retirees then the system collapses unless we continue to ratchet up taxes on the working population or pay out less to retirees than we promised.

But, no, it’s not a Ponzi scheme in the broader sense. The intent of a Ponzi scheme is to enrich the initiator and early investors by bilking later investors; they fully know the pyramid will collapse on others will be left holding the bag. The intent of Social Security is to provide a bare minimum pension for the elderly; it’s been doing that quite nicely for 75 years.

Is it in trouble? Well, the Trustees think so:

Projected long-run program costs for both Medicare and Social Security are not sustainable under currently scheduled financing, and will require legislative modifications if disruptive consequences for beneficiaries and taxpayers are to be avoided.

The long-run financial challenges facing Social Security and Medicare should be addressed soon. If action is taken sooner rather than later, more options and more time will be available to phase in changes so that those affected have adequate time to prepare. Earlier action will also afford elected officials with a greater opportunity to minimize adverse impacts on vulnerable populations, including lower-income workers and those who are already substantially dependent on program benefits.

Both Social Security and Medicare, the two largest federal programs, face substantial cost growth in the upcoming decades due to factors that include population aging as well as the growth in expenditures per beneficiary. Through the mid-2030s, due to the large baby-boom generation entering retirement and lower-birth-rate generations entering employment, population aging is the largest single factor contributing to cost growth in the two programs. Thereafter, the continued rapid growth in health care cost per beneficiary becomes the larger factor.

Social Security expenditures exceeded the program’s non-interest income in 2010 for the first time since 1983. The $49 billion deficit last year (excluding interest income) and $46 billion projected deficit in 2011 are in large part due to the weakened economy and to downward income adjustments that correct for excess payroll tax revenue credited to the trust funds in earlier years. This deficit is expected to shrink to about $20 billion for years 2012-2014 as the economy strengthens. After 2014, cash deficits are expected to grow rapidly as the number of beneficiaries continues to grow at a substantially faster rate than the number of covered workers. Through 2022, the annual cash deficits will be made up by redeeming trust fund assets from the General Fund of the Treasury. Because these redemptions will be less than interest earnings, trust fund balances will continue to grow. After 2022, trust fund assets will be redeemed in amounts that exceed interest earnings until trust fund reserves are exhausted in 2036, one year earlier than was projected last year. Thereafter, tax income would be sufficient to pay only about three-quarters of scheduled benefits through 2085.

Under current projections, the annual cost of Social Security benefits expressed as a share of workers’ taxable wages will grow rapidly from 11-1/2 percent in 2007, the last pre-recession year, to roughly 17 percent in 2035, and will then dip slightly before commencing a slow upward march after 2050. Costs display a slightly different pattern when expressed as a share of GDP. Program costs equaled roughly 4.2 percent of GDP in 2007, and are projected to increase gradually to 6.2 percent of GDP in 2035 and then decline to about 6.0 percent of GDP by 2050 and remain at about that level.

The projected 75-year actuarial deficit for the combined Old-Age and Survivors Insurance and Disability Insurance (OASDI) Trust Funds is 2.22 percent of taxable payroll, up from 1.92 percent projected in last year’s report. This deficit amounts to 17 percent of tax receipts, and 14 percent of program outlays.

The 0.30 percentage point increase in the OASDI actuarial deficit and the one-year advance in the exhaustion date for the combined trust funds primarily reflects lower estimates for death rates at advanced ages, a slower economic recovery than was assumed last year, and the one-year advance of the valuation period from 2010-2084 to 2011-2085.

While the combined OASDI program continues to fail the long-range test of close actuarial balance, it does satisfy the conditions for short-range financial adequacy. Combined trust fund assets are projected to exceed one year’s projected benefit payments for more than ten years, through to 2035. However, the Disability Insurance (DI) program satisfies neither the long-range nor short-range tests for financial adequacy. DI costs have exceeded non-interest income since 2005 and trust fund exhaustion is projected for 2018; thus changes to improve the financial status of the DI program are needed soon.

Does that mean we’ll simply stop paying out on old folks, making it a Ponzi scheme in effect if not by design? It’s simply inconceivable. Most likely, we’ll instead address the issue by some combination of modest increases in taxes, modest increases in the retirement age, and modest means testing.

FILED UNDER: Economics and Business, Quick Takes
James Joyner
About James Joyner
James Joyner is Professor and Department Head of Security Studies at Marine Corps University's Command and Staff College and a nonresident senior fellow at the Scowcroft Center for Strategy and Security at the Atlantic Council. He's a former Army officer and Desert Storm vet. Views expressed here are his own. Follow James on Twitter @DrJJoyner.

Comments

  1. Tano says:

    “Social Security is a Ponzi scheme in the limited sense that, if there aren’t enough young folks to pay for the burgeoning population of retirees then the system collapses unless we continue to ratchet up taxes on the working population or pay out less to retirees than we promised.”

    That does not make it a Ponzi scheme, even in this limited sense. A Ponzi scheme needs new people joining at the base – by design. Social Security is simply a transfer program from all workers (not just the young) to retirees. It is, by design, perfectly stable. The existence of a demographic bubble, the baby boom, makes the finances of SS a bit easier when the boomers are working, and a bit strained when they retire – but the absolute worst case scenario is that benefits are cut 30%, or taxes raised or some other minor tweak to get past the boomer bolus.

    There is nothing even remotely Ponzi-like in this arrangement.

  2. OzarkHibilly says:

    Kevin Drum figures the fix on Soc Sec is fairly innocuous

    “By 2030, the income-outgo gap is about 1.5% of GDP, so all you have to do is pick and choose from a menu of options that gradually raise revenue and cut benefits by a combined total of 1.5% of GDP. That’s it.”

  3. An Interested Party says:

    Does that mean we’ll simply stop paying out on old folks, making it a Ponzi scheme in effect if not by design? It’s simply inconceivable. Most likely, we’ll instead address the issue by some combination of modest increases in taxes, modest increases in the retirement age, and modest means testing.

    A pity so many of your fellow travelers can’t also admit that this is a rather sensible way to make sure Social Security is stable and available for a very long time…but of course, admitting that would get in the way of their ideological goal of getting rid of Social Security altogether…

  4. Does that mean we’ll simply stop paying out on old folks, making it a Ponzi scheme in effect if not by design? It’s simply inconceivable. Most likely, we’ll instead address the issue by some combination of modest increases in taxes, modest increases in the retirement age, and modest means testing.

    Doesn’t increasing the retirement age and means testing qualify as stopping paying out on old folks? The people between the two retirement cutoffs or above the means cutoff aren’t getting the payments promised when they were contributing.

  5. JKB says:

    Of course it isn’t a Ponzi scheme. A Ponzi scheme collapse after later investors get smart and stop paying in money. The US government has the point of the tax man’s gun to prevent that. It was a fraud though, not initially but within 2 years when the first Congress stole the “reserve” fund and had to raise taxes again to cover their expropriation. Social Security was sold as an insurance/pension plan but never had any of the features of an insurance/pension plan. It was sold that way by FDR because the People would never have bought off on it as a welfare plan. But unless we dig the old dead guys up and put their corpses on trial, how do we hold people to account?

    But as generations of politicians and citizens have perpetrated this fraud upon themselves, can there really be prosecution. The great failure of the plan was to underestimate the power of the market economy to improve the longevity of the population, the decrease in working class jobs where the workers paid longer and died earlier, and the collapse of the ability to offer gainful employment both to the young and to those past the “retirement age”.

  6. James Joyner says:

    @Stormy Dragon: Paying into FICA is mandatory and there’s no promise made of exact payouts. When I started paying into the system, retirement was at 65; now it’ll be 67 for my cohort. By the time I get to 67, it’s quite likely that there will be some sort of offset in payouts for those with more than a modest threshold of other retirement income.

    Does that sort of suck? Sure. But the point of the system is to ensure old folks don’t starve or free to death because they can’t afford food and utilities, not to ensure that the well-off have a supplement to their golf fund.

  7. @Tano:

    Social Security is simply a transfer program from all workers (not just the young) to retirees.

    The 2007 median household net worth by age of head of household:

    -35: $11.8k
    35-44: $86.6k
    45-54: $182.5k
    55-64: $253.7k
    65-74: $239.4k
    75-: $213.5k

    And why exactly are we redistributing wealth from the poorest parts of society to the wealthiest parts?

  8. @James Joyner:

    Does that sort of suck? Sure. But the point of the system is to ensure old folks don’t starve or free to death because they can’t afford food and utilities, not to ensure that the well-off have a supplement to their golf fund.

    I’m not arguing that (in fact I’m in favor of means testing). I’m just arguing your rather odd assertion that restricting benefits further doesn’t constitute a reduction in payments. The people whose benefits are restricted are necessarily getting less payout than they would have absent the restrictions. Indeed, if that weren’t the case, there wouldn’t be any point in the restriction; that’s their whole point. But while reducing payments is necessary, that doesn’t change the fact they are payment reductions.

  9. Tano says:

    @Stormy Dragon:

    And why exactly are we redistributing wealth from the poorest parts of society to the wealthiest parts?

    I am sure that a more complex explanation is warranted, but just off the top of my head it seems like your list is simply reflective of the fact that most people reaching retirement age have paid off the mortgage on their modest homes.

    So, to answer your question – old folks need to (deserve to) stop working at some point, and SS helps to insure that they can eat and clothe themselves without liquidating their only significant asset, and ending up on the street.

  10. catfish says:

    the government needs to give the people some options with their ss funds, such as being able to invest a certain amount; only if they wanted to. In this way, many would have enough time to become millionaires way before retirement

  11. Rick DeMent says:

    “Social Security is a Ponzi scheme” …

    So is capitalism which is fully dependent on future growth in order to pay back the debt racked up today. No growth no paying back the debt = Ponzi.

  12. @catfish: Yes, because there is long and strong evidence that individual retail investors can beat the market, and there is evidence that there is never any timing risk (oh forget about 2000 or 2008-2009), and there is no evidence that individuals tend to be massively optimistic and have short-run biases that strongly suggest that most individuals given either a lump sum or accessible cash reserves will not properly insure against the fact that they could live longer than they thought… no evidence for any of these claims…. no sir, not at all, let’s cunniling the magic of the free market fairy.

  13. JKB says:

    @catfish:

    Individuals have no claim to SS funds. The Congress can alter payments, alter conditions, just choose not to pay out any claims at will. See the Supreme Court decision for details. Any proceeds in excess of current expenditures is “invested” by Congress in current spending.

    The fact that it was sold as a pension fund but one without any legal claims on it by the “contributors” is further indication of it being a scam. But SS was constituted for a very good reason but they had to lie about it because at the time, even for old people, the Progressive welfare state couldn’t be sold to the population at large without prevarication.

  14. Console says:

    A social security tax increase is more analogous to raising a premium than to lying to get someone to put more money into a fake investment. To me, that’s the sticking point. Social security works like retirement insurance. It never has been or will be an investment. And there’s no mystery about that.

    Secondly, social Security payments aren’t guaranteed because the program can fail? Welcome to any business, investment, pension plan, mutual fund etc.in existence. All that “guarantee” stuff is a red herring.

  15. An Interested Party says:

    But SS was constituted for a very good reason but they had to lie about it because at the time, even for old people, the Progressive welfare state couldn’t be sold to the population at large without prevarication.

    Oh, like the war in Iraq or “tax cuts pay for themselves”…

    As for Social Security, you and people like you are certainly free to present the “truth” to people in an attempt to end it…good luck…