Social Security's Ponzi Problem

  Every few years, somebody declares that Social Security is a Ponzi scheme. Indeed, I’ve been known to draw that inelegant comparison myself.

The “scheme” that gave rise to the label was crafted by Charles Ponzi in the 1920s. He promised investors outsized returns — famously, doubling their money in 90 days. There actually was an arbitrage opportunity behind the pitch,[i] but demand quickly overwhelmed it. So Ponzi wound up using money from new investors to produce the “returns” promised to earlier ones.

Social Security operates somewhat similarly: current payroll tax contributions are largely used to pay current beneficiaries. For decades, revenues exceeded benefit payments, with the surplus accumulating in the Social Security trust funds. But demographics, benefits and eligibility have changed — and the cushion between what comes in and what goes out has steadily eroded. Under current projections, within the next decade there won’t be enough incoming revenue and accumulated reserves to pay the full benefits currently scheduled under law.

So, yes, it can look a lot like a Ponzi scheme.

Purists rightly point out the differences; there is no investment fund, no individual account into which your withholdings are invested, and no promised “return” on those contributions. And unlike Ponzi, Social Security doesn’t have to continually recruit new investors; the federal government can mandate the collection of payroll taxes.

Still, if you’re a young worker watching a significant portion of your paycheck go to finance benefits for people who have already retired — or an older worker who has paid those taxes for decades only to hear now that the benefit formula might change just when you’re depending on it — it’s not hard to understand why the comparison persists.

The problem is that calling it a “Ponzi scheme” also carries a moral judgment, suggesting that someone perpetrated a criminal deception that can — and should — simply be undone.

Let’s be honest. Social Security has changed substantially since it was enacted in 1935. Benefits didn’t begin until 1940. The original retirement age was 65, at a time when life expectancy at birth was roughly 61 for men and 66 for women. Spousal benefits came in 1939, disability benefits in the 1950s, and automatic cost-of-living adjustments not until 1972. The 1983 reforms raised the retirement age gradually and made some benefits taxable under certain circumstances, among other changes.

In other words, the “promised” benefit has never been quite as immutable as the rhetoric sometimes suggests. The problem is that politicians have generally found it easier to expand benefits than reduce them.

And now the math — the assumptions and compromises underlying the 1983 reforms — has caught up with us.

So the question isn’t whether Social Security is a Ponzi scheme. It’s what new variables we’re willing to introduce into the equation: More revenue? Lower benefits? Changes to the benefit formula? A higher taxable wage base? Some combination of those — or something else entirely?

It’s encouraging to see members of Congress[ii] finally giving more attention to the problem, particularly as we approach the point where — absent legislative action — trust fund depletion would leave incoming revenues sufficient to pay only a portion of scheduled benefits.

But as Congress considers options, the questions worth asking aren’t whether Social Security was a “scheme,” or a “scam,” or who is to blame.

They’re much harder:

What did we promise — and why? What can we afford — or afford not to do? How much are we willing to change — to today's workers, today's retirees, and tomorrow's retirees — to make the system work? And what does the system “working” actually mean?

Unlike the “Is Social Security a Ponzi scheme?” question, those are questions we actually need to answer.

And soon.

— Nevin E. Adams, JD

 

[i] The basic story was that postal reply coupons could supposedly be bought cheaply in one country and redeemed for a higher value of U.S. postage stamps in another because of exchange-rate differences following World War I.

[ii] See Senators Introduce Bill to Kickstart Social Security Reform Process

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