Market Related Articles » Ponzi Scheme » Social Security - WHAT - a Ponzi
During my research for the Ponzi topic I ran across references to the US Social Security System. I found it intriguing to see that
the United States Government took the time - on their website - to defend itself against being, yes, you guessed it, a PONZI SCHEME!
My hunger grew on the subject and I knew there had to be an opposing position to the government's view, if only because they took the time to write a defensive position about it in the first place. Well it did not take me long!
Professor Clifford F. Thies, Professor of Economics and Finance at Shenandoah University did just that, and I have concluded this article with his brief writings.
The Logic of Pay-As-You-Go Systems
In contrast to a Ponzi scheme, dependent upon an unsustainable progression, a common financial arrangement is the so-called "pay-as-you-go" system. Some private pension systems, as well as Social Security, have used this design. A pay-as-you-go system can be visualized as a pipeline, with money from current contributors coming in the front end and money to current beneficiaries paid out the back end.
There is a superficial analogy between pyramid or Ponzi schemes and pay-as-you-go insurance programs in that in both money from later participants goes to pay the benefits of earlier participants. But that is where the similarity ends. A pay-as-you-go system can be visualized as a simple pipeline, with money from current contributors coming in the front end and money to current beneficiaries paid out the back end. So we could image that at any given time there might be, say, 40 million people receiving benefits at the back end of the pipeline; and as long as we had 40 million people paying taxes in the front end of the pipe, the program could be sustained forever.
It does not require a doubling of participants every time a payment is made to a current beneficiary. (There does not have to be precisely the same number of workers and beneficiaries at a given time--there just needs to be a stable relationship between the two.) As long as the amount of money coming in the front end of the pipe maintains a rough balance with the money paid out, the system can continue forever. There is no unsustainable progression driving the mechanism of a pay-as-you-go pension system and so it is not a pyramid or Ponzi scheme.
In this context, 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 retiree, there will be another generation of workers behind them who will be the source of their Social Security retirement payments. So you could say that Social Security is a transfer payment, but it is not a pyramid scheme. There is a huge difference between the two, and only a superficial similarity.
If the demographics of the population were stable, then a pay-as-you-go system would not have demographically-driven financing ups and downs and no thoughtful person would be tempted to compare it to a Ponzi arrangement. However, since population demographics tend to rise and fall, the balance in pay-as-you-go systems tends to rise and fall as well. During periods when more new participants are entering the system than are receiving benefits there tends to be a surplus in funding (as in the early years of Social Security). During periods when beneficiaries are growing faster than new entrants (as will happen when the baby boomers retire), there tends to be a deficit.
This vulnerability to demographic ups and downs is one of the problems with pay-as-you-go financing. But this problem has nothing to do with Ponzi schemes, or any other fraudulent form of financing, it is simply the nature of pay-as-you-go systems. (Of course one might want to argue that there are better ways to finance Social Security than its traditional pay-as-you-go approach. However one views this policy question, we are concerned here only to correct the mistaken idea that a pay-as-you-go system is the same thing as a Ponzi scheme.)
The Start-Up Problem In Pension Programs
There is one other aspect of Social Security, and many private pension systems, that sometimes leads people to a mistaken analogy with Ponzi schemes, and that is the "bonus" paid to early participants in a pension system.
During the start-up of a new pension system the money paid to early participants is usually much in excess of their contributions and higher than the "return" to later participants. This is because people who are nearing the end of their working career will not have an opportunity to participate in the pension system long enough to accrue a significant benefit if computed strictly on an actuarial basis.
There are three options: exclude such people from the system; leave them with an inadequate pension; or provide some kind of subsidy to early participants beyond what is justified by their contributions. In private pensions this differential is usually made up by subsidies from the employer. In public pensions this differential is funded by assessing higher taxes than would otherwise be necessary to pay a level benefit to all participants.
The first recipient of monthly Social Security payments was Ida May Fuller. Miss Fuller worked for about three years under
the new Social Security program and paid $24.75 in payroll taxes. Her first Social Security check in January 1940 was for $22.54 - she almost got her money back in her very first payment. Miss Fuller lived to be 100 years old and collected more than $22,000 in benefits.
This type of "bonus" to early participants should not be confused with the mechanics of pyramid schemes. This type of benefit to early participants in a pension system has nothing to do with an investment scheme using Ponzi-like progressions to show false returns to early participants. In private pensions this bonus is simply an expression of the employer's beneficence. In public pensions it is an expression of public policy. In the context of the early years of the Social Security program it was an expression of a public policy which held that workers already old should not be turned away penniless. This spirit of public generosity has nothing to do with Ponzi schemes.
Ponzi vs. Social Security
Social Security is and always has been either a "pay-as-you-go" system or one that was partially advance-funded. Its structure, logic, and mode of operation have nothing in common with Ponzi schemes or chain letters or pyramid schemes.
The first modern social insurance program began in Germany in 1889 and has been in continuous operation for more than 100 years. The American Social Security system has been in continuous operation since payroll taxes were first collected in 1937.
*Remember, this was written for the US Government's website. The author was Larry DeWitt.
Clifford F. Thies, "Professor of Economics and Finance"
"We, in America, should not gloat over the misfortunes of the Albanians and Haitians, or of those who kept their money in stocks following the Panic of 1837 or the Crash of 2000. We have our own Ponzi scheme to worry about. A massive Ponzi scheme that threatens to bankrupt our entire country. I'm talking about Social Security.
Social Security worked marvelously for the first couple generations in the program. They paid little or nothing into the system, and retired on benefits provided by taxing the working-age generation. The working-age generation was promised that one-day it would be their turn to live off of somebody else.
For longer than five decades, a growing population provided an expanding tax base from which to support those receiving benefits (even so, the social security tax rate kept being raised). Then, the passing-through of the "baby-boom" generation allowed Social Security to reap a bonanza of revenue, which was "invested" in the federal government's deficit instead of in productive assets.
Now, the aging of the baby-boom generation looms ever so large before us, and it is growing clear that there will be no fix. If you want to see what will happen in the United States, look to the welfare states of Europe. There the disaster will happen first and worst.
Being susceptible to scams, both on an individual basis (being a sucker) and as part of society (being subject to occasional financial manias and to disasters of fiscal policy), is part of life. Our vulnerability makes us nervous and joining-in is a temptation.
Most of us enjoy the idea of scamming the scammer, as played-out in the 1973 movie "The Sting," starring Paul Newman and Robert Redford, and the winner of the Academy Award for best movie. There's a certain justice to it. But, I think the best advise regarding scams is always, "if its sounds to good to be true, it probably is."