A couple of years ago, I claimed on this blog that Social Security is a Ponzi scheme. Various commenters objected but didn't persuade me. This week, John Seater, an economist whom I respect a great deal, wrote that it is not a Ponzi scheme. He's given the best argument I've seen yet for that view. I'm still not persuaded. Seater wrote: Medicare is neither a chain letter nor a Ponzi scheme. Those are closed-loop circular arrangements in which the scheme eventually comes around to the same people who already have paid into it and asks for more money than those people got. Medicare and Social Security are open-loop intergenerational transfers in which the person receiving benefits now is never asked to pay in the future because he is dead by then.
Both Medicare and Social Security in principle could remain solvent, in contrast to chain letters and Ponzi schemes, which necessarily cannot. In practice, Medicare and Social Security were undone by two unrelated things. First, the politicians saw they had vote-buying goldmines in both programs and kept ramping up the benefits associated with each, necessarily ramping up the costs, too (but of course politicians never talk about the costs of anything). Second and more important, there was a major demographic shift in the form of a huge drop in the number of children born to fertile couples, leaving far fewer young people to pay for the benefits being received by old people. That was bad luck as far as financing Medicare and Social Security was concerned, but it was in no way a necessary outcome of either program. It's not necessarily the case that Ponzi schemes must circle around to the original people who invested in them. If the scheme offered modest enough returns and spread slowly, it could last forever in a country with a growing population. Therefore, Ponzi schemes, contra Seater, could remain solvent.
I'm back to the point I made in my original post, a point I quoted from my book, The Joy of Freedom: An Economist's Odyssey: There are two main differences between Ponzi's original scam and the Social Security system. The first difference is that Social Security is run by government and, whatever its constitutionality and its questionable ethics, is legal. The second difference follows from the first: Whereas Ponzi had to rely on suckers, the government can and does use force.
Wouldn't another relevant difference be that ponzi schemes rely on fraud? Perhaps you could argue that politicians have been dishonest about the costs of Medicare and Social Security, but the framework of the programs and the details of the funding are there for everyone to see. And while participation in them is mandatory as long as they are the law, voters are free to vote in politicians who would dismantle them (as difficult as that may be, practically).
I think it is pretty clear that Social Security is a Ponzy scheme in the sense that the latest participants pay for the earlier participants and that the later you participate, the lesser your return. (until your return becomes negative) This is why I don't participate in Ponzy schemes and why I don't try to time the market. You just can never know what part of the scheme you are at. Of course, I have to make an exception when men with guns force me to participate in said scheme. Ergo, I pay into Social Security.
I remember studying in grad school these old papers that were Ponzi schemes that made everyone better off. http://128.83.172.192/~cooper/og09.pdf
I think that the key thing that distinguishes a Ponzi scheme from the sort of legitimate pension program that Social Security's advocates would like us to see it as is that a Ponzi scheme cannot sustainably work as advertised.
Social Security fails on this criterion. The tax rate has increased sixfold since the program's inception because politicians could not resist the temptation to promise better returns than could be sustained at contemporary tax rates. The only reason they haven't had to raise tax rates further in the last 20 years is that the Baby Boomers have been in their peak earning years; once they retire it will again be impossible to pay out the promised returns without raising taxes.
Social Security cannot sustainably work as advertised, ergo it's a Ponzi scheme.
What's the point?
I mean, really, Social Security is Social Security. Everyone knows how it works. Arguing whether it's a Ponzi scheme is just an argument over how to define a Ponzi scheme. The outcome of that argument has no bearing on whether the program is itself good policy.
No Ponzi Scheme can last for 75 years.
Ponzi Schemes are born to fail. Social Security is a government-run transfer payment program. It can be run poorly or it can be run well. There is no inherent reason why Social Security must fail.The same cannot be said of a Ponzi Scheme.
David, you were right the first time.
Both Social Security and the chain letter can survive only if they find new victims -- people who will never volunteer to be vicims if they know all the facts.
This is an interesting characterization of a system which has been abused and neglected for entirely too long. The premise that a social security trust fund exists is a joke in light of the national debt of this country and the wasteful spending of monies borrowed against the social security trust fund. The way in which the system is mismanaged creates a negative externality in my view. Social security withdrawn from citizens and businesses is merely an underhanded additional tax for which the government has an obligation to fulfill that it cannot under the current fiscal circumstances. Either the system needs to be reformed in a way where the funds are legitimately set aside or we need to abolish the entire social security tax. The reason for this is that taxpayers are always going to feel a sense of entitlement when they pay into a system which promises a benefit whether they possess a financial need to receive the benefit or not. I propose a quasi defined benefit/defined contribution plan (vis-à-vis privatization of social security). The defined benefit segment would require those who have the economic means to contribute to a government controlled account which is set aside to provide an annuity of income at retirement if the individual has inadequate assets and income to support basic needs. There would be no reported account balance to the individual. It would merely be looked upon as a tax, much like social security, for which the individual receives a commitment that he or she will receive enough income during retirement to satisfy basic needs, not vacation money. The key here is that an actual account (pooled with other taxpayers) would exist possessing the money to fund this commitment. Should the individual at retirement not qualify through a means test, these monies would go towards funding those who were not able to pay into the plan during their lifetime but are drawing on this benefit. The taxpayer (or participant) would then have the opportunity to fund the defined contribution portion of the plan up to a certain maximum. Again, these dollars would be placed into an actual account which would report a future annuity amount to begin at retirement and terminate at the participant's death. A cash value would exist with this plan during the lifetime of the participant which benefactors would receive at death. In order to incentivize individuals, these dollars would go in pre-tax and would come out tax free, hence the need to set caps on contributions. Our current mismanaged social security system isn't providing the minimum which citizens need in order to provide for survival during retirement. Instead the system is setup to augment a lifestyle. If you remove the entitlement which the system has set in the minds of participants, I feel the system could become sustainable. The phase-in of such a system would be complex and would require political leaders to grow some gonads and have the courage to stand up to their constituents and enact real and meaningful reform.
My understanding of a Ponzi scheme is that it is not a closed loop--that the scheme works by constantly bringing in new people to repay the earlier people. I think your economist friend missed that. What you quoted from your self as the main differences on the bottom are important. The force involved is very important. Without force, social security would have already fallen apart like all other Ponzi schemes. If you removed force, I and millions of others would immediately stop paying into the scheme. Like most other government programs, it's force that gives it legs where a private program like it would have failed a long time ago. I wish I weren't forced.
Maybe we should reframe the question to ask "Is Social Security performing as it was intended to do?" Roosevelt intended for tne program to be self supporting, with no use of general revenues. That has been the case for current beneficiaries, who get paid from current payroll taxes. It is the future beneficiaroes who have to use the trust fund who are being paid with general revenues, not payroll taxes. Actually, the future is here, in that the trust fund is already being utilized, in that current payroll taxes are less than what is being paid out to current beneficiarioes. Social Security is completely pay-as-you-go. Without a reserve for future beneficiaries, it may not be considered a ponzi scheme, but it is a dangerous way to run an insurance program that was intended to be self supporting. Don Levit
I suggest that you and John Seater bet on which of these two systems will require a default first:
1. The U.S. Federal government's system of issuing bonds to finance its deficits.
2. China's national government's system of using people's deposits into state banks to finance its deficits.
If John Seater is right, then the Chinese system will collapse first. If you are right, then the American system will collapse first.
Indeed one can argue that the American system may collapse as soon as August 2, 2011, and therefore the bet doesn't make any sense. Sorry, too late to change history.
The purpose is to ignore the rhetoric of what a Ponzi game is and to focus on both the high levels of government spending and the costly financing of this spending. FYI, the relevant level of government spending is much higher in China than in the U.S., but most likely the Chinese government owns a much larger amount of marketable assets than the American government. Remember that the beauty of a Ponzi game is how little everyone (including Ponzi) knows about when it will collapse.
I agree with you David. When I read his quotation I thought, "It's just an issue of timing."
Is the Defense Department a Ponzi scheme?
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