Tuesday, September 13, 2011

Is Social Security Worse Than A Ponzi Scheme?

Since Rick Perry declared Social Security to be a Ponzi scheme, much debate has erupted, with some pointing out that even such SS supporters as Paul Samuelson (in 1967) and Paul Krugman (in 1996) described it as a "Ponzi scheme that works." See for more detailed discussion. Samuelson said that "The beauty of social insurance is that it is actuarially unsound," and then argued that it was OK to promise current workers more after they retired than they were paying in due to the high growth rate of the economy and the growing population. As all that slowed down, the system was adjusted in 1983 to have people pay in more and retire later, thus putting off the date of "unsustainability." The argument that SS is a Ponzi scheme is based on the fact that current recipients are past payers and rely on new recruits to pay, which was a part of the original scheme by Charles (Carlo) Ponzi in 1919-20, although varying in an important way from Social Security.

Now, it has come to pass that while I have not actually seen any blogposts on this, some on Facebook who do blog, such as libertarian Steve Horwitz, are declaring that not only is SS like a Ponzi scheme, it is actually worse than one due to being mandatory. Even though participants in Ponzi schemes are being defrauded with phoney information, they participate voluntarily (and in the case of the original scheme got their money back plus 50% if they moved fast enough). That SS is not voluntary thus supposedly makes it worse, given that supposedly people are being deceived about its "true nature," although anyone is free to ignore the rantings of various politicians and read the Social Security Administration Trustee reports, which are not at all fraudulent, even if they are not always all that easy to understand. Is there anything to this?

I think it may be worth revisiting the original Ponzi scheme to understand crucial differences, with some similarities. The main one is indeed that future current people pay in and then they receive benefits paid in by later payers. That it is mandatory is what guarantees that there will be payments in the future, even if some of this must be adjusted from time to time as growth rates and so on may change. Otherwise it is different, and not just because of the lack of fraud, even though people are amazingly ignorant about the nature of SS, including many young people believing that if the system goes "bankrupt," they will get nothing, whereas according to the mainline projection by the SSA, such a bankruptcy would lead to recipients in 2037 receiving on the order of 120% more in real terms than current recipients, a fact known to very few people apparently.

The key to Ponzi's original scheme was that there was no ongoing source of income beyond the upfront contributions of new recruits (who were promised 50% returns within 90 days). Ponzi claimed he was making the money in arbitraging foreign currencies, but he never engaged in a single such transaction (although he did buy two firms with the money). Once people put money in, they put no more in, and could only get money from new recruits joining. In the case of SS, it is not just some upfront payment that people make and then sit back to receive. They keep on paying in through the taxes, even if this is mandatory. But then all taxes are mandatory.

In fact, Social Security really is best described as "social insurance," the term first used by von Bismarck when he first proposed it in Germany in 1881 and used by FDR when he proposed it in 1935. Yes, it has some differences with private insurance, and is at least partly a welfare plan for old people dressed up to make it look like an investment, but it does indeed serve the insurance function of guaranteeing people against falling below a certain income level when they are old.

Indeed, this is worth keeping in mind when people start going on about how its returns are not as good as other investments (maybe), an issue in some sense aggravated by Samuelson's old remarks from a different era, when in fact there were positive returns for one paying in (at least on average, obviously depending on how long one lived). In private insurance one does not expect on average to earn a positive return, which is how private insurers make a profit. Some make a positive return, but most do not. They are paying for peace of mind, and that is what one is getting from Social Security.

In any case, the discourse on this topic has become severely degraded. I hope that this can be overcome in the near future, and that people can be better informed about what really is going on with the system.


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