If you follow politics at all, you probably hear this Ponzi scheme label come up from time-to-time. Conservatives use it to criticize the Social Security system and liberals mention it to note the apparent unseriousness of the conservative position. Most recently, we saw Hillary Clinton deploy this tactic in her closing remarks at Saturday’s Democratic debate:
Social Security, which Republicans call a Ponzi scheme, may face privatization.
It’s pretty transparent what’s going on here. By noting the Republicans’ seemingly hyperbolic position on the subject, one can dismiss any criticism as just the usual partisan bickering. But given that the Social Security system is currently unsustainable, this is a subject that needs criticism and debate. And since most people are probably intrinsically opposed to Ponzi schemes (or virtually anything described as a scheme, for that matter), it’s worth asking the question:
Is Social Security a Ponzi scheme?
Of course, to answer this, we must begin by defining precisely what a Ponzi scheme is. For the uninitiated, Ponzi schemes refer a general type of fraudulent investment management setup. The most famous of these recently was the Bernie Madoff scandal. The details of the schemes can vary somewhat, but here are a few of the essential characteristics as described by Wikipedia:
- Returns – The investors are promised unusually high returns
- Source of returns – Old investors get paid out using money invested by the new investors. That is, instead of making a return on profitable investments, there is simply a redistribution of money from new investors to the older investors.
- Misleading financials – To keep up appearances, false financial statements are generated and shared with the investors.
- Cause of failure – If there aren’t enough new investors coming in, the scheme falls apart, and all remaining investors in the fund realize their money is gone.
- Returns – The taxpayers are promised an income that is sufficient to support them indefinitely after they retire.
- Source of returns – The old taxpayers’ income is provided almost exclusively out of payments collected from new taxpayers.
- Misleading financials – The government doesn’t apply the same kind of accounting logic that companies have to when accounting for future liabilities. That is to say, if General Motors accounted for its pension liabilities in the same way the government accounts for Social Security pensions, their CFO would be guilty of defrauding investors. As a result of these unique accounting practices, the national debt figures that usually get cited are deeply misleading.
- Cause of failure – As more and more Baby Boomers reach retirement and start withdrawing money from the system, there aren’t enough new workers to finance them at current tax rates.