Is Social Security a Ponzi-Scheme?
If you’ve travelled in enough libertarian circles you’ve probably heard someone say that Social Security is a Ponzi-Scheme. Well, considering how much of the future projected expenditures for the U.S. Federal Government is Social Security payments, it’s probably worthwhile to examine these claims.
So first, we need to understand what a Ponzi-Scheme is.
It got its name from an Italian Immigrant named Charles Ponzi, who spent four years at the University of Rome, where he drank and gambled all his money away and left without a degree. Being broke, he took what was left of his savings and immigrated to the United States in 1903. Some suspect that he was actually fleeing Italian Police for some crime he committed in an attempt to get rich. He bounced back and forth between the United States and Canada for a number of years, trying numerous get rich quick schemes, which landed him in jail in both countries.
It was in 1919 that he found the scheme that would eventually bear his name. His plan was to buy International Reply Coupons, which are a special type of coupon for buying stamps. You buy one of these coupons in one country, and in another country you can exchange this coupon for the equivalent amount of stamps. Ponzi’s idea was that he would buy a bunch of these coupons in Italy, where inflation after World War One had made IRCs incredibly cheap in US dollars, and exchange them in the U.S. stamps that could be sold below their printed value, and still make large profits. Ponzi wanted to get a loan to fund this operation, but there weren’t any banks willing to put money into it. In order to get the money he started a Stock Company, where he raised funds by promising people a big return on investments in a short period of time.
Initially there were high profits to be made. And as more and more profits were made more people began investing in his company. However, these profits were coming from investors, and not the IRCs. He used connections back in Italy to buy IRCs, but getting them back to the U.S., exchanging them for stamps, and selling those stamps was going to cost more than the stamps were worth. Journalists got suspicious of Ponzi’s company and began investigating, and publishing articles questioning how such large profits could be made legally through the IRC scheme. These stories caused investors to panic and cash out 2 million dollars. This sudden transfer of funds forced law enforcement to look into his books, which resulted in Ponzi being arrested, and the financial ruin of at least 5 banks, and the many investors.
Structurally, a Ponzi-Scheme works like this.
You have a person, or perhaps a company. They offer high profits in a short period of time in exchange for your investment. The first group of people invest their money. The Schemers then get more people to invest money, which he uses to pay off the original investors, some of whom decide to reinvest. That money, plus money from a new round of investors pays off the second round of people. This scheme can keep going so long as they maintain a certain level of cash-flow. If the cash-flow gets too low people can’t be paid back, and if people can’t get paid back authorities get suspicious, investigate the company, and uncover there is no actual investing going on. That’s a key part for something to be considered a Ponzi-Scheme, there must not be any actual investing occurring on the schemer’s part.
So then, how well does Social Security fit into the Ponzi-Scheme model? To figure that out, we need to understand how Social Security works.
I’ld give you the history of Social Security, but I’m planning on doing that in a future video. The short version is, it was started in the 1930s during the Great Depression as Part of the New Deal. All workers, except for a few segments that were politically connected were required to join. If you are an adult who isn’t getting paid under the table, then you pay a tax on every paycheck that goes to social security, which is supposed to help subsidize your retirement or unemployment.
Social Security is often portrayed as a kind of bank account that you deposit into throughout your working life, and then withdraw from when you’re older and unable to work. However, that’s not exactly how it works. The money collected from Social Security Taxes are paid to a Trust Fund managed by the U.S. treasury. This fund then pays out current Social Security beneficiaries with current revenues. Whenever more is collected in revenue then there are expenses, the Trust Fund is required to purchase a special government bond that is not re-sellable. This procedure is why a majority of the U.S. national debt is owned by other parts of the Federal Government, of which the Social Security Trust Fund is one of the largest holders. The mechanics of how Social Security work are intertwined with how the national debt works, which has many, especially more libertarian leaning people worried.
When Social Security was started there were 159 people paying into the program for every one person receiving benefits. As of 2013 there are only 2.8 people paying into it for every person receiving benefits. This is probably the biggest argument for Social Security being a Ponzi-Scheme. When you look at the payout and investing, the number of people paying in is getting smaller, while the number of people being paid out is getting larger. And by their own estimates, the Social Security Trust fund will begin paying out more than they take in by 2029. This funding structure leads many people to label Social Security a Ponzi-Scheme.
Now, does this make Social Security a Ponzi-Scheme? Strictly speaking, no. As I mentioned earlier, in order for something to qualify as a Ponzi-Scheme the entirety of its payouts must be made from payments made by other investors. The Social Security Trust Fund is not just funded by the taxes we pay into it, it also receives revenue from Government Bonds. This one factor makes Social Security not fit the definition of a Ponzi-Scheme, however you could argue that this is still technically a Ponzi-Scheme because those government bonds are repaid to Social Security with tax dollars that the same Social Security investors pay the government. This is a complex funding mechanism, and it doesn’t even cover the problem that is the U.S. National Debt. If you want to know more about how the National Debt could complicate the Social Security payments and other operations I have a playlist of videos you can watch about that by clicking the “I” in the upper right hand corner.
There is one other big difference between a Ponzi-Scheme and Social Security. A Ponzi-Scheme is voluntary, while Social Security isn’t. You can’t fall victim to a Ponzi-Scheme unless you voluntarily invest money in it. Sure, someone could coerce you into investing in a Ponzi-Scheme, but at that point it kind of ceases to be a Ponzi-Scheme and just becomes extortion. Social Security on the other hand is mandatory. There are very few ways to get out of the program that don’t involve never getting an over the table job. And when looking at the payment structures for both a Ponzi-Scheme and Social Security, the reason a Ponzi-Scheme eventually falls through is because you don’t have enough investors. Social Security has only lasted as long as it has because it is involuntary. Everyone pays into it regardless of whether or not you ever get paid by it.
At this point I could very easily turn this video into a fear stoking mini-documentary about the instability of current government expenditures, but that’s a video for another day.
So, is Social Security a Ponzi-Scheme? By the strictest of definitions, no. But it has the same structural flaws as a Ponzi-Scheme, which should be just as concerning.
Payers to Beneficiaries Ratio
2029 Viability Estimate