The answer, for the umpteen-thousandth time: It’s not! Here’s why.
The Ponzi metaphor is back with a vengeance. Minnesota Gov. Tim Pawlenty, snatching hard at the “Republican presidential hopeful” tag, last month posted an op-ed on Politico.com in which he accused the entire federal government of being a “Ponzi scheme on the Potomac.”
But of course the current round of joking goes back to late 2008, when Bernard L. Madoff’s high-wire fraud, probably the largest and most sustained Ponzi scheme in history, collapsed.
“Put Madoff in charge of Social Security,” the Wall Street Journal’s Holman Jenkins jeered at the time. Syndicated cartoonist Chip Bok ran a panel showing a glum Madoff being led before the SEC by a guard who tells the commissioners, “He ran out of new investors to pay off his old investors.” One of the latter responds, “Madoff ran Social Security too?”
The Ponzi epithet for Social Security originated in a 1967 Newsweek column by Paul Samuelson, the eminent economist and author of the benchmark college textbook in his field. “The beauty about social insurance,” he wrote, “is that it is actuarially unsound. Everyone who reaches retirement age is given benefit privileges that far exceed anything he has paid in. And exceed his payments by more than ten times as much (or five times, counting in employer payments)!” The mechanism worked, according to Samuelson, because “there are always more youths than old folks in a growing population…. A growing nation is the greatest Ponzi scheme ever contrived. And that is a fact, not a paradox.”
Samuelson was speaking with tongue in cheek, not implying that Social Security was either a criminal enterprise or a misuse of participants’ contributions. He was only making the point that it was a system of generational transfers, with each wave of recipients deriving their benefits – most of their benefits, anyway – from the contributions of the current generation of active workers. And it was true that most of what the IRS collected every year in payroll taxes went directly to pay for the benefits of current retirees. Only what was left over went into the Social Security trust fund.
But with his Ponzi analogy, Samuelson handed Social Security’s critics a metaphor that refuses to die. A Ponzi scheme relies on successive waves of believers to maintain the flow of funds until there are either no more potential participants or the scam is found out and the good faith that fueled it thereupon dries up. Social Security “is akin to an inter-generational chain letter,” conservative economist John Shoven once said. “If today’s system could stay in place, today’s adults would get $11 trillion more from Social Security than what they will pay in from now on.”
But the analogy doesn’t hold. First, there’s nothing illegal or especially Ponzi-like about paying benefits out of money raised from new investors. Large companies with sound financial reputations routinely pay dividends even while they’re raising money by selling new shares. Second, Ponzi schemes don’t last long. Charles Ponzi’s 1919 pyramid was designed to generate returns extraordinarily rapidly. The returns were the fruit of an investment strategy that couldn’t be verified by anyone but Ponzi himself and that eventually turned out to be nonexistent. Even Madoff’s scheme only lasted a bit more than 20 years before a market slump sunk it in a wave of withdrawals.
Social Security has a quite different profile: benefits accumulate slowly, over lifetimes of participation. While some of current workers’ contributions go to pay retirees, the rest are invested in Treasury bonds, which is another way of saying they are invested in the federal government. Expectations of future benefits from Social Security are essentially a bet on the future growth of federal revenues, from payroll taxes and any other receipts Congress may decide to use to fund the program in years to come.
This in turn is a bet on Washington’s ability – through its expenditures on vital services such as infrastructure, research, education, and public health – to keep the economy growing and becoming more productive over time, which in turn helps keep those tax revenues rising. Unlike Ponzi’s scam, none of this is secret; it’s all completely transparent.
Its track record is also very easy to check. Over the past 200 years, federal revenues has grown to the point where the United States government is one of the largest enterprises of any kind in the world, with one of the best credit ratings.
Looked at this way, Social Security payroll taxes are a good and safe investment, even in today’s wretched economy. Ponzi’s scam, which pledged investors an unheard-of 50% return over just 45 days and then in perpetuity, had little or nothing in common with a program that promises to pay a modest benefit to each generation out of payroll taxes paid in over decades by current workers, their children, and their children’s children. The one was based on chutzpah and flim-flam. The other is based on reasonably plausible notions of how GDP, population, and other factors are likely to evolve over time.
Of course, the real point of the Ponzi scheme analogy isn’t to accuse the creators of Social Security of a literal crime or scam, but of having granted a huge, unfair windfall to the first generations of retirees under the program. “Policymakers have been able to give away $11.4 trillion in unearned benefits to the windfall generations,” Shoven and Sylvester J. Schieber wrote in their 1999 anti-Social Security study, The Real Deal. “Now they are going to have to start taking some of it back from those born after 1937.”
But how outrageous is this, really? Another way to look at what Schieber and Shoven denounce as a “giveaway” is that it merely institutionalized a benefits system that had already existed informally. Previous generations of workers and their families had taken care of their elderly and infirm relatives out of their own pockets; Social Security translated this system into a funded government program with a far wider base of support, without changing its intergenerational nature. If the first generations of retirees under the program had received no benefits, they would have been deprived of support they had earned by caring for their own aged parents and bringing up their children who were now paying payroll taxes.
Besides, it’s hard to imagine how any pension scheme – public or private – could gain political acceptance in the first place if the initial cohorts of retirees received very little from the program. As for the debt those first generations passed on to us, another name for it is Treasury bonds: which the vast majority of their recipients would regard as an addition to their personal wealth rather than a burden.
Or would someone care to argue that Alexander Hamilton, the father of the U.S. Treasury bond market, was the moral equivalent of Charles Ponzi?