Ponzi to Perry: The Truth About Social Security

AEI economist Andrew Biggs (formerly principal deputy commissioner of Social Security) writes in the American.com (emphasis added): 

"What makes the Social Security/Ponzi references so common is the similarity in the way they are financed. In both cases, early participants receive payments, not from interest on their own investments, but directly from inflows from later participants. If you were describing the mechanics of how Social Security’s financing works, it wouldn’t be illogical to refer to a Ponzi scheme. 

And, also like a Ponzi scheme, Social Security paid early participants incredible returns on their money, because they contributed to the system for only a few years but received a full retirement’s worth of benefits. A person who retired in 1950 received around a 20 percent annual return on the taxes he paid (which happens to be exactly the same return that Madoff promised to his investors). Put another way, that person received around 12 times more in benefits than he’d paid in taxes. That helps explain why Social Security became so popular: it was simply an incredibly good deal. 

Similarly, like a Ponzi scheme, there really isn’t any actual investment going on with Social Security. While the trust fund has a $2.5 trillion balance it can call on to pay benefits, this fund won’t be of any help to the taxpayer. When Social Security goes to redeem bonds in the trust fund, the Treasury must raise taxes, cut other programs, or borrow the money—exactly the same steps as if there weren’t a trust fund at all. The trust fund records how much we have borrowed from Social Security but, as the Congressional Budget Office points out, “trust fund balances convey little information about the extent to which the federal government has prepared for future financial burdens.” While legally important, the CBO says, the trust fund has “little economic meaning.” 

The biggest difference may be that Social Security can go on forever while a Ponzi scheme can’t, but that’s mostly because Social Security can force you to participate. If Madoff could find enough people willing to accept a 2 percent return rather than a 20 percent return, his plan could keep going indefinitely. With Social Security participation mandated, the program can go on forever, so as long as Congress makes the changes necessary to keep the system from going broke. 

Which, in the end, is what Perry and the other presidential candidates—including President Obama, I might add—should be talking about. Whether Social Security was constitutional and whether its pay-as-you-go financing structure is optimal, we’ve got what we’ve got. A differently designed Social Security system in 1935 might have produced better outcomes today and in the future, but we can’t turn back the clock. We have to deal with the system we have and figure out how to make it solvent and how to make it work better in the future. Instead of arguing about what’s wrong with Social Security, we should be thinking about how to put things right. (For my part, I put together this proposal.)"