Wednesday, September 14, 2011

Social Security is a Ponzi Scheme?

Monday night’s Tea Party debate featured discussion about Social Security as a Ponzi scheme. Over the past several days this conversation has garnered an increasing amount of blog space. Given the extensive attention currently being paid to this topic and potential that it continues through next year's election, I decided to offer my own thoughts.

Before outlining my view, I think it’s important to clarify the criteria being considered to determine a Ponzi scheme. The following is directly from the SEC’s website:
“A Ponzi scheme is an investment fraud that involves the payment of purported returns to existing investors from funds contributed by new investors. Ponzi scheme organizers often solicit new investors by promising to invest funds in opportunities claimed to generate high returns with little or no risk. In many Ponzi schemes, the fraudsters focus on attracting new money to make promised payments to earlier-stage investors and to use for personal expenses, instead of engaging in any legitimate investment activity.”
While I believe this definition should be used as the basis for discussion, recent commentary suggests various other definitions are being considered. If that is the case, I’d urge politicians and others offering opinions to clarify their definition. Without knowing the basis for comparison, it is difficult to judge the merit of their views. However, since alternative definitions have not been provided, the one noted above will serve as the standard for my argument.

Although I disagree with the opinion that Social Security is a Ponzi scheme, acknowledging why some may make that argument will aid in debunking the theory. The basic design of Social Security provides benefit payments to older, retired individuals that are largely funded from payroll tax revenues paid by younger, income earning individuals. When the baby-boom generation entered the work force, yearly payroll tax revenues greatly exceeded Social Security benefit expenses and a trust fund was created to “hold” the surplus funds while accruing interest. Now, as the baby-boom generation retires and starts collecting benefits, payments have begun exceeding revenues. Based on demographics, these yearly deficits will continue to widen, ultimately exhausting the trust fund. Since payroll taxes will no longer cover all benefit payments, the expectation is that Social Security cannot fulfill its current promises. Whether or not one deems this outcome to be fraud, I believe this scenario leads many to believe Social Security is a Ponzi scheme.

Having established a basic premise for calling Social Security a Ponzi scheme, the deficiencies of that argument can be set forth. In the above scenario, an assumption is made that when the trust fund is exhausted, Social Security will be unable to pay promised benefits in full. A critical error within this assumption is the apparent view that Social Security is a stand alone program, not incorporated within the federal government’s budget. To some this may seem an inconsequential difference, however this small fact is crucial to determining the eventual solvency of the program.

The US government is a currency issuer, which means that under the current monetary system, the government can never run out of dollars. Ponzi schemes ultimately fail when a sufficient amount of new funds can not be obtained to repay all investment "returns" and withdrawals. With Social Security, when payroll taxes are no longer sufficient to provide the entirety of earned benefits, the government is required to supply the difference. Since the government never has to borrow funds in order to spend, regardless of tax revenue, Social Security benefits can always be paid in full.

As long as the US government remains a currency issuer, claims that Social Security is a Ponzi scheme are as foolish as comparing the solvency of the US government to either Greece or households. Apart from self-imposed constraints, the US federal government can always repay debt denominated in dollars, including future Social Security benefits. The one crux of this argument is that excessive money printing (deficit spending) can create inflation during periods of near full-employment. Stemming from this issue, the true question regarding Social Security and all government expenditures is whether tax levels are appropriate for the chosen size of government.

Social Security benefits can be provided indefinitely and therefore suggestions that the system is a Ponzi scheme are misunderstandings, at best, or at worst, intentional misrepresentations. Too much recent time and effort has been directed at worrying about deficits, both current and future. Our nation would be better served to focus on current problems of excessive private debt and longer-term concerns about the desired size of government. Hopefully our leaders will direct their attention and the nation’s to these problems in the days ahead.

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