Charlie Bulman
In recent weeks, Democratic and Republican presidential candidates have wrestled with how to put Social Security back on solid financial footing. The program is currently paying out more in benefits than it collects in revenue, making up the difference by drawing from the Social Security trust fund. But the trust fund is projected to be exhausted by 2035, which would trigger a 24 percent cut to benefits if Congress took no additional action.
Despite the program’s current shortfalls, Sen. Bernie Sanders (I–Vt.) has proposed expanding benefits and paying for the more generous allocations by lifting the current cap on income subject to Social Security taxes. On the Republican side, New Jersey Gov. Chris Christie has suggested trimming benefits for retirees making more than $80,000 a year and eliminating benefits entirely for workers earning $200,000 or more. And other Republicans have supported raising the retirement age, the earliest age retirees can begin collecting Social Security checks without seeing reduced benefits.
The debate is nowhere near as explosive as in 2011, when then Texas Gov. Rick Perry claimed that Social Security is a “Ponzi scheme.” Perry was lambasted for tarnishing a program that has widely been credited with keeping millions of American seniors out of poverty. But was his claim that off the mark?
In a traditional Ponzi scheme, the architect of the scam recruits investors with the promise of large returns on their contributions. But instead of investing the money, they pocket the cash for themselves. A second larger round of investors is then recruited, with their money being used to return the first investors’ contributions, plus the promised returns. The profits delivered to the initial investors lure even more contributions, and the pattern continues until the individual behind the scheme can no longer find enough new investors to pay off previous contributors. At that point, the scheme collapses.
Upon closer inspection, Social Security resembles a Ponzi scheme in a number of critical ways. Retirees do not receive payments from assets purchased with their previous contributions. Instead, Social Security is structured as a pay-as-you-go program, meaning payroll taxes are immediately used to pay current retirees benefits.
The initial “investors” in Social Security, who paid into the system for a few years before receiving guaranteed minimum benefits for the remainder of their lives, came away with windfall profits. Ida May Fuller, the first recipient of Social Security, paid $22.54 in Social Security taxes and collected $22,888.92 over the course of her life.
But, like a Ponzi scheme, Social Security can only pay current beneficiaries by recruiting new workers to pay into the system. As the ratio of retirees to workers continued to climb, taxes paid by later workers were repeatedly raised to meet existing guarantees, resulting in lower returns for later participants who received less in benefits per dollar in taxes paid. Because of the demographic trends that have taken shape over the past century, the structure of the program is increasingly unattractive to younger workers, who now see smaller returns than what their investment could earn in the private market.
Diverting a portion of workers payroll taxes to private investment accounts wouldn’t solve Social Security’s near-term financial problems, but such an arrangement could generate significantly higher returns for future generations.
A study by Michael Tanner of the Cato Institute compared the Social Security benefits received by three individuals who had began working in 1965 and retired in 2011 to the returns they would have received had their payroll taxes been invested in the private market. For low, medium and high income workers, investment in either low-, medium- or high-risk portfolios yielded greater returns than if the worker had paid in to Social Security. Remarkably, private investment remained a better option even if the worker cashed out his or her securities when the stock market bottomed out after the 2008 financial crisis.
Unlike Social Security, investment accounts would allow workers in future generations to garner significant returns on their income and reliably secure their retirement. While steps must be taken to deliver on the promises made to current beneficiaries and middle-aged workers, simply tinkering with Social Security and locking younger workers into a broken system is not the answer. For our generation and those to come, the Ponzi-like structure of Social Security must be wholly replaced.