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Social Security as Ponzi January 2, 2009

Posted by A Texan In Grad School in Economic Theories, Federal Debt.
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The recent Madoff scandal has brought renewed attention to the Ponzian nature of Social Security.  But, is Socially Security really a Ponzi scheme?  Michael Mandel at Business Week’s Economics Unbound says that because technology advances more than population does, Social Security is not a Ponzi scheme. The key to any debate is to define the terms.  So let’s look at the definition of Ponzi Scheme:

An investment swindle in which high profits are promised from fictitious sources and early investors are paid off with funds raised from later ones.

That’s according to The American Heritage Dictionary.  From this definition, it seems that Social Security is a Ponzi scheme.  Generation A pays in, then Generation B pays in while A receives, so on and so on.  But, interestingly I noticed that some dictionaries have a slightly tweaked definition of a Ponzi Scheme:

an investment swindle in which some early investors are paid off with money put up by later ones in order to encourage more and bigger risk

That’s from Merriam-Webster.  The intriguing part of this definition is the idea that a Ponzi scheme has the goal of encouraging more and bigger risk.  Who is taking these risks and what they are is ambiguous.  Social Security encourages some risks because people don’t feel as much a need to save for their own retirement because Uncle Sam will pay them to be old.  But I don’t think this is the kind of risk Merriam & Webster have in mind.  So, under this (I believe poor) definition, Social Security is not a Ponzi scheme.

But, ultimately what seperates Social Security from a Ponzi scheme is the ability of the government to always make good on its promises.  The government can always raise taxes or print more money.  The government could even stop forcing people to pay in to Social Security while still paying people.  Obviously this would have perverse effects on inflation and debt, but it’s possible.  Social Security does  not require that people pay in, so that it can pay out to others, at least in nominal terms.  Therefore Social Security is not a Ponzi scheme.  But, that isn’t exactly a good thing.

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