Is Social Security a Ponzi Scheme?

The following is a guest post from YFS from YourFinancesSimplified.com. Enjoy!

Yes, this might be a bit drastic, but people have asked this question before.

Most recently, Rick Perry, the governor of Texas claimed that this is indeed the case at the Republican Debate.  Is there some grain of truth to this controversial claim, or was Perry simply gunning for attention by being controversial? We’ll try to obtain an answer to this question in today’s post.

What is a Ponzi Scheme?

By definition, a Ponzi scheme is a form of fraud. People are brought into a Ponzi scheme with the promise of high returns as a result of small investments. These schemes have to have a lot of people to work, and the head of the scheme works to recruit many people. In the end, the group or organization running the scheme is not profiting from actually doing anything, and they use the payments from new investors to pay earlier investors.

Often, the later investors never actually receive money; they simply receive payment records that detail how much they are supposedly earning. Eventually, these schemes always collapse because eventually, investors pull out or the amount needed to pay earlier investors is higher than the amounts being newly invested. Sometimes, the person or group in charge of the scheme simply disappears with all the money.

Perry’s Claim of Social Security Being a Ponzi Scheme

Perry is relating the government to the person in charge of the scheme who is simply going to “take the money and run,” like Bernie Madoff.

However, Social Security was never designed to be a form of fraud, and that is one of the main differences between the two systems. Everyone knows exactly what they are paying into. When you pay Social Security taxes, you expect to be able to draw on that money when you are eligible, and you expect that other able workers will pay into it like you did.

Social Security is a pay-as-you-go system.  You pay money now to get money later.  The fact that Ponzi schemes and pay-as-you-go programs (like Social Security) both utilize money from later participants to pay the benefits to earlier participants is the reason why many people compare Social Security to a Ponzi scheme.  But, that is where the similarity ends.

The State of Social Security

The strain on the system now is the massive efflux of Baby boomer retirees and the high unemployment rate. This means that there are a lot of people drawing on Social Security’s reserves, but there are not enough people paying into the system. Currently, the government is paying out everyone’s benefits. There are fears that in the near future, about 25 years from now, that the government will not be able to pay every retired individual who is eligible for Social Security benefits. The fact that people are living longer lives is also putting a strain on the system.

Without change, Social Security will collapse. In this way, it is exactly like a Ponzi scheme. It has become so large that it is untenable. However, this can be remedied, though that does not mean that we are going to like it. There are a few ways to make Social Security work. First, payroll taxes could be increased, and with that, more money will go into Social Security. Additionally, the amount of benefits that seniors currently receive might be decreased, and the age at which they can receive them will certainly increase.

Returning to Perry’s statement, it is likely that he was being controversial for attention. Social Security will not collapse like a Ponzi scheme, and it is not a fraud. Social Security will change, and whoever receives the added burden will complain, but once we reach 67 or 70 or whatever the required age ends up being, we will all be glad to receive our Social Security benefits.

How about you all? What are your thoughts on Social Security?  Do you agree or disagree with Rick Perry’s view of Social Security being a Ponzi Scheme? How much longer do you think Social Security will be around?

 
Jacob’s Thoughts – Listed below are my random thoughts as I was reading this article.

  • Thanks so much for sharing this guest post, YFS! I’m always happy to have a fellow Yakezie participant do a guest post, especially one on a topic as important as Social Security!
  • Personally, I think that calling Social Security a full-blow Ponzi scheme is not quite fair and a little bit of stretch. After all, Ponzi schemes are illegal (fraud) and Social Security is not, as you mentioned above.
  • However, I won’t deny that Social Security does have some of the same characteristics, or flavor if you will, of a Ponzi scheme/pyramid scam.
    • It would actually be quite interesting to hear some of the considerations and debates in Congress when Social Security was just being formed. I wonder if they really knew what they were getting in to committing for years to come to a huge government program like this.
  • Regardless of what we label Social Security, the fact of the matter is that the United States government and people are stuck with it, as many people rely on this today for supplemented living (a few of my relatives in fact).
  • As such, the more important questions I ask are 1) how can we improve Social Security, if at all? and 2) will it be around when future generations (mine, for example) retire? Or, will the funds be totally depleted? Let’s take a look at these questions one at a time.
    • Regarding ways to improve Social Security, I have not analyzed this nor do I know enough about the workings of the program to offer suggestions. However, I did read a post this past summer from Ashley @ Money Talks that discussed an interesting idea of privatizing Social Security. It’s quite an idea, and definitely worth the read!
    • Regarding the second question about whether or not Social Security will still be around when future generations retire, I believe that it will be in some limited form. However, I would strongly encourage against depending on Social Security money for retirement living needs. Instead, invest regularly in a Roth IRA and 401k.
  • Another common question that I wonder is this – Are the ever-popular “network marketing” (often called Multi-Level Marketing, or MLM) programs Ponzi schemes and/or pyramid scams? 
    • Some of these common programs include Empowerism, 4Life, Avon, and Amway.
    • Truthfully, it’s somewhat of a legal masterpiece the way these opportunities are set up. The way it works is listed below:
      • The business offers products for sale (makeup, skin cream, vitamins, etc).
      •  The company does not have to pay any full time sales reps, but instead offers the product sales “business opportunity” to individuals looking to earn a part time salary.
      • However, on top of selling the normal company products, the part-time sales people can recruit others to work in their “network” or “team.” The existing sales person earns money whenever new people enter in to their network. So, new money is funding the people already in the organization, similar to a Ponzi scheme.
    • To me, the way these programs are set up seems a little “hairy.” However, they have time and time again been proven 100% legal by the court system, since the sales reps also offer real products for sale.
    • What’s my problem with this, though? The problem I have is that in my experience (I’ve tried Empowerism and 4Life back when I was younger and nieve) and from what I’ve heard from others who have used network marketing, it’s nearly impossible to sell the actual products through these programs. Instead, most people make money on the programs through promoting the business opportunity.
    • So, I ask you all – do you think network marketing programs are pyramid scams? I’ll let you make up your own minds.