Recently, Alex Tabarrok published a thought-provoking piece at Marginal Revolution titled, “Is Social Security a Ponzi Scheme?” In a bold assertion, he concludes that it indeed resembles one.
This commentary echoed my own reflections on Social Security, which I elaborated upon in my 2001 book, The Joy of Freedom: An Economist’s Odyssey.
Let’s revisit the beginning of that chapter.
I propose we dismantle the existing [Social Security] framework and instead implement a scheme where individuals simply add their name to the bottom of a list, send money to the person at the top of the list, and then… Oh, wait, that IS our current system.
—Dave Barry, “Election could come down to who kisses most orifice,” Miami Herald, September 24, 2000
Back in 1991, a student of mine, Stephen Banus, reached out to the Social Security Administration for clarity regarding his contributions and anticipated benefits. In response, Gwendolyn King, then-commissioner of Social Security, assured him:
I want to assure you that Social Security is built on a sound financial foundation. Social Security benefits will be there when you need them.
A diligent planner, Banus made a similar inquiry in 1995, only to receive a markedly different response from the new commissioner, Shirley Chater:
The latest report of the Social Security Board of Trustees says the Social Security system can pay benefits for about 35 more years. This means there’s time for Congress to make the changes needed to safeguard the program’s financial future.
In a mere four years, the emphatic promise of benefits being available “when you need them” was tempered to a cautious “about 35 more years.” What transpired in that timeframe?
Essentially, the difference lay in the honesty of the officials involved. The reality is that Social Security has never been on a “sound financial foundation.” Contrary to the Social Security Administration’s optimistic rhetoric, a genuine trust fund does not exist. Approximately 80 percent of payroll taxes collected from current workers are directly funneled to current retirees, with minimal delay, while the government allocates the remainder elsewhere. The so-called trust fund merely consists of bonds issued by the government—a collection of IOUs that promise to pay but, in effect, are as substantial as promises made by a child about future chores.
Retirees from the early 1940s enjoyed generous benefits after only a few years of minimal tax contributions. However, as the system has matured, those who have been paying into Social Security their entire working lives are receiving significantly lower returns.
While an individual who orchestrated such a financial scheme would face incarceration—think Charles Ponzi, who was imprisoned in 1920 for his fraudulent promises—the government operates under a different set of rules. The first distinction between Ponzi’s scheme and Social Security is simply legality. The second is even more telling: the government has the power to compel compliance. Payroll taxes—labeled as “contributions” at a hefty 10.6 percent (with additional levies for disability and Medicare)—are mandatory. Attempts to evade these taxes can lead to severe repercussions, as demonstrated by Valentine Byler, an Amish farmer who faced the seizure of his horses for unpaid taxes in the 1960s.
Currently, officials claim the Social Security fund will remain solvent until 2037. What they mean, however, is that by that year, the last of the special federal bonds held in the “Trust” Fund will be liquidated. This transaction is essentially a mere shuffle of funds within government accounts; to pay these bonds, the Treasury will need to either issue new bonds, increase taxes, or cut spending elsewhere.
A more pressing date to monitor is when benefits begin to outstrip income from payroll taxes and bond interest—anticipated to occur in 2024, coinciding with the peak retirement phase of the baby boomer generation.
In the late 1990s, government actuaries warned that maintaining promised benefits would necessitate increasing the tax rate from its current level of 12.4 percent to over 18 percent. At an 18 percent tax rate, Social Security taxes could comprise approximately 7.5 percent of the overall GDP. However, since the 1950s, total federal revenues have fluctuated between 18 to 20 percent of GDP. If this trend continues, Social Security could consume a staggering 40 percent of total federal tax revenues, leaving a mere 60 percent for other essential services like Medicare, debt interest, and national defense. This scenario seems implausible, indicating that significant tax rate increases are unlikely. Consequently, future benefits may well fall short of what has been promised.
