When I shared my thoughts on Social Security being akin to a Ponzi scheme on March 11, I certainly didn’t anticipate the level of engagement it would spark. This discourse has inevitably led to a broader conversation about our current predicament and the potential paths forward.
Thus, I’ve resolved to share the remainder of my chapter from The Joy of Freedom: An Economist’s Odyssey in segments. This upcoming section will touch on potential remedies for our plight.
Here’s the next installment.
Flawed from the Start
How did we find ourselves navigating this complex and precarious situation? The roots can be traced back to 1935 when President Franklin D. Roosevelt and Congress crafted Social Security as an intergenerational “chain letter.” This foundational characteristic essentially set the stage for a significant mess for generations to come. Interestingly, during the debates surrounding the proposal, the chain-letter nature was barely mentioned. Both Democratic and Republican politicians seemed unfazed by this crucial element of the plan. Initially, some supporters viewed the Social Security tax as merely a means to extend the income tax to those earning lower wages. W. R. Williamson, an actuarial consultant for the first Social Security Board, argued that Social Security was a way to make federal income taxes “democratically” accessible to lower-income brackets.[1]
Moreover, Roosevelt and Congress dismissed the Clark amendment, named after Missouri Senator Bennett Champ Clark, which proposed to exempt employers and employees with government-approved pension plans. Despite the Senate supporting the amendment with a 51 to 35 vote, it was ultimately discarded. Had this exemption been part of the law, the number of individuals participating in Social Security would have likely decreased, particularly as private pensions gained traction over the years.
Roosevelt was a staunch advocate for financing the program through payroll taxes. By branding these taxes as “contributions,” the federal government intended to instill a sense of ownership among citizens, leading them to believe they were entitled to benefits. This rationale drove FDR’s preference for a dedicated payroll tax over general revenues. He believed that if people saw their payroll taxes as a contribution towards their future benefits, they would feel entitled to claim them. As Roosevelt famously articulated,
“Those taxes were never a problem of economics. They are politics all the way through. We put those payroll contributions there so as to give the contributors a legal, moral, and political right to collect their pensions….With those taxes in there, no damn politician can ever scrap my Social Security program.”[2]
In essence, Roosevelt recognized that once the entitlement mentality took hold, dismantling or reducing Social Security would be a Herculean task. What he didn’t explicitly state—but what the chain-letter financing inherently suggested—was that older citizens would continuously lobby for sustained benefits, compelling politicians to impose ongoing taxes on the working populace, who, in turn, would expect similar treatment when they retired. This cycle of intergenerational fiscal dependency is the legacy of FDR’s design, which continues to haunt us today.
The situation worsened under Presidents Johnson and Nixon. Between 1967 and 1972, both the Congress and the President significantly increased Social Security benefits by 72 percent (a 37 percent rise after adjusting for inflation). When Wilbur Cohen, Johnson’s Secretary of Health, Education, and Welfare, suggested a modest 10 percent increase in benefits, Johnson quipped, “Come on, Wilbur, you can do better than that!”[3] Nixon, eager to outdo Cohen, engaged in a bidding war with Congressman Wilbur Mills, resulting in an additional 20 percent increase in benefits.
MIT economist Paul Samuelson provided some intellectual rationale for these policies, famously stating, “The beauty about social insurance is that it is actuarially [italics Samuelson’s] unsound.” His argument was that if real incomes were rising, each generation could expect a greater return from Social Security than they contributed. Critics have labeled Social Security a Ponzi scheme, but Samuelson was prescient enough to acknowledge it as such in 1967, asserting that “A growing nation is the greatest Ponzi game ever contrived.”[4]
Today, the cost of participating in this “well-crafted” Ponzi scheme is staggering. When accounting for employer contributions, over 62 percent of families now pay more in payroll taxes (primarily for Social Security) than they do in federal income taxes.[5]
Initially, the payroll tax rate was a modest 2 percent on the first $3,000 of income, shared equally between employer and employee. By 2001, this figure had escalated to 10.6 percent on income up to $80,400, with zero taxes levied on any income beyond that. This substantial increase in tax rates is not merely an inflation adjustment; the $3,000 threshold in 1938, when adjusted for inflation, amounts to less than $38,000 today—around half of the income base currently taxed. To illustrate, the maximum combined tax (from both employer and employee) now stands at $8,077, compared to just $60 when the program began. Had the tax merely kept pace with inflation without any additional increases, it would only amount to about $750 today. See Table 14.1.
Table 14.1 Maximum Tax for Social Security (excluding Disability Insurance)
| Calendar Year | Maximum Tax | Maximum Tax in 2000$ |
| 1939 | $60 | $735 |
| 1950 | $90 | $636 |
| 1955 | $168 | $1,066 |
| 1960 | $264 | $1,518 |
| 1965 | $324 | $1,750 |
| 1970 | $569 | $2,496 |
| 1975 | $1,234 | $3,902 |
| 1980 | $2,341 | $4,835 |
| 1985 | $4,118 | $6,512 |
| 1990 | $5,746 | $7,483 |
| 1995 | $6,438 | $7,187 |
| 1997 | $6,932 | $7,348 |
| 2001 | $8522 | $8,274 (estimated) |
Source: Tax rates and tax base from Social Security Board of Trustees Report, various issues; inflation adjustment from Economic Report of the President, various issues.
Ponzi versus Stocks
Critics of Social Security often argue that current retirees are reaping benefits at the expense of younger generations, and while there is some truth to this—youth indeed seems to be a disadvantage—many current retirees are also feeling the pinch. The core issue lies in the stark contrast between the returns from Social Security and those available in the stock market.
A 1987 study published in the National Tax Journal by Stanford economists Michael Boskin, Douglas Puffert, John Shoven, and Boston University economist Laurence Kotlikoff analyzed the returns on Social Security taxes[6]. The real rates of return ranged from minus 0.79 percent to 6.34 percent, heavily influenced by age (older individuals fared better), income level (lower earners benefited more), and marital status (married individuals with a non-working spouse had advantageous returns). Notably, even the highest earner in their study—born in 1915 and the sole breadwinner of a married couple earning $10,000 a year in 1985 dollars—achieved a return of 6.34 percent. However, all other income categories fared worse.
In a more recent analysis,[7] conducted by Harvard economist Martin Feldstein and Dartmouth economist Andrew Samwick, the average rates of return on Social Security taxes are illustrated in Table 14.2.
TABLE: Average Real Rate of Return on Social Security Taxes Paid
| Year of Birth | Pre-1915 | 1915 | 1930 | 1945 | 1960 | 1975 | 1990 |
| Real Rate of Return | 7.0% | 4.21% | 2.52% | 1.67% | 1.39% | 1.39% | 1.43 |
Source: Feldstein and Samwick, “The Transition Path in Privatizing Social Security,” National Bureau of Economic Research, Working Paper # 5761, September 1996.
When juxtaposed against stock market returns, these Social Security rates of return appear dismal. According to Ibbotson Associates, which tracks stock market performance, the average rate of return on stocks from 1926 (pre-crash) through 1997 was 11.0 percent, or an inflation-adjusted 7.7 percent. Over any 30-year stretch, the real return has never dipped below 4 percent. While shorter intervals can yield varied results, the overarching trend highlights that private investments in stocks outperform government-managed systems for those with long-term investment horizons. Of course, caution is warranted—one should not invest all savings in stocks if planning to withdraw within a decade, given market volatility.
Another revealing method of comparison looks at how Social Security taxes and benefits influence individual wealth. Economists typically undertake this analysis in three stages: first, they calculate the present value of all Social Security taxes paid by the individual and their employer, assuming those taxes accumulate compound interest until retirement age. Next, they estimate the present value of anticipated Social Security benefits at retirement, using the same interest rate applied to the taxes. Finally, they subtract the present value of taxes from that of the benefits.
The interest rate used for this evaluation is critical. A conservative estimate of 4 percent is justified, given that even during the worst 30-year period for stocks, returns exceeded this figure. Research conducted by Shawn Duffy, a student at the Naval Postgraduate School, calculated that someone born in 1929, who paid the maximum Social Security tax throughout their career and retired in 1994, would have been $120,000 wealthier with a private savings plan than relying on Social Security. An average wage earner would be $54,000 better off without Social Security, while even a retiree who earned minimum wage their entire working life would find themselves $9,000 ahead with a private savings strategy.[9] Under a more optimistic 6 percent real rate of return, the disparity widens: the maximum-earning retiree in 1994 would have lost $262,000 in wealth due to reliance on Social Security, with the average earner losing $160,000 and minimum-wage earners losing $66,000.
It’s worth noting that the earliest beneficiaries of Social Security enjoyed remarkable returns. This was primarily because they contributed for a mere few years, yet reaped substantial benefits over many years. Take, for instance, Miss Ida Mae Fuller, the first recipient of Social Security, who collected $20,000 in benefits after contributing only $22 in taxes. However, as the system matured and future beneficiaries began paying taxes over entire working lifetimes, the notion of a windfall for current and future retirees became an illusion.
[1] “26,000 in Brooklyn Defy Security Law,” New York Times, November 29, 1936, p. 37.
[2] From Arthur M. Schlesinger, Jr., The Age of Roosevelt, vol. 2, The Coming of the New Deal (Houghton Mifflin, 1959), pp. 309–310, referenced in Martha Derthick, Policymaking for Social Security, Washington, D.C.: Brookings Institution, 1979, p. 230.
[3] This anecdote is recounted in Peter G. Peterson, Will America Grow Up Before It Grows Old?, New York: Random House, 1996, pp. 93–99.
[4] Samuelson’s quotes are sourced from Newsweek, February 13, 1967, and cited in Derthick, p. 254.
[5] Referenced by Andrew Mitrusi and James Poterba, “The Distribution of Payroll and Income Tax Burdens, 1979-1999, National Bureau of Economic Research, Working Paper No. 7707, May 2000, p. 24.
[6] Boskin, Michael, Laurence Kotlikoff, Douglas Puffert, and John Shoven, “Social Security: A Financial Appraisal Across and Within Generations,” National Tax Journal 40, 1987, pp. 19–34.
[7] Martin Feldstein and Andrew Samwick, “The Transition Path in Privatizing Social Security,” National Bureau of Economic Research, Working Paper # 5761, September 1996, p. 20.
[8] My gratitude goes to Heather Fabian, public affairs manager at Ibbotson Associates, for providing the necessary computations.
[9] Shawn P. Duffy, Social Security: A Present Value Analysis of Old Age Survivors Insurance (OASI) Taxes and Benefits, Naval Postgraduate School, Masters Thesis, December 1995.
