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Social Security Ponzi Scheme: Really?


The US social security system has come under a lot of criticism.

Often the argument is that it is a kind of Ponzi scheme where the money from new investors is used to pay off the older investors.

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Technically, this is true about the social security system in some ways.

So the question that comes to our mind is that whether the US social security is really a Ponzi scheme?

If you track the growth of the social security system, you would realize that it has grown manifold from the initial phase.

Every expansion meant that the older investors needed to be paid off.

Along with that those who have already retired don’t have to pay any additional tax and those nearing retirement have to bear the tax burden just for a few more years.

But all of these people continued receiving benefits, increased ones as well and the burden of funding these fell entirely on the newer generation.

So in common terms, whatever we have understood about Ponzi scheme it would appear, that in many ways, the Social security system is confirming to these.

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Understanding a Social Security System

Social Security Ponzi SchemeBefore we delve deeper into the criticism about social security vs Ponzi scheme, it is very important to comprehend the basics of the Social Security system.

The US Social Security created in 1935 is primarily funded via employee payroll taxes.

It is also either known as the FICA or the Federal Insurance Contribution Act Tax.

All salaried employees barring a few exception are bound to pay this tax, and the extent of their contribution is pre-decided by the law.

It is also otherwise known as Self Employed Contributions Act Tax or the SECA.

These tax deposits are collected by the US revenue department, IRS and then handed over to the Federal Disability Insurance Trust Fund and Federal Old-Age and Survivors Insurance Trust.

These are the two US Social Security Trust Funds.

As per 2015 data, the total social security expenditure was close to $900 billion all inclusive.

In fact, this social security contribution is seen playing a major role in reducing the overall poverty rate Americans above 65 years to 10% from a whopping 40% earlier.

But then the question is whether the social security a Ponzi scheme?

Predominantly for those in favor of the argument take into account the investment methodology that the social security system follows to draw the similarities and hence the allegation.

Criticism Against Social Security System

Many people have said that the social security is a Ponzi scheme by a number of factors that are similar to the way a Ponzi scheme is run.

1. Money Not Invested

A significant part of the money that an average US citizen pays as social security is not invested anywhere.

The money is directly routed towards paying benefits to those citizens who are retiring or perhaps you can call the early investors in Ponzi scheme terminology.

2. High Returns

Essentially the subsequent generation is the next layer in the so called pyramid, and they bear the burden of paying for the benefits enjoyed by the previous generation.

It obviously comprises of a great scheme for those investors who got in really early, the older generation.

For example, there are many who paid less than $100 in Social Security taxes but enjoyed benefits exceeding $20,000.

This type of high returns was considered possible only in a Ponzi scheme.

But in a social security, it was made possible as the number of people who were retiring was far lesser than the total number of people who are paying the taxes.

3. Funds Drying Up

However, as the pyramid grows bigger, the claimants begin to expand and exert pressure on the existing system.

If you look at data, nearly 16 workers used to support every retiree, and by 2030, there will be just 2 who would be supporting every retiree.

As seen in the case of many Ponzi schemes, the number of new contributors is undoubtedly drying up.

A stage will come when paying the promised returns will become a lot more difficult than now.

As a result, when the current set of employees who are paying the taxes retires, the relative rate of return will be much lesser.

Social Security Is Not a Ponzi Scheme

While if you analyze purely on the basis of structure, perhaps it is easy to draw up similarities, but the fact is that a social security system is a lot more than a mere Ponzi scheme.

1. Different Types of Transparencies

For example, the transparencies of a social security vs Ponzi scheme are completely different.

In a Ponzi, it is impossible to trace the origin and absolutely no way to gauge the actual return-generating mechanism.

But on the contrary, there is nothing obscure about the social security system.

Every employee who pays it knows pretty well the terms and conditions and can calculate the relative rate of return going forward.

The payouts have all been underwritten by the tax revenue that is collected, and the interest that is earned by the Government on Treasury bonds is essentially helped for the payout in lieu of social security system.

2. No Fear of Collapse

A private Ponzi is susceptible to a collapse, and those who invest their money can suffer severe losses.

There is also no guarantee that they will ever get back their original investment. But that is never the case for the social security system.

Apart from the Government underwriting every payout, the other factor is that this is dependent on the population growth.

The investments can actually grow at an exponential rate if the population grows exponentially.

Therefore, it can be easily concluded that while there are some similarities in the basic structure of a Ponzi and social security scheme, the biggest difference is that a social security number will never collapse.

The Government underwrites every payout and people will never suffer losses or lose their investment made in this format.

Hence Social security is not a Ponzi scheme.

The most important thing is that even if US social security is really a Ponzi scheme, it will not be a big deal because the US government is behind it and it can easily resolve any kinds of problems.

For example, in a private Ponzi scheme like Bernie Madoff, when the number of new investors and the money they invest is not enough to pay the previous investors and those who are the higher levels of the pyramid, the scheme collapses and turns to a big scandal.

However, if such a thing happens with US social security, the US government can easily pay the retirees and older investors through the other resources.

But the private Ponzi scheme has no resource but the money that the new investors pay.

This is true that in the US social security program, the older investors are paid with the money that the new investors and tax payers invest for now.

However, it doesn’t mean that if one day the money that new investors pay, didn’t suffice, the whole US social security system would collapse and the old investors wouldn’t receive anything.

A big government and nation and unlimited sources of income is behind this program.

On the other hand, a private Ponzi scheme can never keep on attracting new investors forever.

But in the US social security program, there are always new employees who start working and paying tax.

People have to work and make money to survive, and so, they pay tax too because they have to.

And, this cycle will be continued forever.

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