Lawmakers, candidates and columnists who support cutting Social Security benefits and/or privatizing the program often claim that Social Security is a “Ponzi scheme.” The history and facts about Ponzi schemes demonstrate that the accusation is absurd.
What is a Ponzi scheme?
Charles Ponzi was a Boston investment broker who in 1920 developed an investment plan offering bonds which would pay 50 percent interest in 45 days and 100 percent if held for 90 days. Although the initial clients’ money was invested in foreign postal coupons, as promised, the returns on the investment were miniscule compared to the promised return. To make good on his promise, Mr. Ponzi paid his initial investors with funds raised from his second round of clients, rather than investing these funds. As word spread about the unbelievable return on investment, clients flocked to Mr. Ponzi and he continued to use new clients’ money to pay off existing clients. The investment scheme’s “assets” were completely phantom – there were no investments made.
The problem with this type of scheme is that the number of new investors has to increase geometrically to pay old investors. In other words, to pay a 100 percent profit to the first 1,000 clients within 90 days, 1,000 new investors are needed within 90 days; then, 4,000 new investors are needed to pay the original 1,000 clients plus the 1,000 used in the first round of payouts. To pay these 4,000, you need 8,000 new investors, then 16,000. The scheme collapses when there are not enough new investors to pay the existing ones – the number of new investors is eventually exhausted, and the scheme becomes unsustainable. Mr. Ponzi’s scheme lasted barely 200 days.
A more recent example of a Ponzi scheme is that of former stock broker and investment advisor Bernie Madoff. His Ponzi scheme, considered the largest financial fraud in U.S. history, defrauded thousands of investors of billions of dollars.
Why Social Security is not a Ponzi Scheme
Social Security is a pay-as-you-go system. Current contributors pay for current beneficiaries. It transfers income from the current generation of workers to the current generation of retirees, with the promise that there will be another generation of workers to pay for the current generation of workers’ retirement. It does not require a doubling of participants every time a payment is made to a current beneficiary or a geometric increase in the number of participants. In its essence, Social Security is a contract between generations, binding together the interests of both young and old in a system that provides protection to all.
Unlike a fraudulent secretive Ponzi scheme, Social Security’s finances are transparent to the public, as required by law. Each year Social Security’s actuaries release a detailed report on the system’s finances. Its dedicated funding source – Federal Insurance Contributions Act (FICA) payroll taxes of current workers – are used to pay benefits for current beneficiaries. For years, these taxes more than covered the cost of the benefits, with the surplus (currently, $2.9 trillion) invested in U.S. Treasury securities, widely considered by finance industry professionals and foreign governments as the world’s best and safest investment. The U.S. government has never defaulted on its Treasury security obligations.
According to Francis X. Cavanaugh, the first Executive Director of the Federal Retirement Thrift Investment Board and a former Department of the Treasury official:
“…the [Social Security] trust fund actually gets a much better deal than the private funds that buy Treasuries in the market. The trust fund, by law, may redeem its securities before maturity at par value, rather than at the sometimes deep market discounts suffered by private investors during periods of rising interest rates. Also, since the trust fund gets its securities directly from the Treasury, it avoids the market transaction costs which private investors must pay. Finally, the law requires the Treasury to pay the trust fund an interest rate on all of its investments in Treasuries equal to the average yield on long-term Treasury marketable securities. This is a significant benefit to the trust fund, since long-term rates are generally much higher than short-term rates.”
Some of the interest on these securities is now being used to cover the gap between what is collected in FICA taxes and the cost of benefits for current retirees.
Finally, Social Security is a mandatory program. Given that workers are required by law to pay FICA taxes, the program has a guaranteed and dedicated source of revenue in perpetuity.
Social Security remains strong and will be able to pay full benefits for many years to come – until 2034. Thereafter, there will still be enough payroll tax revenue coming into the program to pay 78 percent of all benefits owed. Congress has adjusted and revised the program many times since its inception over eighty years ago and there is every reason to believe it will do so again before trust fund reserves are depleted in 12 years.
Social Security vs. Ponzi Scheme Made Clear
The following chart illustrates the differences between the Social Security program and Charles Ponzi’s scheme:
|Law passed in 1935
|Bonds offered by criminals to investors
|Voluntary (Facilitated by deception)
|U.S. Treasuries which have never defaulted
|None – assets used to pay prior investors
|Yearly report by Social Security Administration Actuaries
|No public accounting
|Available to anyone meeting eligibility requirements
|Exorbitant for early investors, only losses for later investors
|Length of Operation
|Has paid full benefits for 80+ years
|Less than 200 days
There is no credible comparison between Social Security and a Ponzi scheme. Social Security has fulfilled its promise to workers since the first benefits were paid in January 1940. With the support of the American people, the President and the Congress, there is no reason to believe that Social Security will not keep its promise to future generations and continue to pay benefits for years to come.
Government Relations and Policy, February, 2022