The voices of Urban Institute's researchers and staff
March 26, 2014

Social Security is not a Ponzi scheme

March 26, 2014

Last week, I heard two of my friends argue that Social Security is a Ponzi scheme, worrying that we millennials should expect no benefits when we retire. Pundits and politicians have made similar claims.

Fortunately, neither is true. (See a video of The Urban Institute’s Rudy Penner busting some big Social Security myths.)

Social Security is not a Ponzi scheme. A Ponzi scheme is based on a lie in which the perpetrator promises a few people a great investment with high and steady returns. Then he promises the same (nonexistent) investment to a few more people, paying the first investors with the second investors’ money, rather than actually making a strategic investment.  The scam inevitably collapses when the pool of “trickable” people runs dry.

Social Security, in contrast, is clear about why you pay, what happens to your money, and what you’ll get out of it. Yes, similar to a Ponzi scheme, it uses contributions from today’s workers for today’s retirees. But the pool of contributors will never run dry - if you work legally in the U.S. (with a few exceptions) you have to pay into Social Security. What’s more, any of that guaranteed revenue that exceeds what is paid to retirees accumulates in a big pot called the trust fund that earns interest over time.

So what is wrong with Social Security? Despite those important differences, Social Security’s biggest problem is similar to what inevitably collapses a Ponzi scheme. Birth rates and the labor force participation have shrunk slowly for decades, and now baby boomers are retiring in droves. Each year, there are fewer workers supporting more retirees (by 2035, there will be only two workers for every retiree, down from three today). As this disparity grows, retirees’ benefits will be taken from the trust fund, drawing it down slowly until it’s gone (assuming we make no reforms to the system in the meantime).

Social Security will keep paying benefits. But even if Congress passes no reforms at all millennial retirees will get 75-80 percent of their promised benefits. The trust fund will be depleted by the late 2030s, but payroll taxes from current workers will keep rolling in.

What’s more, those benefits at 75-80 percent of promised levels may still give millennial retirees similar purchasing power as today’s Social Security beneficiaries. Why? To calculate a retiree’s benefits, her earnings are adjusted by the change over her lifetime in average salaries. Because salaries have historically grown faster than prices, 30 years from now, 75 percent of statutory Social Security benefits will likely have about the same purchasing power as 100 percent of today’s benefits.

None of this means that we shouldn’t reform the system as soon as possible—and there are many proposed reforms out there—but both are topics for subsequent posts. 

Follow Zach McDade (@zmcdade) on Twitter.

Illustration by Daniel Wolfe, Urban Institute

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