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Thursday, September 08, 2011
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Is Fraud Required to Make Social Security a Ponzi Scheme?

There has been renewed debate, after some comments leading up to last night's Republican Debate, as to whether or not Social Security is a Ponzi Scheme. When defending Social Security against this particular claim, it's supporters generally include a list of attributes of a Ponzi Scheme, and how Social Security doesn't meet the criteria. But before we get too much into this, what exactly is a Ponzi Scheme? Here is one good definition I found:

A Ponzi scheme is a fraudulent investment operation that pays returns to separate investors, not from any actual profit earned by the organization, but from their own money or money paid by subsequent investors.

Fairly straight forward. It is a scheme in which no real investment occurs, but instead money is paid to early entrants by later entrants into the scheme. As long as money keeps getting paid into the system by later entrants, then the scheme continues paying the earlier entrants. Now, so far, I think that Social Security meets this definition. No real investment actually occurs in this scheme. While some people may consider "Treasury Bonds" to be an investment, all you're actually doing is funding government operations on the promise of later payments from future taxpayers, who also have to buy into Social Security. So those general tax revenues to pay off the Treasury Bonds, combined with the Social Security taxes paid by current workers, pay for the benefits of past workers.

The one thing that many people argue make Social Security differ from a Ponzi Scheme is the notion of fraud. It is argued, correctly, that Social Security is not fraudulent, because regular public reports are made regarding all these income sources and payments. However, is fraud a necessary attribute of a Ponzi Scheme? The real question is, why is fraud one of the attributes of a Ponzi Scheme?

The answer lies in the fact that a Ponzi Scheme is voluntary. People voluntarily invest their money into the scheme, because they believe it is a real investment with a good rate of return. The fraud is only necessary to fool people into buying it. In fact, once the reality of the scheme is discovered by investors, and they stop paying in, the scheme collapses. This idea begs the question... is there an alternate way to get people to invest into a Ponzi Scheme that doesn't require fraud?  The answer is yes, and is how Social Security operates. Also unlike a typical Ponzi Scheme, Social Security is not voluntary. This is why fraud is not a necessary component to the system, because there is no choice but to invest.

To truly answer the question as to whether Social Security is or isn't a Ponzi Scheme, one merely needs to ask what would happen if Social Security stopped being mandatory, and instead was a voluntary system. With all the information known about how Social Security operates, would people continue to voluntarily pay into the system? More importantly, if people stopped paying into the system, would it collapse? The answer to the latter question is a resounding yes, and the answer to the former is probably.

In fact, when possible solutions to Social Security's solvency are discussed, one of the popular options is to raise the Social Security tax. A normal Ponzi Scheme operator would never be able to get away with this once the scheme began it's downfall. Only a system where payment was not voluntary could say that current entrants must pay more to keep the early investors solvent. A normal voluntary Ponzi Scheme would collapse. The Social Security Ponzi Scheme on the other hand merely forces the current "investors" to pay more.

And that is why Social Security is a Ponzi Scheme even without an element of fraud.

# Posted at 10:32 AM by Nick  |  Comment Feed Link No Comments  |  No Trackbacks

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