Tuesday, January 06, 2009

Is social security really a Ponzi scheme?

Business Week offers an interesting perspective by Michael Mandel “Is Social Security a Ponzi Scheme,” dated Dec. 28, 2008, link here, with many reader comments.

The motivation for the article is the Bernard Madoff collapse, and the sudden public attention to Ponzi schemes. Such a scheme is set up when the operator pays original “investors” with funds collected from later “investors” instead of actually making money with economically productive activity. The colloquial term is “chain letter.” Generally, for example, ISP’s like AOL prohibit chain letters as part of their “terms of service”.

In a sense, social security is a chain letter because retirees today are paid by FICA taxes on people currently working, and these FICA taxes seem to be always increasing, or the upper taxable limit keeps increasing. There have been some anomalies, such as how federal workers were brought into the system during the Reagan years (1983).

Social security has been able to pay its way until now because the working population grew and because technological innovation increased productivity. So there has been more “real wealth” to pay the benefits. But that soundness is threatened by several factors. One is longer life spans. That concern is offset somewhat by the fact that in the United States the fertility rate is about at replacement (unlike much of Europe and Russia, which are in real trouble demographically) and legal immigration does add to the workforce. The actual economy and ability to maintain full employment, given the economic downturn, is more the issue. Over consumption, particularly of imports predicated on cheap overseas labor, and of over-priced housing also undermines the eventual soundness of social security but of all defined benefit pension programs. But, of course, that has a lot to do with our economic crisis today. The article says that our economy needs more “seed corn.”

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