Social Security is no Ponzi scheme


The conventional wisdom has long held that Social Security is the “third rail” of politics, so popular that criticizing it amounts to committing political suicide. Evidently no one bothered to warn Texas Gov. Rick Perry, who repeated his critique that Social Security is a “Ponzi scheme” shortly after entering the race for the Republican presidential nomination. His hyperbolic denunciation, which has resonated with segments of the GOP and the “tea party” movement, reflects some of the real problems in the 76-year-old program. But it misconstrues what those problems are and how they can be fixed.

Perry contends that it’s a “monstrous lie” to tell young workers that Social Security is still going to be around when they retire. Never mind that Congress has periodically raised the payroll tax and adjusted the benefit formula to put the program back on solid ground. The fact that actuaries identify new threats to its long-term health seemingly every decade feeds the suspicion that there’s something fundamentally wrong.

The suspicion stems in part from a misunderstanding about what Social Security is. It’s not a retirement savings program; it’s an insurance plan designed to help the elderly, the disabled and their families stay out of poverty. And unlike a savings program’s returns, there isn’t a direct relationship between what workers pay into Social Security and what they get out of it. Instead, those who had high salaries receive a smaller percentage of their average wages than those who worked in low-paying jobs.


As with many insurance plans, Social Security is set up primarily as a pay-as-you-go system. Current workers’ contributions are mainly used to fund current retirees’ benefits. Here’s the problem. The program was created in an era with high birthrates and a steady influx of new workers. As a result, there were far more workers contributing to the system than there were receiving benefits. That ratio of workers to retirees has declined over the years, increasing the cost pressure on younger workers. But other factors — such as shifting workforce patterns, wage growth and immigration — have reduced that pressure.

Congress responded to the demographic changes by increasing Social Security tax rates 20 times and the maximum amount of wages subject to the tax 43 times between 1937 and 2009, as well as gradually raising the age at which recipients could start collecting full retirement benefits. Benefits increased too, but there was no escaping the fact that later generations had to pay more for their Social Security benefits than their predecessors had.

The last major set of changes in the payroll tax, which were enacted in 1983, were designed to kill two birds with one stone. In addition to fixing a short-term shortfall, the increases were supposed to prepare for the retirement of the baby boom generation — an unusually large group whose numbers threatened to overwhelm the program. For about 20 years, the system would build up trillions of dollars in reserves by collecting more from workers than the program paid out in benefits. The reserves would then help pay for the boomers’ benefits.

Those changes were supposed to put the program on a sound financial footing for 75 years. By the mid-1990s, however, it became clear that Congress hadn’t gone far enough. The latest projection is that the program will fall $6.5 trillion short over the coming 75 years. That’s not because of the dwindling ratio of workers to retirees, however. An advisory panel reported in 1997 that lawmakers had correctly factored in that change. Instead, the main problems have been slower wage growth and larger disability benefit costs than anticipated, as well as the limitations of trying to measure a host of variables 75 years into the future.

In other words, Social Security isn’t built on a faulty foundation. It does, however, need regular adjustments to keep the tax and benefit formulas in line. As the advisory panel noted in 1997, Congress needs to adjust it again — by broadening its tax base, increasing payroll taxes, raising the retirement age, reducing the annual increases in benefits or some combination thereof. The longer it waits to do so, the larger the adjustments will have to be.

Even if lawmakers do nothing, the Social Security program would soldier on indefinitely, albeit at a reduced level. The Social Security Trust Fund (currently valued at more than $2.6 trillion) would keep growing for about a decade, largely thanks to the interest it accumulates. Then it would help maintain the current rate of benefit growth until about 2036. Once the trust fund was exhausted, the benefits for retirees would fall sharply; payroll taxes would generate only enough money to pay 77% of the benefits owed under the current formula.


Even at that level, benefits should be at least as large for most retirees as the ones paid to retirees today. But such a sharp reduction would be unconscionable, considering how many Americans rely on Social Security just to get by. The program’s monthly checks account for at least 90% of the income received by more than a third of today’s 54 million beneficiaries.

Perry contends that the day of reckoning for Social Security is coming far sooner than 2036. In his view, the trust fund is filled with worthless IOUs because Congress borrowed the money to cover part of the cost of operating the government. Those IOUs take the form of special Treasury securities that can’t be sold to the public; instead, the Treasury Department has to buy them back. That means the federal government will have to borrow the money needed to redeem the trust fund’s holdings unless it cuts spending or raises taxes enough to create a budget surplus. That borrowing won’t require an increase in the debt limit, though — the “intragovernmental debt” owed to the trust fund is already included in the amount subject to the limit.

So no, the Social Security Trust Fund isn’t stuffed with cash. But the securities in the trust fund are backed by the full faith and credit of the United States, just like T-bills or any other federal bond. Defaulting on them would cause an order-of-magnitude more damage to the U.S. credit rating, and in turn its economy, than Washington’s recent brinkmanship over raising the debt ceiling. Such a step would be unthinkable, but then, so was a major presidential candidate calling Social Security a Ponzi scheme.