SANTA CLARA, Calif. — Rick Perry got himself into trouble by suggesting that Social Security is a Ponzi scheme. He's not the first to do so; economists have sometimes talked in similar terms. But when economists use this language, they're usually not serious.
Ponzi schemes are frauds in which the operator promises or credits investors with exceptional returns, supposedly based on the performance of the assets purchased. The organizer acquires no assets, pays maturing promises or other withdrawals with funds from new depositors and skims money off the top to support lavish personal consumption.
They bear some resemblance to chain letters. When I was 10, I received one, asking me to send a postcard and the letter to six individuals, adding my name at the bottom, and removing that at the top.
I was warned of dire consequences for those who broke the chain and promised hundreds or thousands of postcards in return. I sent out six postcards. Eventually, I received four.
Chain letters, like Ponzi schemes, require continued growth in participants to allow early investors to pocket outsize returns, which is why they are sometimes called pyramid schemes. If they involve money, they are considered gambling — illegal, since in this country you can't use the mail to gamble.
Bernie Madoff's operation was a Ponzi scheme. Social Security is not. It doesn't require continued growth in the number of participants to pay benefits. And there is no fraud. Plentiful information on the system's finances can be found on its website.
Social Security is an insurance system in which people make contributions while they work and receive benefits when retired or disabled. Payroll taxes, interest income on bonds in the trust funds and, since 1983, revenue from taxes on benefits fund the annuities.
The system has lower costs per benefit dollar than private insurance systems. The poverty rate among the elderly is below that of the general population, thanks largely to Social Security.
Social Security pays the bulk of benefits out of current contributions. To remain almost entirely self-financing, the system runs surpluses now to fund deficits later because the ratio of those paying in to those drawing out, which stood at 4.0 in 1965, is declining — it's projected to fall to 2.1 in 2035 before stabilizing.
Anticipating boomers' retirement, 1983 legislation raised payroll taxes and made other changes that have generated surpluses. These are invested in special government bonds backed by the full faith and credit of the United States, which has never defaulted.
Relying on Social Security for retirement income does require relying on the government to honor its promises. Given the interest rates Uncle Sam pays, investors believe this is more likely than that any private entity will.
If the more conservative assumptions are right, the system could still pay more than three fourths of promised benefits in 2036, when the trust funds would be depleted. This shortfall could be remedied by gradually increasing the full retirement age, or subjecting higher incomes to the payroll tax.
Unlike Medicare, the Social Security system is basically sound.
Participants, including those just entering the system, should not be scared into believing they are contributing to the equivalent of a chain letter, or a Madoff-style Ponzi scheme.
Alexander J. Field is a professor of economics at Santa Clara University.
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