Here's CNBC's Jim Cramer comparing disgraced financier Bernie Madoff to Social Security -- apparently the one thing they have in common is "pay-as-you-go" financing:
“In a Ponzi scheme, investors get the returns from the money paid in by subsequent investors and eventually the whole thing falls apart. The last people to invest get hosed. In Social Security, a program I love, workers pay for the benefits of current retirees and hope someday future workers will pay for their benefits – it’s all a Ponzi scheme.”
Cramer is correct that, like a Ponzi scheme, payments to earlier participants in Social Security are financed by payments from later participants. Moreover, also like a Ponzi scheme, in Social Security or any pay-as-you-go program the highest returns flow to the earliest participants.
What makes a Social Security program sustainable is its ability to alter the returns paid to succeeding generations of participants. The earliest participants in Social Security received average annual returns of over 20 percent. Were these returns promised to later participants then, like a Ponzi scheme, the program would collapse. However, returns for following generations have been far more modest, if not modest enough to make the program affordable at current tax rates.
All that said, it's important to make policy distinctions between a Ponzi scheme, for which the sponsor rightly goes to jail, and a paygo program like Social Security, which has both advantages and disadvantages based on its choice of financing.
It's often said (even by me) that a paygo program pays lower returns than a fully funded program that invests in real assets, but that's not really true. A mature paygo program pays a lower rate of return at any given time, but it also paid returns to a generation of retireees who would have received no benefits at all under a fully funded system (that is, individuals who were retired at the time the funded system began). Moreover, this initial generation of beneficiaries received very high returns under the paygo program. Once this difference in the number of generations receiving benefits is accounted for, the rate of return difference between a paygo program and a funded program narrows considerably.
Moreover, a paygo program can potentially spread risk between generations in ways that a funded program can't. In theory, a paygo program can enable redistribution between richer and poorer cohorts, as I discussed here. Unfortunately, the current Social Security program isn't well set up to accomplish this risk-sharing between generations. But with reforms, this Ponzi aspect of Social Security could end up being beneficial.
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But Cf. this rule of thumb on Social Security and Ponzi:
http://underbelly-buce.blogspot.com/2008/12/rule-of-thumb-on-social-security.html
We might remember that back in its glory days Social Security was praised as "a Ponzi scheme that works" by supporters as smart, prominent and economically astute as as Paul Samuelson.
... What makes a Social Security program sustainable is its ability to alter the returns paid to succeeding generations of participants. The earliest participants in Social Security received average annual returns of over 20 percent. Were these returns promised to later participants then, like a Ponzi scheme, the program would collapse.
However, returns for following generations have been far more modest, if not modest enough to make the program affordable at current tax rates...
The last sentence meaning future returns will be even more modest than today's "far more modest" -- when either benefits are further reduced or taxes are increased to finance them (or both). Which may in the end make the Social Security Ponzi Game (maybe from now on we should call it a "Madoff Game"?) as unsustainable politically as any other Ponzi game. At least as we know it today.
The "sustainable politically" call is too early to make now -- we're only about half-way through the game today, at the turning point.
As has been discussed here before, the first half of the game gave participants about $15 trillion more than they put in, above market return. And much of that was in world where it wasn't easy for the average person to invest in financial markets for retriement at all.
So among the participants until today ... who wouldn't want to sustain that?
But as future participants get back $15 trillion less than they put in (a certainty, being that with a paygo system pay must equal go), in a world where they have a multitude of easy investment opportunities, and only a government can guarantee negative returns on 12.4% of pay over a 40-year horizon ... sustainabilty remains an open question.
And even if Social Security by itself might be politically sustainable, it won't be by itself. It's rising tax/falling benefit cost is going to be tied at the hip to Medicare's, Medicaid's, unfunded federal/military pensions and the rest -- currently on course to raise income taxes a good 50% to fund them by 2030. A tax increase that cannot imaginably come through the polticial system easily and without compromises on the benefits side.
E.g.: When I try to imagine the incentives facing voters in the 2020s, I find it hard to think of any at all who will benefit by voting to raise income taxes substantially to pay off the SS trust fund bonds to pay SS benefits to the rich, on top of the other huge tax increases coming in the day.
Voters deciding to instead avoid that tax increase by means-testing the rich out of benefits seems politically entirely plausible -- and if that occurs SS will become a rich-pay-for-poor program, with nobody assured of receiving any meaningful benefit from their contributions (should they become financially successful in life), totally changing it from the program we know today.
So it seems too early to make the "politically sustainable" call -- all Ponzi games are sustainable until the returns go negative. We're only approaching that point.
All that said, it's important to make policy distinctions between a Ponzi scheme, for which the sponsor rightly goes to jail, and a paygo program like Social Security...
Oh, I guess ... but the cynic in me thinks of the >$2 trillion in liabilities incurred on an accrual basis annually for Social Security, Medicare, etc., (>$40 trillion total so far) which are not included in the published figures for the deficit and national debt on the rationale that the government isn't legally committed to pay them (! -- tell that to AARP!) ... and then I think of the comparatively trivial, teeny, liabilities Enron kept off its books by similarly unconvincing ploys, and all the people who went to jail for it.
It reminds me of Senator Plunkitt of Tammany Hall's famous description of "honest graft" in politics: sure it's graft, but it's all perfectly fine, honorable and legal because we politicians write the law.
But I'm a cynic. ;-)
There are a lot of thoughts in here, all of them good, but it's hard to say where it ends.
Re political sustainability, I'm not sure the program isn't sustainable, at least in the sense of being able to more or less keep itself in place (not in the broader sense of having widespread support among all age/income groups). My guess is we'll see some benefit cuts for high earners, but we may see as much tax increases for high earners given the recent political dynamic.
The insidious thing about paygo financing is that it's very difficult for future policymakers to unwind, since the windfalls are gone and the only way for current workers to get out is to cut off current retirees. While there are folks who like to argue that 'there's no such thing as transition costs', my own take is that Social Security reform is primarily ABOUT transition costs.
“While there are folks who like to argue that 'there's no such thing as transition costs', my own take is that Social Security reform is primarily ABOUT transition costs.”
Transition costs are a reality. The only thing is this. It costs as much to keep SS-OASI going as it does to dispend it. Why is this true? Transition costs balance both sides of the equation. On one side of the equation we have assets in SS-OASI worth about $2.2 Trillion earning about 5.5% a year. On the other side of the equation we have liabilities which based on those with ten years worth of credited work history have earned a SS-OASI benefit based on a wage indexed benefit formula defined in 1977. This liability is not difficult to determine. The formula is defined and based on Wage Growth and Bend Points that are adjusted yearly be wage growth. If you know the wages, you know the wage growth; bend points and ultimately the future SS-OASI benefit. Assuming a U.S. Treasury rate of 5.5% and using the SSA population file it becomes very easy to determine the average SS-OASI benefit of each and every cohort. The liability is now just over $21 Trillion based on the SSA’s population file through 2080.
If the Treasury rate drops, the unfunded liability increases dramatically since the trust fund does less work. With a treasury rate approaching zero and the trust fund being so small, it is very safe to say that even a few years at low interest rates of zero, the liability will exceed $40 trillion. The only way to keep this from happening is if workers earn less each year, thereby turning the U.S. wage negative and reducing the bend points of future workers, resulting in lower initial SS-OASI benefits.
The cost of transition from SS-OASI pay-as-go is equal to the total present value of liabilities minus the present value of SS-OASI assets.
Many think private accounts as defined by President Bush's plan is a viable alternative.
In general private accounts allow a worker to divert some percentage of their Social Security taxes to a private account. In exchange, the individual's Social Security benefit would be reduced by the value of the equivalent annuity of the diverted tax dollars plus interest at the Treasury rate. This is referred to as the "Offset" condition
The Social Security benefit formula would also change. Currently previous year’s wages are indexed by the change in the US Average Wage Growth, but now would be indexed by inflation. In addition the number of work years averaged would increase from 35 to 40. This would reduce current promised benefits by up to 30%.
All private accounts do is repackage the problem. It reduces the problem by legislating nearly a 40% benefit cut on those who retire in the future. They all fall far short of yielding the promised Social Security benefit under current law. 44% of your benefit comes from an 8.6% Social Security tax while 56% of your benefit comes from your diverted 2%. Theoretically diverting four percentage points could reduce your social security benefit to zero.
One must pay particular attention to the terms "payable benefits" and "promised/scheduled benefits." Payable benefits are generally equal to 60% to 70% of promised benefits. It is important to note what reference base is being used when evaluating private accounts. The only way payable benefits can equal promised benefits is for the combined assets of the trust fund and private accounts to total $21 Trillion by years end. The moral is "You cannot get something from nothing."
Will you be sliced when it's time to cut off Social Security?
If you think American workers will always accept higher taxes to support Social Security, you are mistaken. At some point in time, taxes will hit a level from which they will rise no further.
We could be at that point now.
In this case, the only alternative is to cut benefits. As a worker, is it better for you to delay the fix, continuing to pay a high tax for low benefits, or would it be better to "take the money and run"?
A person can choose to support Social Security, knowing it is a loss from the start, or they can support repealing Social Security, allowing them the opportunity to save 10.6 percent of wages.
Saving 10.6 percent of wages in the very same investment as Social Security yields a benefit that is three times larger than Social Security can pay. To put it another way, you would have to lose 70 percent of your portfolio balance at retirement to reduce you to the level of a Social Security benefit.
You are playing hot potato with Social Security. Will it be your birth year for which those who are asked to pay your Social Security benefits say no?
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