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.