Madoff's Inspiration

The cartoon below amusingly depicts a serious problem: the Social Security systems shares similarities to a Ponzi scheme.

Unlike private pension plans, Social Security does not take the taxes paid into the system on your behalf and create a dedicated account which grows in value by earning a rate of return from which future benefits are drawn.

Instead, the payments you receive in retirement come from taxes paid by current workers. If those workers stopped paying taxes (hypothetically), then you couldn't receive your payment.

Moreover, based on the rate of return implied from taxes paid and benefits received, Social Security proved to be a "good deal" for the initial recipients. But to overcome this initial deficit, in recent years the rate of return on Social Security has become terrible, on average well below that which could be earned on U.S. Treasury bonds.

So here are the Ponzi scheme elements of Social Security: a lack of assets which therefore can't earn a genuine rate of return, requiring that Social Security benefits must come from the payments of future contributors - and a good deal for initial contributors but a worse deal for later ones.

Social Security differs from the Madoff scheme in a couple of important ways. Future contributions to Social Security are mandatory since they are a tax liability. Even though returns on Social Security are well below what could be earned in a private retirement plan (even if you conservatively just invested in Treasury bonds), you can't opt out of Social Security in the face of these poor returns and demand your money back.

So the collapse that must come eventually to all private Ponzi schemes, when either returns don't live up to their promise and/or investors demand their money back which doesn't exist, is not a problem for Social Security.

Correspondingly, private Ponzi schemes work because of the promise of high returns, or more cunningly in the case of Madoff, decent returns consistently "delivered". Social Security has dealt with this problem by simply reducing the rate of return going forward, and since it has the taxing power of the government to ensure the inflow of new cash to pay benefits to retirees, it doesn't have to worry about contributors fleeing due to the new, lower return expectations.

Instead, we all lose, slowly but surely.