by Dr. Daniel Thornton, D.L. Thornton Economics

Guest Contributor: Social Security Is A Ponzi Scheme. Here's How To Fix It - broken piggy bank

Late last year on the op ed. page of the Wall Street Journal, Jeremy Siegel, Professor of Finance at the Wharton School of the University of Pennsylvania, challenged the conventional wisdom that the rich don’t pay their fair share of Social Security because the earnings that are subject to the social security tax are capped ($118,550 in 2016). He noted if he lives to 90 he will receive far less in Social Security benefits than he would have received if the Social Security “contributions” had been invested in Treasury bonds.

Two commentators wrote letters to the WSJ suggesting that Siegel forgot to notice the “social” in Social Security. David Robinson wrote, “Social Security is by design a system to transfer wealth to low-wage earners in their retirement. There’s simply no way that a janitor could save enough in his working years to provide a decent retirement.”

Mitchell Orfuss wrote, “Mr. Siegel’s math may be accurate. Less accurate is that it would have been ‘easy’ for workers to put away the equivalent dollars on their own and end up doing significantly better. Had ‘contributions’ been voluntary, not ‘forced,’ few workers would have volunteered or invested the equivalent FICA deductions elsewhere. Did Mr. Siegel consider where so many about-to-be-retireds would stand today without their Social Security annuity?”

Guest Contributor: Social Security Is A Ponzi Scheme. Here's How To Fix It - thornton chart5

Messrs Siegel, Robinson, and Orfuss miss a point that, if they had noticed it, suggests that Social Security harms essentially everyone, but especially the people that Messrs. Robinson and Orfuss argue it is designed to help, i.e., the ones who put the social in Social Security. This essay explains why the people Messrs. Robinson and Orfuss suggest Social Security helps are, in fact, the most harmed. I suggest how Social Security should have been designed from its beginning and how it can be fixed.

Before we get to the crux of the matter, let’s first understand Mr. Siegel’s argument that Social Security harms the “rich.” Specifically, he noted that if he lives another 20 years (to age 90) he would receive $840,000 ($42,000 a year for 20 years) in Social Security benefits, more than twice what he paid in. He suggests, that while some might call this a “good deal,” it is a pittance compared with the $1.28 million he would have had at age 70 if his and his employer's Social Security “contributions” had been invested in U.S. Treasuries or the $2.27 million he would have had if the contributions had been invested in a stock index fund. We will come back to this example later.

The major flaw in Social Security is...

... the FACT that Social Security is a government-operated Ponzi scheme (named after Charles Ponzi who served some time in a federal prison and died in a charity hospital in Brazil). More recently, Bernie Madoff operated a Ponzi scheme and was sentenced to a 150 years in federal prison. A Ponzi scheme is simple:

  1. Take money from investors by promising a higher rate of return than they can get elsewhere.
  2. Use the funds to finance a lavish life style and to pay off investors who withdraw their investment.

As long as you show investors that their account balances are increasing rapidly, most are willing to keep their investment deposited with you. The scheme usually unravels when someone becomes suspicious that the high returns promised are not feasible and more and more people want to withdraw their funds which, of course, are not there because they have been financing a lavish life style.

Of course, no one willingly invests in Social Security. Social Security forces employees to “contribute” 6.2% of their salary into Social Security and forces their employers to match that “contribution” (tax). Social Security requires 12.4% of workers’ salary be contributed to Social Security. What does Social Security do with these funds? Prior to 2010, it paid off previous contributors who were retired and used the rest to finance other government programs, i.e., to live a lavish lifestyle.

Since 2010, benefits paid have exceeded contributions, so Social Security is not paying benefits. The government has made up the shortfall by borrowing, i.e., issuing debt—the Ponzi scheme is already unraveling. Not because Social Security is not paying benefits, but because it is adding to the deficit and will continue to do so unless benefits are reduced or contributions are raised or both. Some might be saying, “But I thought there was a Social Security Trust Fund?” Well, the trust fund only exists if you are willing to believe the government’s left hand is somehow independent of its right hand.

Here is the truth:

The federal government works on a cash (pay-as-you-go) accounting system. The Trust Fund is nothing more than an accounting gimmick to keep tract of which of the many hands of government the funds are coming from. Social Security contributions generally exceeded Social Security benefits paid before 2010 so a bookkeeping entry was made to show that the government issues non-marketable debt to Social Security in the amount of the overpayment; the funds are then used to finance other government expenditures during the year.

Beginning in 2010, Social Security benefits paid have been larger than Social Security contributions received, so the Treasury has issued new debt to make up the shortfall. A bookkeeping entry has been made to reflect that FACT. The Social Security Trust Fund is nothing more than an accounting gimmick that Congress designed in 1939 to make people think that the Fund’s existence somehow kept Social Security solvent. The accounting gimmickry is rather elaborate. Figure 1, based on Social Security data, here, shows that the Trust Fund balance has continued to increase in spite of the fact that benefits paid have exceeded contributions since 2010.

Guest Contributor: Social Security Is A Ponzi Scheme. Here's How To Fix It - thornton chart1

How can this be?

Well, it happens because of several other fictitious bookkeeping entries. The largest is the net interest “paid” to the Trust Fund by the Treasury for the Trust Fund’s holdings of non-salable Treasury debt—the federal government pays itself interest. I started doing that, but quickly found out that it didn’t improve my finances one bit. It turned out that when my right hand paid my left hand interest, I was exactly in the same position; nothing improved!

The ruse doesn’t stop there.

The Trust Fund also gets a credit for the tax revenue generated by taxes paid on Social Security benefits received each year (since 1983 all but very low income earners pay some tax on theirSocial Security benefits) and “reimbursements” from the General Fund, but as the figure shows, these are typically trivial.

All of this is done to make Social Security appear to be “solvent.” But there is no stash of cash or securities that are sold to pay current benefits or that can be sold to pay future benefits. Figure 2 presents the truth. It shows contributions received, benefits paid, and benefits paid minus contributions received—the contribution of Social Security to the federal deficit. The figure shows that from 1957 to 1985 contributions and benefits were essentially equal. 

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From 1985 to 2009, contributions exceeded benefits. Social Security made a positive contribution to general revenue, which permitted the Federal deficit and, hence, the public debt, to be smaller than they would have been otherwise. Since, 2009 the reverse has been true. Social Security benefits exceeded contributions, so Social Security has caused the deficit and the public debt to be larger than they would have otherwise been.

The Congressional Budget Office (CBO) projects that benefits paid will exceed contribution into the indefinite future. The figure below (labeled Exhibit 4) shows actual Social Security tax revenues (contributions) and outlays from 1985 through 2015 as a percent of GDP, and the CBO’s projections through 2090. The figure shows that the gap has been widening since 2010 and is projected to become much wider.

The CBO estimates that the Social Security trust fund will be depleted in just 13 years, 2029, at which time the CBO is projecting a 29 percent reduction in Social Security benefits. But this is silly. The U.S. has been issuing interest-bearing public debt to finance the Social Security shortfall since 2010 and will continue to do so even if the accounting gimmick shows that the right hand no longer owes the left hand anything.

If the government doesn’t discard its fictitious bookkeeping system (which it is likely to do) the books will show that Social Security now owes the U.S. Treasury. If this happens, perhaps we would then call it the Social Security “No Trust” Fund. 

Guest Contributor: Social Security Is A Ponzi Scheme. Here's How To Fix It - thornton chart3

The CBO’s estimates show that Social Security will be causing the federal deficit to increase steadily to nearly 2% of GDP from 2010 to 2029 and by 1% or more much earlier so it is unlikely that Congress will wait until 2029 to make adjustments to the program. “When Ponzi’s and Madoff’s Ponzi schemes came undone they served time in a federal pen. What will happen to Congress?”


Like emperors and kings of antiquity, Congress will simply change the rules of the game. Indeed, Social Security’s rules have changed more or less continuously since Social Security began. Social Security contributions have been increased over time from 2% to 12.4% of salary. Small business owners, who were initially exempt from Social Security, now contribute the entire 12.4% (they are both a worker and a business).

The age at which one can receive full Social Security benefits has been raised from 65 to 67. Indeed, before January 1, 1984, members of Congress, the President and Vice President, federal judges, other executive-level political appointees of federal government, and all federal government employees were exempt from Social Security. Apparently, the program was just too good for the people who created and administered it so they fell on the sword and exempted themselves—they waited 47 years to take advantage of the benefits of Social Security.

“How will Social Security change?”

Well, it is difficult to predict such things, but I told my children that they should expect to receive little or no Social Security benefits. I believe that eventually Social Security payments will be “means” tested. If you have saved enough, you will not receive any benefits: Mr. Siegel should behappy. If he were born 30 years later it is likely that he would receive far less than $42,000 a year; perhaps nothing.

“How can you say this?" There have been a number of proposals to “fix” Social Security.” Indeed, there have been. All of these recommendations involve increasing Social Security taxes in one way or another, reducing benefits, or more often than not, both. But it is important to note that these fixes are problematic because Social Security is not the only government program that is actuarially insolvent. The government has a number of other unfunded liabilities (promises). Social Security gets most of the attention, but Medicare is far and away the bigger problem.

The government’s pension liabilities are large and growing, but rarely get discussed. While Social Security can be tweaked, what happens to Social Security is not independent of the resource needs of other unfunded government promises or discretionary spending. It is wishful thinking to even talk about these programs as if what happens to one is independent of what happens to the others or to the rest of government spending—the right hand is not independent of the left!

Analyzing how one program will be “saved” independent of the funding needs of other programs is wishful, dare I say naïve, thinking. “Ok, so Social Security is a Ponzi scheme and the Social Security trust fund an accounting gimmick, but Social Security provides retirement income to people who do not earn enough to save for their retirement as Robinson and Orfuss have argued.” Well, yes and no.

It’s more complicated than that. 

To understand why, let’s return to Mr. Siegel’s example. While Mr. Siegel didn’t say it, the $1.28 million he would have had at age 70 if he had invested his Social Security taxes in Treasuries, could have generated $42,000 a year for his life if his $1.28 million portfolio of assets earned just 3.3%. Moreover, he could still leave $1.28 million to his heirs. Under Social Security, he will get $42,000 a year for life, but his heirs will get essentially nothing when he dies.

The fact that he would have had property rights to this portfolio of assets (the essence of capitalism) means that he could have left as much of the $1.28 to his heirs as he liked. If he was a selfish person, he could consume it all and leave them essentially nothing. If he was altruistic, he could leave it to his favorite charities. This won’t happen because he was FORCED to “save” this income with Social Security. He not only will get less than he would have been able to get if the Social Security FORCED him to invest 12.4% of his income in other assets, but he could have lived like a king or improve society by leaving his wealth to charity.

Guest Contributor: Social Security Is A Ponzi Scheme. Here's How To Fix It - thornton chart4

I can hear people saying “Who cares about him, he’s rich and will have plenty of wealth to support him in retirement.” True, but the problem is Social Security takes this option away from everyone covered by Social Security. This “social” aspect of Social Security is most harmful to the people that Robinson and Orfuss suggest Social Security benefits most.

Unlike Mr. Siegel, and other higher income earners, low income individuals are much less likely to save beyond what Social Security FORCES them to save in Social Security. Consequently, they are much less likely to be able to create wealth that can be passed on to their heirs. Indeed, Mr. Robinson’s statement that “Social Security is by design a system to transfer wealth to low-wage earners in their retirement,” is patently incorrect.

Social Security transfers income: It prevents the accumulation of wealth by low-wage earners, thereby making them more dependent on the vagaries of a government program that made them dependent on it. I can now hear my good friend saying “Many of the low-wage earners would not save without Social Security.” I agree completely. I am not arguing against the forced saving requirement of Social Security.

While forcing people to save runs counter to my belief in personal freedom, and free choice, I believe that human nature suggests that many wouldn’t save unless forced to and society would have to pay for their bad decision, just as society pays for other bad decisions. In any event, Social Security is a forced saving program, so we already have forced saving.

I am more concerned that Social Security inhibits the accumulation of wealth by all and essentially prevents the accumulation of wealth by those in society who could benefit most from accumulating wealth. Moreover, as I argued earlier, Social Security cannot be fixed independent of the government’s unfunded or under-funded promises unless it is made truly solvent. So here is how Social Security should have been designed and how it can be fixed.

Fixing Social Security:

Social Security doesn’t need to be tweaked; it needs to be completely overhauled. Here is a framework for overhauling Social Security:

  1. Social security taxes will remain unchanged, but will beinvested in a portfolio consisting of a wide range of domestic and foreign assets designed and managed by acommittee consisting of individuals from government, industry, and academia.
  2. Each Social Security participant will own a pro-rata share of the common portfolio based on his/her accumulated Social Security“contributions” plus interest on those contributions.
  3. As is the case under Social Security, no person willbe able to have access to their pro-rata share until they reach a “full retirement age” determined by the committee and approved by Congress.
  4. Upon reaching that retirement age, all individuals will receive a retirement benefit equal to the annual net rate of return (the interest rate less administration expenses) on the portfolio times their pro rata share.
  5. If the annual income from an individual’s share is less than the federalpoverty level, they would receive a supplement equal to the difference.
  6. In order to receive the minimum income benefit, individuals must “contribute” to Social Security for some minimum period of time (for SocialSecurity it is currently 40 quarters).
  7. Upon death, before or after retirement, the individual’s pro ratashare of the portfolio will be transferred to whomever the individual chooses. That decision is made by the individual when enters the program, and can be changed at any time.

My Social Security program would also include an educational program that shows the dangers of the excessive use of credit and lauds the benefits of personal saving and the accumulation of wealth.

Social Security would no longer be a Ponzi scheme.

It would no longer hamper or prevent low income earnersfrom accumulating wealth. The program would be solvent. Hence, Social Security recipients would not have to worry or lobby Congress about changes in Social Security Benefits. Congress would no longer have to engage in elaborate and costly accounting gimmickry.

While Social Security income payments would change with changes in the net return on the portfolio, the minimum benefit requirement (the “social” in my proposed Social Security) would protect those below the poverty line. The new Social Security program will have to be phased in. Individuals below some age will be automatically come under the new program, while those beyond that age will stay in the old.


I doubt this can be done without causing relatively large, albeit temporary, increases in the federal deficit. But this is just the price society must pay to fix a deeply flawed program. I don’t have a recommendation for doing this in the least costly way because I don’t know enough details. This will have to be done by those with such knowledge.

However, I do know that the present system is deeply flawed. It’s a Ponzi scheme that guarantees that the last in, many of whom are not yet born, will be the big losers. More importantly, a capitalist country should not have a government program that inhibits the accumulation of wealth and essentially prevents it for a large segment of society — people who are likely to benefit most from this opportunity. I believe my proposal is worthy of serious consideration. I hope it gets it.

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Editor's note:

This is a Hedgeye Guest Contributor research note written by Dr. Daniel Thornton. During his 33-year career at the St. Louis Fed, Thornton served as vice president and economic advisor. He currently runs D.L. Thornton Economics, an economic research consultancy. This piece does not necessarily reflect the opinion of Hedgeye.