Is Social Security a "Pyramid Scheme"?

Recently, there has been much talk in the news -- including by potential candidates for the presidency -- about whether social security is a pyramid scheme. The SSA's official response is here; numerous folks on the internet say it is lying.

The readers of this blog should be able to tell the answer. There are similarities between pyramid schemes and social security: the main one being that money is paid to those who are earlier in the system from those who are latecomers. But this in itself, however, is not enough to make something a pyramid scheme! Consider a private medical insurance company: on the whole, it pays those who joined years ago (and are now older and need more medical care) from the income (the premiums) of those who joined later (and are thus still younger and need less medical care). Does this mean medical insurance is a pyramid scheme? No.

Why? because, like social security and unlike MLMs, there is no need for the number of insurers to grow exponentially. There is no need for the number of young insured every generation to double for the medical insurance company to remain viable. If the ratio of workers to retirees -- or older to younger medically insured -- remained constant, or at least didn't rise above a certain level, then both social security or the medical insurance company could continue to go on indefinitely.

Does this mean there's nothing to worry about? Not quite.

Again, imagine, if you will, a medical insurance company founded in 1935 (like social security) with the motto, "we insure everybody!". Assume there were 10% of the population that was sick at the time. In theory it is quite possible for them to have charged enough premiums to cover the expenses of treating those who are sick. There is no logical necessity for the number of sick people in the population to increase. So long as it remains the same, or decreases, the company will remain viable.

But suppose the number of sick people, for some reason, rises a lot. That instead of 10% who are sick, you have 20% or 30% of the population who are sick. Naturally in this case the company might well go bankrupt if it continues to charge the same premiums and give the same benefits. But would that mean it's a pyramid scheme? No.

Replace "sick people" with "retirees" and "healthy people" with "workers" you see social security's problem: the constant growth of the ratio of retirees to workers. The reason? The increasing life expectancy. So, yes, social security cannot be funded in its current form indefinitely. It will probably have to increase premiums, or cut benefits, much like a private insurance company might. Or, perhaps more reasonably, it might raise the eligibility age for benefits -- after all, in 1935, the average life expectancy was barely above 60, so the number of those getting benefits was quite small.

Will Social Security reform in such a manner? Maybe. A further problem -- not applicable to a private medical company -- is that this might be politically difficult to do; unlike a private company, where the stock holders have an interest in maintaining long-term viability, with social security, anybody suggesting reform of social security will be crucified, no matter how reasonable the suggestion is. Imagine, if you will, a private insurance company which, for religious or other reasons, considers it an unshakable dogma that the premiums must not be raised and benefits must not be cut under any circumstances.

But if social security eventually fails, it will not be due to its pyramid structure (it is not a pyramid in that sense), but due to these problems -- much like a medical company might well fail if it continues to charge the same premiums and give the same benefits when 30% of those it insures are sick, as it did when 10% were.