Wednesday, December 05, 2012

Government Ponzi Schemes That Could Fail

A Ponzi scheme pays current investor returns from payments made by new investors rather than from earnings on investments.   Ponzi schemes are illegal and usually have a poor ending as exemplified in the the Bernie Madoff case.

Based on my observation, state and federal governments seem to manage some finances using Ponzi scheme approaches.   Here are some examples I have come across:
  1. Social Security.  Although Social Security is theoretically supported by a trust fund, it is actually covered by current workers.  Unfortunately, the number of workers per beneficiary is declining.  In 1950, there were 16 workers per beneficiary; now there are only 3 workers per beneficiary.  It is expected to decline to 2 workers per beneficiary by 2030.   Although technically not a Ponzi scheme, it sure has the feel of one.
  2. Government pensions.  Based on a brief involvement with a county job, my observation was that our state's pension system depends on current tax revenues to cover paymentssince the pensions are not fully funded.  If tax revenues falls significantly or if a municipality goes bankrupt, pension payments may not be sustainable at current levels.
Although I am not receiving any payments, I am currently a participant in the Social Security system.  When I was part of the state retirement system, I chose the defined contribution (fully funded) plan over the defined benefit (pension) plan.  When I quit the county job, I rolled over my contributions into an IRA and left the state retirement system.

It will be interesting how Social Security benefits are affected by the fiscal cliff solution.  At this point, I don't know how Social Security reform will affect me, since I am below the threshold age for keeping current benefits.

For more on The Practice of Personal Finance, check back every  Wednesday for a new segment.

This is not financial advice. Please consult a professional advisor.

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