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Is Social Security a Ponzi Scheme?

Last night, Rick Perry put the financing of Social Security and its essential nature front and center in the 2012 presidential campaign. He had called it a Ponzi scheme in a book he published last year, and he didn’t back away from the accusation last night. But is it a Ponzi scheme?

Well, yes and no.

A Ponzi scheme is a species of fraud where the fraudster promises great returns on money invested and pays those returns out of money paid in by new investors. If the money comes in fast enough, the amounts involved can get quite impressive. Although he didn’t invent the idea, the fraud is named for Charles Ponzi, who promised investors a 100 percent return in 90 days. In February 1920, he took in $5,000. By July, he was taking in $250,000 a day. The tricky bit, of course, is knowing when to take the money and run. Ponzi mistimed it and spent three-and-a-half years in federal jail for mail fraud and seven years in state jail as a “notorious and common criminal.” Bernard Madoff ran the greatest Ponzi scheme of all time until his arrest in December 2008.

Social Security is a Ponzi scheme in the sense that the sums invested in it by today’s workers are paid out to today’s retirees. It is most certainly not a Ponzi scheme in the fraudulent sense, as the mechanism is above board and visible to all. The problem is a profound demographic shift since Social Security began in 1935. Then, there were some 20 workers for every recipient, and life expectancy was about 65, the age when retirees became eligible to receive benefits. Today, there are only three workers for every retiree, and life expectancy is fast approaching 80. By 2030, there will be only two workers for every recipient and life expectancy is likely to be well over 80.

Obviously, the current system cannot be sustained without ruinous FICA tax increases, drastic cuts in benefits for future retirees, or a vast and lethal plague that affects only the elderly. Liberals can vow to protect Social Security all they want, but that is “Canutinomics”: the mathematics are inexorable. As the late economist Herbert Stein famously explained, “If something cannot go on forever, it will stop.”

Gradually raising the retirement age, adjusting the way cost-of-living increases are calculated to bring them more in line with economic reality, and ceasing to raise Social Security benefits to keep them in line with increasing wage rates would go a long way to making Social Security financially stable. A gradual transition to the Chilean retirement scheme touted (quite correctly) by Herman Cain last night, in which people make mandatory payments into an account they actually own and which is managed, very conservatively, by independent financial institutions, is the long-term solution.

If you want fraud in the current Social Security system, however, it is in what happened to the surpluses that were run up by Social Security to help fund the retirement of the baby boomers. The money was transferred to the Treasury, which called it income, in exchange for non-marketable federal bonds, and Congress promptly spent it. If someone in the private sector tried a scheme like that it would be accounting fraud and earn him a stretch in Club Fed. One reform Congress should enact tomorrow–but won’t–is to require that Social Security surpluses be invested in federal bonds bought in the bond market. This would keep the surpluses out of the hands of politicians (and, by the way, lower the interest costs on other federal borrowing).



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