Republican presidential candidate Rick Perry recently referred to Social Security as a “Ponzi scheme.” Not surprisingly, he is taking some heat for knocking the “third rail” of politics in such fashion. National Public Radio claims this is just rhetoric. So is it?
Well, what is a Ponzi Scheme? In 1919, 16 years before the Social Security Act was signed into law, a Boston investment broker named Charles Ponzi opened a company in which people were asked to invest their money for a 50% return if he was allowed to hold their money for 45 days, or a 100% return on money held for 90 days. The money was allegedly used to buy international postal coupons, which actually could yield a fractional profit due to the strength of the dollar at the time. However, the profit was not the 50% or 100% promised by Ponzi. So how could the broker deliver on his promise?
Ponzi relied on a type of pyramid scheme to deliver early investors the promised profits. He used the deposits of new investors to pay the returns to the investors that had made previous deposits, rather than using the actual profits of the stamps in which his customers were investing, all while maintaining the appearance that the returns were due to the “lucrative” postage stamp market. He relied on the promise of the extravagant profits to attract new money.
For a time, it worked. Enough people bought into the company that Ponzi was actually able to pay the earliest investors. When people saw that some investors were apparently getting their money’s worth, they assumed the profits were legitimate and flooded Ponzi’s business with new cash. This allowed his business to temporarily grow at an exponential rate, and within seven months, Ponzi had collected an astounding $10 million. His assets, however, were only worth about $2 million, and when the Massachusetts attorney-general halted his deposits, people began to get suspicious. He was eventually jailed for fraud. His investors ended up getting back about 37 cents on every dollar they had deposited once the courts had sorted everything out.
So how could such a blatant act of criminality be associated with the sacred Social Security program we all hold dear? Let’s examine the very first monthly Social Security recipient, Ida May Fuller. Mrs. Fuller, over three years, paid into the program a total of $24.75. Her first monthly check once she retired was $22.54, due to her particular classification in the benefit structure of the program. When she died at the age of 100, she had collected a total of nearly $23,000 in Social Security benefits. Where did the money come from, if not from her own contribution? Other tax payers. In Ponzi Scheme terms, an early investor’s promised profits were financed by other, newer deposits.
Now, if by law, Congress mandated that the program work like a savings account, where you receive exactly what you put in, there could be no comparison to a Ponzi Scheme. The Social Security Trust Fund would simply be a holding account for later withdrawal. But that is not how it is set up. There are numerous projections and estimates that comprise the receipt/payout structure of the program. The Cost Of Living Adjustment (COLA), the Consumer Price Index (CPI), and other factors are all considered in determining how to fund and dispense funds in the program.
It gets better. As you know, Social Security is funded through payroll taxes. When the amount of payroll taxes exceeds the cost of the benefits in a particular year, the surplus is invested in special U.S. Treasury bonds, which can be used for deficit spending! Ever wonder how Bill Clinton was able to run a surplus? Bingo. The federal government borrowed the excess payroll taxes and gave Social Security an IOU in return. That means that many people’s payroll taxes, designated specifically for Social Security payments, financed Clinton’s (and many other Presidents’) spending in unrelated areas. My friends, this is far worse than Ponzi’s plot. Not only are people paying for the previous generation of recipients, they are financing the out-of-control spending of the government with money that is kept in what should be a rainy day fund. Worse than that, the program is mandatory!
You can imagine what could happen if payroll taxes, which are paid via one’s employer, start to decline due to high unemployment (which is currently the case), or if the number of people retiring starts to increase in proportion to those paying in (a phenomenon which is also on the rise). In order for the program not to go broke, there has to be at least as much money coming in through taxes as money going out through benefit payments. Congress has to find the right algorithm (I.e., manipulating payroll tax rates or benefits based on the COLA and CPI, etc.) in order to maintain that balance. This is comparable to the promise of exorbitant profits in order to keep fresh money rolling into the Ponzi Scheme – if Congress can be clever enough, they can find ways to keep the program funded.
Although this is a simplified comparison, the differences between Social Security and the Ponzi Scheme are really quite trivial. Some say that since Social Security is not a program in which voluntary investors are lured in with false promises that it technically does not meet the requirements. I would argue that in light of 1) the program’s mandatory participation, and 2) a political climate in which talk of reforming the program is generally met with scorn, Social Security is actually worse than a Ponzi Scheme. Both are based on unsustainable models and both require bookkeeping gimmicks and/or false promises (i.e., assuring citizens that the program is sound) to attract (or worse, mandate) new deposits.
So was Perry right? I’d say mostly so. Either way, he re-introduced the “third rail” into the mainstream of political discourse. And that, I believe, is positive.