Worse Than a Ponzi Scheme?

RALEIGH – Is Social Security a Ponzi scheme?

Well, its fundamental structure does look an awful lot like the kind of pyramid fraud that Charles Ponzi made famous in the 1930s. When the Roosevelt administration introduced its retirement program as part of the 1935 Social Security Act, virtually employed person in the labor force was going to be paying taxes into the system, while only a small number of retirees would be receiving benefits from it. The ratio of payers to payees began at about 40 to 1. For years to come, policymakers knew, the financial base of the Social Security pyramid would remain very broad compared to the beneficiaries. In 1950, the ratio was still a viable 16 to 1.

But because of inexorable demographic and economic forces, the shape of Social Security’s finances was destined to become more than an obelisk than a pyramid. By the 1970s, the dependency ratio was approaching 3 to 1. That’s why Washington policymakers started changing the program, adjusting both benefits and revenues to perpetuate the program. The implicit deal got worse and worse for taxpayers.

Although politicians have long used rhetorical devices such as “trust fund” and “contribution” to propagate the illusion that Social Security was a forced saving and investment program, the reality was far different. Payroll taxes collected in excess of Social Security payments weren’t used to buy real income-producing assets – for private investment, in other words. Neither were excess Social Security revenue necessarily used for true public investment, such as highway construction, although some of it was.

In truth, Social Security payroll taxes became simply another means of funding current federal spending, which increasingly came in the form of immediate consumption rather than long-term investment. That’s what made the system analogous to a pyramid scheme whose operators pay initial investors a sizable return not through investing in assets but by attracting subsequent investors. Charles Ponzi and Bernie Madoff are the most famous perpetrators of such frauds in the private sector.

As the Cato Institute’s Michael Tanner argued in a recent paper, Social Security is actually worse than a Ponzi or Madoff scheme in one sense: participation isn’t voluntarily. At least the financially wary have the ability to resist the pyramid schemer. American taxpayers aren’t given the same opportunity. Whether they like it or not, the federal government collects a sizable chunk of their income in payroll taxes, offering in return only a legally unenforceable promise of annuity benefits in the future.

Social Security could have been set up in a different way. It could have been a real investment program for American retirees. Rather than requiring workers and employers to pay payroll taxes that could only be spent on paying current benefits or buying federal treasury debt, the program could have required that workers and employers pay into personally owned, portable accounts from which workers could pay their bills or buy an annuity upon retirement. Workers could have kept these accounts in cash or in higher-yielding assets such as bonds and stocks.

The financial capital thus being accumulated over time would have transformed America into a nation of citizen-investors decades before that actually happened (it wasn’t until the 1990s that most Americans were directly or indirectly invested in financial markets), which would have had many salutary economic and political benefits.

Such a system would still have protected seniors from impoverishment by their own profligate spending or irresponsible financial planning – because participation in the savings program would be mandatory, not voluntary – without large-scale income redistribution. And it would have kept a larger chunk of America’s financial capital invested in the private sector, rather than sopped up and wasted by the U.S. Treasury.

But that’s not what happened. Instead, the federal government has prosecuted the Bernie Madoffs of the world, despite running the largest pyramid scheme in the history of the world.

Hood is president of the John Locke Foundation.