A Politician's Version Of Ponzi Scheme

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Some of the original designers of Social Security understood the vast demographic forces that were sweeping America, and they accurately predicted the aging of our population that has helped bring our national retirement system to the brink of insolvency. What they did not anticipate, I suspect, is that a future generation of American politicians would change the way that the surplus in Social Security is treated by the federal budget so that the early cushion built up by the program would essentially disappear through an accounting trick that has helped pull forward the crisis in the system by decades.

Looking out over the policy decisions that have shaped Social Security, it may not be accurate to call it an investment fraud. But it does seem to resemble what I call the politicians' version of a Ponzi scheme, that is, a spending program whose long-term unsustainability is clear early on and often in subsequent years, but whose advocates leave it to some future generation of political leaders to do the tough (and politically unpopular) job of fixing it.

In polite circles, we describe Social Security as a pay-as-you-go national retirement system. In this model, the system relies on taxes extracted from today's workers to pay today's retirees, and the program is sustainable as long as the ratio of workers to retirees remains relatively healthy. Even if that ratio changes just somewhat, policymakers can fix the system easily enough with slight modifications to benefits or small increases in taxes.

But the ratio of workers to retirees has changed massively as part of a population shift that began in the U.S. more than a hundred years before the federal government created Social Security, and has continued relentlessly since then, both here and in every other developed country (and more than a few developing countries, too). There's even a name for the population trends driving this shift -- the demographic transition. In 1929 an American demographer, Warren Thompson, formulated the first theory that described and attempted to explain the great shift. By the mid-1930s, when Washington was considering Social Security, experts clearly understood some of the implications of the shift.

Today, we often refer to this demographic transition when we talk about the aging of our population, although that phrase is often misunderstood to signify that the problem is chiefly that people are living longer thanks to medical advances. Yes, more and more people are surviving until they are 65: Some 75 percent of 21-year-old adults will reach age 65 today. And once they reach 65, people today will live about another 16 years on average, compared with about 12 years in the 1930s.

But the problem is broader than that. Falling fertility rates are another culprit in population aging because they also change the ratio of the young to the old, in the process changing the composition of a nation's population. And declining fertility is nothing new. In 1800 the average fertility rate of an American woman was slightly more than 7 children in a lifetime; by 1900 that rate had already fallen to under 4 children, and by 1930, just a few years before Washington began considering Social Security, the American fertility rate had declined to 2.45 children per woman. After a brief but dramatic bump-up in the 1950s and early 1960s (the baby boom), our country's fertility rate has stabilized at just around 2 children per woman, which is barely replacement level.

One can see the impact of this population shift in the continual growth of the percentage of our population that is 65 and over. In the middle of the 19th Century, just 2.7 percent of the population was aged 65 and older. By 1900 the number was 4.1, and by 1930 it was 5.4. The planners of Social Security guessed accurately that the percentage would continue rising significantly after that. Their projections, contained in materials provided by the Committee on Economic Security in 1935 to President Roosevelt, estimated that 12.7 percent of the population would be 65 and older by 2000. The actual number, according to the 2000 Census, turned out to be 12.4 percent of the population.

The implications of that aging were apparent again and again over the years. In 1954, just 14 years after the government began paying out benefits, Washington amended Social Security to give state and local government workers, who had previously been excluded from participating, the right to join the program. One goal was to increase the number of workers contributing to the program because the dependency ratio of workers to retirees was shrinking fast, cut from 16 workers per retiree in 1950 to about 8 in 1955. Today there are fewer than three. At the current rate we may well be at two workers per retiree by 2030.

In fairness to the early planners, Social Security has built up a surplus at times in its history. For instance, although the Baby Boom generation will soon become a burden to Social Security through massive retirements, the Boomers were initially a boon when they brought significant numbers of new tax-paying workers into the system. But changes to federal budget practices in the late 1960s essentially mean that there is no real surplus sitting anywhere waiting to be used. The federal government has spent the money on other programs and replaced it with IOUs.

Advocates say that's fine: Uncle Sam's credit is golden. But the impact on the federal budget is all the same. As Social Security pays out more than it takes in from payroll taxes, the federal government has to start paying back those IOUs out of its budget. Even worse, academic research suggests that the practice of spending the Social Security surplus on other programs and replacing it with IOUs has probably helped encourage increases in federal spending by creating the illusion that there was more money to go around.

This habit of promising big benefits in a program, then ignoring a day of reckoning is common. We've all seen how state and local politicians, for instance, designed pension systems for public employees that hid the true costs to taxpayers of these pensions, and how those costs then only became apparent years later, when millions of public sector workers had already earned their benefits and demanded that they be paid out. And if our policymakers understood the implications back in the 1930s of the demographic transition, surely in the mid-1960s they had some inkling of what that same transition to an older population would do over time to the cost of the new program of health care for the aged they were proposing, which came to be called Medicare.

The politicians' version of a Ponzi scheme may not be quite precisely an investment fraud, but it is an all-too-common political stratagem that plagues our federal, state and local fiscal health. It's not just Social Security, but a whole host of spending problems we now have to dig out of because of this stratagem.


Steven Malanga is an editor for RealClearMarkets and a senior fellow at the Manhattan Institute

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