"Ponzi Scheme" Doesn't Quite Cover the Evils of Social Security
The Republican primary context has become a referendum on Social Security, with Texas Governor Rick Perry standing by his earlier statements denouncing the program as a Ponzi scheme, and Mitt Romney seeking to revive his presidential bid by defending Social Security. With Perry as the runaway front-runner, and only gaining in the polls, it looks like this will be a preview of the general election battle.
So is Social Security a Ponzi scheme? Yes it is, in its own way, but that doesn't quite cover it. In reality, Social Security is much worse than a Ponzi scheme.
The analogy to a Ponzi scheme is accurate and necessary, because it captures the basic economic unsustainability of the program. A Ponzi scheme is unsustainable because the returns it promises are backed, not by any underlying productive investment, but solely by the scheme's ability to recruit an ever increasing number of new suckers to contribute to it. Some have objected that Social Security is not a Ponzi scheme because it has the power to coercively recruit new contributors. But even that does not guarantee that the mathematics will work out. From its very inception, the number of contributors forced to pay into Social Security has been declining relatively to the number of beneficiaries. The numbers are well-known, and Charles Krauthammer rehearses them succinctly: "When Social Security began making monthly distributions in 1940, there were 160 workers for every senior receiving benefits. In 1950, there were 16.5; today, three; in 20 years, there will be but two."
Krauthammer describes the results. To keep the scheme going, the amount that has to be wrung out of each new victim keeps increasing: "in 1940, the average worker had to pay only 0.2 percent of his salary to sustain the older folks of his time; in 1950, 2 percent; today, 11 percent; in 20 years, 17 percent." Correspondingly, what each new contributor gets back from the program keeps decreasing. As Andrew Biggs observes, this is another thing that Social Security has in common with a Ponzi scheme.
[L]ike a Ponzi scheme, Social Security paid early participants incredible returns on their money, because they contributed to the system for only a few years but received a full retirement's worth of benefits. A person who retired in 1950 received around a 20 percent annual return on the taxes he paid (which happens to be exactly the same return that [Bernie] Madoff promised to his investors)....
[A]n average wage earner born in 1950 will receive around a 2.2 percent return from the system, which is less than what you could earn on guaranteed government bonds. A person entering the workforce today will receive only around a 1.7 percent return.
At some point soon, that return is going to become negative, meaning that Social Security will present every young person with the prospect of forty years' worth of dead loss the moment he enters the work force. From this perspective, the fact that Social Security can coercively recruit new contributions makes it worse. At least a private Ponzi scheme is self-liquidating. It collapses the moment its victims realize they are being defrauded. Social Security is a Ponzi scheme with no escape, as if Bernie Madoff had been exposed--and then promoted to Secretary of the Treasury.
That brings me to the most important similarity to a Ponzi scheme. Both Krauthammer and Biggs grant that Social Security was not founded with the intention to defraud. They're dead wrong. Social Security is not an actual investment scheme or insurance plan, because its tax receipts are immediately spent rather than being invested in productive enterprises. Yet from the very beginning it has been relentlessly sold to the American people as if it were an ordinary pension plan. Even a group of South Carolina Tea Party supporters described the system in those terms, telling a reporter, "We paid into Social Security," "It's not an entitlement, it's ours," and, "That's my money that I put into Social Security-I deserve it."
These people are the victims of an enormous, decades-long swindle, because the economic reality is that the money they paid into Social Security is long gone--and the legal reality is that the benefits they think they are owed do not belong to them. Court rulings have affirmed that the government isn't obligated to pay them any definite amount, only whatever Congress chooses to pay.
The awful truth is that Social Security's beneficiaries, who have been misled into believing that they are merely collecting the funds owed to them by a pension plan, are in reality just another faction of welfare recipients. They receive benefits, not because they own money in an investment account, but only because politicians in Washington, DC, want to appease a pressure group, buying their votes by giving them handouts.
If Social Security is actually a welfare scheme, then it is the most unnecessary welfare program in history. The system's primary beneficiaries are members of the middle class. Yet the middle class is, by definition, that segment of a society that does not need welfare. The defining characteristic of the middle class, what differentiates the middle class from the poor, is that they are prosperous enough to pay their own bills and to be independent and self-sustaining.
The middle class are those who make enough money to support themselves and to build up savings. This is the really diabolical aspect of Social Security. It is designed in a way that openly discourages and prevents saving, particularly on the part of the middle class.
The rich and the poor tend to escape the ravages of Social Security. The rich earn incomes well in excess of the maximum that is subject to payroll taxes, so a relatively small portion of their income is taxed to pay for Social Security. The very poor have various tax breaks, such as the earned income tax credit, designed to refund their Social Security taxes back to them. But there is no escape for the middle class. They are not poor enough for a tax credit, but all or most of their income is subject to the full payroll tax. They will see 13% of their income (counting the employers' portion of the payroll tax) drained out of their paychecks for their entire working lives.
Now consider that number, 13%, and compare it the national savings rate--the percentage of his income that that average person puts into genuine, productive investments. After years of hovering near zero (and dipping below zero, i.e., a net drawdown of savings, shortly before the financial crisis), the national savings rate briefly climbed to 7% and is now somewhere in the neighborhood of 5%. Social Security suppresses that number, both directly, by seizing 13% of a middle-class worker's income and making it unavailable for savings, and indirectly, by lulling potential savers into a false sense that they have already set aside money for their retirement. This suppression of saving amounts to an enormous destruction of private wealth for the middle class. And for the overall economy, it means an enormous drain of capital from the primary capital-producing class.
This is the mechanism by which the fraud of Social Security turns an independent, economically self-sufficient majority into just another welfare-state pressure group. The middle-class workers who have the potential, through their own diligent saving, to become "the millionaire next door" are instead encouraged to become the welfare dependent next door.
If you think this is an accident or an "unintended consequence," think again. The defenders of Social Security have fought tooth and nail to prevent any reform that might move the middle class out of the system. That is why they have fought so hard against "means testing" that would reduce the benefits paid to the more well-off, and that is why politicians voted to expand Social Security benefits in 1970s by, for example, indexing benefits to the growth of wages rather than to the (usually smaller) rate of inflation. They did not want Social Security to become just a bare minimum designed to keep the elderly out of poverty, because such a program would become irrelevant to the well-being of the middle class. The supporters of the system made the deliberate decision to keep the middle class dependent on Social Security, because it wanted to retain them as part of the permanent constituency for big government.
The economic independence of the middle class is why it has always caused such trouble for corrupt and tyrannical political systems. Every other segment of society can be bought. The very rich can be co-opted through cronyism (think Jeff Immelt and General Electric), and a demagogue can always tempt the poor with the promise of handouts. But the middle class is the segment of society that is both prosperous enough and numerous enough that its members are cantankerously independent of the state, making them a thorn in the side of power-hungry rulers--until the advent of the middle-class welfare state.
That leads us to the final evil of Social Security: the destruction it has wreaked on our very form of government. As Robert Samuelson recently observed, "In 1960, national defense was the government's main job; it constituted 52 percent of federal outlays. In 2011--even with two wars--it is 20 percent and falling. Meanwhile, Social Security, Medicare, Medicaid and other retiree programs constitute roughly half of non-interest federal spending." The dominant business of the federal government used to be protecting our lives and property. Now the federal government's main job is sending checks to people who don't work.
So we have a system that is fraudulent and unsustainable in its design, which suppresses capital accumulation for individuals and economic growth for the economy as a whole, and which reduces a self-sufficient majority to supplicants of the state. The whole system is intellectually dishonest, economically destructive, and morally corrupting.
A mere Ponzi scheme? We should be so lucky.
We will need to have a "national discussion," to use the standard politician's phrase, about the best and most politically palatable way to unwind this scheme. But it is a fraud and a monstrous lie, and the sooner we tear it down, the better.