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Friday, September 2, 2011

Ponzi Unmasked

Caveat adsiduus.

Texas governor and Republican presidential aspirant Rick Perry stirred up a fuss when he impolitely called Social Security “a Ponzi scheme.” Was he right?

Ponzi schemes, which appear to be investment programs, have two elements. First, no investment actually takes place. People are promised returns on their money, but those returns don’t come from profits on successful investments; rather they come from new contributors to the scheme. Ponzi tells Contributor 1 that if he turns over a sum of money, he will see a handsome return next week. One week later Ponzi makes good on his promise — not by investing C1’s money, but by making the same promise to Contributor  2. Once C2’s cash is in hand, Ponzi can pay C1, and so on. Obviously, this is unlikely to last forever.

Now it so happens that this is indeed how Social Security works, except unlike Ponzi, the government uses compulsion. People are forced to pay FICA taxes, assuming that when they reach 65 they will receive a monthly check. Where will that money come from? From revenue extracted from the current working generation. No one’s contributions are invested. Until recently Social Security ran a large surplus; it took in more than it paid out to retirees. Was the surplus invested? No, it went into the government’s general fund.
But the so-called trust fund wasn’t left empty-handed. The Treasury deposited a special nonnegotiable bond – an IOU.

Now that the trust fund runs a deficit, it must redeem the bonds at the Treasury for cash. The Treasury has its own deficit, of course, so it has no spare cash and must borrow from the public. Hence, inter-agency debt transforms into public debt. (This Freeman article imagines trying to run a family college fund like Social Security.)

Requirement #2

Social Security therefore meets one requirement of a Ponzi scheme. But there are two requirements. The second is deception. That should have already been clear. You couldn’t run a Ponzi scheme if you told your contributors the truth: “Give me $1,000 today, and I will double your money – as soon as I find two more people willing to give me $1,000 on the same condition.” That wouldn’t get very far.

The question, then, is: Does Social Security dishonestly represent itself as an investment, or insurance, program? It often has done so. The regressive payroll tax is formally known as FICA: Federal Insurance Contributions Act. (It also funds Medicare.) Besides that, the Social Security website mentions insurance on its history page, which features a picture of the father of “social insurance,” nineteenth-century German chancellor Otto von Bismarck:

The significance of the new social insurance program was that it sought to address the long-range problem of economic security for the aged through a contributory system in which the workers themselves contributed to their own future retirement benefit by making regular payments into a joint fund. It was thus distinct from the welfare benefits provided under Title I of the Act [Grants to States for Old-Age Assistance] and from the various state “old-age pensions.”

In other words, Social Security can’t be transfer, or welfare, program because it’s an insurance program to which workers contribute through a joint fund. Franklin Roosevelt insisted that Social Security be financed through separate “contributions” rather than general taxation precisely to maintain the appearance of insurance and to give workers an apparent stake in the system.

Money Long Spent

But it is a transfer program. By the time you go on Social Security your money has long been spent, and the money you receive is taken from current workers through taxation. That’s a transfer, or welfare, program in insurance clothing.

While the government has usually tried to fool people into thinking Social Security is insurance, it has operated on a different track when necessary. Will Wilkinson notes, “The Act was scrupulously drafted to ensure that the tax and the government transfers would not appear to have anything to do with each other. And the program is never described therein as ‘insurance.’”

The reason is that the government needed to protect itself — from the people. Wilkinson: “In anticipation of a constitutional challenge, Social Security officials went out of their way to purge their informational materials of insurance language.” When court challenges came, the government argued that the payments were taxes and benefits were not a matter of contractual right.

“The old-age monthly benefits program which Title II of the Social Security Act establishes is not a federally-administered ‘insurance’ program,” Health, Education, and Welfare Secretary Arthur Sherwood Flemming said in his brief in Flemming v. Nestor (1960).  “The contribution exacted under the Social Security plan is a true tax. It is not com­parable to a premium promising the payment of an annuity com­mencing at a designated age” (emphasis added).

Court Agrees

The U.S. Supreme Court agreed (twice): “Appellee’s right to Social Security benefits cannot properly be considered to have been [an ‘accrued property right’],” it stated in Flemming. “It is apparent that the noncontractual interest of an employee covered by the Act cannot be soundly analogized to that of the holder of an annuity, whose right to benefits is bottomed on his contractual premium payments…. To engraft upon the Social Security system a concept of ‘accrued property rights’ would deprive it of the flexibility and boldness in adjustment to ever-changing conditions which it demands” (emphasis added). Flexibility and boldness equals congressional caprice.

As the act says, Congress is legally free to change the terms of the program at any time. There is no contract. The entitlement really isn’t. (See more here by John Attarian.)

Once the program was safe from challenge, however, the government resumed its insurance propaganda.

So … Social Security: Ponzi scheme or not?

I think we have to say it once was, but is no more, because Social Security was unmasked as a coercive transfer scheme long ago and critics remind us of that fact constantly. If everyone knows (or can easily find out) something is a Ponzi scheme, it’s no longer a Ponzi scheme. Ponzi schemes are sustained by deception. Social Security and Mediare are sustained by coercion. That’s a big difference.

Anyone who thinks Social Security is insurance just isn’t paying attention.

Caveat adsiduus. Taxpayer beware.

  • Sheldon Richman is the former editor of The Freeman and a contributor to The Concise Encyclopedia of Economics. He is the author of Separating School and State: How to Liberate America's Families and thousands of articles.