All Commentary
Tuesday, January 1, 2002

Uncle Sam’s Retirement Scam

The Social Security Ponzi Scheme Is Crumbling

Doug Bandow, a nationally syndicated columnist, is a senior fellow at the Cato Institute and the author and editor of several books.

The legendary third rail of American politics, Social Security, is lighting up. The administration has proposed to move, ever so gently, toward a private system, while a bipartisan congressional coalition is determined to keep Americans locked into an inferior retirement system.

Social Security was long viewed as America’s most successful social program. But it worked only because of demographics: when first created, dozens of workers supported each worker. Taxes were low, benefits secure.

But Ponzi schemes succeed for only a limited time. When Franklin Roosevelt was posing as the savior of the elderly, almost half the people died before collecting their first check. No longer, however. Most people receive not just the first check, but many more. By 2050 Americans will be living 12 to 14 years longer, on average, than they were in 1940.

As people live longer and parents have fewer children, the population itself is aging. Thus as the Baby Boom bulge hits retirement in the coming years, every retiree will become dependent on just two workers, down from three today. That will destroy the system.

Indeed, in just 15 years Social Security will be paying out more than it takes in. The program’s defenders argue that $5.4 billion will be stockpiled in the Social Security “trust fund,” but the money has been spent. All that sits in Social Security’s vault are government IOUs to itself, which will require the government to hike taxes, borrow money, or cut other spending.

Even Senate Democratic leader Tom Daschle admitted in 1996 that “there is no such fund.” If the system’s special-issue bonds, which are not marketable to outsiders, disappeared tomorrow, nothing would be different. To pay promised benefits the government would have to hike taxes, borrow money, or cut other spending.

Perhaps the oddest argument comes from economist Paul Krugman, who contends that the trust fund is “a real asset” because “every dollar that the Social Security system puts in government bonds—as opposed to investing in other assets, such as corporate bonds—is a dollar that the federal government doesn’t have to borrow from other sources.” How can someone so smart make such a silly argument?

The dollars collected by the Social Security (FICA) tax were originally real assets. But the government has spent them. All that remains are some paper IOUs sitting in a government file cabinet.

The deficits will grow as the baby-boom retiree bulge grows. Deficits will go from tens to hundreds of billions a year.

Here Krugman is a bit more honest than his political allies. Don’t worry about the meaningless trust fund, he writes. Just use general tax revenues to pay the bill.

At least that would destroy the illusion, long fostered by the Social Security system itself, that it is an actuarially balanced annuity program. Everyone would see it for a tax-funded welfare scheme, like any other.

But the taxes won’t be cheap. The annual deficit will rise from $93 billion in 2020 to $271 billion in 2030 to $318 billion in 2035, in today’s dollars.

Krugman, like most other welfare-state enthusiasts, suggests repealing the Bush tax cut. However, Social Security actuaries warn that doing nothing now will require doubling the system’s “cost rate,” essentially, the tax rate, by 2031, when the last of the boomers reach the usual retirement age.

Such a hike might not bother a well-compensated academic like Krugman. It would understandably anger most other Americans.

He could argue that higher taxes wouldn’t be so bad if the return were good. But today the average return is less than 2 percent.

Many younger workers will actually lose money—a higher-income 38-year-old will have to live to 92, nine years past his life expectancy, just to break even. Minorities, who have shorter life spans, and women, who are disproportionately dependent on Social Security, do even worse.

In contrast, the average annual rate of return on private investment over the last 75 years, through the Great Depression, is almost 8 percent. Safe investments such as Treasury bonds pay about 3.4 percent.

It has taken only two decades for Social Security to go from Sure Thing to Rip-Off. In 1980 an average worker got back his and his “employer’s” taxes, plus interest, in just 2.8 years. It will take 16.8 years in 2001. In 2030, assuming no tax hikes or benefits cuts, it will take 23.5 years.

But, of course, those, along with borrowing, are the only alternatives to “save” the system. Using the intermediate projections of the Social Security Trustees, Congress would have to hike taxes by 37 percent or cut benefits by 26 percent to fulfill its promises in 2040.

Or it could engage in an orgy of borrowing—about $7 trillion by 2040 and $47 trillion by 2075, in current dollars. This would be a larger share of GDP than at the end of World War II.

Thus the only way to look at Social Security is that it is in crisis. People are getting ever less for more. The trend will only accelerate as the baby boomers retire.

The answer is obvious. Allow people to invest their money in private, actuarially sound investments, rather than have it tossed into Social Security’s black hole.

This is no radical concept. Nearly half of American families now invest in the stock market. Moreover, countries ranging from Chile to Britain to Sweden to Australia have moved or begun to move to fully funded private pension programs in place of government Ponzi schemes like Social Security.

Indeed, even President Bill Clinton was prepared to push for private accounts before the Monica Lewinsky scandal struck, forcing him to rely on left-wing allies to survive. And House Minority Leader Richard Gephardt, notable for the demagogic abuse he recently poured on the President’s National Commission on Social Security Reform, suggested in 1998 that private accounts “can be part of the answer.”

The alternative is what Democratic Commission member Robert Pozen calls the “do-nothing plan.” Sit around while the system crumbles, then enact draconian tax hikes while cutting benefits. Such a strategy won’t bother the wealthy, who will have ample private investments to fall back on. It will wreck the retirement of the poor and disadvantaged, who foolishly relied on the government for security.

  • Doug Bandow is a senior fellow at the Cato Institute and the author of a number of books on economics and politics. He writes regularly on military non-interventionism.