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Social Security is a Ponzi Scheme   July 19th, 2007
       

 
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One of the biggest problems the United States faces--and one of the problems that is most often ignored--is Social Security. There's no way to put it gently: The Social Security "Trust Fund" is a fraud and it will collapse most spectacularly, and bankrupt the United States Government, if significant reforms are not instituted soon.

Social Security's History

When Social Security was implemented in the early 1940's, total payments to Social Security recipients were approximately $50 million a year to about 1.5 million people (in 2003 dollars, that's about $668 million). In 2003, total payment to recipients has increased to $474 billion paid to 47 million recipients . In other words, the number of people receiving social security has increased about 30 times and the total amount paid to recipients has increased by over 700 times, in real terms. To further illustrate the problem, when the program was instituted there were 16 people contributing to the system for every person drawing from the system while today there are only 3.3 people for each person receiving benefits .

As these numbers would suggest, Social Security has repeatedly been recognized as unsustainable. Congress has passed legislation to compensate for that. The Social Security tax rate increased from 2% when it was first created and, after a number of social security tax hikes over the decades, is 12.4% today. It used to apply only to employees working for companies with more than 10 employees and did not apply to employees of smaller companies or the self-employed; today it applies to everyone. The retirement age has been pushed further and further back and benefits have been cut.

It's well-understood that Social Security is not sustainable. That's why Congress has been forced to increase the social security tax rate, decrease benefits, and increase the retirement age many times over the years. Each time, the viability of Social Security has been extended by a few years or decades. But the problem has never been solved, it has only been postponed. These adjustments by Congress have not changed the underlying structural problem, they have only changed the numbers.

The Problem of the Social Security Trust Fund

The underlying problem of Social Security is that it isn't a trust fund. The money you pay into Social Security over your working life is not saved in your name. Instead, the Social Security Administration uses your money to pay current Social Security recipients and, if there's any money left over, "invests" your money "conservatively" in United States Bonds. The problem is that that's the only thing the Social Security Administration invests in. When they buy a bond, the U.S. Government takes the money and gives SSA the bond--which is nothing more than an I.O.U. which the SSA can redeem later. The U.S. Government, with that money in hand, then spends the money in its normal operations.

Effectively, the Social Security deductions from your paycheck are given to SSA which in turns gives it to the U.S. Government at which point the U.S. Government owes that money to Social Security. Your Social Security deductions literally become part of the national debt! That's why if you check the U.S. National Debt, you'll see something called "Government Account Series" with $3.8 trillion in the "Intragovernmental Holdings" column . What that means is that the Federal Government owes various "trust funds" (primarily Social Security) $3.8 trillion. That's money that has been "saved" by Social Security but spent by the Federal Government. The $3.8 trillion that was supposedly saved has already been spent. Literally.

This has been great for the Federal Government because it has had all that extra money it could spend without having to take the unpopular step of raising taxes. At the same time, Social Security hasn't been impacted because, for the time being, it's still collecting more money from you and me than it's paying to recipients.

However, as the number of recipients continues to increase as the baby-boomers retire, we're going to see the number of recipients almost double between 2000 and 2030, growing by 34 million to approximately 70 million, while the number of workers contributing to Social Security will only grow by 24 million. By 2017, it is expected that Social Security will be spending more money than it's receiving from you and me .

When that happens, the Social Security Administration will start cashing in all those bonds it has. The SSA will take its bond to the U.S. Government and say, "Here are those bonds I bought, here they are, please pay me what you owe me." The U.S. Government, not having actually saved any of that money, will have to pay the SSA with money from the current federal budget. That will either be accomplished by increasing taxes or by borrowing more money from the public.

So, by 2017, our Social Security deductions are not going to be enough to sustain the system. The government will have to spend our federal tax dollars to pay back the money it has borrowed and spent from Social Security over the decades. Since the Federal Government isn't exactly swimming in extra money (as evidenced by the debt), it really doesn't have the money to spend. And since a lot of the money it is borrowing now is actually from Social Security and that money will no longer be available to borrow, we have a double-whammy which will put a lot of stress on the federal budget. Presumably this will start in about 2017 and get worse from there.

    Update 3/31/2009: The Social Security "surplus" which was expected to vanish by 2017, as I wrote above almost two years ago, may end up vanishing by 2010 due to the current economic crisis. And the quote below affirms the potential consequences.

    With unemployment rising, the payroll tax revenue that finances Social Security benefits for nearly 51 million retirees and other recipients is falling, according to a report from the Congressional Budget Office. As a result, the trust fund's annual surplus is forecast to all but vanish next year -- nearly a decade ahead of schedule -- and deprive the government of billions of dollars it had been counting on to help balance the nation's books....

    The Treasury Department has for decades borrowed money from the Social Security trust fund to finance government operations. If it is no longer able to do so, it could be forced to borrow an additional $700 billion over the next decade from China, Japan and other investors. And at some point, perhaps as early as 2017, according to the CBO, the Treasury would have to start repaying the billions it has borrowed from the trust fund over the past 25 years, driving the nation further into debt or forcing Congress to raise taxes.


How to Patch The Current System

There's a right way and a wrong way to do anything. Our senators and representatives have a history of doing things the wrong way. That's how they've addressed the unsustainability of Social Security for decades and that's probably what they'll do again. Rather than fixing the underlying problem of Social Security (that the government spends everything Social Security "saves"), it will probably adopt one or more of the following "patches."
  1. Increase Retirement Age. The easiest way for the politicians to avoid an immediate crisis is to simply increase the retirement age. By making fewer people eligible for Social Security, the SSA will have reduced outlays and won't have to cash in its bonds. This is politically attractive since many of the voters see their retirement as so far off that they won't punish their politicians for increasing their retirement age from 67 to 69 or 71, or whatever. After all, it's 20, 30, or 40 years away. They have more pressing issues to worry about.

  2. Decreasing Benefits. Another option is to decrease benefits. This option, though, is very unlikely. Social Security is a political hot potato that very few politicians want to be seen as attacking, and decreasing benefits of retirees would draw heavy political consequences from special interest groups such as the AARP. It's far easier for Congress to increase the retirement age than to decrease benefits, so it's unlikely that they'll decrease benefits.

  3. Increase Social Security Tax. This has certainly been done before. Since the Social Security tax started at 2% and is now 12.4%, Congress has shown very little hesitation to increase our taxes. If they've spent all our money, they can just soak us for more.

As 2017 approaches, I'd expect to see talk of some combination of increasing the retirement age with increasing the social security tax. It might be too late to fix the impending deficit by increasing the retirement age, though, so I'd bet we'll see the social security tax increase.

This, however, is only a temporary work-around. This would buy us some time--how much time depends on how much the tax is increased by. The whole system is still inherently a Ponzi scheme, though. It seems likely that medical progress will continue to increase our life expectancy. In such a situation, the only way to sustain the system is to get even more working people contributing to our social security system. Since our birth rate is not increasing, our entire social security system really depends on us continuing to receive new immigrants to continue to swell our population. A generation later, we'll need even more immigrants to pay for the previous generation.

The system is simply unsustainable. While I will not be at all surprised to see politicians implement one or more of the three possible work-arounds above, what we need is a real solution. We need to fix the structure of Social Security so that it is sustainable.

How to Fix The Current System

Instead of temporary patching the system by increasing taxes, decreasing benefits, or increasing the retirement age, we should really be looking at a permanent fix.

I believe the best solution is to completely privatize social security. The government could mandate a minimum level of contribution to private retirement plans instead of running the social security scam. The government could even collect the social security contributions, but they should be immediately forwarded to a private financial institution rather than being spent by the Federal Government.

For some reason, some people seem hesitant to privatize social security. This is illogical. The most corrupt, most poorly run private system has a better chance of working over the long-term than our current government-run social security system. The government is spending our retirement but, for some reason, we don't take it seriously. If social security were a commercial entity, its CEO and directors would be in jail long ago.

It's time that we start taking the looming social security crisis seriously. The longer we wait, the higher the probability that the system will collapse and that we'll lose all the money we have contributed into the system over our lifetime.

Update 1/7/2009: In the wake of the Madoff Ponzi scheme on Wall Street, an article was written at CNN that claims that Social Security is not a Ponzi scheme. The most amazing thing is that the article acknowledges the basic Ponzi nature of Social Security but claims it isn't a Ponzi scheme primarily for two reasons: 1) No-one is being deceived as to what Social Security is and how it works. 2) The government can raise taxes or decrease benefits to keep it from failing. But neither of those points changes the fact that Social Security is an unsustainable (in its current form) transfer of wealth: A Ponzi scheme. Considering their "proof" doesn't support their conclusion that Social Security isn't a Ponzi scheme, it makes you wonder why they even bothered to write the article.

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