“Americans are more and more aware that Social Security contributions are not “invested” to finance future benefits; instead, they are used to disguise the true amount of borrowing necessary to fund the Administration’s unprecedented spending spree. As the General Accounting Office stated last September: ‘The present situation, in which trust fund surpluses are combined with and partially offset a deficit in the general fund, means that the payroll tax is being used, not to make provision for future retirement benefits, but to pay for today’s general operations of government.’”

–R.C. Whalen
“Mess With Social Security — Change It From Ponzi Scheme To Private Pension Fund”

Barron’s, March 4, 1991

 

One of the dangers of using your Dad as a prop in a commentary is that he may call you out on it:

I am not as much of a cynic as you make out to your readers. I want you to write about solutions, how to create new credit. There are not many people alive today who remember the deflation of the 1930s, when I was born. Be careful what you wish for. We need to avoid severe deflation. This young, spoiled country of ours is still trying to figure out its politics. We must avoid extreme economic swings to avoid extreme political outcomes.

The desire to avoid extreme swings in US economic life is ingrained in my dad’s generation. They still feel the fear and uncertainty of past years of deflation and unemployment, one of the reasons that debates over things like Social Security generate such visceral reactions. Yet whether we talk about the federal safety net or how we purport to “manage” the US economy, Americans talk like “capitalists” — whatever that is (please send comments below) — but behave very much like socialists.

Take the comment by GOP presidential contender Rick Perry that Social Security is a “Ponzi” scheme. See James Kwak’s “Ponzi Schemes for Beginners” for a “it’s not a Ponzi scheme” perspective on Social Security.

I differ with Kwak, but he and I seem to agree that Social Security is not a funded retirement scheme. But there is no shoe box — no assets separate from the finances of the republic — to make Social Security payments. Ponzi himself could not help but smile.

Since the 1930s, the youthful population of the US allowed Washington to pay current beneficiaries in what is known as a “pay-as-you-go” system, dreamed up by Franklin Delano Roosevelt. Social Security built up a substantial cash surplus because 80 years ago there were more than 10 workers for every retiree. The government spent the cash on other activities and the Social Security Administration (SSA) got a piece of paper from Uncle Sam, promising to pay on demand with interest, etc., etc.

Wind the clock forward. The US population is aging. The SSA is in deficit, meaning that Treasury must start to raise cash to redeem the bonds given to the SSA. This will represent a growing part of overall Treasury financing operations as time goes on. Too few observers have thought about what the scale of the cash funding requirements of Treasury will be in future years to make good on the debt to the SSA.

Now people like Kwak argue that “there’s nothing wrong in principle with a pay-as-you-go system, as long as the future revenue stream is secure.” Indeed. The future revenue stream in the US is not secure. The dependency ratio, which Kwak discusses in his article, is basically the way to look at the number of workers vs. retirees in the long term to see if the pay-as-ya-run scheme still works.

But at the end of the day, Kwak and other supporters of Social Security always fall back upon tax increases to support benefits to approximately the year 2035, when the demographic effects of the Baby Boom will have run through the system and your faithful blogger will likely be feeding the shrubs. Says Kwak:

As all informed observers realize, you could close the seventy-five-year Social Security budget gap simply by raising the payroll tax rate by two percentage points (or by other means that have a similar financial impact, such as eliminating the cap on taxable income). This in itself should make clear that it isn’t a Ponzi scheme.

No, James, you save your worst argument for last. Rick Perry is right: Social Security is a Ponzi scheme. The nature of the pay-as-you-go system and the high budget deficits being run by the federal government for other services makes it a precise parallel with the work of Carlo Ponzi. The US fiscal mess makes it increasingly unlikely that the federal government will be able to make good on the Social Security payments without resorting to hyperinflation. All of the cash collected from past recipients is gone with no assets to show for it but Treasury debt.

As former Fed Chairman Alan Greenspan famously said in his 2005 Congressional testimony on Social Security from The Daily Bail:

I believe that we should maintain the principles of Social Security, but I think the existing structure is not working. Until we construct a system that creates the savings that are required to build the REAL assets, so that the retirees have REAL goods and services. We don’t have a system that is working. We have one that basically moves cash around and we can guarantee cash benefits as far out and whatever size you like, but we cannot guarantee their purchasing power. Do we have the material goods and services that people will need to consume, not whether or not we pass some hurdle with respect to how legal financing occurs. Financing is a secondary issue and it is a means to create the REAL wealth, not an end into itself.

Photo: Gail Sredanovic (L) and Ellyn O’Toole join the California Alliance for Retired Americans at a demonstration outside the office of U.S. Senator Dianne Feinstein (D-CA) in San Francisco, California August 17, 2011. The group was urging Feinstein to protect social security benefits. REUTERS/Robert Galbraith