This article was originally published in the McAlvany Intelligence Advisor on Monday, July 1st, 2013:

 

Every Ponzi scheme fails, some sooner than others. The Wall Street Journal just outlined the predictable unraveling of along with suggestions on how to keep it solvent. None of them will work.

In 2010 payouts exceeded payroll taxes for the first time since 1983 and it is now dipping into its reserves to stay afloat. The trustees’ report says those reserves will be gone by 2033. Don’t count on it lasting even that long. Reason: the disability benefits program (SSI) will run out of money by 2016 – that’s three years from now. It’s partly due to demographics, partly due to the increasing entitlement mentality, and partly due to the economy. There are nearly nine million people receiving disability checks, an increase of 50 percent in just the last ten years. When that part of the program goes broke, Congress will likely take the easy way out and transfer the liability of SSI to the general fund rather than raise taxes. That will be a short-term answer to a long-run problem and will hasten the eventual ending of the system altogether.

Why is this so predictable? Eventually it will run up against the wall of inevitability: fewer workers supporting more takers to the point where the workers either vote to end the program altogether or it goes bankrupt and the checks stop going out. In the usual Ponzi scheme, early investors are paid off with new money coming from later investors. Charles Ponzi’s scheme lasted only 200 days. is coming on to 80 years. The difference: Ponzi didn’t have a gun.

Richard Salsman, writing for Forbes, has a much more realistic view of Social Security: It’s a fraud, and can’t be fixed. Part of the is that it has to be enforced at the point of a gun. From the very beginning, in 1935, it was called the Federal Insurance Contributions Act (FICA) in order to co-opt the credibility that insurance companies had at the time compared to banks. But it was never meant to be actuarially sound. As Salsman explains:

To better understand why is fraudulent, one should grasp the valid workings of annuities, pensions, trusts, and similar investment vehicles. In such cases, purely voluntary contracts are written and enforced by courts; clients pay money into the vehicle, the fiduciary invests and grows it, and over time pays back funds with a gain to clients.

Of course, results depend on the investment climate, but the integrity, safety, and soundness of this private contract-based system fosters saving, investment, and prosperity. If fiduciaries or trustees violate contracts in any way, they can be sued, fined and/or jailed.

On the other hand, none of these are in place in Social Security. Explains Salsman:

A “Ponzi scheme” (the term made famous by Charles Ponzi in the early 1920s), like Bernie Madoff’s recent scheme, and like any “pyramid” scheme or “chain letter,” is an operation that pays alleged “investment returns” to clients from the clients’ own paid-in funds and with payments by subsequent clients, rather than from investments in productive assets or securities….

Unless the scheme keeps growing and spreading, in time it must collapse, as the outflows swamp inflows; the game of “musical chairs” halts when claims exceed cash….

He summarizes the difference magnificently:

Today only fools or frauds dare deny it. Private-sector Ponzi schemes have built-in sensors, enemies, and anti- laws to prevent and terminate them, while Social Security has the opposite: built-in perpetuators, coercion, muzzled and shrinking rivals, a growing pool of serfs, millions of admiring heralds, and a superficial air of legality.

It was fraudulent from the very beginning. The first beneficiary, Ida May Fuller, paid into Social Security for less than three years, her contributions totaling $24.75. She retired in November, 1939 and received her first monthly check for $22.54. She lived to be 100. She collected $22,888.92 in benefits. As Dartmouth College professor Alan Gustman put it: “People who were first in the system got a great rate of return. It’s the younger generation that is going to be in the most difficult position.”

The only way the system could be sustained was to increase the number of workers it covered so that those new contributions would increase. In 1935 the program covered only workers in commerce and industry. In 1939 it was expanded to include seamen and bank employees. In 1946 it was expanded again to include railroad workers, and in 1950 to include farm workers, the self-employed and federal employees without pension plans. In 1954 it was expanded again to include home workers plus state and local government employees. In 1956 it covered the military, firemen, and policemen, in 1965 it started to cover interns, self-employed doctors and those receiving tips. In 1967 it was extended once again to include clergymen and in 1983 to all federal civilian employees hired after that year, plus Congress, the President, the Vice-President, federal judges, and employees of non-profits.

The other way to keep this system afloat was to increase taxes. In 1935 the tax rate was 2.25% of pay whereas today it’s 16.2%. The payroll tax originally covered just the first $4,800 but now applies all the way to $113,700.

Oh yes, there’s that Supreme Court case, Flemming v. Nestor, where Ephram Nestor learned to his disappointment that even after paying into Social Security for 19 years, he had no enforceable contract guaranteeing his benefits. It is, purely and simply, an income tax to be spent as the government, or the Social Security administration sees fit.

What about that $2.7 trillion that Social Security currently has in reserves? It turns out that they are just IOUs that Congress exchanged for the money it already spent on other things. When they are “redeemed,” they will have to be paid for by new income taxes.

Finally, just how much does Social Security owe to its beneficiaries? According to the 2010 trustees report, it’s about $20 trillion, or about seven times what’s in reserves. According to Laurence Kotlikoff, however, it’s much higher. Following is an excerpt from an interview with Joseph Lawlor at Real Clear Policy back in December:

RealClearPolicy: Cox and Archer argue that the U.S.’s underlying debt is much higher than the officially stated debt of $16 trillion. They argue that if you add up the unfunded obligations the government has – to Social Security, Medicare, federal workers’ pensions, and so on – the real debt is about $87 trillion. Can that be right?

Kotlikoff: That’s wrong. It’s $222 trillion.

That’s what we economists call the fiscal gap. I don’t know what those guys are looking at, but we economists do it a certain way. We’re not politicians. We’re just doing it the way our theory says to do it. What you have to do is look at the present value of all the expenditures now through the end of time. All projected expenditures, including servicing the official debt. And you subtract all the projected taxes. The present value of the difference is $222 trillion.

So the true size of our fiscal problem is $222 trillion, not $87 trillion. That’s comprehensive and incorporates the official debt. The official debt in the hands of the public is $11 trillion, so the true problem is 20 times bigger than the official debt.

That’s the real reason that Social Security, Medicare and SSI are going to go away a lot sooner than most people think. The fact that it’s a Ponzi scheme just guarantees it.

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Sources:

MarketWatch: 10 things Social Security won’t tell you

How a Ponzi scheme operates

Forbes: Social Security is Much Worse Than a Ponzi Scheme

Social Security’s first beneficiary: Ida May Fuller

Social Security is not guaranteed:  Flemming v. Nestor

Interview with Boston University Professor Laurence Kotlikoff

 

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