A Ponzi scheme is a white-collar crime that primarily victimizes those whose greed dominates their common sense. Each group pays money to the preceding groups, and so as long as each successive group of investors is larger than the preceding group, the early investor groups cannot help but gain.
In fact, stories of huge early returns help attract the later investors who don't want to be chumps left out of automatic winnings. The stories are true for a while. But eventually it becomes impossible for the succeeding investor groups to keep growing, and the scheme collapses.
Unfortunately, we now have politicians who seem to want to gain electoral favor by likening Social Security to a Ponzi scheme, most recently at Wednesday night's GOP presidential debate where Texas Gov. Rick Perry called it a "monstrous lie" to "our kids." Others claim that the trust fund has been "raided" and unable to serve its function of supplementing the payroll tax as baby boomers retire. Some even claim the system is "unconstitutional."
These politicians understand neither Social Security nor Ponzi schemes. As former Vice President Dick Cheney said recently, the program is effectively and reliably serving millions of people and has for 80 years. Why the confusion? Why is this a perennial issue?
Ponzi schemers cannot divulge how their plan works; it is essential that all internal workings of a Ponzi scheme be secret. By contrast, the Social Security Administration provides a mountain of explanation and data (see annual trustee reports at www.ssa.gov). Charles Ponzi never issued a trustee report.
The Social Security System is remarkably solvent — a fact better known to the few who actually study the workings of the program than it is to the many who criticize it. It is an insurance program that most workers are forced to participate in, paying a payroll tax as the "premium" to insure against poverty in old age. True, the program is expensive and relies on one generation to pay the benefits of the preceding generation; however, unlike a Ponzi scheme, there is reciprocity between those generations: the older generation passes on to the young the physical and knowledge capital of the nation. The immense value of this transfer enables younger workers to produce the national income out of which the retirees take their piece. There is no similar reciprocity in a Ponzi scheme.
Some of the conflation of Social Security with a Ponzi scheme stems from the fact that when the program got started, the first generation of Social Security recipients received a very large rate of return on their investment. In fact, the first recipient, Ida May Fuller, received her initial check in 1940. Prior to her retirement, she had contributed $24.75. By the time she died in 1975, at age 100, she had collected $22,888.92. Similarly, the rest of that first generation received far more in benefits than they paid in. Of course, this was the same generation that pulled the country through the Great Depression and World War II, thereby contributing mightily to the welfare of the nation. Consequently, there was little fuss made over the extraordinary return on their payroll taxes. Later generations of retirees receive more normal returns.
All such pay-as-you-go systems are stable if each succeeding generation is a bit larger than the preceding one. However, because of the large size of the baby boom generation, this will not again be the case for Social Security until around 2060. The baby boomers number 77 million, and the subsequent generation is only 47 million. Recognizing the implications of this disparity, President Ronald Reagan established a "trust fund" with Treasury bonds purchased by Social Security from funds provided by an increase in the payroll tax rate. His vision was for Social Security to cash in those bonds during the boomers' retirement bulge when the cash flow from payroll tax revenue would be insufficient to meet the promised retirement benefits.
Reagan was no Charles Ponzi. Comparing Social Security to a well-known type of criminal enterprise distracts from another fact: that the retirement benefits are managed at far less cost than private sector retirement plans. In fact, the Congressional Budget Office calculated that the administrative costs of Social Security are approximately 1.5 percent of benefits, in contrast to the nearly 30 percent for some private accounts options it reviewed when Social Security reform was studied.
The program is sound. As the trustee reports and the Bowles-Simpson report show, the future of the program is secure with only minor adjustments. The monstrous lie about Social Security is not that it will be there for future generations but rather the notion that it won't. This falsehood fosters intergenerational distrust at a time when we need to be one nation with reciprocal responsibilities among generations.
Charles O. Kroncke is associate dean in the University of South Florida College of Business. William L. Holahan chairs the department of economics at the University of Wisconsin-Milwaukee.