Last updated: September 06. 2013 7:50PM - 58 Views

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Republicans primary politics are moving front and center, and claims made by various candidates are being heavily scrutinized for their accuracy. Hopefully, most are factually correct while some are patently absurd, such as Michele Bachman’s claim that she can bring back $2 per gallon gasoline. Still others are of questionable accuracy, such as Texas Governor Rick Perry’s claim that Social Security is a Ponzi scheme and an outright lie to this nation’s young people, that is, the system will not provide them the benefits guaranteed under current law. Some other Republican presidential wannabes have stated this is totally untrue — particularly Mitt Romney — while others seem to waffle on the issue. So, who seems to be correct on this issue as it relates to Social Security?

First, it seems fitting to define precisely what serves as a “Ponzi scheme.” According to Merriam-Webster’s on-line dictionary, it is an illegal “… investment scheme in which some early investors are paid off with money put up by later ones in order to encouraged more and bigger risk.” Also often mentioned by other sources as characteristics of a Ponzi scheme are the efforts to create the illusion of profitability (so monies continue to flow into the operation and allow it to prosper over time), and the ability of the Ponzi-scheme originators to skim funds from the unwary “investors” to promote their own extravagant lifestyles.

So, does Social Security seem to meet the definition and characteristics of a Ponzi scheme?

On one issue the answer is clearly no, since the Social Security system is a legally enacted effort to provide (in most instances) supplemental income for eligible — and generally retired — senior citizens. Chalk one up for those bashing Rick Perry.

Beyond this one issue, Social Security does a pretty good imitation of a Ponzi scheme. Given its pay-as-you-go nature, it is certainly true that individuals presently paying into Social Security are being used to pay off earlier “investors.” Of course, all of this is being done through what amounts to an intergenerational transfer, which does provide a distinction with a traditional Ponzi scheme, which often have a very short life to them given the inability to keep the swindling operations undetected over time. But this is not always true, as with Bernie Madoff’s scam.

As to the issues of giving the appearance of profitability and providing for a lavish lifestyle for the originator(s) of the scheme, Social Security could still reasonably be considered a Ponzi scheme. How so?

Consider the issue of a profitability appearance. Since changes made in the early 1980s, excess funds paid in the system go into a “Trust Fund” to insure future solvency. But such funds are, in fact, spent by the U.S. government as they “borrow” the funds from the Social Security system, and replace the borrowed funds with non-marketable Treasury securities. This provides the appearance of a financially sound (profitable?) system. But as retired Americans discovered during the recent debt ceiling impasse, should the government be unable to expand its borrowing capabilities, Social Security payments could be disrupted or even halted altogether. Since the non-marketable Treasuries held in the Trust Fund can only be purchased by the issuer — the federal government via the U.S. Treasury — should access to financial markets be impaired, the “financially sound” Trust Fund would default on its obligations. Sounds a lot like a Ponzi scheme, right?

Also, consider the issue of the originator living the good life at the expense of the investors in the scheme. In this case the originator is the U.S. government and the politicians attempting to keep the system from going belly up. As noted above, the monies “borrowed” from the Trust Fund allow the government to pay for its current (extravagant) spending without raising revenues from current taxpayers. Such an operation allows politicians (and the government) to appear more fiscally responsible than they really are and promotes long/prosperous legislative careers for politicians.

By the late 2030s, the Trust Fund is depleted and future Americans (Rick Perry’s “young people”) will get no more than 70-75 cents per dollar of promised Social Security benefits under present law. While 70-75 cents per dollar of guarantees may be good by Bernie Madoff standards, one would hope for something better from the U.S. government.

In the final analysis, Rick Perry is probably wrong to call Social Security a Ponzi scheme, but arguably accurate if he changes just slightly and classifies it as a “Ponzi-like” scheme.

Dr. James Newton serves as chief economic advisor to Commerce National Bank and is an auxiliary faculty member in economics and statistics at OSU-Marion and OSU-Newark. Dr. Newton’s views do not necessarily reflect those of Commerce National Bank or OSU-Marion/Newark.

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