Social Security Shock Coming?

This year, large numbers of baby boomers are retiring on Social Security, which turns 80 next year. That calls for a review of one of the federal government’s largest Ponzi-type scheme, and that description is not a stretch.

In 1919, Bostonian Carl Ponzi promised investors a 50 percent return on their money within 90 days. He was soon raking in $200,000 a day but performed no investing whatsoever. He simply took money from new investors and paid off his earlier recruits.

Many investors lost their life savings, and Ponzi eventually went to prison. But his illegal venture seems insignificant when compared with Social Security.

As in Ponzi’s scheme, funds are never saved and invested but rather passed along to current recipients of Social Security to spend as they wish. No open fraud is involved but the federal government can do something Ponzi couldn’t.

When Ponzi’s scheme was exposed, he was unable to attract new investors, and everything collapsed. In contrast, the federal government simply forces workers to pay the taxes to cover the promised benefits to Social Security retirees.

In 2012, Social Security outlays were nearly $770 billion and have doubled in size relative to GDP, increasing from 2.4 percent to 4.7 percent, from 1960-2012. They will continue to grow as more baby boomers retire.

As expenditures grow, so will Social Security taxes. Workers and their employers nominally share the cost of Social Security taxes equally, but the actual tax burden falls mainly on the workers. Half of the tax is deducted explicitly from their paychecks, whereas the other half is largely passed on to workers in the form of lower wages than they otherwise would have been paid.

The combined Social Security tax rates have soared from their initial level of 2 percent of the first $3,000 of earnings to 12.4 percent of the first $117,000 of earnings in 2014. While the percentage rates have been stable since 1990, the rate may rise sharply as more baby boomers retire.

Fully funded private retirement programs pay out according to what was paid in. In contrast, pay-as-you-go Social Security has allowed our elected federal officials to build a non-transparent welfare element into the program. Lower-income retirees receive proportionately more benefits relative to taxes paid – sometimes a lot more – than higher-income retirees.

Social Security also redistributes according to marital status. Social Security gives married couples a bonus even if only one partner worked outside the home and paid Social Security taxes.

Consider also the “trophy bride rule.” An older man who earned $100,000 in his last working year could retire, marry a younger woman, adopt her child, and add more than $1,000 a month to his $2,000 a month in Social Security benefits.

Baby boomers are also learning that Social Security substantially reduces the nation’s savings. Those savings enhance our economy’s ability to grow and prosper. Reducing savings lowers the standard of living we all enjoy. Personal savings as a percentage of disposable income has been declining fairly steadily since 1975.

The Social Security system substitutes for personal savings and reduces them by as much as 60 percent, according to Martin Feldstein, Harvard economist and director of the National Bureau for Economic Research. The overall losses in savings are likely in the trillions.

Politicians may tout Social Security taxes as a form of savings that will help fund retirement. But money from the taxes is not saved. The government simply passes it on to other people, in the style of swindler Carl Ponzi.

On top of that reality, and many other problems, Social Security adds nothing to U.S. productive capacity. Despite grand intentions, it is merely a promise to tax someone in the future. Current taxpaying workers and retiring baby boomers may find that future less rosy than they imagined.