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Wednesday, September 30, 2009

Social Security: The Government’s Ponzi Scheme

In spite of the burdensome and complex regulations that preside over financial markets, criminals like Bernie Madoff can pull off schemes that destroy the lives of many innocent people. One is left to wonder how a person can manipulate the system with such ease. Perhaps criminals like Madoff devise their schemes from the “legal” ones resembling Social Security. Is that a bit of a stretch? Probably. However, the parallels are quite interesting and close enough to make the assertion with the stark difference being intention, of course. The government does not intend to rip people off – it just doesn’t foresee the economically catastrophic consequences of programs designed to help people.

The definition of a Ponzi scheme is “a fraudulent investment operation that pays returns to investors from their own money or money paid by subsequent investors rather than from any actual profit earned; or an investment swindle in which high profits are promised, and early investors are paid off from funds raised from later ones.” A Ponzi scheme is essentially a pyramid scam since it relies on future investors to pay returns to the initial investors.

An examination of the Social Security system reveals some similarities to illegal pyramid schemes. Social Security is a “pay as you go” system. A payroll tax exists in which funds are taken from a worker’s paycheck and distributed to those who currently qualify for benefits. The government does not have individual bank accounts set up in which the money you contribute can grow until you reach retirement age. Therefore, the Social Security system relies on “new investors” to pay returns to the people who are eligible.

The Social Security tax burden is equally shared by the employer and employee. However, just because the employer pays half, does NOT mean that it doesn’t come at the employee’s expense. Businesses designate a certain amount of dollars that they deem an employee is worth. The government takes their cut from payroll taxes, and the employee is left with the difference, which translates into lower gross pay. If a company affords a $50,000 salary for an associate, the 12.4 percent employer/employee Social Security burden reduces gross pay to $43,800. (1) This does not include other payroll taxes such as Medicare tax and income tax.

Social Security has built the “pyramid” over the years, and a pyramid scheme is an unsustainable business model. Eventually, there are too many people requiring a return and not enough people buying into the scheme. Before life expectancy increased and differences in population growth (“baby boomers” vs. “generation X”) took hold, Social Security was able to thrive since there were more people paying into the system than drawing on benefits. For example, in 1950, the ratio of people aged 20-64 was about 7.25 to 1 to people aged 65 and over. (2) This means that there were 7 people paying into the Social Security system for every one person collecting. This number does not include those under the age of 20 who were also working and paying into the system. In 2007, the ratio has fallen to about 4.7 percent. Due to the falling ratio, the government has raised tax rates and delayed benefits to younger generations to adjust for longer life expectancies.

Bernie Madoff’s investors probably didn’t know how their money was being invested. They were simply promised a very high return. Social Security was sold to people under the guise of financial security in later years. How many individuals know what the government does with Social Security dollars? How many know that the government spends Social Security funds on other programs? These “loans” are called “intergovernmental holdings.” The Treasury department issues bonds to the Social Security Administration; and those bonds are held in a “trust fund.” Bonds are simply a promise of future tax increases, which means that taxpayers are funding other government programs via Social Security. Would you mind if Vanguard or ING Direct borrowed from your 401k contributions to pay other investors? Only the government can make loans to itself with other peoples’ money, require a loftier investment from people in the future to pay off the loan, and no one winds up in jail.

What would happen if workers’ were given a 12.2 percent increase in pay today with a stipulation in place that a certain percentage of one’s salary had to be placed in a retirement fund? Imagine if workers actually had a say in how their money is invested, and they were given quarterly statements that show an account balance to assess their progress. Imagine retirees being able to pass on their savings to their children and grandchildren instead of receiving a $255 death benefit.

Isn’t it time that people take control over their financial future instead of contributing to a government slush fund? How secure is Social “Security” when a worker pays into the system all of their life, but dies at age 66? The surviving spouse has a choice between taking their benefit or their deceased spouses’ – whichever is greater. They do NOT get both, and children are not entitled to benefits unless they are disabled or under the age of 16. The rules are complex and have some exceptions; however, the key point is that people should be able to designate freely who their beneficiaries are and be able to KEEP all that they invested.

The Social Security pyramid is going to collapse. The ratio of those paying into the system versus those receiving benefits will continue to drop. It is estimated by 2016, a deficit will exist, and the deficits will be made up by redeeming trust fund assets. (3) America’s economic performance will determine how long it will take the government to deplete the trust fund.

Social Security will have disastrous economic consequences if the move to abolish the program is not made soon. It all boils down to individual as opposed to statist control over your golden years.


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