By Arthur Middleton Hughes
A Ponzi scheme is a fraudulent investment operation that
pays returns to investors, not from any actual profit earned by the
organization, but from their own money or money paid by subsequent investors.
The Ponzi scheme usually entices new investors by offering returns other
investments cannot guarantee. To keep
the scheme going there must be an ever-increasing flow of new money from
investors. The scheme is named after Charles Ponzi who became notorious for
using the technique in 1920.
In normal investments, individuals give their money to a
broker who puts it into mutual funds or stocks. The stocks are shares in the
ownership of companies that make a profit from their business – making and
selling anything such as soap, steel, or services. As a result of this profit, the companies pay
dividends to their stockholders who experience a return of 4%, 6%, 8% or more
on the money invested.
In a Ponzi scheme, the money is not necessarily invested
anywhere. The benefits are paid to
existing investors out of the contributions by new people who want to get in on
the unusual returns. The scheme works as
long as there are new people who put their money in which is used to pay the
In Social Security the funds paid in by workers are not
invested anywhere. As soon as the Treasury receives these “contributions” from
workers and their employers, the funds are used as general revenue by the
Treasury: they are used to fund regular government programs such as defense,
Medicare, Medicaid or Social Security checks. In return for using these “contributions”
the Treasury writes an IOU (a Government Bond) to the Social Security system. By
2011 there are about $2.6 trillion of such bonds which are part of the total
national debt of $14.3 trillion.
In 2011, 56 million people are receiving Social Security
benefits, while 158 million people will be (if they are working) paying into
the fund. This is a ratio of 2.8 workers for every beneficiary. Of those receiving benefits, 46 million are
receiving retirement benefits and 10 million get disability benefits. In 2010,
total Social Security contributions were $781.1 billion and expenditures were
$712.5 billion, which meant that the Treasury was able to use the surplus to
pay other government expenses.
Starting in 2015 and continuing thereafter, program expenses
are expected to exceed cash revenues. This is because at this point there will
be more paid out to recipients each year as the number of older retirees and
other beneficiaries grows (old people are living longer) and the amount
contributed by the fewer number of young workers declines (the birthrate is
going down). So, if there are no changes in the system, there will be no more
bonds issued. Instead, the regular taxpayers will have to chip in to pay the shortfall
in social security revenue.
By dollars paid, the U.S. Social Security program today is
the largest government program in the world and the single greatest expenditure
(20.8%) in the federal budget, compared to 20.5% for discretionary defense and
20.1% for Medicare/Medicaid.
So, what rate of return does Social Security provide to its
retirees? It varies very much depending
on the situation. Overall, the Cato
Institute calculates an average return of about 6.41% for the average retiree who
made between $50,000 and $100,000 during his working life. That is a very good
rate of return. What is wrong with
that? For the retiree, it is great. But,
it is still a Ponzi scheme. Why? Because the 6.41% does not come from earnings
on investment. There are no earnings. It comes from the young people who are working
and contributing today, and the general taxpayers who will be contributing
their income taxes to pay for any shortfall in the retirement benefits paid out.
The money paid in is not invested in
anything and generates no returns. By
definition, Social Security is a Ponzi scheme, pure and simple.