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Wednesday, September 14, 2011

The Perfect Ponzi

From Wikipedia- Charles Ponzi
Governor Rick Perry has been under a lot of criticism for his reference in his book to Social Security as a ‘ponzi’ scheme, despite the fact that it has been called a ponzi scheme by both the left and the right for over 50 years, as well as in most economics textbooks. Of course it makes good copy to suggest that Perry would do away with Social Security as a criminal enterprise, but it is pretty far fetched to think that he might do that as President, if not downright legislatively impossible.

However, the Democrats are scared to death of Rick Perry—and of the possibility that he might actually reform Social Security and make it viable, thus killing two birds with one stone, solving the inherent flaws of Social Security, and making it a Republican banner instead of a Democrat one. Losing the White House in 2012 would be small potatoes to this dagger in the heart of Democrat group-think and political planning.

But what exactly IS a ponzi scheme?

It’s named after Charles Ponzi, a con man of actual little historical significance other than his manipulation of numbers into a racket more popularly described as a pyramid scheme. According to the Social Security’s own website (of all places!) as well as a ponzi scheme is:

…an operation that pays returns to separate 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, in the form of short-term returns that are either abnormally high or unusually consistent. The perpetuation of the returns that a Ponzi scheme advertises and pays requires an ever-increasing flow of money from investors to keep the scheme going. (Ponzi Schemes. US Social Security Administration Website)

Ponzi operated his own scheme using postal stamps and postal coupons, reportedly swindling millions from his victims. Interestingly, he named his bilker firm the ‘Securities and Exchange Commission’ and eventually was arrested in 1920, spending the rest of his life in and out of prison for various swindles and cons.

However, the definition of a Ponzi scheme is exactly what Social Security is—a return that is unusually consistent relative to the investment, and pays out returns directly from new investors capital rather than from the return on an actual investment. Perry is 100% correct in his description, and if it was anyone else but the government handling the Social Security program, they would be locked up in prison.

Now, many people are questioning the premise of its criminality because as long as it continues to grow in size (in the form of new investors) and pays its benefactors, there is no swindle. Since everyone is required to pay Social Security taxes, a new pool of investors is virtually guaranteed. It's the perfect Ponzi scheme, since it assures a non stop flow of money into the fund.

Or is it?

More than 50% of the population now pays little to no income taxes and with almost 20% of the population either out of work or ‘under working’ (such a part time or low paying minimum wage jobs), the pool of new entrants to the Social Security system is waning. For the first time in history, Social Security may actually spend more than it takes in (via taxes) and essentially become insolvent unless change or reform comes and soon. Most want to alter benefits, some (like Newt Gingrich) suggest that simply altering our tax structure and increasing the profitability of the economy at large is a better plan since as the economy would grow, so would Social Security funding.

More than 50% of the population now pays little to no income taxes and with almost 20% of the population either out of work or ‘under working’ 

It’s also why Republicans are against the payroll tax cut being extended—doing so would put the Social Security plan as we know it today at risk. The payroll tax cut on Social Security means employees are now paying about 5.6% of their paychecks into the fund instead of the typical 6.1% they have paid historically. Incidentally, employers still have to pay their 6.1% of matching funds. The Democrats are putting Social Security at risk, not Republicans.

The real flaw though in Social Security though is not the fact that it may become insolvent. It is the flaw that was the real reason Ponzi was arrested all those years ago—that the returns ultimately are far lower than what a future recipient could do on their own.

A person making 40k a year from the age of 20 to 65 (45 years) would get about a 1250.00 monthly income (15k) based on the current plan. Take the same 12% taxation schedule on a per annum basis (4800/yr) and invest it at only a safe 3% rate of return for the same 45 years gets you 458,406 dollars which you provide you about 35k a year in income instead of the 15k you get from Social Security—almost double. Deduct out 1000/yr for disability insurance contributions you still get over 366K or 30k/yr in money at age 65. You could also pass it on to your heirs too, unlike Social Security.

Now you know why Republicans want the plan reformed or some portion of it privatized into regular safety net equities like CD’s and annuities. You can privatize substantial portions of it with no risk to the taxpayer and still come out ahead of where we are now.

That’s not destroying or eliminating care for the elderly.

That’s guaranteeing their protection.