Social Security and Medicare: The world’s biggest Ponzi schemes?

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According to the Medicare trustees, the program will run out of money in 2026. The previous estimate was 2029. Social Security (SS) will similarly run out of money in 2034. Americans are continually surprised when these facts are tossed into a conversation. Yet in truth, the whole concept was doomed to fail from the start.

Americans’ view of Social Security

When Social Security was first instituted in the mid-1930’s, most people regarded it as retirement insurance. The majority of Americans thought that the government would take a small portion of their weekly or monthly wages and place that money in an individual, personal account to fund their retirement at a certain, designated age. Most viewed Social Security as a forced savings program for retirement. This, over time, would assure that elderly Americans would not impose a burden on society.

Most Americans still believe that when the government withheld part of their paycheck for Social Security and FICA taxes, the Feds then stored those funds in a secure place. They even assumed that money earned interest until they needed it for retirement. Upon retirement, taxpayers would gradually get this money back, paid out as an annuity for the rest of their lives. The final amount of that annuity depended on the amount each taxpayer contributed.

Federal officials re-enforced this view when they considered privatizing Social Security. In this hypothetical situation, a wage earner’s contribution (tax) would transfer into an investment account owned by each individual contributor.

The government wanted each wage earner to contribute some of their wages. The percentage was initially 1% of wages. Today it is 12.4% of wages, with the wage earner paying half and the employer paying the other half.

The amount of Social Security tax paid would have a maximum, meaning that the amount of wages taxed would be capped. The current cap is $128,400.

Is Social Security a Ponzi scheme?

Social Security does not operate the way many people may have thought. Instead, it has the same characteristics as a Ponzi scheme.

The Securities and Exchange Commission defines the term.

“A Ponzi scheme is an investment fraud that pays existing investors with funds collected from new investors. Ponzi scheme organizers often promise to invest your money and generate high returns with little or no risk. But in many Ponzi schemes, the fraudsters do not invest the money. Instead, they use it to pay those who invested earlier and may keep some for themselves.

“With little or no legitimate earnings, Ponzi schemes require a constant flow of new money to survive. When it becomes hard to recruit new investors, or when large numbers of existing investors cash out, these schemes tend to collapse.”

The reality of the Social Security program is that the money that we pay is given to retirees as benefits. In other words, older investors are paid from the contributions of new investors. Medicare works in a similar manner.

An alternate view of Social Security and Medicare.

Some would argue that Social Security and Medicare are not Ponzi schemes. The programs represent an annual expense of government and the taxes collected represent annual revenue for that program. All government programs have a cost. And the government can only pay for such programs through increased tax revenue. That means if the government decides to pay an expense $1 billion in benefits, it must collect $1 billion in tax revenue.

That argument does make sense. If the government intends any program to endure, however, the government must necessarily raise enough revenue to pay the program’s annual expenses. There are a three assumptions that must be made if the revenue/ expense argument is followed.

The first assumption: Five or six people must pay into the system for each retiree who receives benefits. Another assumption: The economy will sustain reasonable annual growth, averaging at least 3%. This assures increases in revenue without raising the tax rate.

How long will you work?

The third assumption is that an individual will work at least 45 years and then collect for about 10 years.

All three assumptions no longer hold, which is why the systems are going broke. Due to demographic patterns, more people collect Social Security every day, while fewer contribute to the pool. As the massive Baby Boomer contingent hits retirement age, relatively few millennials are working and contributing. Today, about three people work for each person who currently receives benefits.

Annual economic growth has been below 3% since 2005. And people are living much longer, often 25 years or longer after retirement.

This result is that the SS and Medicare programs are about to go broke. Whether you view it as a Ponzi scheme or as an annual government program, the government must reform the situation sooner rather than later.

There are no painless solutions.

One solution is to raise the Social Security tax. This is probably not possible since the 12.4% rate is already high and the mood in the country is to cut taxes. The government could also remove the current income limits on Social Security so the tax applies to all wages earned.

However, since the government caps the annual benefit received, it seems fair to cap the maximum an individual should pay in any given year.

The last option is to raise the retirement age to at least 70 and probably 75. That would increase the number of people paying in and reduce the number of people collecting benefits. It also means that retirees would collect benefits for a shorter time period.

While that’s not a pleasant solution, it is the least unpleasant solution and the only one that may be politically possible.

Michael Busler, Ph.D. is a public policy analyst and a Professor of Finance at Stockton University where he teaches undergraduate and graduate courses in Finance and Economics. He has written Op-ed columns in major newspapers for more than 35 years. @mbusler

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