When established in 1935, Social Security made its first payments to Americans age 65. These first recipients never contributed and were paid from contributions made by younger Americans. Those Americans and successive generations believed their contributions were investments, and that they would be paid at retirement by the earnings on those investments.
In fact, those younger Americans were paid by the contributions of successive generations of "investors," as the federal government spent their money to help finance operating deficits. With the ratio of retirees to contributors rising, the Social Security Trust Fund will run out of money by 2036, if not sooner.
Such a scheme could only continue if the working-age population grew more rapidly than the number of retirees, but it hasn't because Americans live longer and the birth rate has declined.
President Barack Obama's claims notwithstanding, Social Security is now a growing burden on federal finances, as the difference between the trust fund's income and what it pays out grows each year. As we approach 2036, either payments will have to be drastically curtailed or the government will have to shut down, on a massive basis, other activities.
Either Social Security fails, or the United States fails.
Texas Gov. Rick Perry and others have referred to Social Security as a Ponzi scheme. In a Ponzi scheme, original investors are paid immediate returns by money collected from subsequent investors, who are in turn paid by later investors.
Social Security did not even ask the first recipients to put up a dollar, and by any reasonable reading of the definition of a Ponzi scheme, Social Security qualifies.
Still, Social Security can work — as long as it finds more and more workers to support the growing number of retirees. But it can't do that because the system encourages people, who once relied on their children and savings to help them through old age, to have fewer children. And by its nature, it reduces incentives for savings and investment, thereby slowing economic growth and making it more difficult for each successive generation to support the elderly.
Governor Perry is right to criticize Social Security for what it is, but he is wrong to think going to a privately funded system — investing Americans' contributions in stocks and bonds — is the answer. The reasons are fourfold:
•First, the government would still have the burden of paying off the present and next generation of retirees, so not enough of young folks' money could be invested for their old age. The government would still have to provide a subsidy.
•Second, there is no getting around the fact that people above a certain age can't work and that some of what is made by the economy — think of it as a slice of a big pie — must be transferred from working-age folks to support them. Whether done by the government or through investments, a public vs. a private system only determines how the claim of old folks is defined.
•Third, individual investors are not particularly good at managing money, and guaranteeing investors a minimum return, as Congressman Paul Ryan proposed, is just a back door to the present, poorly run system. Moreover, the U.S. stock market has not returned a dime to investors for more than a decade, and interest on bonds and savings accounts are too low to make the system work.
•Fourth, most ordinary Americans are already too heavily taxed by falling real incomes and ever more acquisitive federal and state governments to invest enough additional dollars that a truly private system (not guaranteed by the government) would require.
In the end, the only way to make the system work is to ask Americans to work longer. If Governor Perry or Mitt Romney wants to fix the system, instead of arguing over terminology, they must address the retirement age. It simply must be raised to something close to 70, with no exceptions but for the truly disabled.
Americans won't like that, but it beats what President Obama is offering. Characteristic to his thinking on economics, he prefers to believe what his liberal ideology, not the facts, require — and incorrectly insists the system is solvent.
Social Security, by the findings of Mr. Obama's own Social Security Administration, is insolvent and hence is indeed a Ponzi scheme. Americans seeking dignity in retirement would be better served by hearing the truth.
Peter Morici, a professor at the University of Maryland's Smith School of Business, is former chief economist at the U.S. International Trade Commission. His email is firstname.lastname@example.org and his Facebook page is http://www.facebook.com/pmorici1.