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IPFS News Link • Social Security

What Charles Ponzi's Scheme and US Entitlement Programs Have in Common

•, Daniel Kowalski

When Charles Ponzi's investment opportunity to sell international postage stamps was exposed to be a scam in 1920, its basic premise would forever be associated with the man's name. A Ponzi Scheme promises investors massive returns on an investment that does not really exist. Instead, unknown to everyone but the person or people running it, old investors are paid with money that comes in from new investors. This set up usually goes undetected until the one day when the well of new investors dries up and the money stops flowing in.

The structure of Ponzi's scheme must have really impressed the policy makers that were coming to age during this era because they would use the same set up for the nation's new Social Security system in the 1930s. Starting in 1937, employees and employers needed to fund the system and in 1940, retirees began to draw benefits. The financial amount of these benefits dwarfed what the first retirees put in during their working careers. This might seem unfair to most of us, but because there were far more people putting into the system than there were taking out, no one seemed to mind very much.

Medicare's Downward Spiral

Because of the post war baby boom, Social Security's scheme was able to work and remain financially solvent. While the public was skeptical of the program at its beginning, more and more people became won over by it as they contributed, saw others benefit, and then eventually benefitted themselves. It was so popular that the government decided to expand its role as a provider of social benefits by introducing the Medicare system in 1965.

There is no doubt that Medicare was an attempt at solving a real problem that most seniors faced in regard to private health insurance; it was very expensive. About three times the amount for a younger person. Today's Medicare system consists of four parts but for simplicity we will focus on Part A, which is funded through payroll taxes like Social Security. And like Social Security, it is not sustainable over the longer term because it is structured like a Ponzi Scheme where new money needs to flow in to pay the older folks that are cashing out.