By Joe Boyles
Texas Governor and presidential aspirant Rick Perry created quite a stir when he said that Social Security is a Ponzi scheme. He’s being attacked from both the right and left over his claim. Is it in fact true? Who was Carlo Ponzi? Why was he sent to prison and an illegal business practice named for him?
Carlo was an Italian who had a “get rich quick” mentality. He came to America as a young man shortly after the turn of the last century and got into banking trouble in Montreal where he served a short prison sentence. After release, he moved to Boston where he tried several business pursuits unsuccessfully.
In the inflationary days following the end of World War I, he discovered a postal scheme which involved exchanging discounted Italian postal coupons for American ones that he could sell for a profit. Ponzi reasoned that if he could exchange enough coupons, he could become rich in the process, but in order to do that, he needed volume and cash.
In early 1920, Carlo promised his investors a quick and substantial profit. Those first investors were paid handsomely and they spread the word. Within days, ordinary working class people were beating a path to Ponzi’s door to invest their money. Many took out mortgages and sold valuables to cash in on the bonanza that Carlo promised.
In fact, most of the money paid out was not from the exchange of foreign postal coupons, but rather, the income from the newest investors. In a few short months, Ponzi had created a massive, broad-based pyramid scheme that relied on a lot of money coming in from the bottom to pay a few at the top. Carlo himself profited the most, becoming a millionaire overnight.
Within a few months, reporters began to investigate Ponzi’s claims and apply simple mathematics in their analysis. Carlo’s get-rich-quick scheme was exposed and blew up overnight. He was indicted by the Treasury Department for mail fraud and later, by the state of Massachusetts for larceny.
Interestingly, there is also a Florida connection which may have captured my family in this sad story. In 1925, Ponzi came to Jacksonville and entered the infamous “Florida Land Grab” conspiracy, selling Columbia County swamp land by mail order to unsuspecting investors. It’s entirely possible that this was the scheme that trapped the Boyles family the next year when they moved from Nebraska to Florida.
So, what does a Ponzi scheme have to do with Social Security? It turns out that there are several important similarities between both financial systems. Ponzi needed the income from new investors to pay off the early investors. So does Social Security which uses current payroll taxes (FICA – 12.4 percent of income) to pay benefits to current recipients. Ponzi really had no assets and neither does Social Security. For more than forty years, FICA taxes have been put into general revenue and used for current year expenditures. FICA surpluses have been returned to the Social Security Administration in the form of IOUs which are merely promises that future generations of workers will need to make up.
In one sense, Social Security is worse than Ponzi’s illegal scheme because FICA taxes are mandatory for everyone who receives a paycheck. At least, Ponzi’s scheme was voluntary.
Technically, Social Security isn’t a Ponzi scheme because what Carlo did is illegal, but what Congress did in 1935 is not. I think you can make a rational case that Social Security is structured much like a Ponzi scheme, but it isn’t a good idea to make that claim, especially if you’re a politician. There are simply too many voters receiving Social Security who get riled up when you suggest that they’re receiving benefits from something that is illegal.
Governor Perry isn’t the first person to make this claim, nor the last. In 2005 when I took on this issue, I made the same claim which was disputed in a counter argument by the late Ernest Page. It seems that it just isn’t ‘politically correct’ to claim the Social Security is a Ponzi scheme, so I’m not going to repeat that mistake. At the most, I’ll say that Social Security has several important characteristics like a Ponzi scheme, and then explain in greater detail what those characteristics are. Are you listening Governor Perry?