Acton Commentary

Social Security Has Its Own Accounting Problems


The recent spate of accounting scandals has underscored the indispensable role played by moral rectitude in a healthy market system. When the desire to gain outruns the responsibilities of honesty and integrity, short-term gain may indeed be the result, but the personal and economic consequences cannot be delayed indefinitely.

While the scandals associated with the apparent cases of fraudulent accounting schemes at Enron and WorldCom are serious, they pale in comparison to the current fraudulent accounting schemes employed by the United States government in connection with the Social Security system. It is almost humorous to watch members of Congress scurry to investigate cases of private failure and deception, while refusing to honestly consider the morally dubious accounting schemes they have created to obscure the true state of the Social Security program. To use the word hypocrisy to describe this behavior on the part of legislators would seem to be too light a moniker. It seems that politicians refuse to remove the logs from their own eyes while trying to remove the splinters from the eyes of private business leaders.

To explain why this is the case, it might be useful to provide an illustration of the kind of accounting fraud that the government has practiced in connection with Social Security. Suppose for a moment that I just received a pay raise that nets me an additional $500 a month in disposable income. With that money I plan to save for the purchase of a new automobile. However, rather than actually saving the money by lending it at interest, I intend to spend it by borrowing against myself. My plan is to dutifully borrow the money by writing a “Cleveland Treasury Bond” each month for $500 and to make those bonds out to pay 8 percent interest. At the end of four years of acting in this way, would I have the financial wherewithal from these “securities” to purchase a new car? Of course not! Where would the money come from to pay the claim that my self-made securities represent? It is obvious that no such money would exist. I would have spent the money during that four-year period on other things. The “trust fund” that I created would be filled with worthless paper. It is clear in such a scheme that no real assets secure that paper. If I wanted to buy a new car, I would either have to realize a new income source, or cut my spending on other things, or hope beyond hope that the money would simply fall from the sky.

This illustration provides some helpful insight into the current state of affairs in the Social Security program. The so-called “trust fund” or “lock box” that was greatly debated in the 2000 presidential election has been filled with worthless IOUs that the government has issued against itself, even as it spent excess revenues entering the program from payroll taxes. This process of spending excess revenues generated by payroll taxes began in the 1980’s when Congress raised the payroll tax rates, generating more revenue than needed to pay the current beneficiaries of the program. Rather than setting the money aside and purchasing assets, government leaders embarked on a spending spree and put nonnegotiable U. S. Treasury bonds in the coffers of what they termed a “trust fund.” Of course, this action was nothing but an abuse of the public’s trust in its leaders to wisely steward taxpayer’s hard earned resources. What is lost on the average taxpayer is that the actual payment of these bonds will require some very hard choices—hard choices that will directly effect all taxpayers.

As it currently stands, payroll taxes will fail to cover the amount the Social Security Administration needs to pay benefits around the year 2016. Supposedly, the Social Security Administration will be able to redeem the bonds held in trust to pay these benefits for many years to come. However, a fundamental question looms—where will the money come from to pay those bonds? The government has already spent that money on other things. The only way the government will be able to make good on paying those benefits is to increase taxes, cut spending on other programs, or borrow the money from some other source. Either way, the costs of any of these options will be enormous, given the predictions of the amount of money that will be necessary to make good on the promised benefits. Of course, there is another option. The government could choose not to make good on the promised benefit payments. When the reality of the coming hardship begins to hit, Congress will likely find it easier to eliminate or radically reduce the benefits that some people receive in order to maintain the apparent solvency of the program.

The reality of this situation should not come as a surprise to anyone. Social Security has not been financially sound a single day of its existence. It has always been a pyramid scheme set up to redistribute money from later generations to earlier ones. In general, pyramid schemes represent fraud on the part of those who promote them because the number of participants and the amount of money needed to pay the benefits continually grows. In the early part of the twentieth century, Charles Ponzi, an Italian immigrant, made a splash in Boston by perpetrating such a fraud. He began by developing an elaborate story about how he could make exorbitant returns in international markets and offered investors in his company an unbelievable opportunity to participate in these returns if they would risk their money. There were not many takers initially, but he was able to induce a few people to invest their money with him. He simply deposited the money in local bank accounts and sought out additional investors. By the time the first notes came due, he had enough money to pay them off and did so in order to establish the reputation that he could actually make good on his promised return. Afterwards, money began to pour into Ponzi’s company. He used it to buy whatever he wanted and bankrolled the rest. However, all along the way the growth of his assets lagged well behind the growth of his liabilities. He was never financially solvent. When word finally got out about what he was doing, there was a mad rush on his company to redeem the notes that had been issued. The rush revealed the truth and Ponzi went to jail for fraud which earned him the title, the Boston swindler.

The only difference between what Ponzi did in New England and what our government is doing nationally with Social Security is that Ponzi’s victims were duped into investing in his company while those of our government’s program are forced to participate. The only financially viable option for Social Security at this point is to begin to privatize the system by allowing people to invest in their own accounts. In this case, real assets would accumulate. Such a system would be most helpful to those on the lower end of the economic spectrum, especially the working poor. However, for this to happen members of Congress would have to “come clean” and be honest with both themselves and their constituencies about the true state of affairs of the Social Security system. It is time that for truthfulness to become more highly valued in both politics and business. Only in this way will we approach the goal of a society efficiently and justly serving the good of the persons who comprise it.