In a speech on Wednesday, Federal Reserve Chairman Ben Bernanke made some comments on the current state of Social Security and Medicare. His message came down to this: To address the needs of the coming demographic bulge of baby boomer retirees, the federal government can do one of three things to keep entitlement programs operating. First, it can increase the payroll taxes that are supposed to be earmarked for these programs. Second, it can cut the level of benefits to recipients, either by directly reducing the amount of payments or by other, indirect means, such as taxing all benefits as ordinary income. Third, it can keep taxes and benefits stable and find money from other sources, including cutting other expenditures or increasing debt levels beyond present levels.
Social Security reform has been a topic of contention for decades. While economists can argue over the magnitude of the problem or even whether a problem exists, there is no denying the fact that a large demographic shift -- in combination with improvements in health-care services and technology that have increased life expectancies dramatically -- will bring unprecedented changes to the way the American economy functions. Nevertheless, too many incentives exist that favor immediate results over long-term considerations.
Government tunnel vision
Consider, for instance, the government budget process. Under current rules, bills that incorporate changes in spending or revenue are evaluated to determine their effect on the budget deficit over a 10-year period. Although this is an eternity in political terms -- longer than a president may serve under the Constitution, five full terms of office for House members, and nearly two terms for senators -- it is a short period of time compared to the effects of some laws that have been created.
Some such laws will have dramatic effects on government revenue for decades. For example, in 1997, the creation of the Roth IRA gave investors the opportunity to save money for retirement in a manner that would avoid any future income tax on earnings. During an initial period, taxpayers had the option of converting assets held in traditional IRA accounts to Roth IRAs, spreading the tax liability on conversion over a period of four years. Although Roth conversions were certainly not the only factor, the four years during which converted amounts were allowed to be spread out -- 1998 to 2001 -- happened to be some of the best results in terms of overall tax revenue, as budget deficits temporarily turned to surpluses. By 2005, according to statistics from the Investment Company Institute, an estimated $145 billion was held in Roth IRA accounts. Assuming paid income of 3% to 5%, the Roth IRA provisions will allow between $4.4 billion and $7.2 billion of income to go untaxed, along with any capital gains on Roth IRA assets. These amounts of untaxed income will only increase over time.
Lawmakers are in a difficult position. While long-term thinking is necessary for successful policy, the pressure to get elected affects congressional representatives almost constantly, and even Senate members must spend as much as one-third of their terms considering re-election prospects. It's no surprise, therefore, that many elected officials spend more time catering to the immediate wishes and needs of their constituents than considering the long-term needs of the country as a whole.
Corporate short-term thinking
Unfortunately, short-term thinking is not limited to the public sector. Many private companies also suffer from a lack of long-term vision. Because institutional investors demand positive financial results in a matter of months rather than years, corporate management must deliver profits quickly in order to avoid expulsion.
Companies are under constant pressure to achieve earnings estimates by outside analysts. While top executives and other key employees want to receive high levels of compensation, taking current cash requires treatment as an immediate expense and can have negative tax implications. On the other hand, the use of stock options allows different accounting methods that have a less immediate effect on the company's bottom line. In the long run, however, these stock options dilute the interests of current shareholders in ways that fully manifest themselves only years after the options are granted.
As if this weren't bad enough, some companies whose stock prices have not risen after option grants have decided that they should modify the terms of previously granted options. (The recent stock-option scandal at Apple (NASDAQ:AAPL) is just the latest example of this practice.) This is done either by lowering the exercise price that executives must pay to acquire stock or by backdating the options to wrap more stock appreciation into the value of the option. The tug-of-war between self-interested company management and demanding stock analysts threatens to leave investors holding the bag.
Don't get trapped
Government and big business seem unable to think about economic issues with a long-term perspective -- but that doesn't have to happen to you. Of course, as a consumer, you're under constant pressure to live beyond your means, using freely available credit to buy anything you want now and leave worrying about how you'll pay for it until later. As an investor, you're bombarded by advertising praising short-term outperformance of various stocks, mutual funds, and other types of investments.
However, ordinary people usually have to face the consequences of short-term thinking much more quickly than government and big business. While you may be able to accumulate debt quickly, eventually you reach credit limits and find additional credit unavailable, and it may take you years to repay your debt. And while you may chase performance in your investments, it often doesn't take long for these high fliers to come down to earth -- at your expense.
So in planning your own financial affairs, think long-term. Don't be fooled by the behavior of government and corporate entities that suffer from an inability to think beyond the next quarter or the next election. They may survive and even thrive in their irresponsible behavior, but you probably won't be as lucky.
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Without some long-term thinking, Fool contributor Dan Caplinger wouldn't be in a position to write this article. He doesn't own shares of Apple. You can count on the Fool's disclosure policy for the long term.
