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Predicting Tax Legislation is Harder Than Timing the Market

Timing the stock market is hard. It’s so hard, in fact, that there’s a reasonably broad consensus that it’s unwise to even try.

And that’s in spite of the fact that, when attempting to time the stock market, you’re really only trying to predict one thing: what will the market do next? And there are only three possible outcomes: go up, stay flat, or go down.

Trying to predict specific changes to our tax law in any way that is useful for tax planning is far, far harder than trying to time the stock market.

Take one example: will distributions from Roth IRAs be made taxable in the future? And how should a person adjust their tax planning based on that possibility?

People ask me about that (and other similar topics) all the time. And it doesn’t seem like it should be that complicated — either some law gets passed that makes Roth IRA distributions taxable or no such law gets passed. Two possible options, right?

Unfortunately, no. There’s also the possibility that it would work like taxation of Social Security benefits. That is, we could see a change where Roth distributions remain nontaxable, unless your income is over a certain threshold. And this third possibility is itself an unlimited number of possibilities, because the threshold could be set at any level. And the calculation (for what percent of your Roth distributions are taxable, based on the amount by which your income exceeds the chosen threshold) could work in any number of different ways.

In other words, you could make a prediction that a bill will be passed that causes Roth distributions to be taxable. And you could be right about that prediction, but you have to get the details right too. If you get the details wrong, any tax planning decisions that you make based on your prediction are as likely to be harmful as helpful.

And if you do somehow manage to get the details right?

Well, there’s still the issue of timing.

You might precisely predict what this new provision in our tax code looks like — but be off by ten years as to when the legislation gets passed. And if that is the case, then you’re again in a situation where any tax planning decisions that you make based on your prediction are as likely to be harmful as helpful.

And even if you are right as to the details of how the new provision works and you are right as to the timing, there’s yet another problem: tax legislation never changes just one thing. Most pieces of tax legislation are hundreds of pages long.

Even if you accurately predict the details of the provision in question and when it will be implemented, some other change made by the same legislation could completely mess up the math in your analysis. And once again you’re left in a situation where any tax planning decisions that you make based on your prediction are as likely to be harmful as helpful.

A vague sort of prediction that “marginal tax rates for people with high incomes might be higher later than they are now” is pretty reasonable. But trying to guess at the specifics of any particular change — and then make specific tax planning decisions accordingly — is just not worth the time and effort.

For More Information, See My Related Book:

Book3Cover

Taxes Made Simple: Income Taxes Explained in 100 Pages or Less

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