PREDICTING THE FUTURE

When Little Orphan Annie in the Broadway musical “Annie” posited that “tomorrow” is always a day away, she sang of a tomorrow with certain optimism; you can “Bet your bottom dollar that tomorrow, there’ll be sun.” Comic strips offer certainty. In real life expected outcomes are always in doubt. That we know the sun will come up tomorrow and fathom scientific laws of the universe, does not guarantee that our predictions about tomorrow will be accurate. In fact, most often fickle human nature or acts of God intervene to make things turn out not as we planned or predicted.

From Secret Father by James Carroll, “It is a rule of life…you get not what you look for. You get what you find.” Miracles and Black Swann events are equally unpredictable. Computer program models predict solutions but the accuracy of those forecasts is limited by underlying program assumptions that depend on human preferences. Wall Street learned this lesson in the Great Recession when risk models employed failed with catastrophic result.

Our carefully calculated plans are no more trustworthy than are our anticipations. In Roald Dahl’s (author of “Charlie and the Chocolate Factory”) maliciously sardonic short story, “A Dip in the Pool,” a man on a cruise wages his life savings thinking he has a sure lowest range bet for the captain’s daily pool on how many miles the ship will travel the next day. When calming weather upsets his belief that the ship will not travel far the next day, he decides to help fate slow down the ship. He will delay the ship by pretending to fall overboard, of course, in sight of another passenger who will alert the crew to a rescue, and abort the ship’s rapid progress. He carefully chooses his witness who must be able to both see him fall and hear his cry for help. The elderly woman chosen does see him fall but, unknown to our hero, is considered feebleminded and her alarm “man overboard” is not believed. The shop sails away leaving our schemer behind to drown. The films “A Simple Plan” and “The Irony of Fate, or Enjoy your Bath” (Soviet era Russian hilarious comedy) exemplify how events can get out of our hands.

UNCERTAIN TIMES FOR TAX PLANNING

Very often tax planning and projections used in tax planning give us a false sense of controlling the direction of our financial lives. We forget that all predictions balance on two pillars – scientific knowledge and complete randomness. Researchers have discerned a pattern in the seeming randomness of the natural universe. But, as Paul Halpern states in his fascinating book, “The Pursuit of Destiny, A History of Prediction, “Human thought and actions are computationally indeterminate.” Thus, any prophesy of a result dependent, even in part, on human endeavor, is highly suspect.

The year 2010 is fraught with great insecurity about a multitude of tax matters and might be called the year of tax uncertainty. Pundits and oracles are busily predicting what Congress may or may not do and individuals and businesses are in some cases hastily scurrying about to adapt tax planning to these speculations. The conjecture about our future tax landscape revolves about a number of musings:

1. The 2001 Act Income Tax Cuts

The supply side theorists, largely Republicans but including some Blue Dog Democrats, want the tax cuts, set to expire at the end of 2010, to be made permanent. The Obama administration and other Democrats want to continue the lower tax rates for most middle class and low earner Americans and allow tax rates to rise for higher earning taxpayers. If Congress does nothing top rates for ordinary income will rise to 39.6% from 35%; and, the tax rate on capital gains will rise to 20% from 15%. The tax rate on qualified dividends would rise to 39.6% from 15%.

These disagreements are both ideological (how to grow the economy and shrink the budget deficit) and political. The looming mid term November Congressional elections, however, elevate political strategy above responsible governing and make compromise very difficult, if not impossible.

After the mid-term elections, apart from uncertainly about which party will control Congress, there is the question of whether both parties will become serious about tackling endemic budgetary problems or continue the political wrangling over votes for the 2012 presidential race.

Making strategic tax bets on the outcome of this fray is akin to rolling blank sided dice. There are no odds for such a bet. Some suggest that tax rates will certainly climb given the budget deficit. That may seem to many a logical conclusion but, politics being what it is, no one should assume that result is certain. That being said: today is known; tomorrow, who knows? Therefore, accelerating income to take advantage of today’s historically low tax rates is not a bad move for those who earn income from wages and savings and who cannot derive huge income from the time use of money (See my earlier newsletter “Thinking about Taxes, Vol. 3, No. 9,September 15, 2009, dealing with the wisdom of tax deferrals).

2. The Estate Tax hiatus

Perhaps those who have passed on during 2010 are smiling in tax heaven for having beaten the tax man. Estate beneficiaries left to deal with carryover basis and Generation Skipping Tax exemption uncertainties, however, may find their smiles turning to frowns. But, these questions pale compared to the doubts about what will happen next. The gift tax of course did not go AWOL and continues to apply during 2010 with a $1 million lifetime exemption and 45% tax rate. One can still make tax free annual gifts up to $13,000 to any number of recipients not counted against the lifetime exemption. The estate tax is set to resume in 2011 also with a $1 million exemption and 55% tax above the exemption. In 2009, the exemption was $3,500,000 and tax rate 45%.

There are many pending proposals concerning these transfer taxes from eliminating them permanently to integrating them again for transfers about some lifetime amount ($1 million to $10 million). There is speculation that Congress will reinstate the estate tax retroactively. Ponder this, however: Congress had 8 years since 2001 to deal with this mess and could not muster 60 votes in the Senate to reach closure on any proposal. So, roll those blank sided dice and conjure any result you desire. In the real world, build flexibility into you documents. Also, carefully review wills with formula clauses that may result in unwanted bequests to the unintended beneficiaries.

3. Tax Provisions in the Health Care and HIRE Acts

One would think that legislation enacted is sacrosanct. But, the history of the investment tax credit says otherwise. Tax Analysts declare that it would be very difficult politically for the next Congress to undo the tax funding provisions of the Health Care Act passed by the 111th Congress and signed by President Obama. These provisions, however, have delayed effective dates, as follows:

A. 2012: Expanded Form 1099 reporting has been widely criticized and likely will be eased in some manner (HIRE Act).

B. 2013: Extra 0.9 Medicare tax on Self Employment Income and Wages of those couples earning over $250,000 ($125,000 for MFS returns and $200,000 for single filers).

C. 2013: Medicare surtax of 3.8% on unearned investment income of those joint filers with Modified Adjusted Gross Income over $250,000 and singles with MAGI over $200,000.

D. 2014: Penalty for those individuals who fail to obtain health insurance coverage.

Under more calm circumstances these enacted provisions would not be challenged. But, President Obama’s falling popularity raises the specter of a one-term presidency. Should Republicans control Congress and take back the White House, the possibility of changes in direction becomes more real.

4. Other Proposals

Adding to our consternation are a plethora of other tax proposals too numerous and diverse to enumerate. These range from extending business and individual tax breaks that expired in 2009, to making the R&D tax credit permanent, to making Schedule K-1 income of S Corporations subject to self employment taxes.

CONCLUSION

In the 1990’s a former Los Alamos scientist ventured into economics forming “The Prediction Company” to advise Wall Street. We should have been humbled in our conceit about human ability to foresee the future by the overstated predictions of doom for Y2K and our failure to grasp the real potential for catastrophe on 9/11.

I’ll end with two more quotes from James Halpern’s book:

“It is not primarily in the present nor in the past that we live. Our life is an activity directed toward what is to come” (quoting Jose Ortega y Gasset).

“It is very hard to predict – especially the future” (saying attributed to quantum theorist Niels Bohr).

Given the fragility of our ability to predict, perhaps we should worry and hope less for the future and as the German poet Rainer Maria Rilke suggested: “Live your questions now, and perhaps even without knowing it, you will live along some distant day to your answers”.