Hindsight Judgments About Taxpayers' Expectations.

Research in psychology has demonstrated the phenomenon labeled "hindsight bias." Hindsight bias means that individuals overestimate the extent to which they-or someone else-had expected a (now realized) event. There are many areas of federal tax law in which tax treatment is to be determined in hindsight with reference to the taxpayer's prior expectations. This paper identifies several such areas in the law and provides a legal analysis of the appropriate reliance to be placed on hindsight in estimating a taxpayer's priors. In addition, the paper reports results of an experiment which tested for reliance on hindsight by tax advisors when evaluating these issues. In the experiment, tax professional subjects read three tax cases and were asked to make judgments based on the case facts. Subjects were randomly assigned to two different groups. Hindsight evidence was manipulated between subject groups by varying the information provided in the last sentence of each case. The experiment provided no evidence of hindsight bias, i.e., non-normative use of hindsight evidence. Rather, subjects' reliance on hindsight evidence was consistent with the analysis of the law provided in this paper. Suggestions for further research on hindsight bias, in general, and on hindsight bias in the tax domain, in particular, are provided.