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Sunday, July 26, 2009

Taxing Punitive Damages, etc.

Update 8/16: We've now got a first shitty draft available for private circulation; if there are tax or torts mavens who wish to read it, please email me asap. Thanks.

It's about four days until my wife is "due." During this pre-baby period, one of my projects has been an effort with my friend and co-author, Gregg Polsky, to finish our "shitty first draft" of Taxing Punitive Damages. I'm happy to say we're almost there. This paper is actually the fourth paper on punitive damages I've been involved with the last few years. The first two came out this past spring (here and here) and I was initially planning on turning to work further on and submit the third one, Punitive Damages and Complex Litigation, later this summer.  But for a cluster of reasons, that piece is now on the back burner and has swapped places with the fourth piece -- the one with Gregg on the intersection of taxation and punitive damages. 

Unlike the earlier co-authoring work I did (and am doing still) with Ethan and Jennifer, where we had overlapping areas of expertise as well as separate ones, this piece with Gregg presents a collaboration where there's really no overlap of expertise. He's the tax guy and I'm, well, the guy who does whatever it is that I do. While I'm definitely not the tax guy -- I never took tax in law school, to my regret, so I've been trying to learn a few things while writing this paper up -- I confess I've had fun learning about all this new legal mumbo jumbo. Tax is fun.  Yeah, I said it.*

Over the next week or so and in the course of a few posts, I'll try to share some parts of the paper's main ideas. There's a rough stab at an abstract after the jump. But keep in mind that all this is tentative, so if you think we're off-base, please let us know.  By the way, we expect to have a circulable draft in the next week or two. If you're a tax person and/or interested in federalism (Brian G? Rick H?), we hope you'll be among the first to read it.

Taxing Punitive Damages
In this article, we address the important but astonishingly under-examined issues associated with the taxation law and policy related to punitive damages. For the most part, the tax consequences of punitive damages are not on anyone’s minds, and as a result of this blind spot, plaintiffs and their lawyers are likely leaving enormous amounts of money on the table in every case involving punitive damages against defendants whose torts occurred in the context of business operations. Of course, even if we assumed that decision-makers regarding punitive damages were aware of the relevant tax effects, there are still a number of other important issues affecting whether a jurisdiction should make punitive damages a) deductible from defendants’ gross income or non-deductible, and b) taxable gains to the plaintiff.  This Article examines those issues, and by doing so, spotlights the policy difficulties associated with trying to use tax law to help achieve the goals of current punitive damages law.  Contrary to a number of scholars who have flatly endorsed the move to a non-deductibility rule to simply increase the putative “sting” of punitive damages, we explain what that change in taxation would augur for a broad array of policy concerns including federalism, settlement incentives, collusion against third parties, and administrative oversight. Because we think a lot of the difficulties associated with the taxation of punitive damages cannot be readily fixed simply by tweaking tax law, we sketch out a vision for what a more attractive punitive damages regime would look like, and how the tax rules would correspond appropriately. 

*Btw, I associated the "Yeah, I said it" line with Chris Rock and his famous joke about who can and cannot be First Lady, but it seems Wanda Sykes may have laid claim to it more prominently by her book title.

Posted by Administrators on July 26, 2009 at 02:00 PM in Article Spotlight, Dan Markel, Retributive Damages, Torts | Permalink


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One friend wrote to me the following comment, which I thought I'd share. My response is below.

Do you really think the actual deductibility of punitive damages is an important issue? A punitive damage award is one of those legal oddities, like piercing the corporate veil, that is wonderful fodder for law professors, but pretty rare in real life, random and serendipitous, far more predictable in hindsight when looking at really egregious conduct that somehow managed to get to a jury verdict, with far less actual deterrent power than law professors bother to determine (concerned as they are with the gedanken and not with the reality).

The real question, in my mind, is whether the threat of a punitive damage award, and the associated deductibility vel non, has any empirical impact on the calculation of settlement positions, and the price at which settlements are completed. My anecdotal experience as an antitrust litigator was that, despite the threat of treble damages, antitrust plaintiffs and defendants largely considered the actual damages in settlement with the threat of treble damages an in terrorem threat, and a pretty weak one at that.

My response:
if you look at the latest empirical surveys of civil litigation (the new Eisenberg et al piece), you'll see that in every case where punis are sought and tried, and where liability is established, they are awarded in about a 1/3 of those cases. That suggest they are not random, nor rare, at least once reasonable baselines for inquiry are established.

More importantly, once punis are legitimately raised as an issue for trial, then well-before that they can cast a shadow effect, though how large remains a bit uncertain. Our point about the deduction vs tax aware/gross-ups means that whatever the shadow effect is, it might be roughly 40% larger in many cases if the lawyers thought the issues through. Moreover, the choice b/w gross-ups vs non-deductibility has a tremendous effect on whether the government or the plaintiff will receive more money, even if the defendant is made indifferent from an after tax-perspective. And there are the federalism, settlement, and administration issues too...

So, I do think it's important; more significantly, I think it's interesting!

And Brian, thanks for the arch offer...

Posted by: Dan Markel | Jul 26, 2009 9:32:54 PM

Yeah, I'll read it.

Posted by: BDG | Jul 26, 2009 2:38:37 PM

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