Making Sense of Legal Nonsense

Our legal system is a cornerstone of our economy. Yet in recent years, the courts have been used in ways that drive up costs for consumers while rewarding irresponsibility. The direct cost of the U.S. tort system is over $180 billion annually—roughly 1.8 percent of the nation’s output. That is two and one-half times greater than other industrial nations. These estimates are conservative and do not include the substantial indirect costs of excessive litigation, such as “defensive medicine,” or the foregone benefits of products and services no longer available or never produced due to fear of lawsuits.

In fact, the United States is in the midst of a liability crisis, with more than 15 million civil cases being processed annually in state courts alone. Frivolous litigation increases the burden on the courts while crowding out legitimate legal grievances. On average, it takes almost 5 ½ years for victims in injury cases to go to trial, 15 months longer than it took in 1990. And the system is a terribly inefficient mechanism for compensating victims. Less than half of every dollar spent goes toward compensation, with administrative costs and legal fees comprising the bulk of the costs.

The tort system has changed dramatically over the last 25 years, expanding in scope and becoming more redistributive in nature. In many ways the tort system has become viewed as a social safety net, providing compensation for injured, regardless of fault. But, as economists always point out, “there’s no such thing as a free lunch.” Someone must pay the litigation jackpots and million-dollar awards. Like any tax, the “tort tax” is eventually paid by individuals. As a study by the Council of Economic Advisers demonstrates, the costs of tort litigation is equivalent to a 2 percent tax on consumption, a 3 percent tax on wages, or a 5 percent tax on capital income.

Tort law was developed with two goals in mind: compensating accident victims and deterring behavior that can cause accidents. Individuals and businesses know that harmful actions or products would not be profitable because victim compensation would offset any ill-gotten profits. Moreover, punitive damages are available to punish wrongdoers, which adds further incentives to avoid dangerous behavior. Applied correctly, tort law minimizes the number of accidents or consumer harm.

Unfortunately, the current legal system does not always apply these principles correctly. In many cases there is little or no relation between compensatory damages and punitive damages, and there is little rationale or predictability for punitive damages. When damage awards become so arbitrary or random, they can no longer provide incentives to reduce dangerous behavior, because there is nothing to link behavior with outcomes. Moreover, trial lawyers who view the litigation process as an entrepreneurial venture can distort legal institutions to the point that the original goals of tort law become lost.

Legal reforms can provide a needed dose of common sense for the legal system. Legitimate concerns can be addressed and victims can be made whole. At the same time, adding a degree of certainty to the proceedings will provide much better incentives to avoid questionable behavior. People or businesses should be required to pay for harms they have caused, but only proportionately to their culpability (currently, someone that is only 10 percent at fault can be required to pay 100 percent of the compensation). In addition, once an individual has been compensated for losses, additional damages aimed to punish should not be awarded unless someone was found to have purposefully caused the harm or acted in an egregious or grossly negligent manner.

Critics of reform assert there is no crisis and the system works. But the data say otherwise, suggesting an increase in claims and frivolous lawsuits. For example, roughly 70 percent of medical malpractice claims result in no payments, but the median cost of defending such a case is $66,000. Claim costs have been rising three times faster than the rate of inflation. Overall, between 1930 and 1994, tort costs grew four times faster than did the U.S. economy.

The current legal system thwarts innovation, raises consumer costs, and limits access to the courts for many with real grievances. A better system would not only enforce contracts and settle disputes peacefully, but also would allow those who are harmed to seek and recover compensation from those who are truly at fault. Reforms, both at the federal level and the state level, are necessary to restore the legal system’s ability to resolve disputes in an efficient manner.