Capitol Comment 231 – Don’t Let the Government Mimic Trial-Lawyer Greed

President Clinton included a provision in this year’s budget that would tax corporations on the punitive damages they pay out for lawsuits. This tax not only makes the federal government an interested party in practically every civil lawsuit in the nation, but also provides trial lawyers another weapon for an arsenal that has wreaked havoc on American businesses for the past 20 years.

Punitive damage awards are already unpredictable and unfair. Congress needs to stand up for American workers and families and stop this tax.

Under current tax law, businesses may deduct punitive damages as ordinary and necessary business expenses. The deduction applies to both economic and punitive damages. The Clinton administration’s proposal would eliminate punitive damage deduction, thereby essentially punishing the business twice. Once when the business pays the award and again when the business pays the tax on the penalty.

In theory, punitive damages are intended not to compensate a victim, but to punish and deter the defendant from committing a bad act. Economic or compensatory damages are awarded to compensate the victim for their out-of-pocket losses, including medical expenses, lost wages and pain and suffering. For instance, if someone punches another in the nose, a court most likely would demand that the “puncher” pay economic damages to the “punchee,” which would include medical expenses, lost wages and pain and suffering. Economic damages are awarded to make victims whole. In addition to these damages, the court may award punitive damages to the “punchee.” In this case, the law seeks to punish the “puncher” and send a message to others.

In cases where a person is injured as the result of simple negligence, courts should not award punitive damages. For instance, if a driver accidentally runs a red light and hits another, that driver would have to pay for any property or bodily damage he caused. Since the damages were accidental and not the result of gross negligence, the driver most likely would not be forced to pay punitive damages.

Throughout the nation, unpredictable punitive damage awards are on the rise. In the past two years, juries have awarded single punitive damage verdicts of $100 million, $167 million and $250 million.1 A Rand Corporation study showed that the average punitive damage award in California equals $5.7 million.2 In Texas, the average award comes out to about $6.7 million. Yale Law School Professor George Priest found that one small rural county in Alabama had an average punitive damage award of $12.9 million between 1989 and 1996.3

The threat of high punitive damages awards often forces corporations to settle unmeritorious claims early, rather than risk losing millions of their shareholders’ dollars. Under President Clinton’s proposal, corporations would have an even larger incentive to settle these claims, because, if found liable, the corporation would have to pay the punitive damage award and the taxes on that award. Clearly, on the margin, taxing punitive damages increases the incentive to settle.

The courts should not be viewed as a source of revenue. If passed, President Clinton’s proposed tax on punitive damages may offer new revenues in the short run. During this short time frame, the government could attempt to maximize its wealth by taking a more aggressive stance in cases where the opportunity for punitive damages arise. Even more disconcerting, the potential for a new revenue source could cause the government to change liability and tax laws in its favor. Specifically, the government might pass a statute creating new causes of action for punitive damages or make it less difficult for plaintiffs to obtain punitive damages. Creating a vested interest for the federal government in the assessment of punitive damages establishes the perverse incentive of creating more lawsuits with punitive damages awards.

Who wins from President Clinton’s proposal? The answer lies with some of President Clinton’s greatest financial contributors — the trial lawyers. Trial lawyers can use the threat of unpredictable punitive damages, coupled with high tax liability, to force more settlements. As the size of the potential loss increases, corporations will settle sooner. With the proliferation of forced settlements, it is the consumer who ultimately pays the cost. The Public Policy Institute estimates that average consumers are already paying an extra $616 a year because of other peoples’ lawsuits.4

Punitive damage awards are already unpredictable and unfair. Clinton’s tax proposal will make a bad situation worse by forcing the settlement of more unmeritorious claims and by making the government a partner in any punitive damage case. Congress needs to stand up for American workers and families and stop this tax.

1Senate Committee on the Judiciary, 106th Cong., 1st Sess. (1998) (statement of Professor George Priest).

2Moller, Pace, and Carroll, Punitive Damages in Financial Injury Jury, Rand Corp. MR-888-ICJ (1997).

3Senate Committee on the Judiciary, 106th Cong., 1st Sess. (1998) (statement of Professor George Priest).

4The Public Policy Institute, An Accident and a Dream, p. 24, March 1998.