July 5, 2010

NYT Op-Ed on Taxing Punitive Damages

We previously blogged about the Senate's recent approval of a measure to prevent corporations from taking tax deductions for punitive damages awards.

Law Professors Gregg Polsky and Dan Markel criticize that proposal in a New York Times op-ed entitled "Damages Control." Profs. Polsky and Markel argue that the proposal won't work because parties will still be able to settle punitive damages cases, and the defendants can characterize the settlements as payments of compensatory damages, which will remain deductible.

Polsky and Markel contend that, instead of eliminating the tax deduction, we should allow plaintiffs' lawyers to explain to juries that punitive damages awards are tax deductible, which would then encourage juries to award higher amounts to offset the fact that the award will be deductible. Polsky and Markel concede, however, that "tax-aware" juries would have to know the defendant's marginal tax rate in order to figure out the appropriate amount to offset the deduction.

It seems to me that the jury would have to know more than that; the jury would have to understand the defendant's overall tax situation to calculate any such offset. If the defendant were not expected to report any income for the year in question, would any offset be appropriate? Would the jury be asked to consider the effect of carry-overs from one tax year to the next? Would the jury be asked to determine the defendant's expected tax liability, based on speculation about what was likely to occur during the remainder of the tax year?

California courts decided long ago that juries should not be asked to consider the tax consequences of any damages awards, because juries would have to engage in "intense speculation about the future" in order to accurately adjust their awards. (See Rodriguez v. McDonnell Douglas Corp. (1978) 87 Cal.App.3d 626, 667-668.) Any proposal that increases speculation by the jury is probably not a good idea.

3 comments:

  1. Gregg Polsky7/6/10, 11:24 AM

    Thanks for mentioning our op ed. In a longer treatment of the thesis in our paper “Taxing Punitive Damages,” we address in detail the issues that you raise. That paper can be downloaded here:
    http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1421879.

    To make a long story short, we conclude that the speculation/complexity concerns are not all that significant, especially considering all the tasks we ordinarily require of jurors (such as estimating future medical expenses, life expectancy, lost wages, retirement age, lost profits, putting a dollar value on pain and suffering, etc...). We also discuss how our proposal might appear inconsistent with the general (though not nearly universal, see e.g., Norfolk & Western Railway Co. v. Liepelt, 444 U.S. 490 (1980)) rule that tax evidence is inadmissible in the context of determining compensatory damages. But once you consider the differences between the compensatory versus punitive contexts, there really is no inconsistency. Finally, keep in mind that, to show that our proposal is better than nondeductibility, we have a very low bar to clear because a nondeductibility rule will be so incredibly easy to circumvent. In short, there is no perfect solution, but it seems clear to us that tax-awareness is better than nondeductibility, which itself is better than the current situation (where jurors don’t realize that punitives are deductible in many cases).

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