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Ending deductibility of punitive damages

One of the Obama administration's tax proposals would end the deductibility of punitive damages, a step previously advanced in Congress without success. [Reuters] The conventionally offered reason for such a change is that punitive damages, like criminal fines, should convey a stigma and not just be handled as something in the course of business. Some proponents may also hope that such a tax change will turn punitive damages into more of a "hammer"; PoL contributor Ted Frank says the move "looks like an indirect giveaway to the trial bar". [Southeast Texas Record]

Whatever the motivation, I suspect the actual practical effects of the proposed tax change will fall far short of what proponents hope, for much the same reason that the popular reform idea of splitting punitive damage awards with the state has put little if any money into state coffers where it has been tried. Nearly all money that changes hands in litigation where punitive damages are demanded does so through settlement at some stage short of enforcement of a final judgment. Even if a jury has in fact voted to award punitive damages, a settlement in-lieu-of-appeal can typically characterize the sums changing hands as compensatory in nature, and thus not subject to the more unfavorable tax treatment (or to splitting with the state, as the case may be). In both cases it will be strongly in one side's interest to insist on the "compensatory" characterization, and not in the other side's interest to insist otherwise.

For the sake of federal budget credibility, I hope Washington is not expecting this change to bring in any great sums in new tax revenues.

More: Ted has now posted at Overlawyered.

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Rafael Mangual
Project Manager,
Legal Policy

Manhattan Institute


Published by the Manhattan Institute

The Manhattan Insitute's Center for Legal Policy.