Overcoming Tradeoffs in the Taxation of Punitive Damages

As explained in a companion piece, there is a curious anomaly in the law of punitive damages. Jurors assess punitive damages in an amount that they believe will best “punish” the defendant. But, in fact, business defendants are not always punished to the degree that the jury intends. This is because jurors do not take into account the fact that these businesses are allowed to deduct their punitive damages awards. To solve this problem, President Obama recently proposed to make all punitive damages nondeductible, a proposal that has in the past been supported by a number of policy makers and academics. Unfortunately, the nondeductibility rule is doomed to fail in practice. Instead, the under-punishment problem is better solved through making juries and courts aware of the tax implications of punitive damages awards. While tax awareness would better address the under-punishment problem, it would at the same time increase plaintiffs’ windfalls. Sadly, there is simply no way under current punitive damages law to reduce under-punishment without simultaneously augmenting plaintiff windfalls.  D‘Alemberte Professor, Florida State University College of Law; Scholar in Residence, NYU Center for Administration of Criminal Law (2011). This Article grew out of a wonderful collaboration with Gregg Polsky, my former colleague at FSU, now at UNC–Chapel Hill. It is fair to say that much of the analysis of the tax rules here would not have been possible in the absence of his tremendous help with this paper, as well as our jointly authored companion article to this one. See Gregg D. Polsky & Dan Markel, Taxing Punitive Damages, 96 VA. L. REV. 1295 (2010). A few other tax scholars were especially helpful in clarifying the arguments here, and I thank Josh Blank, Brian Galle, Steve Johnson, Leigh Osofsky, and Larry Zelenak for their particular assistance. This piece is part of a larger project related to punitive damages, and I am grateful for comments and conversations on this project as a whole, as well as this aspect of it, to Miriam Baer, Shawn Bayern, Beth Burch, Michael Cahill, Jack Chin, Danielle Citron, Tom Colby, Robin Craig, Joseph Dodge, Mike Dorff, Dave Fagundes, Brian Galle, Tom Galligan, Rick Garnett, Mark Geistfeld, Shubha Ghosh, Tara Grove, Andy Hessick, Carissa Hessick, Brant Hellwig, Adam Hirsch, Dave Hoffman, Keith Hylton, Steve Johnson, Adam Kolber, Erik Knutsen, Susan Kuo, Ethan Leib, Wayne Logan, Chris Lund, Caleb Mason, Marty McMahon, Richard Myers, Mitch Polinsky, Michael O‘Hear, Alice Ristroph, Christopher Robertson, Mark Seidenfeld, Cathy Sharkey, Jason Solomon, Tony Sebok, Suja Thomas, Franita Tolson, Bill Turnier, Manuel Utset, Neil Vidmar, David Walker, Sonja West, Adam Winkler, Verity Winship, Ekow Yankah, Jeff Yates & Ben Zipursky; participants at faculty workshops at CLEA, Florida State, and Southwestern-Prawfsfest! 2009; and the students in my 2009 seminar on punitive damages. For excellent research assistance, I thank Matt Daley, Will Ourand, Tiffany Roddenberry & Nancy Rumberger. Comments are welcome: [email protected]. Washington University Open Scholarship 610 WASHINGTON UNIVERSITY LAW REVIEW [VOL. 88:609 The tradeoff is a byproduct of the jumbled way current punitive damages law engrafts “public law” values on a private dispute resolution system not entirely capable of effectuating those values. To avoid such an unfortunate tradeoff, reform of punitive damages law would be required. This Article sketches a vision of such reform and describes its corresponding tax rules. In particular, the appropriate tax treatment of tort damages should depend on the particular purpose(s) being pursued and vindicated. In this respect, the recommendations here stake out a more nuanced middle path between those scholars and policy makers touting nondeductibility for all punitive damages and those endorsing the current rule allowing a deduction for all punitive damages paid by business defendants.