Taxing Punitive Damages

Article — Volume 96, Issue 6

96 Va. L. Rev. 1295
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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, defendants are not always punished to the degree that the jury intends. Under the Internal Revenue Code, punitive damages paid by business defendants are tax deductible and, as a result, these defendants often pay (in real dollars) far less than the jury believed they deserved to pay.

To solve this problem of under-punishment, many scholars and policymakers, including President Obama, have proposed making punitive damages nondeductible in all cases. In our view, however, such a blanket nondeductibility rule would, notwithstanding its theoretical elegance, be ineffective in solving the under-punishment problem. In particular, defendants could easily circumvent the nondeductibility rule by disguising punitive damages as compensatory damages in pre-trial settlements.

Instead, the under-punishment problem is best addressed at the state level by making juries “tax aware.” Tax-aware juries would adjust the amount of punitive damages to impose the desired after-tax cost to the defendant. As we explain, the effect of tax awareness cannot be circumvented by defendants through pre-trial settlements. For this and a number of other reasons, tax awareness would best solve the under-punishment problem even though it does come at the cost of enlarging plaintiff windfalls. However, given the defendant-focused features of current punitive damages doctrine, this cost is not particularly troubling.

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  Volume 96 / Issue 6  

Ex Ante Regulation of Computer Search and Seizure: A Reassessment

By Orin Kerr
96 Va. L. Rev. 1241

Taxing Punitive Damages

By Dan Markel & Gregg Polsky
96 Va. L. Rev. 1295

Habeas Corpus, Due Process and the Suspension Clause: A Study in the Foundations of American Constitutionalism

By Martin H. Redish & Colleen McNamara
96 Va. L. Rev. 1361

The Invisible Hand in Legal and Political Theory

By Adrian Vermeule
96 Va. L. Rev. 1417