Taxation
by Litigation: The Economics of Civil Justice Reform in Massachusetts
Executive
Summary
Tort
law plays an essential role in the American civil justice system.
Traditionally, tort law supplemented commercial prudence and
government regulation in deterring wrongful behavior. Over the
last half century, however, there has been a substantial expansion
in producers' liability for damages purportedly sustained from
the use of their products. The result is a reduction in the
capacity of American business to create jobs and capital. Tort
law has come to impose costs - implicit tort taxes - that penalize
business for creating jobs and capital, with predictable negative
effects on the economy. Various states have initiated reform
measures aimed at restoring tort law to its traditional role
in the civil justice system. In Massachusetts, the legislature
is considering the Civil Justice Reform Act (S-896). The legislation
is an effort by its advocates to improve tort law by addressing
standards of liability and other factors relating to principles
of predictability and fairness within the current civil law
system.
Taxation
by Litigation: The Economics of Civil Justice Reform in Massachusetts
assesses the economic implications of the tort liability system
and estimates the economic effects that adoption of the proposed
act could be expected to exert. The Beacon Hill Institute estimates
that adoption of the act would create:
-
71,649
to 241,224 new jobs;
-
$9.3
billion to $31.9 billion in new capital;
-
$2.4
billion to $8.2 billion in new annual payrolls; and
-
$144.9
million to $488 million in new annual tax revenues.1
Our
estimates reflect the dramatic increase in tort costs that has
occurred as a result of the expansion in the tort system. According
to Tillinghast-Towers Perrin, the U.S. tort system cost $161
billion in 1995, or 2.3% of gross domestic product (GDP), up
from approximately .6% of GDP in 1950 and 1.4% in 1970 (though
down from a peak of 2.5% of GDP in 1986).2
These
data reflect a shift in the role of tort law in deterring wrongful
behavior by producers. Under an earlier, traditional regime,
tort law played a secondary role in deterring such behavior.
Commercial prudence and insurance and, to a lesser degree, government
regulation played the primary roles. Under the existing, more
expansive regime, tort law has come to play a far more prominent
role, deterring not just wrongful behavior by producers, but
production itself. Under this expansive regime, the costs imposed
on producers seeking to protect themselves from increased liability
amount to an implicit tax on sales or production.
In
1992, the average Massachusetts resident incurred 32% more in
tort costs than the average American. In 1994, federal individual
income tax collections were $550 billion. The $151.5 billion
in tort costs incurred in the same year could be interpreted
as a 27.6% surtax on the federal income tax. In 1992 (the latest
year for which published data are available), Massachusetts
tort costs totaled $4.13 billion, or 2.55% of gross state product
(GSP), amounting to a tort cost of $687 for every Massachusetts
resident. Assuming that Massachusetts tort costs fall entirely
on residents, the average Massachusetts resident incurred 32%
more in tort costs than the average American. We estimate that
in 1995, Massachusetts tort costs were $5.1 billion, or $833
for every Massachusetts resident, accounting for 2.68% of GSP.
If revenue equal to 2.55% of GSP were raised explicitly through
the Massachusetts tax on income taxable at 5.95%, it would be
necessary to impose an additional tax rate of 5.24% on that
income. Hence, the total tax burden from the combination of
the explicit income tax and the implicit tort tax would approach
11.19% of taxable income.
Adoption
of the Civil Justice Reform Act would substantially reduce this
tax and, as shown, confer substantial economic benefits. By
raising the cost of living and by putting upward pressure on
prices and state taxes, tort costs diminish Massachusetts' ability
to compete for business and workers. The reason is not hard
to understand. Once tort law abandoned its traditional, contractual
foundations in favor of the current expansive regime, it came
to impose a strikingly high, even if implicit, tax on economic
activity undertaken within Massachusetts.
By raising the cost of living and by putting upward pressure
on prices and state taxes, tort costs diminish Massachusetts'
ability to compete for business and workers. Reducing tort costs
would, by contrast, increase the state's competitiveness and
its capacity to attract new business and to create jobs.
Overview
A
sea change has taken place in the United States regarding the
place of tort liability in the civil justice system. This change,
which began in the 1950s, has brought about a substantial transformation
not only in the civil justice system but also in the capacity
of American business to create jobs and capital. In its modern
incarnation, the tort system imposes an implicit tax - a "tort
tax" - that penalizes business for creating jobs and capital,
with predictable, negative effects on the economy.
Opponents
and perceived victims of the expanded tort liability system
have, with some success, initiated tort reform measures in various
states. A Civil Justice Reform Act now before the Massachusetts
legislature would, in accord with this trend, place new limits
on the rights of tort plaintiffs under Massachusetts law. Our
purpose here is to assess the economic implications of the tort
liability system in Massachusetts and, concomitantly, to estimate
the economic effects that adoption of the proposed Act could
be expected to exert.
Table
1 summarizes the results of our analysis. There, we present
a range of estimates of the economic effects of the Civil Justice
Reform Act, showing a reduction in the implicit tort tax (I)
to the current (1992) U.S. average; (II) by an estimated 26.6%
reduction in tort filings; 3 (III) to the 1970 Massachusetts
level; and (IV) to the 1970 U.S. level. These scenarios show
progressively larger economic effects.
| |
|
Scenario |
|
|
| |
I |
II |
III |
IV |
| Reduction
in Tort Costs to |
Current
U.S. Average of 2.2 GDP |
Proportionate
to Filings Decrease of 26.6% |
1970
Mass Costs of 1.8% of GSP |
1970
U.S. Costs of 1.4% of GDP |
Equivalent
Tax Impact
(% point change) |
-0.72 |
-1.39 |
-1.54 |
-2.36 |
| |
|
|
|
|
| Employment
Impact |
71,649 |
139,940 |
155,303 |
241,224 |
| |
|
|
|
|
| Capital
Impact |
$9.3
billion |
$18.3
billion |
$20.4
billion |
$31.9
billion |
| |
|
|
|
|
| Payroll
Impact |
$2.4
billion |
$4.7
billion |
$5.2
billion |
$8.2
billion |
| |
|
|
|
|
| Tax
Revenue Impact |
$144.9
million |
$314.1
million |
$314.1
million |
$488.0
million |
At
the low end of the range (Scenario I), the Civil Justice Reform
Act would cause a 0.72-percentage-point reduction in the tort
tax. The result would be the creation of almost 72,000 new jobs,
which is to say, a 2.38% increase in Massachusetts employment.
The new jobs would be filled by Massachusetts residents who
are currently unemployed and by the entry of persons (some of
whom would come from out of state) into the Massachusetts labor
force. A further effect would be the creation of $9.3 billion
in new capital spending. The expansion in jobs would cause annual
payrolls to expand by $2.4 billion. The state would collect
$144.9 million annually in new tax revenue. At the high end
of the range (Scenario IV), the tort tax would fall by 2.36
percentage points. The result would be the creation of more
than 241,000 new jobs and of about $32 billion in new capital
spending. The inescapable conclusion is that tort reform would
confer substantial benefits, however estimated, on Massachusetts.
The
Tort Transformation
The
reason is not hard to understand. Once tort law abandoned its
traditional, contractual foundations in favor of its now expansive
regime, it came to impose a strikingly high even if implicit
tax on economic activity undertaken within Massachusetts. The
severity of the economic consequences should surprise nobody.
The purpose of tort law is to deter wrongful behavior and to
provide compensation to the victims of such behavior. Traditional
tort law played a secondary role within our economy in serving
this purpose. The primary roles were played by commercial prudence
and by insurance, along with some support through government
regulation. Deterrence and compensation were generally organized
according to the contractual principles that govern commercial
relationships. Traditionally, a producer was liable for a consumer's
injuries only if the injuries were attributable to the producer's
wrongful behavior. Consumers depended largely on the producer's
commercial sense as a deterrent to such behavior. The reason
is that wrongful acts typically cost an enterprise more, through
various forms of indemnification and through loss of reputation,
than they save in production costs, and so are bad for business.
In this traditional framework, government remedies generally
mirrored the contractual relationships that characterize normal
commercial activity. Hence, workers compensation was introduced
as an insurance program that indemnifies workers for injuries
suffered on the job.
The
contractual principles that govern the provision of private
insurance were imported into the provision of workers compensation,
even if the precise details of workers compensation differed
from what market-based providers might have offered. Playing
its supporting role in this overall system of deterrence and
compensation, tort law came into play in accidents, where the
contractual principles that governed market relationships were
not directly applicable. Automobile accidents were a principal
example. The doctrine of privity of contract restricted the
range over which tort liability roamed. A manufacturer might
sell a ski-like exercise apparatus and perhaps be liable for
the buyer's injuries if he failed to caution the buyer about
the proper use of the equipment. The manufacturer would not,
however, be liable for injuries to a guest of the buyer who
used the apparatus, or to a subsequent owner to whom the buyer
had sold the apparatus, unless the product itself was defective.4
Today
the same manufacturer faces a much-expanded range of liability,
one that goes well beyond liability for product defects. A new
expansive regime has elevated tort law in the American system
of deterrence and compensation from a supporting role to one
of star performer. There are two ways to increase safety. One
way, associated with the traditional, contractual principles
of tort law, diverts economic resources from the business of
repairing the harm done by unsafe products to that of producing
safer products, leaving consumers with fewer injuries but also
leaving overall economic activity undiminished. Another way,
associated with the modern, expansive principles of tort law,
discourages the production of all products, including products
aimed at increasing safety. Tort law, as it has currently evolved,
increases safety at the expense of economic activity and, hence,
of jobs and investment.
A
reduction in Massachusetts tort costs would represent a shift
toward a tort system that values both safety and economic activity.
Tort Costs The economic consequences of the change in tort law
have been dramatic. According to Tillinghast-Towers Perrin,
a management consulting organization, the U.S. tort system cost
$161 billion in 1995, up from $151.5 billion in 1994.5
In 1995, tort costs accounted for 2.3% of GDP, up from approximately
.6% of GDP in 1950 and 1.4% in 1970, but down from a peak of
2.5% of GDP in 1986.6 In 1994, federal individual
income tax collections were $550 billion. The $151.5 billion
in tort costs incurred in the same year could be interpreted
as a 27.6% surtax on the federal income tax. If U.S. tort costs
had remained at 1.4% of GDP, those costs would have been $97
billion in 1994 rather than $151.5 billion. Instead of representing
a 27.6% surtax on the individual income tax, they would have
represented only a 17.6% surtax. If tort costs had remained
at 0.6% of GDP, as in 1950, they would have amounted to $41
billion in 1994, representing but a 7.5% surtax. The data compiled
by Tillinghast-Towers Perrin pertain to the United States as
a whole. Using a methodology similar to theirs, we calculate
the cost of the tort system for each of the 50 states and the
District of Columbia. In 1992 (the latest year for which published
data are available), Massachusetts tort costs totaled $4.1 billion,
or 2.55% of GSP, amounting to a tort cost of $687 for every
Massachusetts resident.
Assuming
that Massachusetts tort costs fall entirely on Massachusetts
residents, the average Massachusetts resident incurred 32% more
in tort costs than the average American. As a percentage of
GSP, Massachusetts tort costs were 18.6% higher than tort costs
as a fraction of GDP. We estimate that in 1995, Massachusetts
tort costs were $5.1 billion, or $833 for every Massachusetts
resident, accounting for 2.68% of GSP. Considering the Tort
Tax Defenders of this state of affairs point out, correctly,
that the increase in tort costs has brought certain benefits.
With increased deterrence, there is a lessening of certain kinds
of risks, at least those that are deterrable through the court
system. In thinking about accidents, however, it is vital to
think about both sides of the equation - about the costs as
well as the benefits of deterring harm. Automobile accidents
exact a large toll each year in lives lost, people injured and
property damaged or destroyed. It is reasonable for society
to limit accidents in an efficient manner and degree. It is
not reasonable, however, to seek to eliminate accidents. Why?
Because doing so would be too costly.
We
could reduce substantially the number and seriousness of automobile
accidents by imposing a highway speed limit of 25 miles per
hour. However, people would almost universally object to such
a measure because the cost of securing this degree of accident
prevention would outweigh the value of the added safety thus
gained. In other words, and more generally, it is important
to consider the cost as well as the benefit side of any system
of accident deterrence. Since the costs of deterrence may well
exceed the benefits, an understanding of the cost side is a
necessary part of any effort to reach an informed judgment about
desirable levels of and approaches to accident deterrence.
It
is the cost side of the equation that is the central focus in
this report. Tort liability adds to the cost of goods, in the
same fashion as a tax, even though it is not explicitly levied
as such. Massachusetts businesses and residents pay a number
of explicit taxes, among them a 5% sales tax and a 5.95% tax
on earned and certain unearned income. They also bear burdens
through the tort system, as a form of implicit tort tax. To
the extent that state government incurs tort costs, and only
to this extent, does the "tort tax" show up as an
explicit part of the tax burden. By far the overwhelming part
of tort liability is embedded in higher prices for the products
people buy through regular commercial transactions. It has been
estimated, for instance, that the price of stepladders is increased
by 30% through the operation of tort liability, which renders
tort liability equivalent to a 30% tax on the sale of stepladders.7
We
estimate the total tort tax liability in Massachusetts to be
2.55% of GSP. If revenue equal to this fraction of GSP were
raised explicitly through the Massachusetts tax on income taxable
at 5.95%, it would be necessary to impose an additional tax
rate of 5.24% on that income. Hence, the total tax burden on
this income from the combination of the explicit income tax
and the implicit tort tax would approach 11.19% of taxable income.
The share of GSP accounted for by the cost of tort liability
was .75 percentage point higher in 1992 than in 1970. This is
equivalent to a 1.54 percentage point increase in the Massachusetts
tax on earned income (as reflected in Table 1, scenario III).
To
be sure, not all of the tort tax borne by residents of Massachusetts
can be influenced by Massachusetts legislation. A portion of
that tax burden is influenced by legislation in other states.
In a scenario such as an accident involving a defendant based
in Massachusetts and a plaintiff located elsewhere, a suit may
be filed elsewhere if the plaintiff expects to receive a larger
judgment in that alternative venue. Some economic activity in
Massachusetts is heavily oriented toward export, and, for such
activity, Massachusetts can exert only a modest influence over
the tort tax borne by its residents.
But
other economic activity is almost exclusively confined to the
state's borders, and there the legislature can exert full control
over the tax burdens borne by state residents. And, of course,
there will be a variety of in-between cases, as in a spectrum
and not a dichotomy, concerning the relative importance of export
production in total state production. Passage of the Civil Justice
Reform Act would limit the tort liability of Massachusetts businesses
and thus reduce the tort tax borne by Massachusetts residents.
By translating tort reform into an equivalent change in the
state income tax and by identifying the range into which that
change is likely to fall, we can assess its effect on employment,
as well as on other economic variables such as capital spending,
payrolls, and tax collections.
The
question, then, is not whether tort reform, considered as tax
relief, would generate economic benefits, but what the magnitude
of those benefits is likely to be. We use the Beacon Hill Institute's
State Tax Analysis Modeling Program (STAMP), a recognized method
for analyzing the effects of state tax-law changes on economic
activity, to generate the range of estimates offered in Table
1.8 As applied to the Civil Justice Reform Act, STAMP
finds the benefits to be substantial. This finding is consistent
with data that show tort costs to be especially high for manufacturing
and manufacturing to be a relatively important but declining
sector of the Massachusetts economy. By raising the cost of
living and by putting upward pressure on state taxes, tort costs
diminish Massachusetts' ability to compete for workers and business.
Reducing tort costs would have the effect, as shown, of increasing
competitiveness and thus the state's capacity to create jobs
and attract new business.
Notes
1
See Beacon Hill Institute, Massachusetts Econometric Tax
Model (Boston: Beacon Hill Institute, February 1996).
2
Tillinghast-Towers Perrin, Tort Cost Trends: An International
Perspective (1995); and Insurance Information Institute,
The Fact Book 1997: Property/Casualty Insurance Facts (New York:
Insurance Information Institute, 1996), 62-63. These figures
rely on data from A.M. Best, the principal publisher of insurance
industry data, “several specialized studies” of self-insurance
and Tillinghast-Towers Perrin’s internal database of state-by-state
medical malpractice costs.
3
In Chapter IV, we estimate this percentage based on the decline
in the number of tort filings in Cook County, Illinois in 1996.
4
In the event of injuries to those subsequent parties and in
the absence of product defects, liability would reside with
the customer and not with the manufacturer. The injuries in
these two instances involved contractual relationships between
the customer and his guest or the customer and the subsequent
owner, and those relationships excluded the manufacturer in
either case.
5
Tillinghast-Towers Perrin, Tort Cost Trends; and Insurance
Information Institute, The Fact Book 1997, 62-63. See
footnote 2. 6 Ibid.7. Peter Huber, Liability: The Legal Revolution
and its Consequences (New York: Basic Books, 1988), 3.8.
See Beacon Hill Institute, Massachusetts Econometric Tax
Model (Boston: Beacon Hill Institute, February, 1996.)
Updated
on
08/09/2007 4:31 PM
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