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The Ultimate Sin Tax

Many people dream of a civilized world without the taxes that seem to go with it. Everything now done by the state, and which needs to be done, will be financed by user fees or charitable contributions.

Unfortunately, that day seems rather far off. Most people have a better chance of escaping death than taxes.

However, it is not unreasonable to seek less objectionable forms of taxation, generally those that most nearly approximate user fees. If they have other redeeming virtues as well, that's a bonus.

Taxing "sinful" activities is very popular with politicians and the public. The taxes tend to discourage the activities, and the burden of the taxes falls mainly on "sinners". That is why tobacco and alcohol are so heavily taxed. If prostitution is ever legalized, it will probably be even more heavily taxed.

There is another activity which, when overdone, can cause more social disruption than alcohol or tobacco use. Abuse of this activity is a large and growing problem in our society. It is long overdue for a sin tax. Moreover, this tax, unlike most other sin taxes, is more like a user fee than a tax. And the "sin" that it discourages really is an assault on the property of others.

What is being proposed is nothing less than a tax on lawsuits.

Here is how the lawsuit tax works. When a plaintiff files a lawsuit, he must specify how much money he is requesting as damages. This becomes the largest amount the court can award in the case.

After notice of the suit has been served on the defendant, and before the case can proceed further, the plaintiff must pay the tax and file the receipt with the court.

The tax is a percentage of the amount of money requested. The rate might be comparable to the general sales tax rate, usually about four to eight percent. There will be no refunds if the plaintiff loses or is awarded less than the amount requested.

There is certainly more justification for a lawsuit tax than there is for a general sales tax. The buyer and seller who pay a general sales tax usually are not asking for any specific government assistance in completing the sale; but the plaintiff in a lawsuit is asking for something only the state can provide in most circumstances -- the use of force to correct a wrong committed in the past. The amount of the tax is, in some crude way, proportional to the amount of force requested.

The lawsuit tax is not entirely a new idea. Many years ago, Ayn Rand proposed a tax on contracts -- which she called an "insurance premium". Untaxed contracts would be permitted, but neither party could sue for redress if the contract was broken. This scheme has some rather serious shortcomings. It would not apply to non-contractual lawsuits, which seem to be the most serious problem in our society, or to oral contracts, because of the difficulty of collecting premiums.

Although I have not researched the subject, I have heard that some other countries, which are much less litigious than the United States, do have taxes or fees of this kind.

The lawsuit tax will have one very salutary effect. It will discourage the filing of frivolous lawsuits and lawsuits asking for grossly inflated damages. The litigation lottery will be taxed out of existence.

The timing of the tax is important. Before a civil case can go to trial, there is usually a process called discovery. During this phase of the case, which can last for years, the plaintiff and defendant can interrogate each other under oath and subpoena any relevant written records. Failure to respond to discovery creates a presumption that the withheld evidence is unfavorable. The process is as coercive as the trial itself. The plaintiff should be required to pay for these powers.

Some cases, particularly product liability cases, may be filed primarily to get discovery powers. Requiring the plaintiff to specify the damages in advance will discourage that.

Excessive judgements are often reduced on appeal. Since the tax discourages excessive damage claims when the suit is filed, appeals of this kind will become much less frequent.

The lawsuit tax will not be a serious impediment in meritorious cases.

Most truly meritorious cases are settled out of court before a lawsuit is even filed. Such cases will not be taxed. Even if a case goes to court, the lawsuit tax on a meritorious claim will usually be considerably less than the legal fees, investigation costs and other expenses that must be paid in advance, either by the plaintiff or by a lawyer pleading the case for a contingent fee. The lawsuit tax should not discourage meritorious litigation any more than a general sales tax discourages retail sales.

If the plaintiff wins, he can recover from the defendant, as part of his costs, the tax paid on the amount he actually wins. For example, if the tax rate is five percent, and the plaintiff files a lawsuit asking for $100,000, he pays a $5,000 tax. If the court awards him only $50,000, he can add five percent of $50,000, or $2,500, to the judgement. The defendant then owes him $52,500.

If the case is settled out of court after the tax has been paid, the allocation of the tax burden will be part of the settlement. Like other settlement terms, it will probably be based on the anticipated results if the case actually went to trial.

Of course, in practice, the tax will not be quite so simple. For example, some lawsuits ask for injunctions instead of money damages. The dollar equivalent of the relief requested will have to be estimated for tax purposes. In some cases, this isn't as much of an additional burden as it seems, since the court must make such an estimate to establish the size of the required bond.

The lawsuit tax will not apply to private arbitration cases unless the winner asks the state to collect the arbitrator's award. Then it will apply only to the amount of the award. The arbitration agency will have its own fee schedules, which may or may not involve fees proportional to the amount requested as an award. The market will decide that.

Another complication lies in the treatment of rejected settlement offers. If the defendant offers to settle before the tax is paid, and the plaintiff wins less than the rejected settlement offer, he should not recover the tax, because he could have avoided it by accepting the offer and dropping the case. This is currently the rule with other kinds of recoverable costs.

A problem also arises with appeals. Is the appeal a separate case, with a new tax to be paid? Or is it merely a continuation of the same case? The latter option seems to be preferable, unless frivolous appeals become as much of a problem in civil cases as they are in some kinds of criminal cases.

In spite of these difficulties, the lawsuit tax will be easier to collect than most other taxes. It will be very difficult to evade because every taxable transaction will automatically come to the attention of the state when a lawsuit is filed.

Perhaps the only good tax is a completely voluntary tax, which actually isn't a tax at all. The lawsuit tax doesn't quite qualify, but it does put the cost of supporting the civil justice system on those who use it, and it will do more to discourage abuse of that system than any of the other litigation reforms currently being considered. That's about as good as a tax can get.

Philip J. Erdelsky
October 10, 2011