The Public Policy Institute

Section 2

New York's “Tort Tax”

The cost of the liability system is immense but invisible, passed through to consumers in the form of higher prices for goods and services of nearly every kind. This cost is sometimes referred to as the tort tax(19) -- and here, as in so many other areas, New York's economy is saddled with one of the heaviest tax burdens in the country.

Peter Huber, a leading critic of the nation's tort system, has put the issue of tort costs in this perspective:

“Unlike better known taxes, this one was never put to a legislature or a public referendum, debated at any length in the usual public arenas, or approved by the president or any state governor. And although the tax ostensibly is collected for the public benefit, lawyers and other middlemen pocket more than half the take.”(20)

Just how large is the tort tax in New York--and how does it compare to liability costs in other states? The best way to arrive at the answer is to gather data on what individuals, state and local governments, and corporate entities must pay--in the form of insurance premiums, and amounts set aside for self-insurance--to cover any claims made against them for personal injuries and other damages.

One widely accepted method of measuring the tort tax was developed in the mid-1980s by the consulting firm of Tillinghast­Towers Perrin, for a series of international comparisons of tort costs. With some adaptations to account for state-level variations in the quality of insurance industry data, the same approach can be used to estimate the tort tax in New York and other states.

Sizing up liability costs

Based on publicly reported insurance industry data, The Public Policy Institute meshed the Tillinghast methodology with state-level measures developed by researchers for the Beacon Hill Institute of Boston in a recent study of the civil justice issue in Massachusetts, and then developed estimates of total 1996 liability costs for every state, as shown in the table on Page 24.

Our tort tax estimate is the sum of three components:

The Empire State's tort tax

Our key finding is this:

New York State's tort tax in 1996 amounted to $14.3 billion--second only to California's in absolute terms. On a per-capita basis, New York's tort tax ranked sixth at $787 per person--about 28 percent above the national average.

As illustrated in the graph on Page 3 and the table on the following page, the burden of liability costs in New York State is among the highest in the nation -- and it is also higher than any tax levied by the state government, except for the personal income tax.

Components of Liability Costs, 1996

The tort tax exceeds the combined burden of state and local sales taxes in New York, which add 7 to 8 percent to the cost of most retail goods, depending on the locality. The tort tax runs a close second to the state's personal income tax. It's more than double the combined total of all business taxes levied by the state. And the tort tax is more than quadruple the amount raised by all remaining New York State taxes combined--including state excise taxes on fuel, tobacco and alcohol, estates and gifts, and real estate transfers.

Like the sales tax, the tort tax is at least partially “exported” to consumers elsewhere; for example, the cost of product liability coverage for New York manufacturers is reflected in prices they charge for products sold throughout the world. By the same token, some portion of insurance and self-insurance costs in New York reflects injuries and losses suffered in other states.

It is important to note, however, that tort tax differences among states are disproportionate to size. For example, California's population and gross state product exceed New York's by 53 percent and 75 percent, respectively, but California's gross tort tax is only 27 percent higher than New York's.

Measuring the tort tax relative to the size of each state's economy, as a percentage of gross state product, is a way of compensating for differences in the way liability costs are distributed within and among states. Even using this approach, New York's tort tax is comparatively high.

New York's tort tax in 1996 was equivalent to 2.35 percent of its estimated gross state product of just over $600 billion, compared to a national average of 2.22 percent. Only seven states had higher liability costs than New York, relative to their economies.

Matching the national average tort tax, as a share of gross state product, would save roughly $800 million a year, or roughly 6 percent, in liability premiums and self-insurance payments in New York. Matching California's tort tax level, which was 1.98 percent of gross state product as of 1996, would cut premiums and self-insurance payments in New York by 8 percent, or nearly $1.3 billion a year.

New York's high tort costs also make it less attractive to firms with heavy foreign competition. According to the Tillinghast study, tort tax rates as of 1994 were 0.5 percent in Japan; 0.8 percent in Canada, France and the United Kingdom; and 1.3 percent in Germany.

Where the money goes

Taxes are supposed to yield benefits for society in proportion to their costs. Does the “tort tax” do so?

Defenders of the current liability system say its benefits take the form of increased safety for consumers as well as financial pay-outs for those who have been injured. However, as discussed in Section 1, the safety claims are vastly overstated--and, as documented by several studies, so are the benefits to injured persons.

“When viewed as a method of compensating claimants, the U.S. tort system is highly inefficient, returning less than 50 cents on the dollar to the people it is designed to help--and less than 25 cents on the dollar to compensate for actual economic losses,” The Tillinghast study noted.(21)

Even when non-economic “pain and suffering” awards are included, Tillinghast has estimated that claimants ultimately collect only 46 percent of the money raised by the tort tax. The remaining cash feeds the system's huge transactional costs--24 percent for overhead and administration, 14 percent for defense costs, and 16 percent for claimants' attorney fees.(22)

Applied to our state tort tax estimate, these figures yield the following breakdown of liability expenditures in New York as of 1996:

In sum, more than half the money extracted from our consumers, our taxpayers and our economy by New York's phenomenally expensive liability system doesn't go to its supposed beneficiaries. The real irony, of course, is that this is exactly what keeps the tort system going--there is so much money to be made by people who live off the process.

Economic impacts

The “tort tax” numbers offer a good approximation of what the liability system takes out of people's pockets, directly and indirectly. But they only partially express the impact on the state's economy of laws that depress employment and wage growth.

A study published in 1995 by the respected National Bureau of Economic Research compared the impact on state economies of “liability-reducing” tort reforms, such as caps on damage awards and reform of joint and several liability, with the impact of “liability-increasing” tort reforms such as required payment of pre-judgment interest on damages and comparative negligence statutes, which allow plaintiffs to collect even when they are partly at fault.

The study's conclusion: “liability-reducing reforms are associated with higher levels of output per worker and employment, in a broad range of industries.” Reforms defined as “liability increasing” had the opposite effect in most industries. In other words, New York is likely to gain more jobs if we adopt the kinds of reforms opposed by the trial lawyers--and we're likely to lose jobs if we enact laws opening the doors to still more lawsuits, as the plaintiffs' bar wants.

19. The use of the word “tax” in this context is bitterly resisted by the trial bar. It is clear, however, that the more juries are pressed to assess damages against a defendant on the basis of the defendant's ability to pay rather than the defendant's actual culpability, the more the tort cost comes to resemble a tax. Like a tax, it uses the force of law to extract money from the general economy (in this case through higher costs for government, higher prices for business, higher insurance premiums), and then to distribute that money to achieve a perceived social good, i.e. compensation to the injured.

20. Huber, Liability: The Legal Revolution and Its Consequences, p. 4.

21. Tillinghast­Towers Perrin, “Tort Cost Trends: An International Perspective,” 1995, p. 3.

22. Ibid., p. 8.

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