Alex Tabarrok analyzes the Governator's proposal to raise money by taxing punitive damages levied in lawsuits.

California Governor Arnold Schwarzenegger is proposing to tax punitive awards at a 75% rate. The idea has some merit, punitive awards are intended to punish the defendant but to serve that purpose it is not necessary that they should flow to the plaintiff. Moreover, punitive awards often have more to do with the defendant's deep pockets or other arbitrary factors like whether the plaintiff is headquartered in or out-of-state than with proof of malice. Giving punitive awards to the plaintiff, therefore, may over incentivize plaintiff's and their lawyers (under the plan contingency fees would be calculated on the compensatory portion of the award only).

Sounds reasonable, right?

Well, there are a whole bunch of ways that the Law of Unintended Consequences could rear its ugly head.

Tabarrok proposes that, "as with any tax we can expect fewer punitive damages after the tax than before," decreasing its revenue potential.

Equally likely is the opposite effect — that jurors will take such a tax into account and increase their awards to plaintiffs accordingly. This results, peversely enough, in even more of a lawsuit burden.

Another possibility is raised by Glen Whitman: "The state might have an incentive to encourage larger punitive damage awards or more tortious behavior."

That might sound as about as likely as police officers encouraging speeding so that they can make more arrests. (Then again, there are many long-abandoned fire hydrants in New York City whose sole use is for ticket-writing opportunities.)

But consider this: if some proposal to actually reduce the number of lawsuits came along, don't you think the California government would feel pressure not to lose that stream of revenue? Kind of like how states are ecstatic about taxing cigarettes, but none (OK, maybe Utah) would ever consider banning them.

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