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A Stimulus You Can Believe In

Friday, May 29, 2009

Direct costs to the United States of tort litigation are $252 billion a year. Indirect costs are far higher. Reform would boost the economy at a critical time.

Gene Weingarten recently wrote a heartbreaking story in The Washington Post Magazine about small children who die of hyperthermia when their parents accidentally leave them behind in locked cars in their child seats. Weingarten interviews NASA scientists who developed a cheap invention that would warn parents of a child left behind. But no manufacturer is willing to develop this safety device, which could save dozens of lives a year. Why? Because in the event of a single failure, even one caused by user error, the resulting lawsuit would erase the profits from all of the other sales. Such is the perversion of modern product liability law, which does more to hinder than to promote product safety.

Our nation’s tort system is the most expensive in the world. Features unique to the United States raise costs astronomically. These include unbounded noneconomic damages; a broader use of punitive damages; contingent fees of a percentage of recovery; the lack of loser-pays system; extraordinarily broad discovery; class-action litigation; and the use of speculative and nonscientific expert testimony in some state courts. Yet, despite these increased costs, there is no evidence that the United States tort system provides benefits superior to those of other nations. For example, New Zealand does not even offer the availability of private medical malpractice litigation, yet no one thinks that medical care in New Zealand is of substandard quality because of that absence. If anything, it is quite likely that the arbitrary nature of the American legal system has distorting effects that make it perform worse than other nations’ systems.

Our nation’s tort system is the most expensive in the world. Yet there is no evidence that it provides benefits superior to those of other nations.

The direct costs to the United States of tort litigation are $252 billion a year, 1.8 percent of GNP, twice that of a typical industrialized nation. But the indirect costs caused by excessive litigation far outweigh the direct costs of paying attorneys and the occasional jackpot justice verdict. Businesses incur nonlegal expenses to comply with the tort system, from document management systems, to executive time lost in depositions and pretrial preparation, to activities foregone because of legal risk. Businesses and individuals change their behavior in inefficient ways because of the misaligned incentives of the tort system.

With the expansion of employment litigation, every hire of an employee (and every decision not to hire) is a potential lawsuit. Employers are rational economic actors and factor in these additional costs by reducing wages and substituting more capital for labor in their capital-labor mix. Fear of liability causes doctors to engage in defensive medicine, manufacturers to refrain from innovation, and pharmaceutical companies to cut back on R&D.

The total cost to the economy from excessive litigation is an estimated $900 billion a year.

Economists have studied all of these effects. As I discussed in recent testimony on Capitol Hill, if one takes conservative estimates from these economic studies and adds it all up, the total cost to the economy from excessive litigation can be estimated to be between $600 billion and $900 billion a year, the vast majority of which is simply wealth destruction. That is between 4 and 6 percent of GNP, a tort tax of between $8,000 and $12,000 a year for an average family of four.

In other words, without spending a dime of taxpayer money, comprehensive tort reform could do more for the economy every year than the entire stimulus package would. In fact, we could still come out ahead if the government spent half of the increased tax receipts on bailing out the trial lawyers who would lose income from real tort reform.

Fear of liability causes doctors to engage in defensive medicine, manufacturers to refrain from innovation, and pharmaceutical companies to cut back on R&D.

These numbers are large, but they are very likely an underestimate. They do not account for the recent favors done for the trial bar by the last two Congresses with legislation expanding litigation. They do not account for the effect of securities litigation raising the cost of capital and adding barriers to entry for start-up companies. Nor do they account for the tertiary effects of the litigation system on the misallocation of economic resources. Because of the demand for lawyers, even now, in the middle of a recession, a graduate of a top-ten law school can expect to make more than a U.S. senator, with a salary and bonus quickly topping $300,000 in a few years. As a result, we have a litigation brain drain: many of the best and brightest college graduates choose to become attorneys rather than join professions where people produce or invent things rather than work to promote or prevent wealth transfers.

Yet Congress is moving in the wrong direction: bill after bill includes what attorney Victor Schwartz calls “trial lawyer earmarks,” hidden provisions that expand litigation. President Obama’s first bill, the Lilly Ledbetter Act, dramatically and retroactively expanded the ability to sue over decades-old employment decisions. Congress is even considering barring consumers from pre-committing to arbitration of disputes, which will raise the cost of credit just as economists are warning of a liquidity trap. Nine hundred billion dollars a year is almost certainly an underestimate of the costs of the American litigation system. With our recent economic crisis, and the absence of evidence of benefits from America’s litigation binge, these new sops to trial lawyers are a decadent luxury the American people can no longer afford.

Ted Frank is a resident at the American Enterprise Institute’s Legal Center for the Public Interest. Before joining AEI, Frank was a litigator in private practice.

FURTHER READING: Find Frank’s recent congressional testimony here. Frank recounts the history of an influential law group, the National Legal Center for the Public Interest, in The American. In “Give Health Courts a Fair Shake,” Mark Crane discusses why special tribunals could be the answer to our medical malpractice mess.

Image by Darren Wamboldt/Bergman Group.

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