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Tuesday, March 27, 2007

The Cost of the Tort System

This estimates that "America's tort system imposes ... an annual "tort tax" of $9,827 on a family of four." That's approximately $2,457 per person:

The Tort Tax, by Lawrence J. Mcquillan and Hovannes Abramyan, Commentary, WSJ: Economists have long understood that America's tort system acts as a serious drag on our nation's economy. Although many excellent studies have been conducted, no single work has fully captured the true total costs, both static and dynamic, of excessive litigation.

The good news: We now have some reliable figures. The bad news: The costs are far higher than anyone imagined. Based on our estimates, and applying the best available scholarly research, we believe America's tort system imposes a total cost on the U.S. economy of $865 billion per year. This constitutes an annual "tort tax" of $9,827 on a family of four. ...

How does the legal system extract such an astounding amount from our economy? We applied the rent-seeking theory of transfers from economic science to pick up where past studies -- including the highly regarded Tillinghast-Towers Perrin study -- leave off. We began by examining the static costs of litigation -- including annual damage awards, plaintiff attorneys' fees, defense costs, administrative costs and deadweight costs from torts such as product liability cases, medical malpractice litigation and class action lawsuits. The annual static costs, $328 billion per year, are well in excess of previous Tillinghast estimates.

But $328 billion is only the beginning. After all, litigation doesn't just transfer wealth, it also changes behavior, and often in economically unproductive ways. Any true estimate of the costs of America's tort system must also include these dynamic costs of litigation -- the impact on research and development spending, the costs of defensive medicine and the related rise in health-care spending and reduced access to health care, and the loss of output from deaths due to excess liability.

Consider the impact of medical liability concerns on the health-care sector. It is a well documented fact that the fear of litigation prompts doctors to engage in expensive defensive medicine..., which must be added to any comprehensive estimate of litigation costs.

At the margin, higher health-care costs also reduce access to care for patients. We estimate that the additional $124 billion in liability-based health care costs adds 3.4 million Americans to the rolls of the uninsured. Uninsured people are more likely to suffer from a number of diseases and serious or even fatal conditions. Economically, the result is that more Americans are absent from the workforce and their productivity declines -- a total loss of output we estimate to be $39 billion per year.

Excessive liability also hampers innovation. ... As liability costs increase, companies respond by shifting funds from research and development into fighting litigation and withholding or withdrawing products from the market. Less R&D spending means fewer new products and less innovation. ...

An overly expensive liability system also increases the cost of many risk-reducing products and services, at the expense of human lives. ... Our analysis ... estimate[s] the human cost of a failure to enact reforms.

Based on data from previous studies, we determined that more than 77,000 people would have been alive today and contributing to the workforce, but are not because of a failure to enact comprehensive tort reforms in the states...

What we're left with, then, are annual dynamic costs of $537 billion resulting from our litigation system. Add that to the static costs of $328 billion and you arrive at the total of over $865 billion per year.

In this study we do not venture to propose a specific litigation-reform agenda. But we do provide all who are concerned with this issue some hard numbers to work with. And if you're wondering who the victims are of a tort system out of control, the answer today: almost everyone.

The tort law system and associated economics is not an area I know a lot about, but the opening sentence, "Economists have long understood that America's tort system acts as a serious drag on our nation's economy" brings up a question. What would the economy be like without a tort system at all? The tort system offers important protections and also offers the institutional structure needed to help capitalism function more efficiently (e.g. economic torts and competition law). I'm sure there are problems that could be fixed, i.e. eliminating the "excessive" part of litigation - as I said this is not a familiar area for me - but I find it hard to believe that the tort system itself imposes a serious drag on the economy or that most litigation can be classified as "excessive." If there was no system at all, I think we would be much worse off.

The authors say they are estimating "the true total costs of "excessive litigation." But it looks to me like they estimate the cost of all litigation, not just the excessive part, however excessive might be determined. That is, they assume that all costs are excessive in their estimates. Here's how the Council of Economic Advisors handled this in a 2002 paper (the CEA uses a much better methodology for estimating the costs as compared to the methodology outlined above and arrives at lower figures):

[R]ecognizing the controversy that exists about the incentive effects of tort liability in general, and punitive damages in particular, this paper will consider several scenarios. For our most cautious estimates of the size of the “litigation tax,” we make the very strong assumption that both economic (e.g., loss of wages, medical expenses) and non- economic (e.g., pain and suffering, loss of consortium, punitive) damages are currently set at an optimal level. We then consider an intermediate case that treats non- economic damages as essentially random and therefore part of the litigation tax. Finally, we consider the case in which all of the costs of the U.S. tort system are treated as economically excessive, which would result if both economic and non-economic damages were largely random and failed to provide proper incentives

That brings up a second point. The article concludes by reminding us of the $865 billion dollar cost estimate. In a part I cut, there's an attempt to magnify this number by noting that "It is equivalent to the total annual output of all six New England states, or the yearly sales of the entire U.S. restaurant industry."

But as noted above, that's only around $2,457 per person. And there is no estimate whatsoever of the benefits from the legal protections offered by the tort system. Certainly there are some benefits, and I can easily imagine that if there were no legal protection at all that we would each incur costs higher than (likely too large estimate of) $2,457 as people took advantage of the lack of legal protection.

For these reasons, I don't think this tells us a whole lot about the net social value of the tort system. We don't know the cost of this system relative to an optimal system, e.g. if the optimal system costs $2,350 per person then the cost of the present system isn't so large, and we don't know the benefits of the present system relative to the optimal system or or relative to having no system at all (which would be optimal for some). It is also not as thorough as the CEA paper in covering the range of possible estimates due to variations in the assumptions about tax incidence, calculation of deadweight losses, the degree of excessive litigation, and so on. I don't mean to imply the CEA document is the final word, for example the EPI sees things quite differently ("[M]ost commonly alleged economic costs and impacts and ... have little or no basis in reality"), but it does appear to be on much firmer methodologically footing. But even it makes no attempt to estimate the benefits.

    Posted by on Tuesday, March 27, 2007 at 12:15 AM in Economics | Permalink  TrackBack (0)  Comments (42)


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