The Impact of Juror Knowledge of Deductibility and Defendants’ Tax Rates on Punitive Damages Awards: Experimental Evidence

Abstract

The US Tax Code allows defendants to treat punitive damages as an ordinary and necessary business expense, thereby reducing their taxable income. Legal scholars posit that jurors are unaware that punitive damages are tax-deductible. Consequently, they claim that there is an under-punishment problem because defendants are penalized at lower damages amounts than they would be if jurors were instructed about tax-deductibility. We conduct an experiment to test this claim. We provide mock jurors with information about tax-deductibility as well as information about the defendant’s (historical) effective tax rate (ETR) to provide some context to jurors to adjust their awards, if they choose to. We find that jurors who are explicitly instructed that punitive damages are tax-deductible award higher damages, but only when the defendant’s ETR is low. When the defendant’s ETR is high, instructing jurors about tax-deductibility does not result in significantly higher punitive damages awards. This result is surprising because defendants with a high ETR are likely to benefit more from tax-deductibility compared to defendants with a low ETR. Our results suggests that jurors evaluate tax-deductibility jointly with other elements of a defendant’s tax situation when that information is provided. Therefore, jury instructions about tax-deductibility of punitive damages should carefully consider the implications of providing additional information about the defendant’s tax situation. Our result should be of interest to regulators and scholars in law, accounting, and public policy.