While politicians from the legislative and executive branches of the US government jousted over war costs and tax cuts this month, the judicial branch made what should come to be seen as an historic improvement in the American business climate.
On Apr. 7, the US Supreme Court set new limits on the punitive damages courts can award in civil cases. The decision is an important move toward bringing under control a tort liability system now weighing on the US economy like a large and growing tax.
The case
In a case involving State Farm Mutual Insurance Co., the court ruled unconstitutional $145 million in punitive damages awarded by a Utah jury and upheld by the Utah Supreme Court. Compensatory damages in the case, in which a State Farm policy-holder sued the company for refusing to settle claims in a fatal 1981 car accident that was his fault, totaled $1 million.
Under a test established in a 1996 case, the federal court ruled that the high ratio of punitive to compensatory damages violated the "due process" clause of the Constitution's 14th Amendment. Beyond that, it said courts generally should not allow juries to consider defendants' wealth when setting punitive damages. Three of the nine justices dissented.
As with any Supreme Court case, future applicability of the decision remains in question. It's a step in the right direction in any event.
Punitive damages have pushed the cost of losing a civil suit to absurd heights. The mere threat of a costly court decision makes litigation avoidance—beyond the responsible behavior civil law is supposed to enforce—a central factor of corporate planning and a large cost of conducting business.
"To the extent that tort claims are economically excessive," argued an April 2002 report by the Council of Economic Advisers (CEA), "they act like a tax on individuals and firms." The council estimated costs of "excessive tort" in 2000 at the equivalent of a 2% tax on consumption, 3% tax on wages, or 5% tax on capital income.
The US tort-liability burden is rising and already high by global standards. The consultancy Tillinghast-Towers Perrin estimates the US tort system in 2001 cost $205 billion. That's up 14.3% from the year before, the largest percentage increase since 1986, partly because of asbestos-case settlements. During 1991-2000, tort system costs increased at an average rate of 3.3%/year. The 2001 total represented 2.04% of gross domestic product. Tillinghast-Towers Perrin estimates the tort-cost relationship to GDP rose to 2.15% in 2002 and expects it to reach 2.21% in 2003. The high point for this measure came in 1987 at 2.34%.
In an earlier study, for 1998, the firm noted the extent to which tort costs in the US exceed those of other developed countries in proportion to economic size. That year, US tort costs represented 1.9% of GDP. Only Italy came close: 1.7%. Among countries with tort costs less than 1% of GDP were Denmark, the UK, France, Japan, Canada, and Switzerland.
These figures reflect trends in which punitive damages play just a part—and not an easily measurable one. Tillinghast-Towers Perrin estimates tort costs on the basis of traditional liability-insurance coverage. Punitive damages don't appear in insurance contracts in all states. The Tillinghast-Towers Perrin data thus don't capture all of them.
Economic depressant
Reporting peculiarities aside, enormous punitive-damage awards obviously contribute to an economic depressant that the CEA study likened to a tax. "As with any tax," its report said, "the economic burden of the tort tax is ultimately borne by individuals through higher prices, reduced wages, or decreased investment returns." An immeasurable part of that burden includes investments not made and products and services not brought to market because companies can't assume normal entrepreneurial risks along with the swelling risk of a major court loss.
A struggling US economy doesn't need such a load. And justice for plaintiffs, says a Supreme Court obviously alert to a costly system flaw, does not need punitive damages calibrated to defendants' wealth. The new limits on juries' generosity with other people's money will be good for the economy and energy markets. The oil and gas industry should hope Congress finds similar appeal in other versions of tort reform.
