The San Diego Union-Tribune

The following commentary by Jamie Court was published in The San Diego Union-Tribune on June 1, 2004:
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Gov. Arnold Schwarzenegger recently grabbed headlines with a flashy proposal to give 75 percent of punitive damage awards to the state to help balance the budget. As with much of Schwarzenegger’s previous work, however, the preview is all that is worth seeing. As a budget balancer, the proposal is a red herring.

In principle, there is nothing wrong with a small portion of punitive damage awards reverting to the state. In fact, that’s something consumer advocates have called for in the past. The big problems with Schwarzenegger’s proposal are his timing and his sense of proportion.

First, there simply are not supersized punitive damages any more after a recent U.S. Supreme Court ruling, State Farm v. Campbell. In April 2003, the court strictly capped every punitive damage verdict in the nation so that juries are no longer free to punish corporations’ for malice and oppression, the standard for punitive damages. Punitive damages can now, as a rule of thumb, be no more than nine times the amount of other compensatory losses. That means if a consumer recovers $1 million in damages for actual losses, punitive damages should not be more than $9 million.

Taking 75 percent of that now-limited amount from injured consumers would be punitive. Even more punitive is, as Schwarzenegger also proposes, stopping makers of exploding gas tanks and other dangerous products from having to pay punitive damages in every case. Schwarzenegger wants to have wrongdoers pay for their malice only in the first product liability case, which would greatly help many of Schwarzenegger’s corporate donors — like Pfizer, which made the dangerous diabetes drug Rezulin. That would actually reduce payouts to the state treasury under his proposal. Given the restrictions of the Campbell ruling, it also would severely reduce deterrence for wrongdoers.

To understand the impact of the State Farm v. Campbell ruling, consider that in the year prior to the ruling $28.5 billion in punitive damage awards were recorded by California courts in cases with total compensation of $29.1 billion. In the year following the ruling, judges and juries awarded only $1.03 billion in cases worth $1.24 billion.

To be sure, $1 billion in punitive damage awards is nothing to sneeze at — that is if those awards conform to the Campbell ruling on appeal, which they may not. The reality, though, is that the vast majority of punitive damage awards by judges and juries in California are never paid. The reason is defendants’ insurance policies in California do not cover punitive damage payouts. As a result, a settlement is usually reached after the verdict, and the payout is not categorized as punitive damages so the defendants’ insurance kicks in.

Plaintiffs have a dual incentive to settle in such cases. First, they will not have to face costly appeals. Second, punitive damages are taxable to the recipient, whereas a lump-sum settlement does not clearly carry tax liability.

The irony of current tax policy is that while the innocent victims who receive punitive damages must pay taxes on them, the payors — those who commit malice and oppression — can write off the payments as a tax deduction. If the governor wants to truly generate money for the state by fixing a legal inequity, he should change tax treatment of all legal damages and settlements.

Let’s start with the notion that any corporation or individual that is held accountable by a court for fraud, intentional wrongdoing, bad faith, extreme and outrageous conduct or civil rights violations should pay taxes on any payout or settlement resulting from the case. Terminating tax breaks for convicted wrongdoers in California could be a real boon for the state treasury, if the governor is willing to take on the special interest groups that will want to keep their write offs.

Congressional debate over tax treatment of punitive damages never resulted in reform, but it did produce a dramatic snapshot of the problem. Exxon‘s $1.1 billion settlement with the U.S. government over the Exxon Valdez oil spill litigation cost Exxon a maximum of $524 million after the oil company’s tax deductions. The Congressional Research Office found that more than half of the civil damages totaling $900 million could be written off on Exxon‘s federal tax return.

In California, where punitive damages are far less frequently paid, the trick for the governor will be to throw a bigger tax net around payments by big companies for wrongful conduct that should not win them a tax deduction.

If Schwarzenegger is the man of the people he says he is, he will balance his budget on the backs of wrongdoers, not innocent victims of malice.
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 Court, a consumer activist, is author of “Corporateering: How Corporate Power Steals Your Personal Freedom and What You Can Do About It.”