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(This post is by Prof. Gregg Polsky and me.) 

Yesterday, the Senate passed an amendment that would make punitive damages paid by businesses nondeductible for tax purposes.  The nondeductible rule is intended to pay for a 90 day extension of the home buyer's tax credit.  On the face of it, this seems like a great idea--after all, why should defendants get tax breaks for malicious or reckless wrongdoing?

But as we've recently argued in our forthcoming paper, Taxing Punitive Damages,  a rule of nondeductibility is the wrong approach. It would be easily circumvented by defendants through settlements that disguise punitive damages as additional compensatory damages. Indeed, easy circumvention is fully consistent with the measly revenue projections from the rule:  a mere $315 million over 10 years.  It would be far, far more effective, in our opinion, to allow plaintiffs to introduce tax evidence against the defendant in the punitive damages phase and encourage juries to "gross up" damage awards to offset the effect of deductibility.  As we explain, a number of other factors (including concerns for federalism and regulatory diversity) also push in favor of our proposed solution over a rule of nondeductibility.      

To be sure, a nondeductibility rule looks good superficially (especially at a time when people are foaming at the mouth for Obama and the feds to do *something*). And no question, the need for immediate projected revenue (no matter how pitifully small) is great.  So while we think there's a decent chance the Senate's proposal will go through, despite its significant real-world flaws, we will be trying to explain along the way why the better strategy in this case is to do nothing and let the states work this out on their own. If it passes, we'll be joining the Office of the Repealer for these limited purposes!  

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