I previously blogged the forthcoming article by Dan Markel (Florida State) & Gregg Polsky (Florida State; moving to North Carolina), Taxing Punitive Damages, 96 Va. L. Rev. ___ (2010). Mark Geistfeld (NYU) critiques the article on our sister TortsProf Blog

They make the nice point that if punitive damages are not deductible, then plaintiffs and defendants have an incentive to “disguise punitive damages as compensatory damages in pre-trial settlements.” Doing so decreases the (after tax) cost of settlement for defendants, creating a gain that can then be shared by the settling parties. By way of extended analysis, Polsky and Markel go on to conclude that the best way to solve the “under-punishment problem” created by deductibility is not to eliminate the tax break, as everyone had previously concluded, but instead to apprise juries of the deductibility issue so that they will “gross up” the punitive award to offset the tax break.

Largely missing from the analysis, however, is discussion of how liability insurance affects the incidence of tort liability. Once this dimension of the problem has been recognized, it becomes apparent that there is a much stronger case against the deductibility of punitive damages. …

They artfully unravel the surprising complexity of what appears to be a rather straightforward issue—whether bad behavior deserves a tax break.