Is the Tort System Costing the United States $865 Billion a Year?--Posner

A study published last month, and favorably summarized in an op-ed in the Wall Street Journal, estimates that the American tort law system costs the nation $865 billion a year. The study, entitled Jackpot Justice: The Cost of America's Tort System, was written by Lawrence J. McQuillan and other members of the staff of the Pacific Research Institute, which published the study. (The study can be downloaded at www.pacificresearch.org.) How did the authors arrive at that figure, and is it meaningful? They begin by estimating that the nominal (that is, dollar expenditures as distinct from social costs) annual cost of the tort system, consisting mainly of attorneys' fees and other costs of administering the system plus the amount of money paid to tort claimants in judgments and settlements, is $279 billion, of which $128 billion is the amount paid out to claimants. The estimate comes from a report (U.S. Tort Costs: 2003 Update) by Tillinghast-Towers Perrin, a consulting firm for the insurance industry, with the report's estimate updated to 2006. It is impossible to determine from Tillinghast-Towers Perrin’s report what the sources for most of its data are, and so the figures I have quoted must be taken with a grain of salt; indeed, so far as I can tell, they may be completely unreliable. They are almost certainly exaggerated, given the financial connection between the firm and the insurance industry. The authors of Jackpot Justice know the difference between a cost, which in economic terms is a reduction in the amount of valuable resources, and a transfer of wealth from one person to another that doesn't reduce the total amount of resources but merely redistributes them. The $128 billion figure is a transfer, not a cost. But as the authors point out, the opportunity to obtain a wealth transfer can generate a cost--a cost incurred to obtain the transfer (incurring costs to obtain a wealth transfer, when socially unproductive, economists call "rent-seeking"). They assume, without analysis or evidence, that the entire $128 billion is translated into a cost. They further assume that 28 percent of the $128 billion transfer represents a deadweight cost, that is, a loss of value. They base this assumption on a study which found that increasing the corporate tax rate by $1 generates 28 cents in deadweight costs. The basis of that finding was that a tax, like a monopoly markup, causes the taxpayer, like a consumer, to substitute for the taxed item or activity something that may cost society more to provide but looks cheaper because it's untaxed, or taxed at a lower rate. The authors of Jackpot Justice do not explain why a tort transfer would have the same effect. Of course the threat of tort liability might well alter the behavior of potential injurers--indeed, it is intended to do so--but it might alter that behavior in the direction of greater efficiency, by making potential injurers internalize accident costs. That is the objective of tort law, though imperfectly achieved. Without tort liability, firms would have weak incentives to invest in safety measures to benefit potential victims of the firms’ activities, unless the victims were either their employees or their customers. With the addition of 28 percent of $128 billion ($36 billion) to $128 billion in assumed rent-seeking expenditures, the authors jack up their estimate of the annual social cost of the tort system to $164 billion. To this they add another $36 billion, on the assumption (it seems---this part of the report is none too clear) that efforts to avoid the deadweight cost will cost that amount. This appears to be double counting, based on the assumption that $36 billion is spent every year in a futile effort to avoid a $36 billion cost. It is possible, however, that some--maybe considerable--costs are being incurred to prevent that deadweight loss from rising from $36 billion to some higher level—for example, legal-counseling costs (not included in the attorneys' fees incurred in actual litigation) or costs in curtailed new-product development (see below). But there is no basis for supposing that the sum of such costs would equal $36 billion; nor do the authors make any effort to defend the figure or estimate the actual costs. They add to their new total of $200 billion the $128 billion transfer, for a grand total of $328 billion. The addition is improper, since the transfer is not a cost. They are adding apples and oranges. They borrow from another study an estimate that tort liability generates some 2,000 accidental deaths a year by discouraging the introduction of risk-reducing products and services. But they fail to offset against that figure (and its monetization) the number of accidental deaths that are prevented by the deterrent effect of tort liability. In the absence of liability, potential injurers would spend less on safety, at least with regard to potential victims with whom the injurers lack actual or potential contractual relations. The authors of Jackpot Justice cite a respectable economic study by Daniel Kessler and Mark McClellan which finds that malpractice liability increases hospital costs by 5 to 9 percent; and they treat the entire amount as social waste. But as I said earlier, the aim of liability is to induce potential injurers to spend more on safety, and so the fact that they do spend more cannot be adjudged a failure to improve social welfare. Medical-malpractice law is in its administration rife with inefficiency, but it would be surprising if eliminating it entirely would be all social benefit and no social cost (nor in fact do the authors argue for eliminating it, as we’ll see). The authors argue that products-liability law is responsible for the loss of $359 billion in new products. They base this on a study by the economists Kip Viscusi and Michael Moore which found that when the ratio of liability costs to sales revenues exceeds 5 percent, firms reduce their investment in R & D. The authors of Jackpot Justice identify product markets such as power tools, fireworks, and cigarette lighters where they believe (relying however on the questionable data in the Tillinghast-Tower Perrin reports) that this ratio is exceeded. Then, using Viscusi and Moore's estimate that 6 percent of the products of the industries that the two economists studied are new products, Jackpot Justice multiplies the output of these markets by 6 percent; with certain other adjustments, this calculation produces the estimate of $359 billion in lost sales. This is not, however, as the authors believe, a social cost. The social cost is the consumer surplus that the sales of the new products would have produced. Suppose that a product costs $10 and is sold in a competitive market for $10, but that consumers would pay $12 for it if it were priced at $12. Then if the product is not produced, there is a loss of consumer surplus of $2. That, not the $10 in lost sales revenue, is the social cost of not producing the product. The sum of $328 billion and $359 billion is $687 billion, which is almost $200 billion short of the authors' grand total of $865 billion. The excess malpractice costs and accidental-death costs they estimate at less than $50 billion, so there is still a big gap. I can't figure out how they fill it. So far in the report, there is nothing about the benefits of the tort system. To estimate those benefits, the authors compare the percentage of U.S. GDP that is accounted for by our tort system with the percentage of GDP accounted for by the tort systems of other developed countries. They base all these percentages on the dubious Tillinghast-Towers Perrin report. The U.S. percentage is estimated at 2.2 percent, twice Germany's and roughly three times Japan's and the United Kingdom's. The average for the foreign countries in the comparison is 0.9 percent, so the authors of Jackpot Justice conclude that the benefits of the U.S. tort system are equal to only 0.9 percent of our GDP. The possibility that our more costly system might generate greater benefits (though not necessarily equal to the greater costs) is ignored. But a more serious weakness is the implicit assumption that a tort system generates benefits exactly equal to its costs. It might generate much greater benefits. Politics, which the authors assume lead to greater than optimal liability, might instead lead, in the countries they compare to the United States, to less than optimal liability. And even if investment in the U.S. tort system has been carried to the point at which the last dollar spent on the system generates exactly one dollar (no more) in benefits, the total costs may be far below the total benefits because average cost may be much lower than marginal cost. This is apart from the possibility that politics may have prevented our investing enough in the tort system to equate benefits and costs at the margin. The authors' estimate of the benefits (= costs) of the average foreign tort system, when subtracted from the $865 billion "cost" of our system, results (with some further adjustments) in an estimate of an annual excess of costs over benefits of almost $600 billion. The figure, however--the authors' estimate of the net social loss created by our tort system--is, as I have tried to show, fictitious.

Comments

[GeorgeNYC]

Germany has socialized medicine. I know that the academic ivory towers love statistics but I think you could ask most plaintiff lawyers what "typical" lawsuit is worth and it will be calculated in some respects as a multiple (usually three or four times) of the "special" damages i.e. lost wages and medical expenses. There are liens put on the medical expenses by health care providers which are paid out of the proceeds (or by the workers' compensation carriers). Again, these "costs" are ignoring the fact that our system does more than merely ascribe fault and pay for "pain" and mental suffering.

[Peter Pearson]

Posner's criticisms seem apt, and echo reservations I had while reading the WSJ piece -- reservations that I suppressed because the work was done by experts and its conclusions matched my preconceptions.

The clearest current evidence that our torts system has gone haywire is the fact that a couple times a year I'm notified that I'm a plaintiff in a class-action lawsuit ostensibly brought by stockholders suing their own company. The logic of the suit emerges when I read that if the plaintiffs win I will receive a coupon good for $3 off on my next purchase of a Boeing 747, while "my" lawyer will receive millions of dollars plus expenses. My options in pursuing this suit are presented in less-than-lucid terms, and it usually seems that if I don't want to compose a letter and address an envelope, the plaintiff's lawyer (that is, "my" lawyer, the one helping me sue my company) gets to pretend he's representing me, without any definite obligation to share the loot.
The most delicious irony emerges if you consider that the reason for the existence of such lawsuits is to rectify the injustice of an evil person taking large amounts of money divided among so many victims that the individual amounts are too small to act on.

[Nelson]

I agree that the dollar amount isn't the problem most people have with torts. I see 2 major problems with our system. The first is that Class Action torts have clear benefits to lawyers, but often no worthwhile benefit to those they represent. The second is that some people abuse the legal system to harass others or put them out of business due to legal costs. This is illegal in theory, but by the time the case is determined (if ever) to be illegitimate the damage has already been done.

[Scott Miller]

The authors of Jackpot Justice cite a respectable economic study . . which finds that malpractice liability increases hospital costs by 5 to 9 percent[.]

Given the significant cost of health care, 5-9% represents some real money.

Medicine's successes bear part of the blame for the evolution of medical liability costs; conditions that would have been difficult or untreatable in the past are often easily addressed today. But, as the patient's contribution to a bad outcome decreases, the public's perception increasingly seems to be that the medical system must have been at fault: "Thanks for reducing my risks; pay me for not making it perfect." The idea that no one may be at fault doesn't seem to fit into the equation, and in many cases a bad outcome is all that is required to initiate an action.

In an effort to defend against events that will be judged with the perfect wisdom of retrospective knowledge, hospitals and physicians order tests (or perform procedures) that usually accrue minimal incremental benefit. Beyond the additional wasted expense, "defensive medicine" exposes patients to unnecessary risks, and some of those patients will inevitably be harmed in the process. It's easier for physicians to say "It was a described risk" than to answer the question "Why didn't you think of this (one-in-a-large-number) possibility?".

The liability costs of obstetric care have decreased the the availablity of obstetric care in many areas of the country, so at least in this instance, medical liability claims seem to be producing an effect opposite of "improving the system." Social costs are probably deserving of a separate commentary, but they shouldn't be forgotten.

Medical costs reflect the incentives in effect for the "medical industry"--and patients. The current medical system is a reflection of what the public says--indirectly--that it wants. The public should quit complaining about the cost of what it has ordered, or decide to change the incentives. The medical malpractice liability system is part of the current incentives.

[n.e.hat]

Ahh... the "Joys of Tort Reform". If you can't beat down the system in the State's Supreme Courts, create a massive PR campaign so that the Fed. picks it up, revises it, and makes it applicable to the states via the Constitution. Judge Posner is right in calling attention to source considerations in anything having to do with tort reform. Especially these days. When it comes to data, numbers, statistical methods that end up with estimated values for supporting a position, pro or con, it's always best to apply the old maxim, "Figgers don't lie, but liars sure can figger".

Perhaps, if we want to close down the advances made in the last hundred years or so by opening up the courts to indviduals (and so making the Law available to the "people") who have suffered a harm through negligence, we ought to reconstitute the old common law principles of barraty, champerty, and maintenance. And once again we'll be back where only the rich can afford their Rights. Things will then be more peaceful and the society much less litigious.

[Eric Truett]

the point of most large class actions is deterrence, not reparative justice, so it is an incomplete critique to say that the "victims" don't get fully compensated. from the standpoint of deterrence, it doesn't matter whether the money goes to victims, lawyers, or the incinerator.

[David]

Glad to see Judge Posner recognize that the tort system has benefits as well as costs. We take for granted in daily life that we won't fall into a hole in the street or sidewalk and suffer serious injury. The same goes for knowing that a product won't blow up in your face, because the manufacturer would be put out of business if it did.

In countries with less developed tort and regulatory systems, one cannot take such things for granted.

As an aside, I increasingly think that big, moneyed interests are systematically using the conservative and libertarian movement to create ideological justifications for their own greed. And I say this as someone who, in college and law school, had libertarian sympathies. Hard-working, middle class Americans are often attracted to "libertarian" values: YOU own your work and your property; the only preferences should be based on "merit"; taxes are taking MY money and giving it to people who are less hard working; people who spill hot coffee on themselves don't deserve $8 million verdicts; and so forth.

But the truth is that only one class benefits when conservative economic thought is taken to its extreme: those who already have money. Yes, the free market largely works. But if one believes that tweaking it through regulation is immoral, then those who have money possess a distinct advantage. Remember, the hard-working intellectual conservatives who fight for deregulation often got their education in public schools and universities. A libertarian universe would make that impossible for the next generation.

Similarly, dismantling the tort system would mean that hard-working people receive no compensation (or inadequate compensation) when they are injured through negligence. There is no deterrent system to protect them; only money can do that, which they don't have enough of.

Dismantling the tax system would leave the capital in the hands of those who have it already. As history has shown, "trickle down" doesn't work from a societal perspective. It creates a lot of "haves," but also a lot of "have nots."

I dare say that 90% of the American people would find pre-New Deal America unrecognizable. And patently unfair and immoral.

This is not to say that conservatives don't make many good points. Government can be overbearing; too much regulation is bad; taxes that are too high stifle growth; etc. The key is to be smart. Experience shows that certain types of regulation are well worth it, from a societal perspective. It is the entrenched interests, not the hard-working citizenry, who have the incentive to make deregulation a "moral" concern instead of a pragmatic one.

[N.E.Hatfield]

Since we seem to be dealing with a numerical analysis of Tort, perhaps introducing Coase's Theorem and Hand's Rule in the calculus of negligence. I never really liked this approach, to me, it always seemed somehow to run afoul of Lord Atkin's principle of "duty of resonable care" articulated in Donohue vs. Stevenson.

[Supremacy Claus]

Judge Posner is a lawyer, and has zero credibility. I will not dignify this member of the hierarchy of a criminal cult enterprise with a detailed rebuttal. I consider him hopelessly lost.

If torts are so great for everyone else, why does the lawyer of Posner's self-dealing ilk absolutely refuse to let the jury regulate the land pirate in legal malpractice claims brought by the adverse third party?

[n.e.hat]

Claus-e, Quite simply, because it's a point of law and not a point of fact. The jury as trier of fact gets to decide factoids, the judge as trier of law, lawtoids. Also, I won't mention the responsibility of controlling "jury nullification". That's the "process", always has been and always will be. ;)

[Paul Eberhardt]

Dear Judge Posner:

This was a great analysis. It is especially credible because those of us who are even passingly familiar with your work know that you have strong libertarian leanings, when the facts of the situation justify them.

This study apparently was prepared as an advocacy document by a group that felt fairly confident that they could sell their political point despite exaggerations which were apparent on the face of the document. Unfortunately, tort reform, like bankruptcy reform, has the possibility of a large windfall to a small group of firms. These sorts of "studies" are merely a part of the political rent seeking which one would expect in this situation. It is one of the highest callings of a public intellectual to refute such things.

As a first level approximation, it would seem that most industries tend to resist regulation (whether by common law, statute or administrative rule). If regulation made their transactions with the rest of the economy more efficient, one would expect it to be welcome, unless it involved a one-time wealth transfer away from the firms presently in the industry. There is quite a bit of legal reform which seems to fall into this category, like the adoption and revisions to the Uniform Commercial Code.

Much of the federal debate, however, seems to be driven by the one-time wealth transfers. For example if there were drastic federal tort reform, one result would be a one-time benefit to insurers who collected premiums based on the pre-reform legal rules - even though the long run result might be to reduce the demand for insurance. Similarly, consumers who bought goods pre-reform would have paid for the coverage of pre-reform tort remedies, which would be denied to them. I suppose this focus is because the wealth transfer effects of various schemes are usually easier to determine than their efficiency effects.

In a way, the politics of this reminds me of the lifecycles of trademarks. Typically, a trademark is built by selling a low volume of high quality goods, and then "cashed in" by attaching it to progressively lower quality goods, and getting a premium for them. This works because changes in expectations lag behind changes in reality.

In politics, the trademark "conservative" built over much of the 20th century because conservative positions frequently turned out to better in terms of long-run economic performance, even if the liberal positions had more popular wealth transfer effects at the time. Now we see "conservative" tort reform, bankruptcy reform and copyright extension which have wealth transfer effects in the "conservative" direction but which also seem to have negative long run efficiency effects.

Its always sad to see one's favorite brand being debased.

[Supremacy Claus]

Until Judge Posner declares his support for ending all lawyer and judge immunities from accountability for the damage done to the adverse third party by their carelessness, he is a hypocrite. He is devoid of credibility and unsuitable for rebuttal, just another of many self-dealing members of the hierarchy of a criminal cult enterprise that has control of the three branches of government. Just one example. Transfer $billions from the productive to sleazeball drug addict plaintiffs, and that is not a cost, that is a zero sum transfer? He insults the intelligence. He is not used to having anyone point out the self-evident in court or class.

Torts are great for everyone else. The lawyer and judge exempt themselves from their great benefits. Posner does not even mention lawyer rent seeking in his economics book, the greatest explanation and predictor of goofy appellate decisions, including his. He is that biased or oblivious.

[Jack]

Yes.. it seems the cleansing aspects of suing corporations is much harder to monetize than the hard costs of law suits.

Back in '84 I bought one of the early Dodge mini-vans and had the misfortune of being rear-ended shortly after. Fortunately I had the "luxury" model with high backed seats and though we were hit pretty hard; I flattened out the power seat, other than a bit of lameness myself and my passenger did OK.

While getting it repaired I noticed a young couple going off in their new wagon which did NOT have the high backed seats. (You'll note that these snubby-nosed station wagons were now "utility vehicles" and thus exempt from a host of safety items that were long std on PASSENGER cars.) I was moved enough to write to Chrysler and got back a nice computer driven bit of hrsht thanking me for my "input".

Well, smiling Lee I. kept thumping the hoods of these cars for the next four years or so. Then? you've probably guessed, an traveling sales guy had traded his Dodge wagon in on one of the new snubby rigs (the regular wagons he purchased for years, no longer available. He was rear-ended with the low backed seat rig and ended up in a wheel chair for the remainder of his life. The lawsuit was something like $20 million.

Now WTF could Chrysler have been thinking??? Let's see; this "getting away with" low back seat gig would have had to have been suggested by someone. Have been engineered by someone. Looked over by marketing wizards? And then passed by C's staff of legal advisers and all must have signed off on it. Then? out of the millions of those rigs, was I the only one to write and suggest this was not only unethical but moronic in any business sense?

Perhaps our large corporations ought to have consumer reps that are similar to Congressional reps (w/o the bribery) whose job it is to mine the wealth of info and input from their consumers? Currently ALL we have is a bludgeon that can be used only AFTER the harm has taken place.

Hey!! perhaps regular folks would have advised them to develop a line of vehicles suitable for $50 oil as they NEVER "get it" and you can now buy your choice of the "Big Three" at break up value while Toyota eats their lunch at noon every day in virtually every time zone. Great eh? Jack

[n.e.hat]

Claus-e, Sounds like your practicing the old defense line of pleadig, "If you got the facts, argue the facts, if you got the law argue the law. If you don't have either, yell and scream a lot and abuse the plaintiff, or in your case the system and its judges." Lose your case did you and are now trying to move it up on appeal?

I believe it was Lord Mansfield who on Judicial decisions said, "You must always render a decision, for decide you must. But, never give any reasons. For your decisions will always be right, your reasons never." ;)

[Andrew]

Supremacy Claus, if you hate lawyers so much, you should move to a place like Iraq or Sub-Sahara Africa. There you will not be bothered by the "criminal cult enterprise" of lawyers. There you won't find winey plaintiffs filing lawsuits, crying about their "rights." There, free of the scourge of lawyers, you can settle your disputes like a real man and do not have to worry about a bunch of lawyers throwing paper around.

I also want to make a quick point about the comparison of our tort system to countries like Japan and Germany. Countries that provide more "socialized care" for their citizens have less of a need for an active tort system. For example, if you had to go on disability as a result of an injury and take a ten percent pay cut, but could not file a lawsuit, you would not be taking a terrible loss. However, here in America if you had to go on state sponsored disability you would probably be losing much more than ten percent of your income, and therefore would be in dire need of judicial redress.

[Supremacy Claus]

Andrew: Some misunderstanding here. I love the lawyer, and I love the judge. I love torts.

I love the lawyer and judge so much, I want them to enjoy the great benefit of torts to improve their services and to achieve all the goals of torts. End all obstacles to claims by adverse third parties. The lawyer and judge should stop selflessly depriving themselves from regulation by jury, while everyone else enjoys the great benefits of being sued.

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