Tax Break for the Trial Lawyers: A Bad Idea
John Park /
Do the nation’s trial lawyers deserve a taxpayer bailout? That’s what they’re after: a special-interest tax break of $1.6 billion.
In fact, after Congress refused to consider giving them that break, they are now trying to get it from the Treasury Department. In order to bestow that gift, though, the Treasury Department would have to reverse the view it took back in the Clinton Administration (which, incidentally, was not known for its hostility to the trial lawyers) and change its 1997 ruling without any intervening change in the underlying facts or the law.
The trial lawyers, who are permitted to loan money for the “up-front” costs of a lawsuit to their clients, want to be able to deduct those loans from their taxes when they make them, even though they fully recover those loans in the vast majority of cases. In fact, these transactions are not really loans; they are a form of deferred billing. The trial lawyers expect that the loans will, almost always, be repaid from the proceeds of a settlement or a court judgment. At that time, the lawyer will recover his or her fee (usually calculated as a percentage of the recovery) and any expenses.
Even if we call this advance of expenses a loan, the lawyers remain in the lawyering business. In economic terms, the loan is part of a related business that the lawyers are pursuing alongside their legal business. They may make money directly in making these loans just like banks do – through explicit interest earnings – or, more likely, by commingling any profit on the loan with their earnings in the lawsuit business. But these loans simply supplement and facilitate their earnings on their legal work.
The trial lawyers want the Treasury Department to say that their loans are different from other loans that look the same. To see how the trial lawyers’ loans should be treated, consider some comparable situations. When a car maker or dealer, a furniture company, or another provider of services or goods makes a loan to the buyer by selling over time, those loans are part of a related business, not a deductible business expense. In fact, those loans generally do not become deductible unless and until there is a default. Why shouldn’t the trial lawyers wait until there is a default to deduct their loans like everyone else?
If the trial lawyers prevail and the Treasury issues a new ruling allowing for the up-front deduction of theses loans, the trial lawyers will have to face up to the recognition of income when the loans are repaid. If a loan is deducted when it is made, income should be recognized when the loan is repaid. Neither the trial lawyers nor the other providers of goods and services that make loans to their buyers currently recognize income with repayment because they do not deduct the loan. If you deduct the loan, you must recognize the repayment, plus interest, as income; if you don’t deduct until default, only the interest is income.
Not surprisingly, the dealings between the trial lawyers and the Treasury Department have not been made public. If, however, the trial lawyers are not trying to trade an immediate deduction for later recognition of income, something is wrong with the deal. The trial lawyers will not just be trying to treat different things alike for tax purposes; they will be trying to treat similar transactions differently, acquiring for themselves a huge and indefensible subsidy in the bargain.
Moreover, allowing trial lawyers to deduct their client loans when they are made will increase their incentive to file lawsuits. Making loans to clients immediately deductible essentially makes the taxpayers finance 30–40 percent of the cost of litigation. As with anything else that is subsidized, that would result in more lawsuits. More to the point, those new lawsuits are likely to be more speculative than the lawsuits that they filed before the change – if the taxpayer picks up part of the tab, why not sue?
Each trial lawyer’s ability to take on additional cases at the margin would result in a substantial number of additional lawsuits when applied across the country. Already, the world views the United States as a litigious place, and the notion of a tort tax is well established. Making the taxpayers finance additional litigation will simply produce more litigation and increase the tort tax on the businesses that are sued.
In 2002, the late Fred Baron, a very successful Texas asbestos plaintiffs lawyer, responded to The Wall Street Journal’s suggestion that “the plaintiffs bar is all but running the Senate,” by saying, “I really, strongly disagree with that. Particularly, the ‘all but.’” Little has changed since 2002. The contributions of the trial lawyers to Congress, including Senate Democratic leadership, dwarf the contributions of all other industries. If the Treasury gives them this tax break, then some of the new funds would likely just be recycled in the form of political contributions.
Given the amount of money that the trial lawyers contribute to Democrats in Congress, it is noteworthy that legislation that would have made this change in the tax law went nowhere. If a change like this can’t get through the front door of Congress, it shouldn’t sneak through the back door by way of private administrative action.
The proposed change in the tax treatment of lawyers’ loans to their clients is a bad idea because it treats similar transactions differently for tax purposes, and it proposes giving a favored special interest group a $1.6 billion tax break that would promote speculative litigation.