The Impact of Juror Knowledge of Deductibility and Defendants' Tax Rates on Punitive Damages Awards: Experimental Evidence

Abstract

The US Tax Code allows corporate defendants to treat punitive damages as a deductible expense. Legal scholars argue that tax-unaware jurors fail to recognize that deductibility significantly reduces defendants' after-tax punishment, leading to an under-punishment problem. They propose that explicitly informing jurors about tax-deductibility could mitigate this problem. We conduct an experiment to test this claim. Compared to a control group of jurors who are told nothing about taxes, jurors who learn about tax-deductibility award higher damages when the defendant's effective tax rate (ETR) is low, but not when ETR is high. Our results highlight the cost of tax avoidance (low ETRs) for firms in a previously unexamined setting. Our findings suggest that allowing jurors to consider tax-deductibility leads to higher damages only under a narrow set of circumstances, offering limited support for the under-punishment hypothesis. Our results should be of interest to scholars in accounting, law, and public policy.