A Tax Break for Foreigners and Trial Lawyers
This may be the most perverse incentive of the U.S. tort system.
America’s one-of-a-kind tort system generates many perverse incentives, but this one takes the cake: Foreign investors receive special tax treatment for financing lawsuits against American companies. Congress should close the loophole that lets Russian oligarchs bankroll legal battles in the U.S. without paying a dime in federal taxes.
America’s already sky-high liability costs grew at an average 7.1% annually between 2016 and 2022, draining capital from productive investment. Litigation finance is a major driver. Funders shunt capital from around the world into U.S. lawsuits, taking a cut of any recovery. One recent estimate puts the lost productivity costs of third-party financed litigation at $54.2 billion annually.
Worse, foreign funders in litigation finance are rewarded with a tax advantage. Take three identical cases. One, a plaintiff pays a law firm $100,000 and recovers $1 million. Two, the law firm fronts the costs on contingency and achieves the same result. Three, a funder contributes $100,000 for the same outcome.
In each scenario, someone invests in a legal claim that generates a positive return, but the tax consequences are very different. The plaintiff and the law firm are hit with a higher tax bill as a result of tax-code provisions subjecting recoveries to ordinary income-tax rates, which top out at 37%.
Economic Dynamism
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