CBO

A

S T U D Y

The Economics of U.S. Tort Liability:

A Primer

October 2003

The Congress of the United States # Congressional Budget Office 

PREFACE

Many controversies and policy issues surround the U.S. tort system, which holds

parties liable for injuries to people or property. Critics charge that the system is costly and

inefficient, arbitrary and open to abuse, and indirectly harmful through its adverse effects on

economic vitality and consumers’ choices. In contrast, defenders argue that the tort system

serves important social objectives, such as compensating injury victims, improving product

safety, and punishing egregious behavior. Several bills now before the Congress propose to

change the rules that govern tort claims for medical malpractice and asbestos exposure and

claims litigated as class actions.

This Congressional Budget Office (CBO) study—prepared at the request of the Senate Budget

Committee—attempts to clarify the issues and policy options surrounding the tort system by

presenting an economic perspective on tort liability. The study outlines the strengths and

weaknesses of tort liability as a tool for promoting economic efficiency and fairness, discusses

the available data on the benefits and costs of the tort system, and analyzes in qualitative terms

the likely effects of various policy options for altering the system. In keeping with CBO’s

mandate to provide objective, impartial analysis, this study makes no recommendations.

Perry Beider and Cary Elliott of CBO’s Microeconomic and Financial Studies Division wrote

the study, under the supervision of David Moore and Roger Hitchner. The authors received

valuable comments and assistance from Heywood Fleisig, Stuart Hagen, and Robert Murphy

of CBO, as well as from Jeff O’Hara, formerly of CBO; Christopher DeMuth of the

American Enterprise Institute; Paul Rubin of Emory University; Alan Sykes of the University

of Chicago; and Paula Hannaford-Agor and Neil LaFountain of the National Center for State

Courts.

Christian Spoor edited the study, and Christine Bogusz proofread it. Maureen Costantino

took the cover photograph and designed the cover. Lenny Skutnik printed the initial copies of

the report, and Annette Kalicki prepared the electronic versions for CBO’s Web site (www.

cbo.gov).

Douglas Holtz-Eakin

Director

October 2003

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CONTENTS

Summary vii

Introduction 1

An Overview of the U.S. Tort System 3

The Expansion of Tort Liability in the United States 3

Characteristics of the Tort System Today 5

Tort Liability as a Tool for Achieving 

Efficiency and Equity 11

The Complexity of the Policy Problem 11

Liability Rules in Principle 13

Liability Rules in Practice 14

Should Tort Rules Be Set at the Federal

or State Level? 16

Tort Liability Versus Insurance and Regulation 16

The Costs of the Tort System 19

Defining the Costs of Tort Liability 19

Evidence About the Costs of the Tort System 20

Are Tort Costs Excessive? 20

An Overview of Policy Options for Changing

the Tort System 25

Options for Reducing the Scope of Tort Liability 25

Options for Reforming the Tort System as a Whole 27

Options for Reforming Certain Types of Torts 31
vi THE ECONOMICS OF U.S. TORT LIABILITY: A PRIMER

Tables

1. Characteristics of Tort Cases Decided by Trial

in State and Federal Courts, 1996 8

2. Summary of Major Tort Liability Standards 12

3. The Primary Effects of Some Broad Options

for Tort Reform 28
Summary

A “tort” is an injury to someone’s person, reputation, or feelings or damage to real or personal property.1

Under the U.S. system of tort liability, courts can hold

injurers liable for many different types of torts, such as

automobile accidents, contract fraud, trespass, medical

malpractice, and injuries associated with defective products.

Several bills now before the Congress seek to address concerns that critics have raised about the tort system or

about certain types of tort cases. Among those concerns

are that: 

# The “transaction costs” of the system, particularly

attorneys’ fees, are too high;

# Punitive damages and compensatory damages for

pain and suffering are often awarded arbitrarily, with

no beneficial effect on safety;

# The class-action mechanism (whereby many claims

that cover similar factual ground are combined into

a single larger case) is easily abused by plaintiffs’ attorneys;

# Medical malpractice lawsuits are driving up the costs

of liability insurance for physicians to the point that

some of them are restricting their practices or retiring; and

# In suits over exposure to asbestos, too much money

and court time are being devoted to people who do

not yet show any signs of physical impairment.

Conversely, supporters of the existing tort system argue

that it serves important policy goals, such as compensating victims, holding injurers responsible for their actions,

and improving safety. Supporters say that critics overstate

the extent and severity of the perceived problems with the

system. They further argue that many of the proposed

changes are too broad and that major problems can be

addressed by the courts or through more narrowly targeted legislation, perhaps at the state level, where the vast

majority of tort lawsuits are filed.

This primer looks at the current tort system—and various

options for changing it—from an economic perspective,

focusing on the goals of efficiency (minimizing the system’s total cost to the economy) and equity (treating all

parties fairly). Data about the overall costs and benefits

of tort liability are too scarce to allow economists to judge

the efficiency of the current system. However, those data

suggest that the system is a relatively expensive way to

compensate victims and, thus, that any justifications for

it must be based on its effects on deterring injuries, promoting equity, or both. 

1. Bryan A. Garner, ed., Black’s Law Dictionary, 7th ed. (St. Paul,

Minn.: West Group, 1999), pp. 1496-1497.
viii THE ECONOMICS OF U.S. TORT LIABILITY: A PRIMER

The economic perspective leads to some other general

conclusions about tort liability: 

# Using the tort system to supplement market forces

may improve or reduce efficiency, depending on

what incentives the system creates for potential injurers and potential victims and on the interactions between those incentives, government regulations, and

private insurance policies;

# Altering the tort system generally involves some

trade-offs—in particular, changes that seem likely to

improve efficiency may be problematic in terms of

equity, or vice versa;

# Federal involvement in what is now mainly a matter

of state law might yield more-efficient interstate

commerce, but it could limit innovation at the state

level (as well as restrict the states’ ability to offer contrasting liability regimes to appeal to different residents); and

# The same policies may not be appropriate for all

types of tort cases, because efficiency requires minimizing the sum of several kinds of costs, which may

vary in their relative importance from one category

of tort to another.

Tort Liability in the United States

The U.S. tort system is not centralized, which makes

collecting comprehensive data about it difficult. Roughly

95 percent of lawsuits over torts are filed in state courts,

rather than federal courts, the Congressional Budget Office (CBO) estimates. Moreover, in the vast majority of

cases, plaintiffs and defendants reach out-of-court settlements, whose terms typically remain private. (For example, 97 percent of tort cases that “terminated” in federal

district courts in fiscal year 2000 were disposed of before

a verdict was reached.)

Data from the Bureau of Justice Statistics that cover 45

of the nation’s 75 largest counties indicate that plaintiffs

won 48 percent of the cases that reached a verdict in state

courts in 1996 (the latest year for which that information

is available).2

 In those cases, the average time between

filing and completion was 22 months. Automobilerelated torts accounted for 49 percent of the cases,

followed by premises liability (22 percent) and medical

malpractice (12 percent). The median award to successful

plaintiffs was $31,000 for all cases, but it varied widely

for different categories of torts: from $18,000 in

automobile-related cases to $286,000 for medical

malpractice and $309,000 in asbestos cases.

Looking at trends over time, data from 16 states tracked

consistently by the National Center for State Courts show

that the number of tort cases filed each year rose by 70

percent between 1975 and 1990 (its peak) and then fell

by 19 percent by 2000. Relative to population, the rate

of filings was 8 percent lower in 2000 than in 1975—

212 cases per 100,000 residents compared with 230

cases.3

Figures that suggest an overall decline in tort cases, however, mask continuing growth in the number or impact

of some important categories of torts. For example, the

Physician Insurers Association of America reports that

median court judgments for medical malpractice rose

from $100,000 in 1990 to more than $300,000 in

2001—an increase of 138 percent after correcting for inflation. And researchers at RAND report that the number

of claims filed for asbestos exposure nearly tripled in just

two years, between 1999 and 2001.

The Basic Economics of Tort Liability

From the economic point of view, the efficiency of the

tort system is measured by how well it minimizes the sum

of several types of costs:

2. Department of Justice, Bureau of Justice Statistics, Tort Trials and

Verdicts in Large Counties, 1996, NCJ 179769 (August 2000).

3. See Brian J. Ostrom, Neal B. Kauder, and Robert C. LaFountain,

eds., Examining the Work of State Courts, 2001: A National Perspective from the Court Statistics Project (Williamsburg, Va.: National

Center for State Courts, 2001), with accompanying spreadsheets

available at www.ncsconline.org/D_Research/csp/2001_Files/

2001_Tort-Contract_Tables.xls.
SUMMARY ix

# The costs of injuries (including medical costs, lost

productivity, and pain and suffering);

# The costs of efforts to prevent or avoid injuries (including efforts to make products safer, which tend

to raise consumer prices) and the opportunity costs

of goods and services that are not provided (such as

potential medical drugs that do not reach the market

or municipal pools that are closed for fear of lawsuits) or goods and services that are provided but

forgone by some risk-averse consumers (such as air

travel);

# The costs of administration and implementation

(particularly attorneys’ fees and the administrative

costs of insurance that potential injurers and victims

buy to redistribute the risks they face); and

# Indirect costs to the economy (such as the disruption

costs of plant closings and bankruptcies).

What constitutes equity in relation to the tort system is

ultimately subjective, but there is consensus that compensating victims for their injuries—at least in some cases

and to some degree—is equitable.

Tort liability is only one means by which society addresses the efficiency and equity issues posed by injuries;

other means include market forces, regulation, and public

insurance funds. Market forces can help control injury

costs in several ways. Under conditions of competition

and good information, producers of goods and services

respond to consumers’ desires for safer products, employers respond to employees’ desires for safer workplaces,

and insurance companies offer policies to respond to potential victims’ desires to reduce the uncertainty they face.

One efficiency rationale for supplementing market forces

with some form of government involvement is simply

that many injuries—automobile accidents, releases of

toxic chemicals, and so forth—are unrelated to any economic transaction. Indeed, some academic economists

favor restricting the scope of tort liability to such

“stranger” injuries. For other types of injuries, making an

efficiency argument for government intervention requires

the existence of some market imperfection: perhaps potential victims lack good information about the risks they

face, suffer from biases that limit their ability to use the

information, or have few choices because of monopoly

or collusion in the market.4

 Of course, government

actions have their own weaknesses and thus may not

improve efficiency in practice. For example, regulation

requires centralized information about costs and benefits,

and regulators may be co-opted by the parties they regulate.

Tort liability supplements the market in a more decentralized way. The basic idea is that making injurers pay

for the harm they cause not only compensates victims but

also gives injurers (if not victims) appropriate incentives

to reduce the frequency and severity of that harm. The

different liability standards used by the courts aim to

achieve those goals in different ways: in particular, under

the doctrine of strict liability, injurers are responsible

regardless of how much care they exercise in trying to

minimize injuries, whereas under the doctrine of negligence, they are responsible only if their actions fail to

meet a standard of due care.5

The tort system is no panacea, however, even in principle—it is difficult if not impossible to craft liability

rules that can consistently achieve the desired levels of

both efficiency (taking into account all of the relevant

costs) and equity. For example, because the expected level

of compensation may affect the degree of care that potential victims exercise, the efficiency objective of costeffective deterrence can conflict with the equity objective

of compensation. Moreover, because the terms of that

trade-off can vary, a single rule may not achieve the desired balance between efficiency and equity in all cases.

In practice, tort liability is further limited because information—particularly the information needed to determine the cause of an injury—is incomplete and costly.

The transaction costs of the tort system derive from

information problems: lack of complete information is

4. There is no presumption that market forces tend to produce equitable outcomes; hence, arguments for government intervention

can also be made on equity grounds.

5. Even in a case judged under strict liability, the injurer may not be

held responsible if the victim’s own behavior contributed too much

to the occurrence of the harm.
x THE ECONOMICS OF U.S. TORT LIABILITY: A PRIMER

what allows plaintiffs and defendants to hold divergent

views and encourages them to devote resources to proving

their respective cases. Information problems are also the

root cause of courtroom errors, and they can make it hard

to set standards for due care at efficient levels.

The Costs and Benefits of Tort Liability

Analyzing the policy questions that surround tort liability

is difficult because of incomplete data not only on tort

cases themselves but also on the indirect costs and benefits of the tort system. Indeed, from the standpoint of

economic efficiency, the actions that the system encourages potential injurers and victims to take (or refrain from

taking) to avoid injuries can be more important than

some of the direct “costs” associated with individual cases.

In efficiency terms, the primary benefits of the tort system are measured not by payments to victims—which

represent transfers of wealth but not gains or losses to society as a whole—but by reductions in injury costs. Those

benefits arise indirectly, through precautions taken by

potential injurers (for example, efforts to design safer

products or reduce production defects).6

 Thus, they are

not observable in data on trials or settlements. 

Several important types of costs are also indirect, including the costs of specific actions that firms take to reduce

the injury risks associated with their products (such as

including air bags in automobiles), the opportunity costs

of goods and services not offered because of liability concerns or not purchased because of liability-related price

increases, and the disruption costs of layoffs and bankruptcies.

Arguments About the Effectiveness 

of Tort Liability’s Incentives

Indirect benefits and costs are very difficult to measure.

In general, data do not exist to show how liability affects

the degree of care that potential injurers take—let alone

how injury costs change as a result of that care. Moreover,

theoretical analysis alone cannot answer the key questions, because the extent to which the potential efficiency

benefits of tort liability are realized depends on the relationship between the true costs of injuries and the expected costs to injurers. If potential injurers expect to pay

one dollar more for each additional dollar of injuries they

cause, they will have the optimal incentive to take all (and

only) cost-effective precautionary actions. But they might

anticipate paying more than one dollar per dollar of additional injury (for example, because of excessive punitive

damages) or less than that (for example, if some of their

torts go undetected or if their liability costs are insured

and their premiums do not rise commensurately). For

potential injurers whose actions are thought at the time

to be harmless—such as the firms that manufactured or

used asbestos before its health risks were identified—there

is no expectation of increased liability costs and hence no

specific incentive for precaution.7

Controversy over both the efficiency and equity effects

of liability has particularly focused on nonpecuniary damages (punitive damages and compensatory damages for

pain and suffering). Critics argue that large nonpecuniary

damages are awarded arbitrarily and unpredictably, with

little connection to the actual harm or to the character

of the injurer’s conduct. In that view, such damages are

not only inequitable but also inefficient: arbitrary and

unpredictable awards do not provide incentives for precaution but do raise costs, thereby distorting price signals.

Critics further argue that nonpecuniary damages, whether

arbitrary or not, have a separate adverse effect on the distribution of risk—in particular, that liability for pain and

suffering implicitly provides consumers with a form of

inefficient overinsurance.8

6. Some indirect benefits may also arise from better distribution of

risk. In principle, risk-averse consumers who expect to be compensated for injuries more fully through the liability system than

they would be through their own insurance may be more willing

to buy certain goods or services (space heaters, perhaps).

7. However, the mere possibility that seemingly harmless activity may

later produce tort claims increases uncertainty and gives potential

injurers general incentives to buy insurance, investigate possible

risks, and take generic prevention or avoidance measures (such as

not researching or developing new products), which may be efficient or inefficient.

8. The argument is that consumers benefit by insuring themselves

against pecuniary losses, such as lost income or increased medical

costs, but not against pain and suffering (as illustrated by the fact

that people generally do not purchase life insurance policies for

their young children). Thus, when producers expect to pay nonpecuniary damages and build the costs of those damages into the
SUMMARY xi

In contrast, supporters of the liability system argue that

large punitive damages can serve equity by expressing

society’s disapproval of behavior that reflects wanton disregard or contempt for potential victims. Such damages

can also promote efficiency, they say, by providing proper

incentives for the prevention of injuries that have a significant probability of going undetected. (For example,

if bolt manufacturers expect the role of defective bolts to

go unrecognized in four out of five accidents that their

products cause, they will have inefficiently low incentives

to prevent defects unless they expect to pay five times the

actual damage on those occasions when they are penalized.) Supporters further argue that pain and suffering

represent real losses that should be reflected in the prices

of products (to send consumers efficient signals) and that

limiting awards for such losses might undercompensate

some injury victims.

Evidence About the Effects of Tort Liability

Without direct data or clear theoretical predictions about

the incentive effects of tort liability, analysts have tried

to tease out the truth statistically. However, their most

detailed efforts to date, which have focused mainly on

punitive damages, have not yielded conclusive results.

The best available study of the effects of punitive damages

in the United States found no evidence that the 46 states

that allow such damages have fewer environmental or

safety torts than the four states that do not allow them.

However, that lack of evidence may simply reflect the

limitations of the data.9

Given the scarcity of data on the benefits and many of the

costs of the current tort system, economists cannot judge

the system’s efficiency. But they can answer a narrower

question about its cost-effectiveness as a means of compensating injury victims. The best available data on the

direct costs of tort cases suggest that victims who file

claims receive an average of 46 cents from each direct dollar spent on the system (with the other 54 cents going to

attorneys’ fees and insurance expenses).10 The best available data show that such transaction costs are proportionately much smaller in public insurance programs—20

percent nationwide in state workers’ compensation programs (though that figure excludes spending on claimants’ attorneys, which is reportedly rising) and 15 percent

in the federal Vaccine Injury Compensation Program. A

no-fault public insurance program for other torts would

probably not lower transaction costs to those levels, in

part because of the costs of establishing which injurers

were responsible for particular injuries. Nonetheless, it

is safe to say that the existing tort system is a relatively

costly way to compensate victims and, thus, that any justifications for it must rest on its effects on deterrence,

equity, or both.

Policy Options for Changing 

the Tort System

The controversies over the costs and benefits of the tort

system have led to numerous proposals for change at the

federal level. This report discusses the potential advantages and disadvantages of various policy options in

qualitative terms. Those options—which were chosen to

illustrate the trade-offs between efficiency and equity that

lawmakers face—fall into three main categories.

Policies for reducing the scope of tort liability include options that would eliminate liability for all injuries or all

“nonstranger” injuries, exempt products certified as safe

by a federal regulatory body (such as the Food and Drug

Administration or the Consumer Product Safety Commission), or replace tort liability with a federal compensation system for injury victims, like the present stateprices they charge for goods and services, consumers implicitly pay

a kind of insurance premium for coverage they would not otherwise

choose to buy. The effect of that implicit premium and coverage

is to shift wealth inefficiently—raising it in the event of an injury,

but not by enough to justify the reduction in wealth in the case

of no injury.

9. One key limitation is that the control group includes only four

states; another is that punitive damages would not be expected to

deter typical torts but only those rare ones that were egregious

enough to be the subject of such damages. See W. Kip Viscusi,

“The Social Costs of Punitive Damages Against Corporations in

Environmental and Safety Torts,” pp. 285-345, Theodore Eisenberg, “Measuring the Deterrent Effect of Punitive Damages,” pp.

347-357, and David Luban, “A Flawed Case Against Punitive Damages,” pp. 359-380, all in Georgetown Law Journal, vol. 87, no. 2

(November 1998).

10. Tillinghast-Towers Perrin, U.S. Tort Costs: 2002 Update—Trends

and Findings on the Costs of the U.S. Tort System (2003).
xii THE ECONOMICS OF U.S. TORT LIABILITY: A PRIMER

level workers’ compensation system and the federal fund

for vaccine victims.

Policies that are more incremental in nature but that could

be applied broadly to all types of torts include options that

would restrict compensation for pain and suffering or

punitive damages, limit fees charged by plaintiffs’ attorneys, reduce the use of joint-and-several liability (under

which one or a few injurers can be held responsible for

paying all of the damages caused by a number of injurers), or modify the “collateral-source rule” (under which

the amount of damages owed by a defendant does not

take into account any benefits that an injured plaintiff has

received from an insurance policy or other independent

source).

Policies targeted toward particular types of tort cases include

options that would create specialized courts to hear

medical malpractice cases, establish minimum medical

criteria for asbestos claims and perhaps set up a victims’

compensation fund, tie the fees received by plaintiffs’

attorneys in class-action suits more closely to benefits

actually received by the class members, or allow defendants to shift more class-action cases from state courts to

federal courts.

In most cases, data limitations make it impossible for

CBO to determine whether a particular option would be

likely to improve or reduce economic efficiency. Nonetheless, the economic perspective leads to some general

conclusions that decisionmakers may wish to keep in

mind as they consider proposed changes to the liability

system.

# The impact on efficiency of using tort liability to try

to improve on market outcomes may be either positive or negative—depending on the incentives that

liability provides for potential injurers and potential

victims and on how those incentives interact with

incentives and constraints from other sources, such

as government regulations and private insurance

policies.

# Most, if not all, options for changing the tort system

involve some trade-offs. In particular, policies that

seem desirable on efficiency grounds may be problematic from the equity perspective, or conversely.

# Federal involvement in an area governed predominantly by state law may be justified by its benefits for

interstate commerce, but it limits state innovation

and experimentation (as well as the ability of U.S.

residents to “vote with their feet” by choosing to live

under one state’s liability regime rather than

another’s).

# Because the efficient solution is the one that minimizes the sum of several different costs, which may

vary in their relative importance, different policies

may be appropriate for different types of tort cases.
1

Introduction

Injuries have many causes, including economic activities: consumers are injured or killed by defective products,

workers are hurt on the job, train passengers are injured

by derailments, and patients are harmed by medical errors.

Markets provide broad incentives to control the number

and costs of such injuries. For example, employers can

save on wage costs by making jobs less hazardous; drivers

with good safety records pay lower insurance premiums;

and enhanced safety features can give a product a marketing advantage over its competitors. In addition, the

insurance market responds to people’s desire to reduce

the financial uncertainty associated with potential injuries.

Society uses three tools to augment the safety incentives

and insurance opportunities provided by the market: regulation, public compensation programs, and tort liability.

In particular, the U.S. tort liability system is intended to

reduce the number of injuries—by providing incentives

for individuals and firms to take appropriate care—and

to compensate those who are harmed.1

“Tort” is defined very broadly in law as an injury to “one’s

person, reputation or feelings” or damage to “real or personal property.”2

 Tort liability is the court-enforced obligation of a “tortfeasor” (injurer) to pay for a victim’s

losses. The concept of tort liability evolved as a generalization of various specific types of injuries—including

trespass, deceit, slander, and assault and battery—some

of which generally occur outside the context of economic

activity. Even today, tort law’s diverse origins are reflected

in a complex and heterogeneous body of common law.

One example of that complexity is the boundary line

between tort law and contract law. Notwithstanding the

broad definition of a tort, injuries caused by a breach of

contract are generally addressed under contract law—with

the exception of injuries involving medical malpractice

or defective or dangerous products, which are addressed

as torts even when the parties have an explicit contract.

Tort law is almost exclusively contained in state law, and

the large majority of tort cases are filed in state courts. Not

surprisingly, therefore, most past efforts to reform the tort

liability system in the United States have taken place at

the state level. In particular, most states have adopted one

or more reforms favoring defendants during the past 30

years—especially in 1986, when a perceived insurance

crisis led to 41 new state laws.3

 The courts have also taken

action at various times: recently, for example, the U.S.

Supreme Court reiterated an earlier ruling that the Due

1. The aims of the tort system are sometimes also said to include

providing a forum for the less privileged to be heard and punishing

egregious behavior.

2. Bryan A. Garner, ed., Black’s Law Dictionary, 7th ed. (St. Paul,

Minn.: West Group, 1999), pp. 1496-1497.

3. Those reforms included limits on nonpecuniary damages, reductions in the scope of joint-and-several liability, and offsets for benefits from collateral sources (which are discussed in Chapter 5). 

CHAPTER
2 THE ECONOMICS OF U.S. TORT LIABILITY: A PRIMER

Process Clause of the Constitution establishes limits on

punitive damages.4

Still, many critics of the current tort system say that

additional federal action is needed for several reasons. At

the general level, they argue that the system’s costs are too

high, particularly because of excessive “transaction costs”

(mainly compensation to plaintiffs’ and defendants’ attorneys) as well as excessive and arbitrary awards for noneconomic losses (“pain and suffering”) and for punitive damages. Such high costs sometimes have perverse negative

effects on safety, they argue—for example, by discouraging

firms from conducting safety research that could create

a legal “paper trail” or by raising the prices of risk-reducing

goods and services, such as medical care. Critics also

contend that plaintiffs frequently bring frivolous lawsuits

when they know that the defendant is inclined to settle

out of court to avoid the costs of litigation. 

The tort system’s critics also take issue with specific types

of cases. They argue that medical malpractice claims are

contributing to a crisis in the cost and availability of

certain health care services, that claims for exposure to

asbestos by people who show no evidence of illness are

burdening the courts and pushing firms into bankruptcy,

and that misuse of the class-action mechanism is allowing

local judges and juries who are biased against distant

corporate defendants to bring verdicts that have damaging

national implications.

Supporters of the current tort system question the factual

basis of some of those criticisms. They note that the number of tort cases filed nationwide has been falling since

1996. Moreover, they say, large awards for punitive damages are rare and are often reduced before payment is

made. They further argue that the costs of the tort system

are worthwhile given the system’s contributions to the

social goals of compensating victims, holding injurers

responsible for their actions, and improving safety. Supporters of the present system also maintain that proposed

reforms are generally too broad and that fewer negative

consequences would occur if the Congress allowed the

states and the judiciary to address any real problems that

exist.

The Congress has modified tort law several times in the

past, although its actions have generally focused on torts

that spring from a particular cause or affect specific industries. For example, the General Aviation Revitalization

Act of 1994 exempted manufacturers of small planes from

liability for crashes if the planes are more than 18 years

old and not used in scheduled service. In addition, federal

compensation programs that have been created for victims

of vaccine injuries and the September 11 terrorist attacks

limit the ability of people receiving compensation to sue

for damages.5

This primer looks at the tort system from an economic

perspective: it discusses the factors that influence whether

tort liability improves or reduces economic efficiency and

analyzes, in qualitative terms, the likely effects of some

reform initiatives. In principle, tort liability can provide

incentives for potential injurers and victims to take precautions, thus reducing injury rates. In practice, however,

implementation problems can reduce the strength and

value of those incentives to the point that liability decreases efficiency and may even have net negative effects

on safety. Although available evidence about the tort

system is too limited to support many firm conclusions,

it does indicate that the system is more costly than other

methods of compensating victims. Thus, an economic

perspective suggests that changes to the system should

focus on improving the incentives it provides, lowering

its costs, or both.

4. The Court held that punitive damages must be “both reasonable

and proportionate to the amount of harm to the plaintiff and to

the general damages recovered.” It also alluded to rough limits on

the ratio of punitive damages to compensatory damages in cases

involving only economic losses. State Farm Mut. Automobile Ins.

Co. v. Campbell, 538 U.S. ___ (2003).

5. For a summary of some federal tort reform laws, see Henry Cohen,

Federal Tort Reform Legislation: Constitutionality and Summaries

of Selected Statutes, CRS Report for Congress 95-797A (Congressional Research Service, updated May 2, 2003).
2

An Overview of the U.S. Tort System

Most legal scholars agree that the scope of liability

in the U.S. legal system has expanded dramatically in the

past three decades. That expansion began early in the 20th

century with a growing acceptance of the notion that more

extensive tort liability would serve to compensate injured

parties and reduce the level of accidents. Although no

complete set of data is available, limited data call attention

to several prominent features of the current tort litigation

landscape—that the vast majority of tort claims are settled

out of court, that state courts handle the bulk of torts, and

that different types of torts have different impacts on

litigants and on the tort system.

The Expansion of Tort Liability

in the United States

U.S. tort law is based primarily on common law—in

which judicial rules are developed on a case-by-case basis

by trial judges—rather than on legislation. Tort liability

is assigned using two basic standards: strict liability and

negligence. Under strict liability, injurers are held fully

liable for their victims’ losses without regard for whether

they were actually negligent or intended to harm anyone.1

Under a negligence standard, by contrast, injurers are held

liable only if they failed to meet a certain standard of care.

According to legal scholars, a number of important developments have increased the scope of liability for torts in

the United States.

Early English tort law, the antecedent of U.S. tort law,

was chiefly concerned with making injurers pay for the

losses of their victims, with little emphasis on fault or

negligence.2

 That standard was used in the United States

until the 19th century, when U.S. common law established

negligence as the basis for tort liability. However, strict

liability continued to apply in certain cases, such as injuries

caused by wild animals kept as pets or damage to crops

caused by trespass of domestic animals.3

 Some scholars

argue that the requirement for plaintiffs to show that defendants had been negligent effectively limited the scope

of the U.S. tort system.4

The turn of the 20th century saw public policy increasingly emphasize victim compensation and accident reduction. The enactment of workers’ compensation laws—

which established a public insurance system aimed at low1. Strict liability—sometimes called “liability without fault”—is based

on the breach of an absolute duty to make something safe. See

Bryan A. Garner, ed., Black’s Law Dictionary, 7th ed. (St. Paul,

Minn.: West Group, 1999), p. 926.

2. See Stuart Speiser and others, The American Law of Torts, vol. 1

(Rochester, N.Y.: Lawyers Cooperative Publishing Co., 1983), pp.

144-145.

3. Ibid., pp. 144-145, note 96.

4. See, for example, George L. Priest, “The Modern Expansion of

Tort Liability: Its Sources, Its Effects, and Its Reform,” Journal of

Economic Perspectives, vol. 5, no. 3 (Summer 1991).

CHAPTER
4 THE ECONOMICS OF U.S. TORT LIABILITY: A PRIMER

ering employers’ payments while making workers’ recovery

of damages automatic—played an important role in the

evolution of tort law and policy.5

 Before workers’ compensation programs, the only remedy that injured workers

had was to prove their employers negligent through the

tort system. Workers favored legislation instead because

they often had been unable to recover damages or had

experienced delays or high costs when they had been

successful. For their part, employers favored legislation

because it limited their liability and made payments

predictable.6

 That shift away from tort law to a public

compensation system led to more thought about how tort

liability could be improved or better applied in other types

of cases.

By the 1940s, legal scholars had begun to think about two

ways in which the tort system could serve the wider goal

of enhancing social welfare. First, they saw the economic

concept of “cost internalization” as a tool for reducing

accident rates: if potential injurers know they will be held

liable for accidents, they will take appropriate action to

avoid liability. In that view, by awarding damages to compensate victims, tort law would serve as a mechanism to

ensure that potential injurers faced the appropriate future

costs of their actions.7

 Second, some scholars argued that

the tort system could provide a kind of accident insurance

for victims. They did not focus on the possibility that an

expanded liability system could increase carelessness on

the part of potential victims, nor did they adopt any of

the methods that traditional insurance policies use to deal

with that problem.8

 Rather, they focused exclusively on

the distributional goal of relieving victims of the burden

of accident losses and spreading that burden across a

broader population.

One area in which those concepts proved appealing in

practice was product liability.9

 Historically, product liability was dealt with either as a breach of warranty under

contract law or as a tort subject to the negligence standard.

Under contract law, recovery in such cases was limited

to repair and replacement of the product; under tort law,

recovery was limited by the difficulty of proving negligence. In the 1960s, the courts moved rapidly toward a

standard of strict liability for defective products; in 1964,

that standard was accepted and recommended by the

American Law Institute in its second Restatement of the

Law volume on torts. By the mid-1970s, most states had

adopted provisions that were either identical or similar

to those in the Restatement.10

5. The first workers’ compensation law was enacted in 1908 to cover

certain federal civilian workers. By 1920, most states had workers’

compensation laws; today, all states and the District of Columbia

have their own programs. See Cecili Thompson Williams, Virginia

P. Reno, and John F. Burton Jr., Workers’ Compensation: Benefits,

Coverage, and Costs, 2001 (Washington, D.C.: National Academy

of Social Insurance, July 2003), p. 6.

6. Depending on the state, workers’ compensation requires employers

to purchase insurance from either private sources or a public

insurance fund, unless they can prove the ability to self-insure.

Employers are responsible for benefit payments specified by state

statute for on-the-job injuries regardless of who is at fault.

7. From society’s perspective, the optimal level of accident avoidance

is the point at which the total cost of additional avoidance is equal

to the total additional benefits obtained. However, without cost

internalization, an individual firm does not take losses to accident

victims into account and thus underprovides accident avoidance,

because the costs outweigh the private benefits. Tort liability works

by aligning the private benefits of accident avoidance with the social

benefits. Markets for products may also lead firms to internalize

the costs of accidents when consumers are well informed about

the products and the risks of injuries do not fall on third parties.

8. See the discussion in Priest, “The Modern Expansion of Tort

Liability,” pp. 31-50. Those scholars also did not note that using

the tort system to provide insurance could adversely affect the supply of goods and services by raising companies’ costs.

9. Early attempts to figure out how the tort system could be used to

internalize costs in the case of automobile accidents failed because

identifying which of the parties should be held liable for such an

accident is generally difficult.

10. Strict liability for product defects can be seen as an evolution of

negligence and warranty law. Gary T. Schwartz, in “New Products,

Old Products, Evolving Law, Retroactive Law,” New York University Law Review, vol. 58, no. 4 (October 1983), pp. 796-852,

points to the fundamental “high correlation between product defect

and manufacturer negligence, making the issue of negligence not

worth the costs and uncertainties of litigation.” Judging defective

products under strict liability rather than negligence reduces plaintiffs’ burden of proof. In particular, a plaintiff need not show exactly what happened inside the factory, only that the product is

defective. 
CHAPTER TWO AN OVERVIEW OF THE U.S. TORT SYSTEM 5

In addition, the concept of negligence has undergone

significant reinterpretation over time, according to legal

scholars. The law now takes into account the fact that

manufacturers often have more ability than consumers

to avoid accidents; thus, it is more likely to view failure

to take inexpensive action as negligence or to attach liability to indirect or partial contribution to an injury. 

Characteristics of the Tort System Today

Getting a complete picture of the state of the U.S. tort

system is difficult because no data are available that cover

all of the tort cases brought in the various jurisdictions

across the country. However, the National Center for State

Courts (NCSC) provides some data on trends in civil

filings in general-jurisdiction courts in several states.11 It

also conducts periodic surveys of civil trials in the nation’s

75 largest counties for the Bureau of Justice Statistics

(BJS). In addition, data about cases disposed of in federal

court are available from the Administrative Office of the

U.S. Courts. 

In 16 states consistently tracked by the NCSC, tort filings

in general-jurisdiction courts grew from 189,520 in 1975

to 260,745 in 2000, which appears to support the common view that the number of tort cases is rising. But controlling for population growth in those states indicates

that tort filings relative to population declined by 8 percent over that period—from 230 per 100,000 residents

in 1975 to 212 in 2000.12 Additionally, total tort filings

in those 16 states were relatively constant from 1986 to

1996 and have shown a downward trend since then, falling

from 320,976 filings in 1996 to 260,745 in 2000.

In drawing inferences about the tort system as a whole,

however, it is important to note several limitations of the

available information.

# Data do not exist for those tort disputes that do not

go to trial, because the details of settlements are usually private.13

# Collecting consistent data between the various jurisdictions is difficult. The overwhelming majority of

tort filings occur at the state level, and the structure

of state courts and the laws under which they operate

differ from state to state. Moreover, those courts have

not tended to view keeping records on the details of

case outcomes as being central to their mission.

# Both anecdotal and statistical evidence about damage

awards can be misleading because the amount of damages actually paid can be reduced after a trial.14

# Overall trends can be misleading because various categories of torts have different economic impacts, and

the timing and disposition of mass torts (cases involving large numbers of people) can significantly

skew the numbers.

Settlement Versus Trial

The majority of tort disputes never reach a trial verdict.

For example, of the 41,696 tort cases that were terminated

in U.S. district courts in fiscal year 2000, only 3 percent

11. Although all states have at least one court of general jurisdiction,

44 states have limited-jurisdiction courts that hear certain types

of cases, such as small claims, traffic, or probate cases. See Neal

Kauder, Examining the Work of State Courts, vol. 1, no.1 (Williamsburg, Va.: National Center for State Courts, August 1995).

12. Data for the early years of that period may not be complete, but

that would only sharpen the finding of a decline. See Brian J.

Ostrom, Neal B. Kauder, and Robert C. LaFountain, eds., Examining the Work of State Courts, 2001: A National Perspective from

the Court Statistics Project (Williamsburg, Va.: National Center

for State Courts, 2001), with accompanying spreadsheets available

at www.ncsconline.org/D_Research/csp/2001_Files/2001_

Tort-Contract_Tables.xls. 

13. The NCSC data are limited to the number of court filings; they

do not give details about cases. They also cover only a subset of

states. Another possible source of data on the outcomes of tort cases

is insurance company records—since a large percentage of tort

awards are paid by defendants’ insurers—but companies do not

regularly make those records available.

14. Many, if not most, court awards are negotiated among the parties

after trial, are reduced by the judge, or are subject to statutory

reductions, such as caps on damages. For example, in the widely

reported case involving a person scalded by a cup of McDonald’s

coffee, the trial court reduced the plaintiff’s $2.7 million punitive

damage award to $480,000 (three times the compensatory

damages). 
6 THE ECONOMICS OF U.S. TORT LIABILITY: A PRIMER

were decided in trials.15 The NCSC similarly reports that

“[t]he vast majority of all [state] tort cases are disposed

through some form of settlement, with only 3 percent of

all tort matters resulting in a jury trial.”16 Litigants have

mutual incentives to save on litigation costs by settling

out of court. They avoid uncertain trial outcomes and delays and can agree to keep settlements confidential.17 In

some cases, settlements may be reached through alternative

methods of dispute resolution, such as voluntary arbitration or mediation.

Generally, details of civil disputes settled before a trial are

not reported to the courts and hence are not included in

publicly available data. Those data therefore show only

part of the picture—there may be important differences

between cases that go to trial and cases that settle out of

court.18 For example, cases that go to trial probably involve

larger dollar amounts, on average. Nevertheless, trial verdicts set precedents for all cases and thus affect the incentive to settle by signaling the value and probability of

success to future litigants.19

Where Are Tort Cases Heard?

The vast majority of tort filings occur in state courts. In

2000, more than 700,000 torts were filed in state generaljurisdiction courts, compared with only about 37,000 in

federal courts, the Congressional Budget Office (CBO)

estimates.20 Liability standards are not uniform among

the various jurisdictions. For example, the extent to which

damages may be reduced if the injured party contributed

to the accident differs among states. In addition, a small

number of local courts have been described as “class-action

magnet courts” and criticized for being biased toward

plaintiffs.21

U.S. district courts have jurisdiction in civil cases when

a case deals with a federal question, the federal government

is either a defendant or plaintiff, or the case involves

“diversity of citizenship.”22 Of the tort cases that were terminated by trial in federal courts in fiscal year 2000, 72

percent involved diversity of citizenship, 18 percent in15. Congressional Budget Office calculation based on “Civil Terminations, 2000,” Federal Court Cases: Integrated Data Base (Federal

Judicial Center, Washington, D.C.), dataset no. 117, available from

the Inter-university Consortium for Political and Social Research

at www.icpsr.umich.edu/cgi/archive.prl?study=8429.

16. Kauder, Examining the Work of State Courts, p. 2.

17. Also, in some circumstances, compensatory damages are not taxable

but punitive damages are. Therefore, plaintiffs who anticipate that

the net value of a trial award will be reduced because of taxes have

an incentive to settle for an amount below the expected trial award.

See A. Mitchell Polinsky, “Are Punitive Damages Really Insignificant, Predictable, and Rational? A Comment on Eisenberg et

al.,” Journal of Legal Studies, vol. 26, no. 2 (June 1997).

18. George L. Priest and Benjamin Klein argue, on the basis of a model

of the determinants of settlement and litigation, that disputes

selected for litigation are neither random nor representative of all

disputes. See Priest and Klein, “The Selection of Disputes for

Litigation,” Journal of Legal Studies, vol. 13, no. 1 (January 1984),

pp. 1-55.

19. Firms such as Jury Verdict Research Inc. provide data to attorneys

to help them value claims on the basis of verdicts for similar cases.

Using their own private information about the probability of success, the litigants can calculate the expected return from going to

trial. Thus, if a plaintiff thinks she has a 30 percent chance of

winning at trial, and successful cases like hers average a trial award

of $1,000, she should be willing to settle the case for $300 or

more—or even a bit less if she is averse to risk.

20. The state figure is based on the information that 537,000 tort

filings occurred in 2000 in general-jurisdiction courts in 30 states

tracked by the National Center for State Courts and that those

states contain 72 percent of the U.S. population. According to the

Administrative Office of the U.S. Courts, 36,586 tort cases were

filed in fiscal year 2000; see Administrative Office of the United

States Courts, 2002 Annual Report of the Director: Judicial Business

of the United States Courts (2003), Table C-2A, p. 132, available

at www.uscourts.gov/judbus2002/appendices/c02asep02.pdf. Those

statistics represent the number of cases filed, not the number of

plaintiffs or defendants.

21. John H. Beisner and Jessica Davidson Miller, Class Action Magnet

Courts: The Allure Intensifies, Civil Justice Report No. 5 (New York:

Center for Legal Policy, Manhattan Institute, July 2002). Some

observers argue that state courts in general are biased against large

corporate defendants; see, for example, Robert J. MacCoun,

“Differential Treatment of Corporate Defendants by Juries: An

Examination of the “Deep-Pockets” Hypothesis,” Law & Society

Review, vol. 30, no. 1 (1996).

22. Federal questions arise from interpretation and application of the

U.S. Constitution, treaties, or acts of Congress. Diversity of citizenship cases are those in which no plaintiff and no defendant are

citizens of the same state and at least one plaintiff seeks $75,000

or more in damages.
CHAPTER TWO AN OVERVIEW OF THE U.S. TORT SYSTEM 7

volved a federal question, and 11 percent involved the U.S.

government as a defendant or plaintiff. Many of those tort

cases did not originate in federal courts: 28 percent were

removed from state courts.23

Categories of Tort Cases

Different types of torts pose different challenges for the

goals of the liability system, so it is useful to track the

trends in filings for important categories of torts. For example, overall statistics on torts can be substantially driven

by developments in mass torts. The General Accounting

Office found that asbestos litigation accounted for half

of the growth in tort filings that occurred in federal courts

between 1974 and 1986.24 Although tort filings as a whole

have fallen significantly since 1996, that overall trend

masks important developments in key categories of torts.

The major areas of tort litigation, based on their share of

total tort trials completed in the general-jurisdiction courts

of the 75 largest U.S. counties in 1996, are automobilerelated torts (49 percent), premises liability (22 percent),

and medical malpractice (12 percent).25 Many of the

common categories of torts pose few policy problems. For

example, automobile torts often have low awards: a median jury award of $18,000 for winning plaintiffs in state

courts in the 75 largest counties in 1996, compared with

a median award of $31,000 for all torts (see Table 1). 

In contrast, torts that have received the most public attention—such as product liability cases (including asbestos

litigation) and medical malpractice cases—often involve

larger stakes and have more significant effects on courts’

resources, victims’ compensation, the viability of businesses, and insurance premiums. Winning plaintiffs in

state courts received a median award of $309,000 in asbestos cases and $286,000 in medical malpractice cases

in the 75 largest counties in 1996. Moreover, about 20

percent of medical malpractice awards and 16 percent of

product liability awards (other than in asbestos-related

cases) were at least $1 million, compared with only 6 percent of state courts’ awards for all torts. (Although punitive

damages were infrequently awarded in medical malpractice

and asbestos cases, they were also higher than the average

for all torts: median amounts of $250,000 and $110,000,

respectively, compared with $38,000 for tort cases overall.)26 At the federal level, medical malpractice cases terminated by trial in U.S. district courts in 1996 had a

median final award of $252,000.

Policymakers and the business community have been concerned about the increasing costs of asbestos litigation.

Researchers at RAND estimate that claims for asbestosrelated compensation totaled $54 billion through 2000,

with estimated future costs ranging from another $145

billion to $210 billion.27 They also identified 67 bankruptcies related to asbestos litigation through 2002, up from

three through 1982. Adding to that concern is the latency

that occurs in the onset of asbestos-related disease, which

makes it difficult to predict firms’ exposure to liability and

to ensure adequate compensation for victims who have

yet to file claims.28

23. Congressional Budget Office calculations based on “Civil Terminations, 2000,” Federal Court Cases: Integrated Data Base (Federal

Judicial Center, Washington, D.C.), dataset no. 117, available from

the Inter-university Consortium for Political and Social Research

at www.icpsr.umich.edu/cgi/archive.prl?study=8429.

24. General Accounting Office, Extent of “Litigation Explosion” in

Federal Courts Questioned, GAO/HRD-88-36BR (January 1988).

25. Department of Justice, Bureau of Justice Statistics, Tort Trials and

Verdicts in Large Counties, 1996, NCJ 179769 (August 2000). The

same data also show that tort cases typically involve individuals

suing individuals (42 percent of all torts) or individuals suing businesses (39 percent).

26. Those medians exclude cases with awards of zero.

27. Presentation by Deborah Hensler at the U.S. Chamber of Commerce seminar “Understanding Asbestos Litigation: The Genesis,

Scope, and Impact,” Washington, D.C., January 23, 2003, available

at www.legalreformnow.com/resources/012303.pdf. See also

Stephen J. Carroll and others, Asbestos Litigation Costs and Compensation: An Interim Report (Santa Monica, Calif.: RAND Institute

for Civil Justice, 2002), available at www.rand.org/publications/

DB/DB397/DB397.pdf.

28. Another factor contributing to the concern has been a recent surge

in new asbestos cases. New filings in U.S. district court for asbestos

cases involving personal injury or product liability rose from 5,041

in fiscal year 2000 to 26,818 in 2002 (see Administrative Office

of the United States Courts, 2002 Annual Report of the Director,

Table C-2A). But federal cases are only a portion of total claims

(which also include state and trust fund claims), and the number

of new cases (which represent old exposures now coming to light

rather than new exposures) fluctuates greatly from year to year.
8 THE ECONOMICS OF U.S. TORT LIABILITY: A PRIMER

Table 1.

Characteristics of Tort Cases Decided by Trial in State and Federal Courts, 1996

Percentage of Cases

Won by Plaintiff

Median Award

(Dollars)

Percentage of Awards

$250,000

or More

$1 Million 

or More

All Tort Cases

State 48.2 31,000 16.9 5.8

Federal 45.8 139,000 38.1 14.6

Automobile Accidents

State 57.5 18,000 8.7 3.4

Federal 59.7 100,000 37.4 11.6

Medical Malpractice

State 23.4 286,000 51.0 20.2

Federal 39.8 252,000 54.3 22.9

Asbestos

State 55.6 309,000 50.6 12.1

Federala 40.0 465,000 50.0 0

Product Liability Other Than Asbestos

State 37.1 177,000 41.2 16.3

Federal 26.6 368,500 62.0 24.0

Source: Congressional Budget Office based on Department of Justice, Bureau of Justice Statistics, Tort Trials and Verdicts in Large Counties, 1996, NCJ 179769

(August 2000), and “Civil Terminations, 1996 and 1997,” Federal Court Cases: Integrated Data Base (Federal Judicial Center, Washington, D.C.), dataset

nos. 103 and 104, available from the Inter-university Consortium for Political and Social Research at www.icpsr.umich.edu/cgi/archive.prl?study=8429.

Notes: State numbers are based on trials in general-jurisdiction courts in the 75 largest counties in the United States in calendar year 1996 (calculated from data

for fiscal years 1996 and 1997). Federal numbers are based on trials in U.S. district courts in calendar year 1996.

Data on awards exclude cases won by defendants and those with awards of zero.

a. There were only two federal asbestos cases with monetary awards in 1996.

Asbestos cases also differ from other torts in the number

of firms affected. The median number of defendants in

asbestos litigation was 18, compared with a median of one

defendant in tort cases overall.29 Over time, the targets

of asbestos suits have expanded from the original manufacturers of asbestos-related products to include customers

who may have used those products in their facilities.

According to RAND, the total number of defendants in

asbestos litigation rose from 300 in 1982 to more than

6,000 in 2000.30

Recent data show no growth in the total number of

medical malpractice tort claims, but the size of awards has

increased. Median payments for medical malpractice

claims at trial rose from about $100,000 in 1990 to over

$300,000 in 2001, according to the Physician Insurers

29. Department of Justice, Tort Trials and Verdicts in Large Counties,

1996. 30. Carroll and others, Asbestos Litigation Costs and Compensation.
CHAPTER TWO AN OVERVIEW OF THE U.S. TORT SYSTEM 9

Association of America.31 (BJS data from the nation’s

largest counties show an increase in median awards in state

courts from $201,000 in 1992 to $286,000 in 1996.)32

That rise coincides with increasing malpractice premiums

for doctors, which critics blame for leading to a reduction

in the availability of health care in some parts of the

country.

Another set of tort claims that concerns policymakers is

cases filed using the class-action procedure, in which a

small number of plaintiffs represent a larger group of

people who were similarly affected by the same product

or tort. Class-action cases are designed to address relatively

small but numerous losses for which individual suits

would be impractical. However, when the class is large

enough, even claims that are trivial individually can have

a significant effect on particular firms and even whole

industries. Limited data are available on class actions, but

those cases are more likely than other torts to be filed in

federal court. For example, a RAND study estimated that

during the 1995-1996 period, 40 percent of reported classaction decisions arose in federal court, whereas CBO

estimates that less than 5 percent of all torts are filed in

federal court.33

31. Data supplied to the Congressional Budget Office by the Physician

Insurers Association of America in spring 2003.

32. See Department of Justice, Bureau of Justice Statistics, Tort Trials

and Verdicts in Large Counties, 1996, and Civil Jury Cases and Verdicts in Large Counties, NCJ 154346 (July 1995).

33. Deborah R. Hensler and others, Class Action Dilemmas: Pursuing

Public Goals for Private Gain (Santa Monica, Calif.: RAND Institute for Civil Justice, March 1999). 

3

Tort Liability as a Tool for

Achieving Efficiency and Equity

Different observers describe tort liability as serving

various combinations of purposes—among them, compensation, deterrence, risk spreading, and punishment or

retribution. In economic terms, those various purposes

can be related to the overarching social goals of efficiency

and equity. The efficiency goal is to allocate scarce resources so as to maximize the total benefits available to

society; the equity goal is to distribute those benefits in

accord with some (necessarily subjective) conception of

fairness or justice. Metaphorically speaking, efficiency

involves making the pie as big as possible, and equity

focuses on slicing it appropriately.

The Complexity of the Policy Problem

If there were just a single injury for policymakers to consider, then once that injury had occurred, the only relevant

policy questions would pertain to equity. That is, the size

of the pie would already be determined by the fact of the

injury, and the remaining issues would involve what punishment (if any) the injurer deserved and what compensation (if any) the victim deserved.1

In reality, of course, policymakers are concerned not with

a single injurious event but with many such events over

time—which gives rise to the efficiency question of minimizing the total cost associated with future injuries. That

total includes not only the costs of the injuries themselves

(in medical care, pain, decreased worker output, and so

on) but also:

# Prevention costs (the costs of efforts to avoid injuries,

which tend to raise the prices of goods and services);

# Transaction costs (the costs of legal and administrative

resources, such as attorneys’ fees); 

# Indirect costs to the economy (for example, from the

disruptions caused by layoffs and bankruptcies); and

# Uncertainty costs (the burden of uncertainty for

potential victims and potential injurers—since driving

the rate of injuries down to zero would be ruinously

expensive, if not impossible—as well as the transaction costs of reducing that burden through insurance or other risk-spreading mechanisms).

That sketch of the policy goals suggests the difficulties that

policymakers face in seeking to address the personal and

social costs of injuries. One potential problem is trade-offs

between equity and efficiency. For example, a particular

conception of fairness might hold that certain victims

should not be considered responsible for exercising some

forms of care, although it would be more efficient if they

1. The equitable levels of punishment and compensation need not

be the same, even in the case of fines and monetary awards. Depending on the facts of the case and on one’s conception of justice,

the victim might be felt to deserve more or less than the injurer

should pay, with any difference coming from or accruing to the

government.

CHAPTER
12 THE ECONOMICS OF U.S. TORT LIABILITY: A PRIMER

Table 2.

Summary of Major Tort Liability Standards

Components of Efficiency

Implications

for Equity

Standard Provides Incentives for Efficiency in

Transaction

Standard Costs

Injurer’s

Degree

of Care?

 Scale of

Injurer’s

Activities?

Victim’s

Degree

of Care?

Scale of

Victim’s

Activities?

Distribution

of Risk?

Strict Liability Yes Yes No No No (Overinsures

nonpecuniary

losses)

High Compensates all 

victims; bundles 

unwanted insurance for

nonpecuniary losses

into product prices

Strict Liability 

with Comparative

Negligence

Yes Yes Depends 

on extent of

reduction in

compensation

to negligent

victims

No No (Overinsures

nonpecuniary

losses)

High Compensates nonnegligent victims 

(partially compensates

negligent victims); 

bundles unwanted 

insurance for nonpecuniary losses into

product prices

Negligence Depends

on the

efficiency

of the 

legal 

standard

of due

care

No Yes Yes No (Overinsures

nonpecuniary

losses, though 

less so than

strict liability

since nonnegligent 

injuries are not

compensated)

High Nonnegligent injurers

not held liable; some

victims uncompensated

Source: Congressional Budget Office.

did so. Even within the single goal of efficiency, policymakers may have trouble identifying the best approach,

given that each approach might have different effects on

injury costs, prevention costs, transaction costs, indirect

costs, and uncertainty costs and that the relative importance of those costs might vary from one type of injury

to another.

Under ideal market conditions, much of the policy problem—the part concerning injuries associated with economic activities—could be solved easily. In particular,

market forces would achieve the efficiency goal for such

injuries by minimizing the sum of the related costs: producers and employers would respond to consumers’ and

workers’ preferences by taking all cost-effective measures

to make their products and workplaces safer, and riskaverse people would buy insurance to eliminate the financial uncertainty surrounding the remaining risks. Any

equity goals involving additional compensation of injury

victims could be met through a government program of

income transfers.2

2. Even in that simpler world, society would still face the issue of

minimizing the costs of “stranger” injuries—those unrelated to

any economic transaction, such as injuries caused by a release of

toxic gases from a chemical plant. Chemical companies certainly

have incentives to maintain their reputations, but there is no presumption that such indirect effects accurately reflect the interests

of potential victims.
CHAPTER THREE TORT LIABILITY AS A TOOL FOR ACHIEVING EFFICIENCY AND EQUITY 13

In reality, the results produced by market forces can only

approximate the efficient outcome, and the accuracy of

that approximation depends in large part on how well potential victims understand the risks they face.3

 Some risks

(such as long-latency illnesses that result from exposure

to new chemical substances) become apparent only years

or decades after they are introduced into the economy.

Other risks, though recognized by experts, are largely unknown or are not accurately taken into account because

of biases in the way people process information about risk

and uncertainty. 

Incomplete information or understanding about risk raises

the possibility that government intervention—through

regulations or liability rules—can improve on the efficiency of market outcomes. There is no guarantee that

it will do so, however. Whether it does depends on the

strengths and weaknesses of the particular interventions,

as discussed below.

Liability Rules in Principle

The various forms of strict-liability and negligence standards used by the courts encourage potential injurers to

exercise care and result in compensation to victims in different ways and to different extents. Neither type of standard, however, reliably induces optimal levels of care and

participation by both injurers and victims, even in theory.

Also, both types are prone to inefficiency in their effects

on the distribution of risk.

In its purest form, strict liability compensates all victims

except those judged to have caused the injury themselves

or to have knowingly and voluntarily “assumed the risk”

of exposure to a particular hazard. Strict liability thus gives

potential injurers an incentive to make all socially efficient

changes in the level or form of their activities, because they

know they will face the full cost of almost any resulting

harm (see Table 2). It may have a very different effect on

potential victims, however. To the extent that they expect

to be fully or almost fully compensated for their losses

(which is more likely to occur in cases involving only

property damage, not personal injury or death), strict liability gives potential victims little or no incentive to take

reasonable precautions of their own.

In cases alleging defective products—a major category of

tort claims subject to strict liability—U.S. courts typically

do not apply strict liability in its pure form. Instead, they

use a doctrine of comparative negligence.4

 Under that

variant of the standard, the compensation paid by an

injurer is reduced if the victim is found to have contributed to the injury through his or her own negligence, as

defined by some explicit or implicit legal standard. (In

1996, about 16 percent of all awards in tort trials in the

nation’s 75 largest counties were reduced because of the

plaintiff’s own negligence. Those reductions averaged 43

percent.)5

 Taking comparative negligence into account

is likely to improve the efficiency of strict liability to the

extent that plaintiffs’ negligence is a broader concept than

plaintiffs’ causation (or assumption of risk) and thus gives

potential victims an incentive to avoid more types of

careless behavior.6

 But it still does not give them cause to

3. It also depends on how well potential injurers understand the costs

of their opportunities to reduce injury risks (that is, their “production functions” for safety). In practice, that factor is probably

less of a constraint on the efficiency of market outcomes than is

lack of understanding of risk on the part of potential victims and

thus is less likely to provide a good rationale for government intervention.

4. Comparative negligence is also widely applied in types of tort cases

that are judged under a negligence standard. Its use in cases judged

under strict liability may seem incongruous: in principle, a defendant may be liable even in the absence of any negligence against

which to compare the plaintiff’s negligence. But current law essentially infers some degree of negligence (whether of design, manufacture, or labeling) whenever a plaintiff shows that a defective

product caused an injury.

5. Department of Justice, Bureau of Justice Statistics, Tort Trials and

Verdicts in Large Counties, 1996, NCJ 179769 (August 2000).

6. The impact of that incentive depends on potential victims’ awareness of it and on their expectations about how their behavior would

affect the compensation they would receive if injured. If they expect

to receive some compensation despite engaging in “mild” negligence, they may not be encouraged to make all cost-effective

changes in their behavior. (Some states allow a defense of contributory negligence rather than comparative negligence; under that

defense, negligent victims have their compensation eliminated

rather than reduced.) Conversely, the possibility of reduced compensation under comparative (or contributory) negligence may be

irrelevant if potential victims face risks of death or other injuries

for which compensation would be greatly inadequate.
14 THE ECONOMICS OF U.S. TORT LIABILITY: A PRIMER

adjust the scale of their risky activities, since standards for

due care do not consider scale itself. For example, a negligence standard may dictate that bicyclists wear helmets

and obey traffic rules, but it will not address how often

they ride. 

The same analysis applies in reverse when injurers are

judged according to a negligence standard. If the standards

of due care are set at ideal levels, potential injurers will

make all efficient adjustments in the way they conduct

their activities. In addition, potential victims who expect

injurers to escape liability through the “safe harbor” of

due care have an incentive to take all efficient precautions

because they will bear the costs of any injuries. However,

the standards for care typically do not provide any incentives about the scale of potential injurers’ activities. Thus,

for example, a manufacturer whose rate of production

defects is low enough to be considered nonnegligent will

have no incentive to consider the costs of injuries associated with its defects when it decides how many units

to produce.

Some observers point to another shortcoming of liability

rules: by compensating victims for pain, suffering, and

other nonpecuniary losses, those rules provide a kind of

excessive and unwanted insurance that distributes risk

inefficiently. (That issue applies less strongly to negligence,

to the extent that injurers are able to avoid paying damages

by meeting the standards of due care.)7

The argument is that pecuniary losses such as medical

expenses and lost income increase a victim’s need for

money (technically, the marginal utility of an additional

dollar), but nonpecuniary losses do not and hence are not

worth insuring against. Persuasive evidence for this argument is the fact that insurance policies bought directly

by consumers typically do not cover events such as the

death of a young child. Notwithstanding the great suffering they would feel, consumers apparently do not find

it worthwhile to buy coverage that reduces their wealth

now (by the amount of the insurance premium) in order

to increase it in the event of such a loss. But liability

awards for pain and suffering shift wealth in precisely that

fashion—the prices that a firm charges for its goods and

services reflect the future liability claims it expects to pay

on them, and thus consumers fund the awards through

higher prices that reduce their preinjury wealth. Whether

such shifts are equitable depends on subjective judgments

(on the one hand, they help compensate victims; on the

other hand, they benefit a few at the expense of the many).

Nevertheless, they do appear to distribute risk inefficiently.8

Liability Rules in Practice

The efficiency of liability rules is restricted not only by

theoretical limitations but also by practical problems. The

most obvious such problem is the transaction costs of the

legal system—particularly, the costs of plaintiffs’ and defendants’ lawyers. Underlying that problem is the fundamental issue that information (in this case, information

about the cause of a tort injury) is generally incomplete

and costly to acquire. The lack of complete information

allows room for disagreement between plaintiffs and

defendants and encourages attorneys to expend effort to

unearth and document additional information favorable

to their case.

Incomplete information also allows errors to occur. Some

torts go unchallenged, unjudged, or undercompensated;

conversely, some defendants pay claims for losses for

which they were not truly liable or in excess of the harm

they caused. For example, one study of medical malpractice torts found that only 1.5 percent of people classified

as likely victims of medical error sued and that relatively

few of those who did sue appeared to have legitimate

7. In principle, if potential injurers are able to avoid liability under

a negligence standard, then consumers face the opposite problem

of being underinsured against the risks of pecuniary losses. Consumers can solve that problem, however, by buying their own insurance to achieve the desired level of protection.

8. Note, however, that failing to incorporate the expected costs of

nonpecuniary losses into the price of a good or service would not

be efficient either. The risks of pain and suffering associated with

an item are real components of its cost and should be reflected in

its price; otherwise, consumer demand for the item may be inefficiently high. Ideally, potential victims would make their decisions about consumption on the basis of an item’s full cost but

would receive some kind of payment to mitigate the impacts of

the nonpecuniary costs on their wealth. One proposed mechanism

for doing that—known as unlimited insurance subrogation—is

discussed in Chapter 5.
CHAPTER THREE TORT LIABILITY AS A TOOL FOR ACHIEVING EFFICIENCY AND EQUITY 15

claims.9 Such errors reduce the equity of the liability

system. They may also reduce its efficiency (as discussed

more fully below) by prompting potential injurers to

overspend or underspend on precautions or to try to avoid

liability in ways that do not reduce the actual risk of

injuries.

Concerns about such errors underlie much of the debate

about punitive damages. One efficiency-based rationale

for punitive damages is that they serve an important corrective role for torts that have a significant probability of

going undetected. Potential injurers who expect to be held

liable only one-third of the time will not have efficient

incentives to exercise care unless they expect to pay treble

damages on the occasions when they are held responsible.10

Conversely, punitive damages may reduce efficiency if they

do more to create errors than to correct them. Critics argue that punitive damages are awarded arbitrarily, at the

whim of juries not guided by any clear or coherent standards, and are often erroneous. As evidence, they cite cases

in which the punitive damages were tens or hundreds of

times larger than the compensatory damages or were

awarded even though the injurer had good reason to

believe that it was not negligent (in other words, that its

behavior satisfied a relevant standard of due care). Whether

such criticisms are valid for only a few cases or for punitive

damages in general is an open question in need of further

study.11

Errors—and information problems more broadly—also

underpin much of the debate about the class-action procedure. By combining many claims that cover similar factual ground, that procedure reduces transaction costs that

could otherwise make it impractical for plaintiffs to pursue

claims that may be large as a whole but are small individually. However, critics argue that class actions are susceptible to erroneous judgments—in part because plaintiffs’ attorneys have wide latitude to bring them in certain

courts that are thought to be biased against out-of-state

corporate defendants—and that such errors can have nationwide implications. In some cases, plaintiffs’ attorneys

may be able to leverage the possibility of such errors to

achieve lucrative settlements of even frivolous claims, if

defendants are sufficiently averse to risk. Also, because class

members may have little incentive or opportunity to exercise effective oversight, plaintiffs’ attorneys in such cases

may pursue settlements that benefit them but are not in

the best interest of their clients.12

A final problem associated with limited information is

the difficulty of setting the standard of due care in a negligence rule at an efficient level. Courts often defer to a

community’s customary standard of care in defining negligence, and a custom that has stood the test of time in

a competitive market may be a good approximation of

the efficient solution.13 But customary standards may be

hard to apply or nonexistent in cases of new risks or new

products. Moreover, any general rule may not be detailed

9. Those findings were based on an analysis of 30,000 medical records

from New York State in 1984; see A. Russell Localio and others,

“Relation Between Malpractice Claims and Adverse Events Due

to Negligence,” New England Journal of Medicine, vol. 325 (July

25, 1991), pp. 245-251. The analysis showed that only 14 percent

of claimants appeared to have legitimate cases; however, that percentage was based on a limited sample (47 claims).

10. In principle, punitive damages could also improve efficiency by

correcting for compensatory awards that do not fully reflect the

amount of harm done. In practice, however, cases in which large

punitive damages are awarded also tend to involve large compensatory awards.

11. The most directly relevant empirical study to date examined the

occurrence of punitive damages in a year’s worth of trials from 45

of the nation’s 75 largest counties. It found a strong statistical

relationship between the level of punitive damages, when awarded,

and the level of compensatory damages, but it did not attempt to

identify factors that would explain which cases (of a given type)

yielded awards for punitive damages and which did not. Thus, the

study left unresolved the question of whether the decision to award

punitive damages is arbitrary. See Theodore Eisenberg and others,

“The Predictability of Punitive Damages,” pp. 623-661, and A.

Mitchell Polinsky, “Are Punitive Damages Really Insignificant,

Predictable, and Rational? A Comment on Eisenberg et al.,” pp.

663-677, both in Journal of Legal Studies, vol. 26, no. 2 (June

1997).

12. Deborah R. Hensler and Thomas D. Rowe Jr., “Beyond ‘It Just

Ain’t Worth It’: Alternative Strategies for Damage Class Action

Reform,” Law and Contemporary Problems, vol. 64 (Spring/Summer

2001), available at www.law.duke.edu/journals/lcp/articles/lcp64d

SpringSummer2001p137.htm.

13. The presumption that customary standards of care are relatively

efficient does not apply to stranger injuries, such as automobile

accidents, which occur outside any market context.
16 THE ECONOMICS OF U.S. TORT LIABILITY: A PRIMER

enough to take into account the specific opportunities and

constraints facing each potential injurer and potential victim and thus may set the bar too high for some and too

low for others.

Should Tort Rules Be Set 

at the Federal or State Level?

Although tort cases are primarily governed by state law,

the Congress has broad Constitutional authority to change

tort rules under its power to regulate interstate commerce.14 Federal intervention in tort law can have two

main benefits. First, it can lower costs by giving manufacturers and other nationwide businesses a single set of

standards under which to operate. Advocates of greater

federal involvement argue that state preeminence may have

been appropriate when most goods were produced locally,

but it is inefficient now that firms typically manufacture

products in a few locations to sell nationally. Second,

whereas state legislatures and courts have an incentive to

favor state residents, and thus to design or interpret their

legal rules to benefit in-state plaintiffs at the expense of

out-of-state defendants, the federal government can potentially take the broad view (in economic terms, “internalize

the externality”) and craft rules that take equal account

of the interests of all parties nationwide.

Supporters of a more decentralized approach argue that

federal involvement in state tort law may not provide equal

treatment of all costs and benefits. Rather, it may reflect

concentrations of political influence, which can tilt toward

plaintiffs at one time and defendants at another. In that

view, maintaining state preeminence in tort law reduces

the risk of nationwide errors in policy. It also allows

greater scope for state innovation and experimentation

and a wider range from which people can choose the type

of liability regime that appeals to them—one with more

extensive protection of injured parties or one with lower

costs for businesses (and hence, presumably, lower prices

for consumers).

Tort Liability Versus 

Insurance and Regulation

As noted above, tort liability is only one of the tools that

society uses to try to supplement market mechanisms, such

as contracts and private insurance. Other tools are regulation and public compensation programs (such as the

workers’ compensation system). All of those policy tools

have strengths and weaknesses—as do markets—so using

them in combination may be beneficial. However, the

interactions among different tools and the market can be

complex and even counterproductive.15

The interplay between liability and private insurance is

perhaps the most complicated. From the point of view

of potential victims, tort liability acts as a partial substitute

for their own insurance—the more comprehensive the

set of injuries for which they receive tort damages, the

fewer the injuries ultimately compensated by their own

coverage. Conversely, from the perspective of potential

injurers, liability increases uncertainty, leading many of

them to buy liability insurance to control that uncertainty.

The extensive use of such insurance makes analyzing the

efficiency of tort liability more complicated, because it

may undermine potential injurers’ incentives to exercise

care. The degree to which it does so hinges on the precautions (if any) that insurance companies require as a condition for providing coverage and also on the thoroughness

of their underwriting. The more they tailor their premiums to policyholders’ specific practices or experiences, the

more incentive potential injurers still have to take costeffective precautions.

The interactions between liability and regulation are perhaps less complex—but in that case also the two can be

14. For a discussion of that general authority and some exceptions to

it, see Henry Cohen, Federal Tort Reform Legislation: Constitutionality and Summaries of Selected Statutes, CRS Report for Congress

95-797A (Congressional Research Service, updated May 2, 2003).

15. The relative use of those different policies varies significantly among

countries. The United States relies more heavily on tort liability

than 11 other industrialized nations do, judging from the estimated

shares of gross domestic product that those countries spend on their

tort systems; see Tillinghast-Towers Perrin, U.S. Tort Costs: 2000—

Trends and Findings on the Costs of the U.S. Tort System (February

2002). The different policy mixes may reflect underlying differences

in national conditions (such as in the homogeneity or diversity of

the industrial sector) and values (such as in conceptions of equity

or willingness to trade equity for efficiency).
CHAPTER THREE TORT LIABILITY AS A TOOL FOR ACHIEVING EFFICIENCY AND EQUITY 17

complements as well as substitutes.16 In particular, tort

lawsuits can be used as a private mechanism for enforcing

regulations, particularly when government agencies lack

the resources to monitor compliance or prosecute violations themselves. Such lawsuits may be explicitly authorized by statute, as in the case of some civil rights laws.

Alternatively, judges may decide that tort claims are an

appropriate means by which to carry out the intent of

particular statutes. For example, a court may allow a tort

claim of deceit under a statute that makes it a crime to

roll back an automobile’s odometer.17

As alternatives to each other, regulation is a more centralized policy tool than liability is. The centralized approach

may be more or less efficient for particular classes of injuries—on the one hand, it tends to have lower transaction

costs; on the other hand, the regulations it produces can

only be as good as the information available to the central

decisionmakers. Whereas tort claims arise after specific

injuries occur, efficient regulation requires before-the-fact

information about risks of injury, types of precaution, and

the costs and benefits associated with particular regulatory

standards. In addition, the more diverse that a given group

of potential injurers is, the greater the amount of information that will be necessary to craft regulations that appropriately reflect the group’s various circumstances. In

practice, the efficiency of regulations can also be lessened

by political factors, such as pressure from interest groups

or excessive influence from the regulated entities.

16. For a more extensive discussion of the potential complementarities

and conflicts, see Susan Rose-Ackerman, “Product Safety Regulation and the Law of Torts,” in Janet R. Hunziker and Trevor O.

Jones, eds., Product Liability and Innovation: Managing Risk in an

Uncertain Environment (Washington, D.C.: National Academies

Press, 1994), pp. 151-158, available at www.nap.edu/openbook/

0309051304/html/151.html.

17. For a discussion, see American Law Institute, Restatement of the

Law Second, Torts (Philadelphia: ALI, 1979), section 874A.

4

The Costs of the Tort System

The efficiency of the tort system is difficult to measure because information about its benefits is so sparse.

In particular, data on the damages avoided because of

additional precaution are not readily available. Some costs

associated with tort liability have been measured, however,

and can be used in a limited evaluation of the costeffectiveness of tort liability as a mechanism for compensating victims. Understanding the nature and magnitude

of tort costs can also help policymakers identify options

that would tend to control those costs while enhancing

the benefits of the tort system.

Defining the Costs of Tort Liability

The most easily measured “costs” of the liability system

are its direct costs—that is, those incurred by plaintiffs,

defendants, and their insurance companies in litigating

and settling specific claims, as well as the court costs that

are ultimately paid by taxpayers. For the purposes of policy

analysis, however, that measure of costs is too large in one

respect and too small in another.

It is too large in that some direct “costs” merely shift

money from injurers to victims and thus are not true costs

to society as a whole. In economic terms, payments that

do not involve any use of resources to produce goods or

services are called “transfer payments.” Those that do involve using resources for production are known as “real

resource costs” (also “social costs” or simply “costs”). Specifically, the portion of a settlement or judgment that goes

to the plaintiffs is a transfer payment. The portion that

goes to the plaintiffs’ attorneys, in contrast, is a real cost

because it reflects the value of the resources (attorneys’

time, office space, equipment, and so on) devoted to that

case and thus not available for other uses.1

Conversely, measures of direct costs are too small for policy purposes in that they naturally exclude indirect costs—

those associated not with specific claims but with actions

that businesses and consumers take or forgo because of

the incentives of the liability system as a whole. Indirect

costs include various kinds of real resource costs, such as:

# The costs of precautions taken by potential injurers,

# The opportunity costs (forgone value) of goods and

services that potential injurers withdraw from the

market or do not create because of liability concerns,

# The opportunity costs of goods and services that consumers do not buy because of liability-induced price

increases, and

1. The statement that all legal costs are real resource costs assumes

that lawyers’ services are priced correctly in the market. To the

extent that legal fees are kept artificially high by some market

imperfection or governmental interference, they include both

resource costs and transfer payments.

CHAPTER
20 THE ECONOMICS OF U.S. TORT LIABILITY: A PRIMER

# The disruption costs of layoffs and bankruptcies

caused by liability problems.2

Indirect costs are not necessarily bad: from the perspective

of efficiency, the question is whether they yield benefits

larger than the costs.

Evidence About the Costs 

of the Tort System

The most comprehensive estimates of tort liability costs

—which cover only direct costs—come from studies by

Tillinghast-Towers Perrin, an actuarial and management

consulting firm.3

 Those estimates take advantage of the

fact that most tort costs are paid through the insurance

industry, in the form of legal costs to defend policyholders,

benefits paid to victims and their attorneys on behalf of

policyholders, and internal costs for handling claims.

Thus, Tillinghast uses financial data from the insurance

industry to estimate insured costs for all types of policies

except medical malpractice insurance. (Those costs are

estimated separately using the firm’s proprietary database

of state-level costs, controlling for the changing mix of

insured versus self-insured providers.) Finally, Tillinghast

estimates self-insured costs (again, except for medical malpractice) on the basis of various specialized studies. Because of a lack of data, the estimates exclude awards and

settlements that cannot be insured in particular states (such

as those for contract and shareholder litigation or for

punitive damages) and certain extraordinary self-insured

costs, such as those of the tobacco settlements.4

By that definition of costs, the U.S. tort system cost a total

of $205.4 billion in 2001, Tillinghast estimates. That

figure represented 2.04 percent of gross domestic product—the largest share among the 12 industrialized countries that Tillinghast investigated.5

 Of that amount, 46

percent constituted transfer payments to plaintiffs: 22

percent for economic damages and 24 percent for noneconomic damages. The other 54 percent represented true

costs: transaction (procedural) costs for plaintiffs’ attorneys

(19 percent), defense costs (14 percent), and insurance

companies’ administrative costs (21 percent).6

Estimates for most of the indirect costs of the tort system

do not exist—which is not surprising given that many of

those costs are difficult to observe. For example, even firms

that keep track of their safety-related spending would

probably have trouble identifying the share driven by tort

liability rather than by regulation or other factors. One

notable exception to the lack of estimates of indirect costs

comes from a recent study released by the U.S. Chamber

of Commerce, which estimated that asbestos liabilities

have caused $0.6 billion to $2.1 billion in disruption costs

from bankruptcies and layoffs.7

Are Tort Costs Excessive?

Costs can be considered excessive if they do not contribute

positively to either efficiency or equity. Even transfer payments may be excessive costs in that sense. Although transfers do not use real resources directly, the incentives they

provide can have real costs that reduce efficiency. In addition, transfers that are arbitrary or otherwise unfair can

reduce equity.

2. Indirect costs may also include transfer payments, but this discussion focuses only on real resource costs.

3. Tillinghast-Towers Perrin, U.S. Tort Costs: 2002 Update—Trends

and Findings on the Costs of the U.S. Tort System (2003).

4. The estimates also omit courts’ administrative costs, but those are

thought to be relatively small. An estimate from the RAND Institute for Civil Justice cited by Tillinghast-Towers Perrin puts those

costs at 1 percent of total direct costs.

5. Tillinghast-Towers Perrin, U.S. Tort Costs: 2002 Update. In its

previous report, dated February 2002, Tillinghast included estimates of tort costs in other countries. That report stated that in

2000, tort costs equaled 1.9 percent of gross domestic product in

the United States, compared with 1.7 percent in Italy and 1.3 percent in Germany—the next two closest countries. 

6. Administrative costs are insurance companies’ overhead expenses.

Tillinghast says it includes those expenses because they are “real

costs, directly associated with administering the settlement of tort

claims.”

7. Jesse David, The Secondary Impacts of Asbestos Liabilities (prepared

by NERA Economic Consulting for the U.S. Chamber of Commerce, January 23, 2003), available at www.legalreformnow.com/

resources/012303secondary.pdf.
CHAPTER FOUR THE COSTS OF THE TORT SYSTEM 21

The Efficiency of the Tort System 

as a Mechanism for Compensation

On the question of whether tort costs contribute to efficiency—which is the focus of economic analysis—the

available data allow a partial conclusion: even leaving aside

the largely unknown indirect costs, the current tort system

seems to be an inefficient way to compensate victims. As

noted above, Tillinghast estimates that only 46 percent

of the total direct costs of the tort system go to victims

in the form of economic and noneconomic damages; 54

percent go to transaction costs. By comparison, in the nofault compensation systems for on-the-job and vaccinerelated injuries, administrative costs make up only about

20 percent and 15 percent of total costs, respectively.8

Those comparisons are not entirely apt, however. The administrative costs of those compensation systems exclude

spending on claimants’ attorneys—which has reportedly

grown in the workers’ compensation system as the regulations governing it have become more complex. Moreover, linking injuries to particular injurers (so their premiums can be adjusted to reflect their own track record,

as the workers’ compensation system does) would be more

difficult with torts in general. Nonetheless, given the large

percentage differences between the tort liability system

and no-fault compensation systems, it seems safe to conclude that the tort system costs more than does an available alternative method of compensating victims.

Some types of torts clearly have little impact on deterring

injuries; virtually their entire value to society is as a mechanism for compensating victims. Asbestos torts are an

example: the injurious actions generally took place decades

ago, and asbestos is now in limited use (as a combined

result of litigation and government regulation), so today’s

cases serve no role in deterring additional asbestos injuries.

The same reasoning applies to any torts that deal with

injuries whose source was unknown at the time.9

 For such

torts, liability costs are indeed inefficient.

The Efficiency of the Tort System 

as a Mechanism for Deterrence

In the more typical case of torts that are intended to provide deterrence as well as compensation, economists have

not reached a consensus about whether costs are efficient.

The tort system may conceivably improve efficiency, despite its high transaction costs, if it is particularly effective

in reducing the number and severity of injuries. Such effectiveness has not been demonstrated, however.

One key issue is the relationship between actual costs to

victims and the liability costs that are faced by injurers.

In a situation in which potential injurers anticipate paying

an extra dollar for every additional dollar of injuries or

transaction costs they cause, they have the right incentive

to take cost-effective steps to reduce future costs.

However, potential injurers may expect to pay more or

less than one extra dollar in liability for each additional

dollar of social costs they cause. If liability awards exceed

actual injury losses—for example, because of punitive

damages—potential injurers may be motivated to overspend on precaution (provided they can identify enough

promising ways to do so). As an example, suppose a firm

expects to pay two dollars in liability for every dollar of

actual social costs it produces. In that case, it will perceive

investments in precaution to be twice as valuable as they

are to society as a whole, and thus it will have an incentive

to spend up to two dollars for every additional dollar in

actual costs saved. All of the spending that returned less

than one dollar per dollar from society’s standpoint would

reduce the net savings from precaution, making it less

likely that tort costs on the whole were efficient. Ironically,

the inefficiency associated with excessive precaution may

result in increased risk. For instance, drug manufacturers

may withdraw or withhold otherwise valuable medicines

8. Those numbers are CBO’s calculation of the proportion of

employers’ costs that are not paid out in workers’ compensation

benefits, using data from Cecili Thompson Williams, Virginia P.

Reno, and John F. Burton Jr., Workers’ Compensation: Benefits,

Coverage, and Costs, 2001 (Washington, D.C.: National Academy

of Social Insurance, July 2003), and CBO’s calculation of administrative costs divided by new obligations for the Vaccine Injury

Compensation Program Trust Fund, using data from Budget of

the United States Government, Fiscal Year 2004: Appendix, p. 409.

9. Suits over asbestos and other “hindsight torts” could conceivably

help deter future injuries associated with other products by serving

as cautionary examples. But once the example was well established,

as seems likely with asbestos, any further suits would have negligible

value as additional deterrents.
22 THE ECONOMICS OF U.S. TORT LIABILITY: A PRIMER

from the market, and physicians may withdraw their

services.10

Efficiency may also suffer if potential injurers find ways

to reduce their liability exposure without reducing the

actual risk of injury. Such avoidance efforts typically have

real resource costs but do not add to the social benefits

of tort liability. That problem arises from errors in assigning liability: if injurers were held responsible for all of (and

only) the injuries that they truly caused, they would have

no opportunities to reduce expected liability costs without

reducing actual risks. A commonly cited example is “defensive medicine,” in which medical professionals conduct

low-value procedures in hopes of avoiding the costs and

stigma of being sued.11

Finally, if potential injurers expect to pay less than one

dollar in liability costs per dollar of additional social costs

—or, more to the point, expect to save less than one dollar

per dollar of reduced social costs—they will have too little

incentive to take preventive action. That situation may

occur if liability judgments have a significant arbitrary

component, if avoidance efforts succeed in obscuring injurers’ roles in causing some losses, or if injurers insure

their liability costs and the premiums they pay do not fully

reflect their injury record. Underinvestment in prevention

can even arise from perverse incentives that associate increased care with higher liability costs—as in the case of

a company that refrains from researching ways to make

its products safer lest it create a paper trail of safety-related

data that could be used against it in court.12 Whatever the

cause, underinvestment in prevention has the same effect

on efficiency as overinvestment: the net savings from precaution are lower than they would be in the ideal case

(here, because some worthwhile opportunities are neglected), and thus they are less likely to outweigh the other

costs of the liability system.

The Efficiency and Equity of Nonpecuniary Damages

Critics of the tort system have particularly questioned the

deterrence benefits of nonpecuniary damages (punitive

awards and compensatory awards for pain and suffering).

They argue that large nonpecuniary damages cannot provide useful incentives for precaution because they are

awarded in a subjective, arbitrary, and unpredictable way,

with little connection to the actual harm or, in the case

of punitive damages, to the character of the injurer’s conduct. In that view, such awards are inequitable as well as

inefficient. Indeed, the Supreme Court has ruled that

punitive damages violate the Due Process Clause of the

Constitution if they are not “both reasonable and proportionate to the amount of harm to the plaintiff and to the

general damages recovered.”13

The accuracy of that characterization of nonpecuniary

damages is a matter of some debate. Supporters of the

status quo argue that large awards for punitive damages

can promote efficiency by sending appropriate signals for

precaution in regard to torts that have a significant proba10. Whether or not potential injurers overreact (they may not if they

lack effective opportunities to reduce their liability), excessive

awards can increase risk in a second way: through decreased consumption of risk-reducing goods and services, such as medical care.

Consumption of such goods and services is likely to decline as their

prices are driven up by liability costs or as price increases for products in general leave consumers with less real income.

11. Most of the available evidence about defensive medicine comes

from anecdotes or conjectural surveys of practitioners. That evidence does not rule out doctors’ own financial incentives under

fee-for-service payment systems as an alternative explanation for

“unnecessary” tests. However, Daniel Kessler and Mark McClellan

have shown that passage of state laws limiting liability for doctors

led to lower spending for certain heart procedures. See Kessler and

McClellan, “Do Doctors Practice Defensive Medicine?” Quarterly

Journal of Economics, vol. 111, no. 2 (May 1996), pp. 353-390.

In addition, Lisa Dubay and coauthors found in one study that

areas with a high risk for medical malpractice claims tended to have

a higher incidence of cesarean births, but without significantly

better birth outcomes. In another study, they found a lower incidence of prenatal care in areas with a high risk for medical malpractice claims. See Dubay and others, “The Impact of Malpractice

Fears on Cesarean Section Rates,” Journal of Health Economics, vol.

18 (1999), pp. 491-522, and “Medical Malpractice Liability and

Its Effect on Prenatal Care Utilization and Infant Health,” Journal

of Health Economics, vol. 20 (2001), pp. 591-611.

12. See François J. Castaing, “The Effects of Product Liability on

Automotive Engineering Practice,” in Janet R. Hunziker and Trevor

O. Jones, eds., Product Liability and Innovation: Managing Risk

in an Uncertain Environment (Washington, D.C.: National Academies Press, 1994), pp. 77-81, available at www.nap.edu/openbook/

0309051304/html/77.html.

13. State Farm Mut. Automobile Ins. Co. v. Campbell, 538 U.S. ___

(2003).
CHAPTER FOUR THE COSTS OF THE TORT SYSTEM 23

bility of escaping detection and judgment. Moreover, they

say, large punitive damages can serve equity by punishing

egregious behavior on the part of large injurers. Supporters

further argue that noneconomic losses such as pain and

suffering are as real as economic losses (albeit harder to

quantify), so setting artificial limits on awards for such

losses may undercompensate some injury victims and may

produce some product prices that are inefficiently low

because they do not fully reflect the products’ true risks.

Economists have tried to shed empirical light on the

question of the efficiency of tort costs, focusing primarily

on punitive damages. However, the limited data have not

yielded a compelling answer. A 1998 study investigated

the deterrent effects of punitive damages by comparing

the four states that prohibit such damages with the 46

states (and District of Columbia) that allow them. The

study found no statistically significant differences in deterrent effects—and in many cases, differences of the “wrong”

sign—for more than a dozen indicators of environmental

and safety risks.14 The author of the study posited two

arguments to explain the lack of an effect: that punitive

damages are awarded too randomly to influence behavior,

and that federal regulations and market forces other than

liability are stringent enough to leave no room for additional deterrence. However, two follow-up papers suggested that the statistical results of that study could merely

reflect limitations of the data. Those papers argued that

four states do not provide a strong basis for comparison

and that punitive damages could be serving their intended

purpose of deterring the most egregious torts—which by

definition are relatively rare—without having a discernable

impact on overall injury rates.15

Conclusions

In short, the current state of data and economic analysis

do not allow CBO to judge whether the costs of the tort

system are efficient or excessive on the whole.16 What is

clear, however, is that those costs are large enough to be

significant for the U.S. economy. That fact helps raise the

question of whether changes to the current tort system

could reduce the system’s costs without undermining its

benefits.

14. The indicators included toxic-chemical accidents, toxic-chemical

accidents involving injury or death, reductions in releases of toxic

chemicals (to surface waters and to all media), total deaths, “medical

misadventure deaths,” total insurance premiums, and premiums

for medical malpractice, product liability, and other liability. See

W. Kip Viscusi, “The Social Costs of Punitive Damages Against

Corporations in Environmental and Safety Torts,” Georgetown Law

Journal, vol. 87, no. 2 (November 1998), pp. 285-345.

15. Theodore Eisenberg, “Measuring the Deterrent Effect of Punitive

Damages,” pp. 347-357, and David Luban, “A Flawed Case Against

Punitive Damages,” pp. 359-380, both in Georgetown Law Journal,

vol. 87, no. 2 (November 1998).

16. A 2002 report by the President’s Council of Economic Advisors

investigated the burden of liability costs on the economy, but it

did not provide new information about the incentive effects of tort

liability. Rather, the report sketched three alternative scenarios,

each of which assumed that certain categories of the direct costs

estimated by Tillinghast have no impact on the behavior of potential injurers and are thus “excessive.” See Council of Economic Advisors, Who Pays for Tort Liability Claims?: An Economic Analysis

of the U.S. Tort Liability System (April 2002).

5

An Overview of Policy Options

for Changing the Tort System

Various scholars and policy advocates have proposed

altering the tort liability system to reduce what they see

as excessive transaction costs and other problems associated

with it. Those proposals are too numerous for all of them

to be discussed here. Instead, this chapter examines a

number of policy options to illustrate the range of choices

available to lawmakers. The chapter outlines each option’s

potential implications for efficiency and equity. For reasons of space, however, it cannot analyze any one option

in full detail. (For example, it does not consider the effects

on state law or the potential transition problems associated

with a particular change, nor does it discuss the many

possibilities for combining policies that are not mutually

exclusive.) 

The options discussed here can be grouped according to

their general approach. The first approach would greatly

reduce the scope of the tort system and rely more heavily

on other tools to control the costs of injuries. The second

group contains options that are more incremental in nature but that could be applied broadly to the universe of

torts. The final set comprises options targeted toward types

of tort claims that have raised particular policy concerns,

such as claims arising from medical malpractice or asbestos

exposure and those litigated as class actions.

In all three groups, most of the proposals can be seen as

addressing one or more of the fundamental barriers to

efficiency discussed in Chapter 3:

# The difficulty of giving both potential injurers and

potential victims incentives to choose the efficient

form and scale of their risk-related activities;

# The added difficulty of optimally distributing (insuring) the risks that remain after efficient precautions

have been taken; and

# Problems relating to the cost and scarcity of information, including transaction costs, errors in judgments and in settlements, and inefficient standards

for due care. 

Other options respond to issues that arise from broader

aspects of the legal system, such as the perceived problem

that some locally elected judges are biased against out-ofstate corporate defendants.

Options for Reducing the Scope 

of Tort Liability

The policy changes in this group—which involve replacing

some or all types of tort liability with private or public

insurance—generally go well beyond the kinds of proposals now being considered by the Congress. They are

included here because they help clarify the strengths and

weaknesses of the tort system or provide useful comparisons with other options.

CHAPTER
26 THE ECONOMICS OF U.S. TORT LIABILITY: A PRIMER

Replacing Tort Liability with Private Insurance

Some academic economists favor the approach of eliminating tort liability, except perhaps for injuries between

“strangers” (such as injuries from automobile accidents).1

Potential victims would rely to a greater extent on their

own insurance for protection against injury risks. In cases

in which potential injurers could cost-effectively reduce

those risks, they would be motivated to do so to the extent

that they could gain a marketing advantage—by advertising the safety of their products or by offering injury

compensation in a warranty, purchase contract, or the

like.2

 Some increases in government regulation might also

occur.

From the standpoint of efficiency, eliminating tort liability

would have several desirable implications, although it

would fall short of the ideal. It would give potential victims the incentive to take all cost-effective precautions and

to obtain the optimal amount of risk spreading through

insurance or other compensation contracts. And provided

that the insurance and contract terms were clear enough,

the amount of litigation would decline significantly, reducing both transaction costs and the inefficiencies associated with erroneous judgments. However, this approach

would weaken incentives for potential injurers to exercise

cost-effective forms of care (at least those not required by

regulation) and could increase inefficiencies associated

with imprecise or too-stringent regulation.

From the standpoint of equity, the implications of shifting

primary responsibility for injury costs to victims could

be considered both good and bad. Lower liability-related

costs for businesses should lead to lower prices for many

consumer goods and services and reduce the extent to

which consumers are implicitly forced to pay for unwanted

insurance for nonpecuniary damages. But victims would

usually get compensation only for pecuniary losses, and

those who had not bought insurance might get no compensation at all. Moreover, injurers would pay compensation only to the extent that they had contracted in advance to do so, and in cases of subtle, delayed, or indirect

harm, some injurers’ roles might go undetected because

few, if any, plaintiffs’ attorneys would be working to identify the causes of injuries.

A narrower variant of the same basic idea would eliminate

liability only for those products (or features of products)

that have been certified as safe by a federal body, such as

the Food and Drug Administration, the National Highway

Traffic Safety Administration, or the Consumer Product

Safety Commission. Many of the arguments for and

against completely eliminating tort liability would apply

here as well, at least qualitatively. For example, the same

efficiency and equity implications would follow from

making consumers bear the risk of using the relevant products. The main immediate difference from the standpoint

of efficiency is that focusing on products that satisfied federal safety regulations would presumably limit the extent

of any increase in injury risks. From the perspective of

equity, removing the threat of liability from firms whose

products met federal standards might be particularly appropriate. Over time, however, this variant could result

in a greatly expanded role for federal regulators—with potentially significant consequences for both efficiency and

equity—as firms and industries seeking to exempt their

products from liability pushed to broaden the scope of

federal safety standards.

Replacing Tort Liability with Public Insurance

Another variant of the previous approach would eliminate

(or greatly restrict) tort liability as described above but

replace it with a public insurance system, like the present

workers’ compensation system or the fund for vaccine victims. In this option, victims would receive compensation

from a government fund according to a fixed schedule

based on the type of injury they had and other relevant

factors.3

 To finance the fund, businesses would pay

“experience-rated” premiums that reflected the previous

record of injuries associated with their products. (Companies would ultimately pass on the costs of those premiums to their customers, workers, or investors in the form

of higher prices, reduced wages, or lower returns on capi1. See, for example, Paul H. Rubin, Tort Reform by Contract (Washington, D.C.: American Enterprise Institute, 1993).

2. Contracting in advance for compensation is not possible between

parties that had no previous contact or relationship, which is one

argument for maintaining tort liability for stranger injuries.

3. Public insurance funds have also been proposed in narrower contexts; an option that focuses on asbestos injuries is discussed later

in this chapter.
CHAPTER FIVE AN OVERVIEW OF POLICY OPTIONS FOR CHANGING THE TORT SYSTEM 27

tal, respectively.) Depending on the details of the proposal,

nonprofit organizations and state and local governments

might also participate. But cost considerations would

probably make it impractical to rate and collect premiums

from individuals, so the injuries they caused might still

be handled through the tort system.

Proponents of this variant hope that by standardizing the

amount of compensation awarded for similar injuries, this

approach would cap or reduce punitive damages and compensatory awards for pain, suffering, and other nonmonetary losses. The effects of reducing such nonpecuniary

awards would be qualitatively similar to (though not as

large as) the effects of simply eliminating tort liability.

Again, potential victims would have better incentives to

take efficient precautions, and risk would be distributed

more efficiently (because consumers would not be implicitly paying for so much unwanted insurance for nonpecuniary damages). However, some injurers might not face

sufficient penalties, and some victims might not receive

full compensation for their pain and suffering.

Other implications of the public insurance approach flow

from its shift away from litigation to an administrative

mechanism. For example, one key argument made for the

approach is that it would significantly reduce transaction

costs from the 54 percent estimated under the current tort

system. (However, transaction costs would probably

remain higher than the 20 percent estimated for state

workers’ compensation programs because of higher costs

for such things as determining which injuries were compensable and associating injuries with particular injurers.)

Conversely, one argument against public insurance is that

the schedule of damages might not do justice to individual

cases. Another is that in some cases of subtle, indirect, or

delayed harm—such as cancers with long latencies caused

by exposure to a particular chemical— victims might not

recognize that they had suffered a compensable injury,

since there would be few, if any, plaintiffs’ attorneys

working to identify injury causes. In addition, this option

would represent a sharp departure from current practice

for injuries that are judged under a negligence standard.

Providers of medical care, for example, are now held liable

only for injuries considered to result from negligence; but

with this option, all compensable injuries to patients under

their care would be reflected in their assessed premiums

for the public fund.

The incentives for potential injurers to exercise care might

be more or less efficient under a public insurance program

than they are now. For a firm to be encouraged to take

all cost-effective precautions, its assessed premiums would

need to reflect all of the effects of its actions on expected

future injury costs, and the experience rating would probably not be that thorough. However, even if the new incentives fell on the low side, the error could be smaller

than it is now if current incentives are inefficiently high

because of mistaken or excessive trial awards.

Options for Reforming 

the Tort System as a Whole

Changes that would maintain the basic structure of the

tort system can take many forms. The options discussed

here focus on nonpecuniary damages, attorneys’ fees, jointand-several liability, and payments from “collateral

sources,” such as victims’ insurance policies. (Those options are summarized in Table 3.) All of the policy changes

could be applied to the broad universe of tort claims or,

alternatively, to one or more subsets of particular concern.

Controlling Nonpecuniary Damages

As noted above, one goal of people who advocate public

insurance as an alternative to tort liability is to control

nonpecuniary damages. That goal can be achieved in other

ways, however—most directly, through statutory limits

or bans on those damages. Many states impose such restrictions, either in general or for particular types of torts.

In addition, several federal bills considered in recent years

have proposed limits in specific contexts. Examples from

the current Congress include the Asbestos Compensation

Fairness Act of 2003 (H.R. 1586), which would prohibit

punitive damages in asbestos cases, and the HEALTH Act

of 2003 (H.R. 5) and the Common Sense Medical Malpractice Reform Act of 2003 (H.R. 321), which would

limit noneconomic compensation in medical malpractice

cases to $250,000 and punitive damages to twice the economic damages or $250,000, whichever was greater.

A second, less centralized way to reduce nonpecuniary

damages would be to allow producers of goods and services to specify in advance the extent of damages they

would pay in the event of an injury. Products carrying

limits on damages could be offered at lower prices (because
28 THE ECONOMICS OF U.S. TORT LIABILITY: A PRIMER

Table 3.

The Primary Effects of Some Broad Options for Tort Reform

Effects on Efficiency

Option Positive Negative Effects on Equity

Control Nonpecuniary 

Damages

Cap or prohibit

nonpecuniary

damages

Improves allocation of risk 

(by reducing implicit overinsurance); may reduce 

distortions of safety 

incentives if current 

damages are excessive 

or arbitrary

May undermine incentives

for care and encourage

excessive consumption of

risky products if current

damages are appropriate

Consumers are not forced to buy as

much bundled insurance for nonpecuniary losses; depending on the

character of existing damages, lower

payments by injurers may reduce 

excessive judgments or punish injurers

inadequately, and lower awards to

victims may represent inadequate 

compensation or smaller windfalls

Allow buyers and

sellers to agree in

advance to limit

liability damages

Same as above Same as above Same as above, except that incomplete

compensation to victims may be viewed

as equitable if it follows voluntary, 

informed choices by consumers

Allow unlimited

insurance

subrogation

Improves allocation of risk 

(by reducing implicit overinsurance) and incentives 

for care by consumers

No major negative effects Consumers can effectively undo the

bundled insurance for nonpecuniary

losses; injurers still pay such damages,

but the payments go to victims’ insurance companies rather than to victims

Control Attorneys’ Fees

Cap contingent

fees

Reduces nuisance suits Makes it harder for some

victims with difficult claims

to find representation

Defendants face fewer claims for both

legitimate and nuisance suits; some

victims receive cheaper representation

but others cannot find representation

Promote early 

offers and limit

fees when such

offers are made

and accepted

Reduces transaction costs 

for some cases; may 

reduce nuisance suits

May indirectly make it

harder for some victims

(though fewer than above)

to find representation if

attorneys cannot subsidize

difficult cases with profits

from easy cases

Defendants may face fewer nuisance

suits and perhaps fewer legitimate suits;

some victims receive cheaper 

representation but others(though fewer

than above) cannot find representation

(Continued)

their expected costs would be lower), and the forces of

supply and demand would determine the options available

in the market. That approach could lead to the elimination

of nonpecuniary damages for risky products—if, as argued

in Chapter 3, consumers would rather have lower prices

than actuarially fair insurance for such damages. In principle, the courts could implement this option on their

own, without legislation, by enforcing damage-limitation

contracts in injury cases. They have not done so up to

now, however (which is why producers today cannot offer

consumers lower prices in exchange for reduced liability).

Moreover, Congressional action could allow a faster and

clearer transition to the new system.4

4. Rubin, Tort Reform by Contract.
CHAPTER FIVE AN OVERVIEW OF POLICY OPTIONS FOR CHANGING THE TORT SYSTEM 29

Table 3.

Continued

Effects on Efficiency

Option Positive Negative Effects on Equity

Restrict or 

Eliminate Jointand-Several 

Liability

May reduce transaction costs 

if the inability to target

injurers with deep pockets

discourages some suits; may

make incentives for care

more or less efficient 

May increase transaction

costs if plaintiffs pursue

larger numbers of 

defendants; may make 

incentives for care more or

less efficient 

Injurers with deep pockets pay lower

damages and transaction costs; victims

get less compensation and may pay

higher transaction costs

Offset Payments

from Collateral

Sources

May reduce erroneous 

findings of liability if some

verdicts are motivated by

concern that plaintiffs need

money for their injuries

(such as for medical care)

Reduces incentives for care

to the extent that potential

injurers expect losses to be

covered by other sources

Injurers pay lower damages; victims are

not doubly compensated, nor are 

victims’ insurance companies and other 

collateral sources reimbursed for the

benefits they provide

Source: Congressional Budget Office.

The efficiency effects of letting producers and consumers

limit tort liability damages through contracts would be

similar to those of capping or prohibiting damages by statute. Again, to the extent that nonpecuniary damages were

reduced, uncertainty would be distributed more efficiently,

but lower prices for risky products would probably lead

to inefficiently high consumption unless consumers took

the risks into account in their decisions about purchases.

The equity implications of the two approaches would

differ, however. According to some conceptions of equity,

limiting victims’ access to compensation for pain and suffering is problematic if it is done by legislative fiat but not

if it results from the victims’ own choices (provided those

choices are adequately informed and voluntary).

A third option focusing on nonpecuniary damages—

known as unlimited insurance subrogation (or substitution)—would allow insurance policies to specify that the

insurance company would collect all of a liability award

or settlement paid by an injurer for an injury covered by

the victim’s policy.5

 In contrast, the limited subrogation

allowed under current law lets a company receive only the

portion of an award that is necessary to reimburse it for

benefits paid under its policy. 

Assuming that consumers continued to insure themselves

only for pecuniary losses, the result of this option would

be that insurance companies could collect more than they

paid out whenever one of their policyholders was awarded

punitive damages or compensation for pain and suffering

(or pecuniary damages in excess of the policy’s benefits).

The expected value to insurers of the net proceeds from

such cases would reduce their costs, and in a competitive

market, they would pass on the savings to consumers

through the premiums they charged. In principle, the

result for the average consumer would be to exactly undo

the inefficient “bundled” coverage for nonpecuniary damages that is implicitly included in the prices of risky goods

and services. Taking into account their savings on premiums and their restricted compensation in the event of an

injury, consumers would be paying for and receiving coverage only for pecuniary damages.

Like the previous two options, unlimited subrogation

would reduce the inefficiency associated with bundled insurance for nonpecuniary damages at the cost of reducing

the compensation received by victims. Indeed, it would

probably go farther than proposals that merely cap such

5. See David Rosenberg, Deregulating Insurance Subrogation: Toward

an Ex Ante Market in Tort Claims, Discussion Paper 395 (Cambridge, Mass.: Harvard Law School, John M. Olin Center for Law,

Economics, and Business, undated).
30 THE ECONOMICS OF U.S. TORT LIABILITY: A PRIMER

damages, by eliminating them for injuries covered under

most, if not all, insurance policies. But unlike the previous

options, it would leave injurers liable for such damages—

the difference being that the awards and settlements would

go to insurance companies rather than to victims.6

 Thus,

potential injurers would still have an incentive to consider

the full social costs of their risk-related actions, and consumers would continue to see those total costs reflected

in the prices of products. In short, the unlimited-subrogation approach would not only allocate consumers’

wealth more efficiently between the uninjured and injured

states (again, by reducing or eliminating overinsurance

for nonpecuniary damages) but would also maintain efficient incentives in product markets.

Controlling Attorneys’ Fees

Typically, plaintiffs’ attorneys in tort cases charge their

clients “contingent” fees that are based on a percentage

of any damages ultimately received from the defendants.

Like nonpecuniary damages, those fees could be constrained by law. The Congress has considered various proposals that would cap such fees in specific contexts.7

In an ideal world without errors and information costs,

attorneys would pursue only meritorious claims; thus,

from the standpoint of efficiency, restricting their incentive to do so by limiting the fees they could charge would

be unambiguously negative.8

 Proponents of such caps argue that in practice, however, the costs of inhibiting some

legitimate claims would be outweighed by the benefits

of reducing the number of “nuisance suits” (such as those

filed solely to extract settlements from defendants who

would face high litigation costs).9 From the standpoint

of equity, capping contingent fees would help some victims by letting them keep a larger share of the damages

they collected, but it could hurt other victims by reducing

their access to legal representation.

Some more-targeted versions of this approach could lessen

the negative effects. Under one variant—called the “early

offers” proposal—a plaintiff’s attorney who charged contingent fees would be required to send claim notices in

all personal injury cases; his or her fees would be capped

only if the defendant made an offer within a specified time

after receiving the claim notice and the plaintiff accepted

the offer.10 Because that variant would cap fees only in

cases for which the plaintiff’s attorney had done relatively

little work, it would be likely to reduce any adverse effect

on the ability of injury victims to find legal representation.

Still, limiting attorneys’ fees in those cases could make

it harder for attorneys to take chances on meritorious but

difficult cases that might ultimately yield them no income.

Restricting or Eliminating

Joint-and-Several Liability

For injuries caused by more than one party, the question

arises of how much liability to assign to each party. Courts

generally use one of two rules in answering that question

(although other approaches can be imagined). Under

joint-and-several liability, any one injurer or subset of

injurers can be held responsible for paying all of the damages. That individual or group often has the right to seek

reimbursement from the remaining injurers. Under several

liability, by contrast, the court determines the relative contribution of each injurer in causing the harm and holds

each one responsible for only that proportion of the dam6. This approach assumes that insurance companies could secure the

cooperation of their injured policyholders at trial. For a discussion

of that issue, see ibid., footnote 22.

7. For example, the HEALTH Act of 2003 would allow plaintiffs’

attorneys in medical malpractice cases to collect no more than 40

percent of the first $50,000 recovered in a case by all plaintiffs,

33 percent of the next $50,000, 25 percent of the next $500,000,

and 15 percent of any amount above $600,000.

8. In that textbook world, the ideal approach would be to allow

attorneys to buy claims from the plaintiffs for agreed-upon amounts

and collect 100 percent of any settlement or judgment, since that

would give them the incentive to pursue cases to the efficient extent. But under current law, such complete transfer of a claim from

plaintiff to attorney (known as “champerty”) is illegal. See Robert

D. Cooter, “Economic Theories of Legal Liability,” Journal of Economic Perspectives, vol. 5, no. 3 (Summer 1991), p. 20.

9. Versions of this approach that would limit contingent fees for court

judgments but not for voluntary settlements would have the additional effect of giving plaintiffs’ attorneys more incentive to settle.

Again, that effect is clearly inefficient in a simple textbook world,

but it may improve efficiency if other factors currently bias attorneys against settlement and toward trial.

10. The capped fees would increase plaintiffs’ incentives to accept early

offers and thus defendants’ incentives to make them.
CHAPTER FIVE AN OVERVIEW OF POLICY OPTIONS FOR CHANGING THE TORT SYSTEM 31

ages. In the past 20 years, many states have either eliminated joint-and-several liability under some or all circumstances or have restricted it in various ways—for example,

by limiting it to certain types of damages or to injurers

whose liability exceeds a certain percentage threshold.

Whether such changes have increased or decreased efficiency is not clear. Ideal incentives require joint injurers

to each face liability equal to the incremental effect of their

own actions, but neither joint-and-several nor several liability reliably achieves that result. To illustrate, consider

a case in which the actions of two injurers are both necessary to cause harm—for example, in which each one disposes of a chemical and the two chemicals then combine

to produce an explosion. Avoiding the explosion is efficient if either party could do so at a cost lower than the

cost of the resulting damage. But neither injurer might

take care if it expected to share liability evenly under either

joint-and-several or several liability and its prevention costs

exceeded 50 percent of the damage.11

What is clear is that several liability has two disadvantages

for plaintiffs—and conversely, two advantages for defendants—relative to joint-and-several liability. First, it makes

plaintiffs bear a higher share of the transaction costs.

Instead of pursuing only a selected subset of the alleged

injurers (often just the single party with the deepest pockets) and shifting the costs of dealing with the remaining

parties to that selected group, plaintiffs must sue everyone

from whom they hope to collect damages. Second, if some

of the injurers are bankrupt, defunct, or otherwise unable

to pay their share of the damages, several liability leaves

plaintiffs partially uncompensated, whereas joint-andseveral liability compensates them more fully, to the extent

that other, deeper-pocketed injurers can be tapped for their

fellow injurers’ shares.

Offsetting Payments from Collateral Sources

Under the law’s traditional “collateral-source rule,” the

fact that an injured plaintiff has received benefits from

some independent source—such as an insurance policy—

may not be considered in determining whether a defendant should pay damages and, if so, how much. In some

cases, the collateral source exercises a lien or right of subrogation and is reimbursed for the overlap between the

benefits and the damages. In many cases, however, the

effect of the collateral-source rule is to allow victims to

receive double compensation for their injuries.

In the past two decades, many states have revised the

collateral-source rule in various ways that could serve as

models for federal action. Those revisions range from

merely allowing collateral payments to be introduced as

evidence in certain types of cases to requiring that damages

be reduced to offset such payments under all circumstances. If verdict errors never occurred, there would be

no clear economic rationale for such changes—efficiency

dictates that injurers should face the costs of their actions

(or, at least, of their negligent actions) regardless of the

other benefits available to victims. However, if judges or

juries sometimes wrongly find defendants liable because

of conscious or subconscious concern that plaintiffs may

lack the resources to deal with their injuries, then such

changes may improve efficiency. In either case, it may be

more equitable for injurers not to pay victims who receive

collateral benefits, at least under some circumstances—

which may argue for allowing information about such

benefits to be introduced as evidence and considered by

juries and judges.

Options for Reforming 

Certain Types of Torts

Most of the recent Congressional attention on tort reform

has focused on specific types of claims, particularly those

arising from medical malpractice or asbestos exposure and

those litigated as class actions. Proposals that target those

types of claims often include the application of one or

more of the broad approaches discussed above, but they

generally also include some options that reflect more

specifically the nature of the particular claims. This section

discusses some of those narrower options.

11. In that case, strict liability could provide efficient incentives if each

party faced potential liability for 100 percent of the damages, rather

than 100 percent for both parties combined. Negligence standards

could also provide efficient incentives here; as discussed above,

however, such standards are not fully efficient in general because

they do not provide appropriate incentives for the scale of nonnegligent activities. See Thomas J. Miceli and Kathleen Segerson,

“Joint Liability in Torts: Marginal and Infra-Marginal Efficiency,”

International Review of Law and Economics, vol. 11, no. 3 (December 1991), pp. 235-249.
32 THE ECONOMICS OF U.S. TORT LIABILITY: A PRIMER

Creating Specialized Courts

Will the tort system function better if special courts are

established to hear particular kinds of claims? For certain

classes of difficult cases, specialized courts may yield one

or both of the following benefits. First, they may achieve

administrative efficiencies that will move cases through

the judicial system faster or at lower cost. The pursuit of

such efficiencies appears to be the main reason that 10

states (as of August 2000) have created courts focusing

on business or complex litigation.12 Second—as advocates

of the creation of special courts to hear medical malpractice claims argue—assigning certain types of complex

cases to judges with particular expertise in a subject may

improve the quality of case outcomes.13 The idea is that

judges who have experience or specialized training can

more accurately interpret scientific or technical issues (in

the terms discussed in Chapter 3, lower the cost of information), provide more consistent application of the law,

or both.

One potential argument against specialized courts is that

to the extent that they make the process of litigation more

efficient, they may encourage additional plaintiffs to bring

suits. Indeed, some analysts argue that efforts to streamline

asbestos cases (in part by consolidating claims for trial)

“actually increased the total dollars spent on the litigation

by increasing the numbers of claims filed and resolved.”14

In addition, a tension exists between using judges with

special areas of expertise to improve case outcomes and

the tradition and values of using nonspecialist juries.

Addressing Asbestos Claims

As noted in Chapter 2, claims for injuries resulting from

asbestos exposure have grown rapidly over the past three

decades, have involved larger amounts of damages than

the average tort case, and have been implicated in the

bankruptcies of dozens of defendants. Another notable

feature of asbestos claims is that a large share of the plaintiffs have not yet become sick—that is, they are not functionally impaired—but nonetheless they are subject to

statutes of limitations that begin when they discover (or

should have discovered) bodily evidence of exposure.

Thus, one option that the Congress has considered is to

specify certain medical criteria that asbestos victims would

have to satisfy in order to pursue claims.15 In effect, asbestos injury would be redefined in terms of impairment

rather than exposure.

Limiting asbestos claims to those involving impairment

would probably improve efficiency by reducing the number of cases and hence lowering total transaction costs.

In addition, allowing injurers to avoid paying damages

to people who have been exposed but are not notably impaired should have little adverse effect on the efficiency

of incentives for precaution against future tort injuries.

From the standpoint of equity, this option would benefit

victims who are sick today by reducing the competition

for court time and injurers’ compensation funds. Conversely, it would impose a loss on victims who are not yet

impaired, many of whom will incur higher medical costs

to monitor their condition over time. Moreover, those

victims would not be guaranteed to benefit if they became

impaired later, because the funds available to pay claims

might be greatly diminished by then.

Another option that the Congress has considered would

combine the approach of setting minimum criteria for

impairment and establishing a public fund that would

compensate victims according to a schedule reflecting the

severity of injury and perhaps other relevant factors, such

as smoking history.16 Such a fund would be a narrower

12. National Center for State Courts, “Focus on Business and Complex

Litigation Courts,” Civil Action: A Briefing on Civil Justice Reform

Initiatives, vol. 1, no. 1 (August 2000), available at www.

ncsconline.org/wc/publications/Res_SpePro_CivilActionV1N1

pub.pdf

13. See the remarks of Philip K. Howard before the Common Good

forum, “Beyond Patients’ Rights: Do We Need a New System of

Medical Justice?” hosted by the AEI/Brookings Joint Center for

Regulatory Studies, Washington, D.C., April 24, 2002, available

at http://cgood.org/medicine/item?item_id=3390.

14. Stephen J. Carroll and others, Asbestos Litigation Costs and Compensation: An Interim Report (Santa Monica, Calif.: RAND Institute

for Civil Justice, 2002), p. 26.

15. See, for example, the Asbestos Claims Criteria and Compensation

Act of 2003 (S. 413). 

16. See the Fairness in Asbestos Injury Resolution Act of 2003 (S.

1125). Another bill, the Asbestos Compensation Act of 2003 (H.R.

1114), takes an intermediate approach: like S. 1125, it would
CHAPTER FIVE AN OVERVIEW OF POLICY OPTIONS FOR CHANGING THE TORT SYSTEM 33

variant of the idea of replacing tort liability with public

insurance, but some of the pros and cons of the broader

idea discussed above would be less relevant here. In particular, because asbestos exposures generally happened

decades ago, using a public fund rather than the liability

system to compensate victims would have little impact

on incentives for precaution against future injuries. The

main issues raised by proposals for a compensation fund

are the potential savings in transaction costs and the

adequacy and appropriateness of the funding sources and

compensation schedule.

Addressing Class-Action Claims

Several approaches have been proposed for changing the

rules that govern class-action claims. One of those approaches would broaden the “diversity of citizenship” rule

to allow more cases to be removed from state court to

federal court.17 That rule—which currently states that U.S.

district courts have jurisdiction in civil cases in which no

plaintiff and no defendant are citizens of the same state

and at least one plaintiff seeks at least $75,000 in damages—could be broadened to a greater or lesser degree.

At the extreme, all cases (or perhaps all cases above some

low monetary threshold) that involve at least one plaintiff

and one defendant from different states could be made

removable. 

In a simple model of how courts work, changes to the

diversity rule would at best be irrelevant—and at worst

be harmful to both efficiency and equity to the extent that

they inhibited some claims by raising plaintiffs’ costs. But

the evaluation is less clear when two complicating factors

are taken into account. On the one hand, if significant

problems of bias against out-of-state defendants exist in

some local courts, an expanded diversity rule may improve

efficiency and equity by circumventing those problems.

Evidence about the highly disproportionate incidence of

class-action suits in a small number of jurisdictions suggests that local bias may indeed be a significant problem.18

On the other hand, if expanded diversity leads to lengthy

delays in trying legitimate claims because federal courts

have more-limited capacity than state courts do, the costs

to efficiency and equity may subtract from or outweigh

the benefits.

A second type of proposal targets a different perceived

problem with class-action suits—namely, that plaintiffs’

attorneys often act independent of any effective oversight

by members of the class and collude with defendants to

reach settlements that reflect their own interests rather

than those of class members.19 Proposals to address that

problem attempt to bring attorneys’ interests more closely

in line with those of the class. One approach might be to

tie the compensation of plaintiffs’ attorneys to the benefits

actually received by class members. (For example, in the

case of a settlement that gave class members coupons for

discounts on future purchases from a defendant, the

attorney’s compensation might be made proportional to

the number of class members who used the coupons.) In

principle, aligning the two sets of interests should improve

both efficiency and equity. In practice, however, it might

be difficult to devise rules that would be both comprehensive (and thus not easily circumvented) and flexible

enough to accommodate the full range of possible circumstances. establish a fund that would offer compensation to asbestos victims

according to a schedule. (Both bills would allow unimpaired victims

of asbestos exposure to be reimbursed for some medical monitoring

costs.) But the fund would be financed on a claim-by-claim basis

through settlements with or judgments against individual defendants, rather than as a public insurance program. Moreover, victims

would retain the right to file claims in court instead of accepting

compensation from the fund.

17. See, for example, the Class Action Fairness Act of 2003 (H.R. 1115

and S. 274).

18. John H. Beisner and Jessica Davidson Miller, Class Action Magnet

Courts: The Allure Intensifies, Civil Justice Report No. 5 (New York:

Center for Legal Policy, Manhattan Institute, July 2002).

19. For examples of seemingly abusive class-action settlements, see Trial

Lawyers for Public Justice, Class Action Abuse Prevention Project,

brochure (Washington, D.C.: Trial Lawyers for Public Justice,

undated), available at www.tlpj.org/caappbrochure.pdf.