The Litigation Tax

A Hidden Added Cost on Everything

This past weekend at the Roots of Progress conference, I heard a fascinating interview with Dan Wang, author of the new book Breakneck: China’s Quest to Engineer the Future. Dan has a lot of interesting things to say about all kinds of topics but the book itself is one of those Big Ideas books. And the Big Idea is that while the United States is run by lawyers, China is run by engineers. While the book is mostly about China (and I highly recommend it even though I’m only through about two chapters so far), I want to focus here on one particular aspect of the downsides of the ‘America is dominated by lawyers’ half of the comparison. We are awash in lawsuits and threats thereof, and it increases costs in ways that, though generally hidden, add up.

We Pay A Litigation Tax- We Just Don’t Realize It

Americans pay what amounts to a litigation tax on nearly everything we buy. This tax shows up in two ways. The first is direct and relatively more visible; it’s the money we spend on liability insurance, legal fees, and court costs. The second is less apparent but no less real. It’s the premium baked into the price of our cars, our doctor’s visits, our childcare, and countless other goods and services. In 2013, the U.S. Chamber Institute for Legal Reform conducted a study that compared liability costs across the United States, Canada, Europe, and Japan using insurance premium data from over 35,000 commercial insurance policies. The researchers controlled for differences in business composition, social safety net spending, and healthcare costs to isolate the true impact of each country’s legal system. What they found should make every American taxpayer and consumer sit up and take notice.

Image Credit: Institute for Legal Reform.

As you can see from their chart, we spend far more on liability costs than our peer countries. We spend more than double the Eurozone average and roughly four times as much as the most efficient European countries (Belgium, the Netherlands, and Portugal) who all clock in around 0.40% to 0.43% of GDP. And, to point out the obvious, it’s not as if the Netherlands is some anarchic Mad Max hellscape. They are well governed. It isn’t clear we’re getting anything for all that money. Even Canada, our neighbor with a similar common-law legal tradition, manages to keep costs at 1.19% of GDP, still high by European standards, but 28% lower than the United States.

The problem has only gotten worse since then. America’s liability costs consume over $529 billion in 2022, which amounts to 2.1% of GDP, or more than $4,200 per household. That’s a lot of money. A lot of these costs emerge from the sheer volume of litigiousness in American society.

The Impact: Where You Feel It

This litigation tax shows up in your household budget in ways most people never notice. In healthcare, medical malpractice insurance costs get passed on to patients through bigger bills and more expensive insurance premiums. A 2010 study estimated that defensive medicine, i.e. the extra tests, procedures, and referrals doctors order primarily to protect themselves from lawsuits, costs the healthcare system $46 billion annually. You pay for that, either through higher out-of-pocket costs or higher insurance premiums. To give another example from medicine, the OB/GYN delivering your baby carries malpractice insurance that can cost $200,000 per year or more. That cost doesn’t disappear; it gets built into what you pay for prenatal care and delivery and more generally what everyone pays for health insurance.

Product costs carry a similar hidden tax. Companies building everything from ladders to playgrounds have to purchase extensive liability insurance and design products with lawsuit prevention in mind. It isn’t just goods. Service sector costs add up across the economy too. Your gym membership includes liability insurance costs. So does your kid’s daycare, your hair salon, and your car mechanic. Every business that interacts with the public faces potential liability, has to have liability insurance (which is driven higher by America’s elevated level of lawsuits) and so must raise prices accordingly.

Housing and construction face particularly steep litigation costs. Builders, architects, and contractors all carry substantial liability insurance. And, as a report from Up For Growth notes, “the way some states legislate condominium defect liability (CDL) is driving housing underproduction in their cities, particularly of affordable homes.” California is particularly bad about this. Their condominium defect liability laws there are so vulnerable to litigation that 80-85% of condo and townhome projects there get sued. Insurance companies now price their policies there on the assumption that most projects will get sued. This adds between $8,100 and $18,300 to each unit of condo housing developed. This has led to such an increase in expenses and uncertainty that many builders have simply stopped constructing condominiums. It is too much liability exposure for too little profit. That contributes to less housing supply and higher prices. And that’s just one example of many that I could give.

The cumulative effect of liability costs like these on household budgets is substantial. If American liability costs matched Canada’s, we’d free up over $1,000 per household per year. That’s real money that could go toward groceries, rent, savings, or paying down debt instead of feeding the liability system.

Reform Is Worth Considering

None of this is to say that businesses shouldn’t have to have insurance or that people who have been unfairly harmed shouldn’t have recourse to justice through the legal system, but it is to say that the litigiousness of American society has real costs, however hidden they might often be. We should think about how to reform this system such that we preserve recourse to justice while also reducing costs.

One way to do this could be to have more mediation. And in fact, some countries like Spain require parties to attempt mediation before proceeding to court. This doesn’t eliminate anyone’s right to sue; it simply adds a speed bump that filters out cases that can be resolved through negotiation. Another option is to encourage parties to use more arbitration, which is a way to resolve a legal dispute outside of court, where both sides agree to have a neutral third party (an arbitrator) hear their case and make a binding decision. It’s often faster and less formal than going to trial, but you typically give up your right to appeal the arbitrator’s decision.

Finally, another potential reform is to have specialized courts for more technical disputes. Patent cases, medical malpractice claims, and construction defect litigation and other areas of the law like that often hinge on complex technical issues that generalist judges and lay juries struggle to evaluate. Countries like Germany use specialized tribunals with expert judges for these cases, leading to faster, more predictable, and often fairer outcomes. The United States actually has a successful model in the Court of Appeals for the Federal Circuit, which handles all patent appeals and has developed expertise that would be impossible if patent cases were scattered across hundreds of generalist courts. Specialized courts like this can also reduce costs by making outcomes more predictable. When both sides can reasonably anticipate how a judge will rule on technical issues, cases settle faster and cheaper. We could expand this approach to medical malpractice and construction defect cases, where technical expertise would similarly be more fair and reduce costs.

My point here is not to pretend this is a comprehensive list of potential reforms. There are many possibilities worth considering. My point is that litigation adds costs to American life that are very real even if they are often invisible and that there are ways to reduce this without running roughshod over fairness, if we think cleverly. That’s what we’re here to do at The Rebuild- encourage our fellow Democrats to focus hard on the cost-of-living and think cleverly about ways to reduce it.

-GW