Question

What would be the effect of a 75 percent tax on lawsuit punitive awards that was proposed by then California governor Arnold Schwarzenegger in 2004 on:

• The number of punitive awards. Demonstrate your answer using supply and demand curves. (You will post your graph as jpg. in your discussion post).
• The number of pretrial settlements.

Answer 1

1st Part:

In general tax increases the overall expenditure. It's a situation where tax is levied on the consumer. It leads to decrease in demand for the same. People will avoid such awards owing to the increased cost.

If punitive awards receive a 75 percent tax, the demand for punitive awards decreases since this large percentage of the award goes to the government as a tax. The demand curve for punitive awards is thus shifted to the left, and the equilibrium of punitive rewards is thus reduced. Because of the tax, people will adjust lower their demand with the value of extra tax cost imposed on. The magnitude of the shift will be equal to the tax implied. In the below diagram it can be clearly observed that the equilibrium quantity is falling from Q1 to Q2.

2nd Part:

A pre-trial settlement is a gathering of competing parties in an case where both sides attempt to resolve a conflict mutually decided without a jury.

In this case pre-trial settlement is beneficial. Because plaintiffs now realize, they have a scope to earn just one fourth of the awards so that they choose to settle cases off court because both the plaintiff and the opposition benefit from it.

This is why the number of pre-trial settlements will go up.

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