Deterrence and tax treatment of monetary sanctions and litigation costs

Abstract

The tax treatment of monetary sanctions and litigation expenditures varies across legal jurisdictions and time. The effects of these different tax regimes – particularly, on crime deterrence – have not been fully explored. Instead, legal intuitions in court decisions and legislative reforms are found. This paper explores the effects of these tax regimes. It shows that our common intuitions are sometimes misguided, since we tend to ignore cross-effects between crime and litigation. For example, contrary to commonly held views, it is shown that non-deductibility of monetary sanctions may increase the level of crime, if litigation expenses are deductible. In addition, if deductibility of legal expenses depends only on a successful trial outcome, this may also increase amounts spent on litigation and time allocated to crime. As this paper shows, however, a complete deductibility regime, under which both monetary sanctions and litigation expenditures are deductible, maintains the pre-tax levels of crime and litigation expenditures for risk-neutral offenders. The paper further explores the effects of different tax reforms.