Deterrence and theTax Treatment of Monetary Sanctions and Litigation Costs

The paper explores the effects of alternative tax rules regarding monetary sanctions and litigation costs on the levels of ciminal activities and litigation expenditures. The key insight is that taxation may affect crime not only by changing the relative expected returns from legal and criminal activities but also because it may affect the costs and benefits associated with litigation. The positive cross-effects between crime and litigation expenditures, that is, the fact that ciminal activities and litigation expenditure may be complements, yield interesting, counter-intuitive results. For example, contrary to common belief, nondeductibility of monetary sanctions may increase the level of crime, if litigation expenses are deductible. In addition, conditioning deductibility of legal expenses on a successful outcome of the trial may also increase amounts spent on litigation and time allocated to crime. The paper shows, however, that a pure income tax, that is, an income tax that allows deductions for monetary sanctions and litigation costs, maintains the pre-tax levels of crime and litigation expenditures for risk neutral offenders. The paper briefly explores the policy implications of these results