Decoupling as Transactions Tax

In an influential paper, Polinsky and Che propose that litigation can be made a more cost-effective tool for setting primary activity incentives (such as for product safety or promissory performance) by reducing plaintiffs’ recovery while simultaneously raising defendants’ damages. Decoupling recovery and damages in this manner reduces the number of filed suits but increases the deterrent impact of each. Litigation costs fall, but if damages are raised sufficiently, the level of deterrence is maintained. Yet this story does not account for the fact that when the state takes from liable defendants more than it gives to victorious plaintiffs, it effectively taxes the transaction that led to the litigation. This tax drives a wedge between the private and social benefits of entering the transaction. The result is that socially beneficial transactions may fail to take place. In this paper we explore how this transaction-discouraging aspect of decoupling affects its propriety.