My Econ paper

I have mentioned the econ paper I am working on this summer several times. I will not lie, it is somewhat.... blah. Remember, this is for a community college class. That said, here is the paper, I think there is still some relevant information in it. I wish I knew how to add a file from my computer, but this site does not seem to support that.

Making Lives Legally Equal
The fundamental ideal of our legal system is equality among people. As Carl Vinson said in his presentation to the University of Georgia: “In the United States people have the right to be treated in a fair and equal way. This protection is contained in the equal protection clause of the United States Constitution. The basic intent of equal protection is to make sure that people are treated as equally as possible” (Vinson, 2004). The intention of the American legal system is to afford every citizen equal protection and treatment in the eyes of the law. In economics, the fundamental goal is efficiency. Economic efficiency refers to an optimal distribution of goods in which each good goes to the person that values it most. More importantly, efficiency is the concept of deriving as much utility (happiness) from a given resource. In law this means assigning responsibility in such a manner as to promote an efficient allocation of resources. While economists understand that scarcity will never allow our limited resources to fulfill our unlimited wants, they realize that through an efficient allocation of resources utility (happiness) can be maximized. It is at one of the many intersections of law and economics, wrongful death lawsuits, that the ideals of efficiency and equality are brought into direct conflict.

The legal tradition in the United States has been to determine the method used in calculating wrongful death damages on a case by case basis and leave the method of arriving at the correct award to the economic experts. While our legal system is based on the verdict being a result of the individual facts, the system has always been driven by the concept that cases are governed by a set of common rules. Traditionally, economic damages have been treated as an issue to be determined individually. The problem is that as our methods of economic analysis become more scientific, drastically different results arising from different methods have started to arise and the court has failed to create a method of determining which economically valid method of analysis should be applied to court cases. As a result of this lack of legal unity and clarity, a pattern of damages has been created in which the state your case is brought in and the economic experts involved can lead to drastically different awards. Wild variances in results of the same case directly conflicts with the central ideas of our legal system. From a legal standpoint this could be argued as a necessary result of federalism, though even under federalism key legal issues are typically unified on a national level. From an economic standpoint however, these differences across states lead to inefficiency. The laws and standards that determine if a person is legally responsible for the death of another person are established on the national level. Since liability is set nationally, but punishments are not, efficiencies are created. If a life in one area is worth less, the efficient thing to do would be to require less precaution, however since the required amount precaution is set nationally, this cannot occur. In order to make our legal system to one of equal treatment, several variables normally left to economists must be standardized, most notably, the discount rate and what place, if any hedonic damages should have in wrongful death compensation calculations.

Significance

It is important that this lack of unity be discussed and hopefully resolved for two reasons. First, the goal of tort law is to minimize the social cost of accidents. This means that companies and people should take an amount of precaution up to the point in which the cost of precaution is no longer greater than the benefit of the precaution (presumably, the reduction in the expected value of accidents). In order to properly determine the optimal amount of precaution, companies and people need to know what the likely costs of accidents are. In the case of wrongful death, the cost of accidents means the compensation owed to the victim’s family. If there is no standard to calculate the cost of accidents (a set of rules that can be used to determine the value of life) then it is impossible to know what the optimal amount of precaution is. Alternately, it is important to discuss these issues because equality under the law is a key value to most Americans. If a human life is simply worth more in certain states, then this value of equality cannot be realized. A lack of equality would mean that a person is better off being killing in one state than in another. Finally, it is important to understand the great power economist have in shaping economic damage awards in wrongful death cases. In a paper discussing jury decisions, economist Stanley Smith noted that: “It is possible to determine with a high degree of accuracy what the jury’s award decision will be, based on observed, objective factors” (Smith, 1998). While it is possible that most juries simply understand that the value of a person in X situation is Y dollars, it is more likely that Smith’s observation is merely a result of juries placing a great amount of trust and weight in the opinions of economic experts.

Background

In order to properly treat this inquiry into economic damage calculation, the frame of this inquiry must be properly understood. This paper is concerned only with the lump sum damages paid to plaintiffs in wrongful death cases. This must examined separately from the cases that arise when a plaintiff is injured but not killed. This is because the process for calculating the value of life, and especially the admissibility of hedonic testimony, varies greatly between these two types of calculations (Smith, 1997).

Before any discussion of the need for unity can truly occur, the process of calculating wrongful death awards must be fully understood. Currently, the starting point for most economic damage calculations is the construction of an age-earnings profile (Glick, internet). From this profile economists use data showing trends in income to arrive at an estimated lifetime income. In order to do this economists consider a range of variables, most importantly of which are age, earnings history, and education. In arriving at these estimations economists use employment trends that show earnings increase at a diminishing rate for a period of time and then decline, which is a result of the fact that experience and training directly affect productivity (Glick, internet). Another important factor in these calculations is worklife. Worklife refers to the period of time over which a person will be employed. What complicates this calculation is the fact that people do not simply work until a certain age. Retirement, death, sickness, layoffs, having children, and changing careers as well as a variety of other factors prevent people from merely working until a certain age (Tierney, 1998). In calculating worklife, economists look at a variety of factors while focusing on what kind of work a person does, what the person is paid, how must work there is available, and how many hours of a given type of work a person can expect to perform over the course of their life (Tierney, 1998). Once economists have combined earnings history (or expectations) and worklife to arrive at a basic earnings estimate, fringe benefits other than the salary that the person receives from employment (such as healthcare or retirement compensation) are added in. Fringe benefits are typically calculated as a percentage of earnings, with heavy consideration given to your education level (Powers, 2005). For people in certain positions executive benefits such as stock options may also be relevant to the calculation (www.behan.ws, 2002). After a total amount of employment earnings is calculated, a person’s household contributions must be figured in. This compensates survivors for the chores and household duties the deceased would have provided. Estimates for this vary from person to person but are largely based on the idea of opportunity cost. Next, courts remove an amount of money corresponding to what the person would have consumed if they were alive. Because a person does not realize all of their earnings, it is important to adjust their total earnings for the goods (such as food) they would have consumed if they were living. The typical method for doing this is the personal consumption method in which an estimate on spending of all items including food, drinks, housing, clothing, transportation, health care, entertainment, and other factors are taken into consideration (Powers, 2005). Even this is not completely standard, however the traditional method of evaluating personal consumption is the use of the Consumer Expenditure Survey (Powers, 2005). Any additional costs such as medical care costs prior to dying and funeral expenses are then added in and the figure is reduced to present cash value using a discount rate determined by the economist.

The Discount Rate

Selecting a discount rate to reduce awards to present cash value is one of the key elements in deciding economic damages and yet the courts have not yet created a consistent and economically valid method for determining the discount rate. The discount rate represents the difference between inflation and the value money accrues over time (Glick, internet). There are two types of discount rates. The nominal discount rate is concerned with figuring out how money will grow over time. The real discount rate is the nominal discount rate minus inflation. The nominal discount rate is only concerned with how the current value will change. The nominal discount rate is not concerned with purchasing power or inflation. The real discount rate represents current dollars compared to future dollars for a base year. In other words the real discount rate is a measure of how much money is needed in the present to equal some future buying power. The rational for this discount is that when a person receives a payment they will invest it and the money they accrue from this investment is additional capital they have available over the time period in which the income would have been spread out if a lump sum payment was not received (Barnes & Stout, 1992). When the discount rate is referred to in wrongful death calculations it is the real discount rate that is being discussed. The chosen discount rate is not merely an academic issue. A small variation in the discount rate can greatly increase or decrease the total award, and the traditional range of accepted rates is rather wide, ranging from the 0 % that will be discussed shortly to the 5% used in Georgia. Without a unified method of calculating the discount rate, economic damages become largely a function of how aggressive or conservative an expert witness is. Since these calculations are attempting to estimate the amount of current money necessary to establish future spending power, the calculation should be based on more than the disposition of the local economic experts or courts. This is important because without standardization the amount of money somebody is awarded becomes, to a large extend, arbitrary. This means that it is impossible to calculate the appropriate amount of precaution that should be taken until after the fact. Furthermore, it means that the value of a human life is largely influenced by an arbitrary decision that even some experts consider to be a minor one. An objection to the claim that the discount rate is important was raised by Mark Glick who claimed: “The source of most controversy among contending experts is typically the procedure for discounting earnings, despite the fact that most studies find that discounting procedures and discount rates make very little difference to the bottom line” (Glick, internet). However, a simple example illustrates how far off the point Glick is. A Defendant paying $500,000 could be paying for damages of $500,000 reduced over 20 years at 0%, $610,095 reduced over 20 years at 1%, $819,308 reduced over 20 years at 2.5%, $903,055 reduced over 20 years at 3%, or $1,326,649 reduced over 20 years at 5%. In other words, 5 different defendants all paying the same lump sum to cover damages that would have accrued over the same period of time (20 years, a relatively short period of time), could be compensating a plaintiff for as little as $500,000 in Alaska to as much as $1,326,649 in Georgia. The longer the time period the damages are accruing over, the greater the disparity in payments becomes. It is safe to say this is not equality and this is not a small difference.

Thus far American courts have proved completely inept at creating any unified standard for discount rates. The only guidance given on this issue by the United States Supreme Court has been a vague statement that it should be: “a rate of interest that would be earned on the best and safest investments” (Powers, 2005). In trying to regulate the discount rate the courts have failed on two counts. First, the courts have exercised bad economics in attempting to set a standard discount rate. Most notably, in Kaczkowski v. Bolubasz (1980), the Pennsylvania Supreme Court chose to emulate the simplest method that was in use at the time and utilize what is known as the “total offset method” in which it is assumed that the future inflation rate and the future interest rate are equal. This means there is no discount rate and thus present cash value is the same as damages over time. This is bad economics for several reasons. First, the assumption that interest rates and inflation are equal is not a correct one. Also, this essentially says money accrues no value over time, a statement that is clearly false. Furthermore, this standard is not consistent with the Supreme Court’s statement that the discount rate should be based on the return of the best and safest investment since government I-Bonds guarantee a rate of return at a set amount above the rate of inflation. Since there are minimum risk investments that guarantee a rate of return above the 0%, clearly 0% cannot be a valid discount rate. In addition to exercising bad economics, the courts have also failed to create equality. It is more costly to cause a wrongful death in Alaska (with their 0% discount rate) than it is in Georgia (with their 5% discount rate). For this to be consistent with the concept of reducing the cost of accidents it would have to be true that money spent to reduce the costs of accidents in Alaska reduces more accidents than the same amount of money in Georgia, a claim that is not logically valid. There are two solutions that could solve this problem. One of them would be a modified version of Canadian tort law. Canadian tort law proscribes the appropriate discount rates in certain providences as between 2.5 and 3% (Bruce, 1996). By expanding on this process, the United States courts could easily create a national standard discount rate for all value of life considerations in United States courts. Alternately, courts could simply adopt a set criteria for how to determine the discount rate. Instead of letting economists use whichever economically grounded method of determining the rate that they feel is appropriate the courts should establish that the correct way of determining the discount rate is by following the market rates, which entails backing out future rates of interest from the nation’s money markets (Bruce, 1996). This process would be largely standardized and would greatly reduce the fluctuations in damage awards that result from variances in the discount rate.

Hedonic Damages

An even more troubling area with even more variance exists in the United States legal system when dealing with the question of how to treat hedonic damages. Within the context of wrongful death hedonic damages can be defined as damages that compensate the family of the wrongly put-to-death for the loss of enjoyment of life (Worth, 2002). Hedonic damages are calculated based upon how much the deceased valued his or her own life. The most common method for calculating hedonic damages is called the “Willingness To Pay” approach and involves dividing how much a person is willing to pay for a life saving feature by how likely the event is to save a life (Worth, internet). Stanley Smith, who is often considered the pied piper of hedonic damages states that: “Consumer safety devices, extra pay for risky work and government safety regulations all provide a great deal of evidence that shows that we routinely value life in the several-million dollar range” (Smith 1997). This concept of damages was first introduced to wrongful death cases in the 1985 Federal District Court case Sherrod v. Berry in which Smith contended that Sherrod have a value of life of $850,000. Since then Smith and other economic experts have attempted to argue in favor of hedonic damages in wrongful death cases to mixed, but mostly negative results. Currently only Connecticut, Mississippi, Georgia, and New Mexico allow testimony on the hedonic value of life (Smith 1997). This again creates a problem of equality because a life taken in any of these four states is, in terms of damages awarded, greater than in any other state. Again, economically this would imply that a dollar of precaution in Connecticut is more useful than a dollar of precaution in Massachusetts, a claim that there is no reason to accept. This large discrepancy in admissibility can lead to differences in verdicts of over $1,000,000 before being discounted to present cash value (Smith, 1997). This clearly calls for a unified national standard. Because of their highly speculative nature, and their lack of wide spread acceptance, hedonic damages must be rejected. In Daubery v Merrell Dow Pharmaceuticals (1993) the Supreme Court ruled that expert testimony must be based o proper scientific methods. It is difficult to call the calculation of things hedonic damages a proper scientific method. First, people do not grasp the difference is very small probabilities. In other words, the figure Smith arrived at is purely speculation. He assumes that the person purchasing an airbag is aware of the fact that it saves 1 in 2000 people and can understand how small of a benefit this is. In reality the person may be willing to pay much more or much less, there is no way to know. Furthermore, Smith’s method assumes that people place some measurable value on human life. To accept Smith’s assumption is to accept the idea that at some amount of money a person would be willing to part with their life. It is difficult to fathom a single 25 year old male accepting any amount of money to part with his own life. Finally, hodonic damages, in theory are true for all people and are simply adjusted based on age (Mark Worth, internet). This claim tears the entire argument to shambles. A man in his late fifties buys the same precautionary devices, perhaps more, that a teenager, yet hedonics adjusts the fifty year old mans value down. This is because the theory is based on one thing (willingness to pay) and being interpreted to say another (how much your life is worth). By examining the correlation between the general life calculation and how it is used however, it becomes clear that in determining value on a case by case basis, the concept hedonics uses to defend itself as non-speculative (that they can measure how much a person is willing to pay) is completely dismissed from the equation. Hedonics essentially uses one criteria to establish itself as non speculative, but a completely separate calculation (average divided by age) to arrive at an application. A brief glimpse into the professional literature surrounding hedonics is telling. Dr. Christopher C. Pflaum sums up the literature most accurately when he states: “Most serious economists disagree with advocates of hedonic damages” and raises the complaint that, “One cannot assume cost of avoidance equals the value of life” (Pflaum, Internet). It is impossible to resolve problem of a lack of equality in the value of life unless a unified stance on hedonics is taken. If hedonics are allowed to exist in some circumstances or in some states then equality necessarily exists since a human life is worth more in these circumstances or states. The only way this could be consistent with the goal of efficiency would be if those circumstances or states made better use of each dollar of precaution, a claim that is not grounded in reality. The conflict between states allowing testimony about hedonic damages and states not allowing testimony about hedonic damages can only be resolved if the Supreme Court takes a universal stance, ideally against hedonic damages, in order to once again restore equality to the laws.
The problems with hedonics and the discount rate are only two examples of how the law and economics have met to create a range of problems that challenge the ideals of equality and efficiency. Countless other problems can be seen at the intersection of the two disciplines such as a lack of a consistent format for presenting and analyzing conflicting damage assessments (Bruce, 1999) and the struggles of lawyers in determining the difference between credible and non-credible expert witnesses and clearly demonstrating that lack of credibility to the jury (Smith, 1996). It is not until the law catches up to contemporary economic calculation methods by creating unity in the approach, method, and rulings regarding various aspects of wrongful death damage calculations that the court system can reach a level of equality and tort law can attempt to accomplish its goal of reducing the societal costs of accidents. While factors such as earnings, age, health, and fringe benefits will always make damages different, identical people with identical jobs for identical pay should not be subject to compensation that differs by millions of dollars simply because of the state they are suing in, and an efficient allocation of resources should not be skewed by the legal policies of the different states. A unified approach to the calculation of value of life is needed in order to bring lasting equality to our legal system and an efficient allocation of resources to our society.


Works Cited

1. Behan Publications. “Determining the Economic Value of Human Life,”
www.behan.ws/publications.htm?Num=6
2. Barnes, David W., Stout, Lynn A. Cases and materials on Law and
Economics. West Publishing Co. Minnesota: 1992, p167.
3. Bruce, Christopher. “Selecting the Discount Rate,” Economica Ltd, Vol. 1,
No. 3, Autumn 1996.
4. Bruce, Christopher. “On Format of Expert Evidence of Economic Loss of
Damages,” Economica Ltd, Vol. 4, No. 1, Spring 1999.
5. Glick, Mark A. “The Law and Economics of Tort Damages,”
www.econ.utah.edu/law/version_2.0/papers/law&econtort.htm
6. Pflaum, Christopher C., “What’s Wrong With This Report?: Handling
Economic Junk Science,”
www.spectrumeconomics.com/specpdfs/MODL2.pdf
7. Powers, David C. “Anatomy of an Economic Damage Report: Wrongful
Death of a Minor Child,” Connecticut Lawyer, May 2005, p. 12-15 & 33.
8. Smith, Stan. “Pseudo-Economists-The New Junk Scientists,” Federation of
Insurance & Corporate Counsel Quarterly, Vol. 47, No. 1, Fall 1996,
pp.95-105.
9. Smith, Stan. “Measuring The Loss of Enjoyment of Life in Personal Injury
Cases in Washington-Hedonic Damages,” Trial News, Vol. 32, Number 5, January 1997, pp. 29-30, Washington State Trial Lawyers Association.
10. Smith, Stan. “Why Juries Can Be Trusted,” Voir Dire, Vol. 5, Issue 3,
Summer 1998, pp. 19-21 & 25.
10. Smith, Stan. “Update on Hedonic Damages in the Courtroom,” May 27,
2005. www.lostcompensation.com/blog/2005/05/hedonic-damages.html.
11. Tierney, John P., Holland, Gwendolyn H. “What Attorneys Need To Know
About Worklife Estimates,” Medical Legal Section of Journal of the
Kansas Trial Lawyers Association. 1998.
Cross-Reference: www.VocEcon.com
12. Vinson, Carl. www.lawhelp.cor/GA/showdocument.cfm.
13. Worth, Mark. “What’s Your Life Worth, Anyway?,”
www.washingtonfreepress.org/02/Worth.html.

Cases Referenced
1. Daubery v. Merrell Dow Pharmaceuticals. United States Supreme Court. 113
S.Ct. 2786 (1993).
2. Kaczkowski v. Bolubasz. Supreme Court of Pennsylvania, 1980. 491 Pa. 561,
421 A.2d 1027.
3. Sherrod v. Berry. United States District Court, Northern District of Illinois,
E.D., 1985. 629 F.Supp. 159.