Senate’s Tax Bill Picks Winners and Losers in Litigation Finance

The US Senate is considering a bill that would impose a tax of at least 41% on investments in lawsuits. The bill is poorly drafted, and some think the effective tax rate could be even higher—posing a threat to financial protection for Davids trying to take on Goliaths. Nonetheless, it has made it all the way into the Finance Committee’s draft of the One Big Beautiful Bill Act.

Even at 41%, the tax rate is nearly double the rate other investors and companies pay. It’s hard to see it as anything other than a transparent attempt to destroy a popular financial product in the service of special interest politics.

Many Americans may be unfamiliar with investments in lawsuits, but they have been around for decades—not only in the US, but throughout the world. Some businesses that file lawsuits for, say, breach of contract or intellectual property infringement don’t have enough money to pay their lawyers all the way through a trial.

Even if they do, they might prefer to spend the money on their businesses, or they might not want to risk a runaway jury at a trial. Instead of accepting lowball settlement offers to exit the lawsuits, they can get investors to pay their lawyers or shoulder the risk. The investors get paid only if the lawsuit succeeds, usually with a multiple of the investment or a percentage of whatever is recovered.

If all of this sounds like it makes perfect sense, that’s because it does. These transactions are just like liability insurance, but for the people who sue rather than for the people who get sued. Yet the Senate bill would tax these investors at at least double the tax rate liability insurers pay.

This tax is clearly an attempt to end these investments. As Chief Justice John Marshall once said: “That the power of taxing may be exercised so as to destroy, is too obvious to be denied.” A discriminatory tax of 41% or more is a transparent attempt to do just that.

We should be skeptical any time the government wants to interfere in the marketplace by favoring one asset class over another. This time is no different.

The reasons that have been offered for this bill are flimsy. Some say investments in lawsuits encourage frivolous lawsuits, but that’s not a very good investment strategy. Investors who get paid only if lawsuits succeed obviously want to invest in the best cases, not the worst ones.

Others say America’s foreign adversaries are secretly behind some of these investments. I am not one for conspiracy theories, but, even if you are, that’s only reason to require disclosure of who the investors are—or, at worst, impose this tax only on foreign investors, not American investors, too.

It’s possible these investments might encourage and prolong litigation. Some studies say no; some studies say yes.

But even if they do, the investments encourage only the lawsuits that businesses couldn’t afford to bring and prolong only lawsuits that businesses would have otherwise settled on the cheap.

I understand there are many who instinctively think lawsuits are bad and anything that encourages or prolongs them must be bad, too. But this instinct is wrong. As long as the lawsuits aren’t frivolous, they can be a good thing.

As the two Nobel Prize-winning, University of Chicago economists Gary Becker and George Stigler once said, “The view of enforcement and litigation as wasteful in whole or in part is simply mistaken. They are as important as the harm they seek to prevent.” If we are against breach of contract and intellectual property infringement, then we can’t be against the lawsuits that enforce those rights.

So what’s really behind this bill? Special interest lobbyists for big businesses. They have been against this financial product for many years. Big businesses don’t need investors to help them pay their lawyers, and they don’t want smaller businesses that sue them to have the same advantage; they want them to have to take the low-ball settlement offers.

The government shouldn’t be picking winners and losers like this. Rather, it should let capital flow to its highest use—even if the highest use is to help small businesses who must bring lawsuits from time to time.

This article does not necessarily reflect the opinion of Bloomberg Industry Group, Inc., the publisher of Bloomberg Law, Bloomberg Tax, and Bloomberg Government, or its owners.

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Brian Fitzpatrick is the Milton R. Underwood chair in Free Enterprise and professor of law at Vanderbilt Law School.

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