A Theory of Tax Effects on Economic Damages

This paper provides theoretical statements about the effect of tax on the present value of lost earnings streams. The paper considers the simple case of flat tax rates on earnings and interest income. It approximate tax effects via the instantaneous rate of change — in present value — when the tax rate goes from zero to a small positive number. In this setting, the paper shows that present value is lower after tax than before tax when the earning stream is short, with the reverse outcome holding when the earnings stream is long. The switch point, where the tax effect goes from negative to positive, depends on the theoretical model’s inputs. The paper characterizes the effect of inputs on this switch point, and illustrates via an example of an injured railroad worker’s claim to economic damages.