New York University Law and Economics Working Papers

A PROCESS ACCOUNT OF THE ENDOWMENT EFFECT: VOLUNTARY DEBIASING THROUGH AGENTS AND MARKETS

Jennifer Arlen et al. — Fri, 10 May 2013 12:44:17 PDT

We contest the loss aversion theory of the endowment effect, in which the effect depends on the status of endowment alone. Instead, we propose that the nature of the trading process determines whether people resist or accept an exchange by affecting the responsibility people feel for their choice. The more they feel responsible for the decision, the more they expect experiencing regret over a negative outcome. Aversion to regret causes people to resist a rational trade and exhibit the endowment effect. In a series of experiments, we analyze two institutions that alter the trading process and reduce perceived responsibility --agency and markets. We find that both mute the endowment effect; moreover, participants intentionally use them to self-debias. Since many institutions shift responsibility, we conclude that the endowment effect is not present in many domains previously thought to implicate it. Institutional design often need not rely on paternalistic intervention.

Economic Analysis of Medical Malpractice Liability and its Reform

Jennifer Arlen — Thu, 09 May 2013 07:46:55 PDT

This Chapter provides an economic analysis of medical error employing a model in which physicians who provide suboptimal medical care may have done so knowingly (as in the traditional model) or accidentally. Accidental medical error is a leading cause of medical negligence: many if not most physicians who provided suboptimal care did not know they were doing so but instead misdiagnosed the patient, unintentionally selected the wrong treatment or erred in treatment provision. Accordingly, in order to promote optimal health care markets, malpractice liability must be structured to both induce physicians to want to provide optimal treatments (when they are informed) and to invest optimally in the expertise and patient safety measures which reduce the risk that they will misdiagnose the patient, select the wrong treatment, or err in the delivery of care. This Chapter shows that negligence liability can achieve both goals, but only if expected damages for accidental negligence are less than the ex post cost of the harm imposed. Malpractice liability can be relied on to induce optimal investment in patients’ welfare only if medical institutions also are directly liable to their patients for harms caused by medical error and if medical providers and insurers are precluded from contracting over liability with patients.

REALITY CHECK: HOW MALPRACTICE FACTS CHANGED MALPRACTICE LIABILITY THEORY

Jennifer Arlen — Wed, 01 May 2013 11:51:06 PDT

Empirical legal studies has transformed economic analysis of malpractice liability. Until recently, economic analysis of malpractice liability has been based on the traditional model of accidents. This model supports the conclusion that malpractice liability may not be needed if health insurers, not physicians, bear treatment costs. Moreover, this analysis implies that even when liability is welfare-enhancing, it need not be mandatory if patients are informed about the costs and benefits of liability. Empirical analysis of medical errors reveals that we cannot rely on the simple model of accidents to analyze optimal malpractice liability because patient safety depends on two different care decisions, only one of which is properly captured by the traditional model. Expanding the model to account for the two distinct ways that physicians protect patients reveals that malpractice liability is needed even when doctors want to select the right treatment. It also reveals why contractual malpractice liability is inefficient even when patients are informed about the costs and benefits of liability.

WHEN THE STATE HARMS COMPETITION ― THE ROLE FOR COMPETITION LAW

Eleanor M. Fox et al. — Wed, 10 Apr 2013 09:13:58 PDT

This article is about the reach of antitrust laws to proscribe or override anticompetitive acts and measures of the states. While it was once the case that antitrust (or competition) laws were reserved for private restraints, a more modern view of the state and the market recognizes the integral relationship between them. The authors surveyed 32 jurisdictions and found that antitrust/competition laws of a number of jurisdictions condemned certain state acts and measures. This article describes and summarizes the research and combines the research findings with conceptual analysis to recommend relevant rules and principles that might be adopted as recommended principles and included in a model modern competition law.

“TO REGULATE,” NOT “TO PROHIBIT”: LIMITING THE COMMERCE POWER

Barry Friedman et al. — Wed, 03 Apr 2013 13:01:16 PDT

Today it is taken for granted that Congress’s power “to regulate . . . Commerce among the several States” includes the power to shut interstate markets down. That is why, for example, Congress is understood to have the power to ban the possession and use of marijuana, even though twenty states have expressed contrary preferences, either for the medicinal or recreational use of the drug. This Article argues that as a matter of constitutional history and theory both, this familiar assumption about congressional power is wrong. First, the Article demonstrates that the original understanding, which prevailed for over one hundred years, did not grant Congress the power to ban markets. Congress could pass “helper” statutes to facilitate state choices, and it could even ban particular goods (such as diseased cattle) “in service” of the interstate market; but it could not simply prohibit all commerce in products of which it disapproved. Second, the Article demonstrates that although this understanding changed following the 1903 Supreme Court decision in Champion v. Ames, none of the reasons supporting the change justify Congress possessing the power today. Finally, this Article examines theoretical justifications for congressional power grounded in law and economics and constitutional theory to suggest that the power “to regulate” interstate commerce should not be understood to include the power to prohibit it. The argument has implications for national bans on articles and activities such as interstate gambling, drugs, raw milk products and assault weapons.

Damages versus Specific Performance: Lessons from Commercial Contracts

Theodore Eisenberg et al. — Fri, 29 Mar 2013 11:47:17 PDT

Specific performance is a central contractual remedy but, in Anglo-American law, generally is subordinate to damages. The familiar rule is that courts will not award specific performance when damages provide adequate relief. Despite rich theoretical discussions of the relative merits of specific performance and damages as contract remedies, little is known about parties’ treatment of the remedy in their contracts. We study 2,347 contracts of public corporations to quantify the presence or absence of specific performance clauses in several types of contracts (clauses that convey the parties’ intent that the court award specific performance in the event of breach). Although a majority of contracts do not refer to specific performance, substantial variation exists in the rates of including specific performance clauses. These clauses appear in some contracts of every type, but their incidence varies widely: high rates of specific performance clauses are found in the area of corporate combinations through merger (53.4 percent) and assets sales (45.1 percent) but much lower rates are observed in loan agreements. It appears, therefore, that treatment of specific performance in sophisticated corporate contracts is more complex than existing theories of contractual remedies allow. We also present results on the associations among contractual acceptance of five default dispute resolution rules: specific performance clauses, arbitration clauses, jury trial waiver clauses, litigation forum clauses, and attorney fees clauses. Rejecting the default damages rule in favor of specific performance is associated with rejecting each of the four other dispute resolution clauses.

Poverty, Not Inequality: Federal Taxes and Redistribution

David Kamin — Thu, 21 Mar 2013 08:35:45 PDT

The federal tax system, and the income tax in particular, is often held out as a key — perhaps the key tool — for combatting income inequality. Especially given the rapid rise in inequality seen over the last 30 years, it is natural to look to the tax code and ask what can be done in response. However, this article’s answer to that question is “not much,” because of the practical constraints on policymaking. Put simply, the effect of the federal tax system on income inequality is — and is likely to continue to be — decidedly limited. When it comes to the distribution of the tax burden, this suggests that other concerns, beyond overall inequality, should take precedence. This article offers an alternative — that of poverty. For even as the tax system can do relatively little to change the overall income distribution within the practical bounds of policymaking, it can do more, sometimes much more, when it comes to the welfare of those toward the bottom of the income spectrum. To sum up, this is a practical argument with the following practical conclusion: when it comes to the distribution of the tax burden, what matters most are metrics like poverty, not inequality and, when it comes to reducing inequality, we should be looking for tools beyond the tax system.

United States National Report on Tax Privacy

Joshua D. Blank — Thu, 21 Mar 2013 08:35:43 PDT

This National Report was prepared for a conference titled “Tax Secrecy and Tax Transparency - The Relevance of Confidentiality in Tax Law", which took place in July 2012 in Rust, Austria and was co-hosted by the Institute for Austrian and International Tax Law at the Vienna University of Economics and Business and by Örebro University, Sweden. The Report describes the current tax privacy protections that apply to taxpayers in the United States and provides an overview of the policy considerations that have contributed to their enactment. Portions of this Report were originally published, in part, in Joshua D. Blank, In Defense of Individual Tax Privacy, 61 Emory L.J. 61 265 (2011).

No Contract?

Oren Bar-Gill et al. — Fri, 08 Mar 2013 08:17:14 PST

'No Contract' is on the rise in many consumer markets. Sellers are luring customers with the assurance that no commitment is required — that the consumer can terminate the service freely at any time, without paying a termination penalty. What explains the increasing prevalence of No Contract? Is it welfare enhancing? We examine the costs and benefits of No Contract, as compared to the lock-in alternative, and conclude that the rise of No Contract is generally desirable, a market response to consumers’ growing awareness and understanding of the costs of lock-in. We argue, however, that lock-ins continue to prevail less conspicuously, through loyalty programs that, like termination penalties, punish consumers for switching. Doctrinally, courts scrutinize lock-in contracts as penalty liquidated damages, and reduce these fees when excessive. We show that while courts’ skepticism of lock-in is generally justified, the doctrinal method is fundamentally misguided, resulting in inconsistent and welfare-reducing outcomes. In fact, with informed consumer choice disciplining sellers’ actions, as evidenced by the rise of No Contract, the need to regulated this type of lock-in contracts is diminishing. Consumers, however, are not as alert when joining loyalty programs, and the distortions arising form such lock-ins are heightened, rather than resolved, by competition. Courts and regulators should be focusing their attention on loyalty programs, not early termination fees.

Tacit Agreement and Relationship-Specific Investment

Clayton P. Gillette — Wed, 06 Mar 2013 09:53:35 PST

Default rules of contract law permit recovery of consequential damages for breach when the breaching party had “reason to know” of those damages at the time of contracting. It is a common observation that sophisticated parties systematically bargain out of these default rules, since the scope of consequential damages is highly uncertain and largely within the control of the non-breaching party. Nevertheless, some parties retain the default rules, and some contracts involving sophisticated actors contain an explicit provision allowing consequential damages, including lost profits, for breach. In effect, these parties satisfy the test that awards consequential damages only when there has been “tacit agreement” to their recovery. That test, which has been repudiated by commentators and most case law outside of New York, limits recovery of consequential damages more severely than the standard “reason to know” test. In this Article, I examine contracts that include explicit “lost profits” clauses and cases in which courts have determined whether parties either tacitly agreed to or had reason to know of prospective lost profits. I claim that the relevant contracts and cases reveal that consequential damage clauses are used to solve a contracting problem that might otherwise frustrate mutually beneficial exchange. Parties and courts have perceived that a commitment to pay lost profits can diminish the threat of opportunistic behavior that is inherent where one party must make a relationship-specific investment prior to performance by the counterparty. In transactions with those characteristics, the investing party risks holdup by its counterparty between the period when the initial investment is made and when the second party must act. I suggest that a commitment to pay lost profits in the event of breach constrains the threat of holdup, and that in these circumstances the value of the promise compensates for the efficiency loss otherwise inherent in assigning consequential damages to the party least able to avoid them. While a pledge of lost profits in the event of breach is not the exclusive response to this holdup problem, it is a plausible and perhaps superior means of avoiding it. I conclude that the combination of near-universal opt-out of the default rule for consequential damages and the explicit adoption of a broad consequential damages clause in investment cases indicates that the “tacit agreement” test may be more consistent with the preferences of commercial parties for a contract default rule that the “reason to know” test.

The Governance Problem in Aggregate Litigation

Samuel Issacharoff — Thu, 21 Feb 2013 09:44:32 PST

Recent developments in class action law and scholarship have forced new attention on the question of how class representation should be assessed. This Article begins with an examination of the governance problem in class action analyzed from the perspective of the customary political theories that would justify legitimate government in public and private domains. Customary accounts of democratic legitimacy or contractual voluntarism poorly capture the distinct world of the one-time aggregation of a class under court-assigned leadership. What emerges is an assessment of how various class action doctrines serve to fill the void in customary indications of legitimacy in governance. The Article concludes with a review of alternative efforts to structure class governance to avoid the agency problems inherent in the power to manage the affairs of others.

Special Interests After Citizens United: Access, Replacement, and Interest Group Response to Legal Change

Samuel Issacharoff et al. — Thu, 21 Feb 2013 09:44:30 PST

The legal literature on campaign finance law and the political science literature on how and why interest groups mobilize use different methodologies to get at overlapping issues. This review integrates some of these insights to better understand the relationship between interest group participation in elections and changes in campaign finance law. The post-Citizens United world of law created some regulatory vacuums that only some groups tried to take advantage of. For example, little corporate money found its way into SuperPACs or groups engaging in independent electoral advocacy. We argue that understanding interest groups’ objectives of using contributions to candidates to obtain access, on the one hand, or using independent expenditures to install friendly candidates in office, on the other, is key to analyzing how interest groups respond to legal developments. We also argue that while interest group participation in elections increased in 2012, the party centric federal election system was largely resilient to increased interest group mobilizations highlighting the difficulties with the replacement-oriented strategy.

Policing Immigration

Adam B. Cox et al. — Fri, 25 Jan 2013 07:07:32 PST

Immigration enforcement is increasingly integrated with local policing. This trend accelerated four years ago when the federal government launched “Secure Communities,” a program designed to check the immigration status of every person arrested by local police. The government views the program as an innovation that enhances the efficacy of crime control and immigration enforcement, while civil rights groups have decried it as an invitation to racial profiling by local police. This paper, part of a larger project providing the first large-scale empirical evaluation of Secure Communities, uses the pattern of the program’s activation to explore a central feature of criminal and administrative law that rarely lends itself to empirical examination — the role of discretion in policing. Constrained by limited resources, the agency staggered the program’s activation across counties, revealing the federal government’s priorities for implementation in the face of competing political and programmatic incentives. The data undercut the government’s claims that the program is all about making communities more secure from crime. Moreover, the fact that early activation in the program correlates strongly with whether a county has a large Hispanic population raises important questions about demographic profiling in immigration enforcement.

Much Ado About Preemption

Katherine J. Strandburg — Fri, 18 Jan 2013 08:51:14 PST

Preemption has emerged as the leading contender for conceptual grounding of the patentable subject matter doctrine’s exclusion of abstract ideas and natural phenomena from patentability. Despite the Supreme Court’s frequent use of preemption rhetoric, however, the concept cannot provide a satisfactory explanation of the Court’s patentable subject matter jurisprudence or a sound theoretical basis for the doctrine. Patentable subject matter jurisprudence has two distinct threads, one concerned with overly broad impact on downstream innovation and the other based on per se exclusion of abstract ideas and natural phenomena from patentability. Most of the Court’s patentable subject matter decisions apply a per se exclusion analysis. While preemption is conceptually related to the downstream impact thread, the term is misleading even in that context. When preemption rhetoric is employed in the majority of cases, which are based on per se exclusion, it leads to confusion and incoherence.

This Article disentangles the preemption rhetoric from the per se exclusion analysis in the Supreme Court’s cases. Per se exclusion analysis necessarily involves two steps: identifying the per se excluded elements in a claim and applying some rule to determine whether additional claim limitations render the claim patentable. The Article identifies these two steps within the Supreme Court’s cases and seeks to prepare the ground for coherent theoretical analysis. Preemption rhetoric is a distraction from important questions that must be answered to give patentable subject matter doctrine a firm theoretical grounding. First, what are the normative bases of the per se exclusions? As the discussion of the cases shows, failing to answer this question leads to seemingly arbitrary (or result-driven) identification of the per se excluded elements in a claim. Second, what rules should be used to determine whether a particular claim incorporating per se excluded elements along with other limitations is patentable subject matter? The current muddle in patentable subject matter analysis is due largely to failure to moor these second-step rules to the normative basis for per se exclusion.

The Bucket and Buffett Approaches to Raising Taxes on High-Income U.S. Individuals

Daniel Shaviro — Thu, 17 Jan 2013 12:07:07 PST

In the aftermath of the 2012 U.S. presidential election, while there is increasing consensus that high-income individuals’ taxes should increase, there is considerable disagreement about how this might best be done. In particular, while some favor raising upper-bracket marginal income tax rates, others prefer an approach that I call distributionally selective base-broadening. Here the idea is to restrict or deny the benefit of various tax preferences in such a way as to target the impact of the base-broadening on high-income individuals who have such items. An inevitable byproduct of such an approach is that different individuals will in effect face different tax bases.

This brief article, prepared for a forthcoming tax policy forum in the Canadian Tax Journal, assesses two such approaches that have received recent attention. The first is a “bucket” approach to limiting the use of particular tax preferences, endorsed by the 2012 Romney campaign. The second is the so-called “Buffett tax,” endorsed at one point by the Obama Administration. It argues that, while either might conceivably be better than politically feasible alternatives, they have significant defects that should be kept in mind as well. Indeed, in some respects both bring to mind the much-reviled alternative minimum tax.

Federalized America: Reflections on Erie v. Tompkins and State-Based Regulation

Samuel Issacharoff — Wed, 12 Dec 2012 08:08:31 PST

The approaching 75^th anniversary of Erie v. Tompkins permits a critical reassessment of Justice Brandeis’s landmark opinion. This article joins the growing body of critical academic literature, focusing on the implausibility of the claimed reasons for overturning Swift v. Tyson. Erie’s claim to safeguard a constitutional place for state law rings hollow when seen in historic perspective, especially if one looks at the underlying question of the role of common law tort claims to control railroad accidents. While the doctrinal claims of Erie may not hold up, the concern about the regulatory consequences of federal court prohibitory injunctions continues to resonate. The article tries to resuscitate this aspect of Erie, perhaps best understood as the Progressive response to the perceived excesses of the Lochner period. Read this way, the concerns of Erie continue to manifest themselves in current controversies over claims of implied preemption, despite the doctrinal distance from the actual doctrinal claims of Erie itself.

Set in Stone? Change and Innovation in Consumer Standard Form Contracts

Florencia Marotta-Wurgler et al. — Mon, 10 Dec 2012 06:42:31 PST

This article studies the rate, direction, and determinants of change in consumer standard form contracting. We examine what changed between 2003 and 2010 in the terms of 264 mass-market consumer software license agreements. Thirty-nine percent of contracts materially changed at least one term, and some changed as many as fourteen terms. The average contract became more pro-seller as well as several hundred words longer. The increase in length is not due to the use of simpler language: contract readability has been constant: the average contract is as readable as an article in a scientific journal. Younger, larger, growing firms, and firms with in-house counsel were more likely to change existing terms and to introduce new terms to take advantage of technological and market developments. Contracts appeared to respond to litigation outcomes: Terms that were increasingly enforced by courts were more frequently used in contracts, and vice-versa. The results indicate that software license agreements are relatively dynamic and shaped by multiple factors over time. We discuss potential consumer protection implications as a result of the increased length and complexity of contracts over time.

The Forgotten Henry Simons

Daniel Shaviro — Fri, 07 Dec 2012 12:21:33 PST

Surely just about everyone in the U.S. federal income tax field has heard of Henry Simons, if only for his famous definition of “personal income.” Few realize, however, that this proponent of “drastic progression” in a broad-based income tax was also a self-described libertarian who generally denounced government economic regulation and was arguably the chief architect of the pro-free market law and economics movement at the University of Chicago. This article provides a brief intellectual history of Simons’ work, aiming in particular to explain how and why he combined these seemingly disparate sets of beliefs, and what we may learn from them today.

Should Social Security and Medicare Be More Market-Based?

Daniel Shaviro — Fri, 07 Dec 2012 12:21:31 PST

Contemporary political debate about Social Security and Medicare often conflates the issue of the programs’ long-term fiscal sustainability with that of whether their design should be made more market-based, such as by transforming Social Security into a private accounts program and Medicare into a voucher-based program. In fact, the sustainability and design issues are fundamentally separate.

This article assesses the case for making the programs more market-based by using two main conceptual vehicles: (1) the model for understanding the programs’ substantive features and rationales that I offered in my books, Making Sense of Social Security Reform and Who Should Pay for Medicare?, and (2) Paul Samuelson’s classic description of Social Security as providing what we would now call an implicit financial instrument that reflects an intergenerational compact. In the end, it reaches largely skeptical conclusions about altering the programs to use either private accounts or vouchers.

An Information-Forcing Approach to the Motion to Dismiss

Samuel Issacharoff et al. — Fri, 16 Nov 2012 06:55:41 PST

This article proposes a new approach to the 12(b)(6) motion to dismiss. The idea works as follows. Defendant moves to dismiss exactly as under current practice. Plaintiff either responds to the motion, thus submitting the matter for decision, or files an affidavit proposing a plan of targeted discovery. After receiving defendant’s response, the court approves, rejects, or revises the proposed discovery plan. If the judge allows discovery, defendant either withdraws the motion or produces the information. If defendant withdraws the motion, the litigation proceeds in the usual way. If defendant continues the motion the parties engage in targeted discovery. The court then reviews the motion taking account of information which either party brings to the court’s attention, including information produced in discovery. If the court grants the motion, the case is dismissed and plaintiff pays defendant’s reasonable fees and costs associated with the motion and associated discovery. If the court denies the motion, the case continues and defendant pays plaintiff’s reasonable fees and costs. Our proposal would incentivize both parties to reveal information pertinent to the court’s decision. It promises to improve the operation of the motion to dismiss regardless of the substantive standard used to evaluate the sufficiency of the claims for relief.