This paper estimates the extent to which legal fees prevent liquidity-constrained households from declaring bankruptcy. To do so, it studies how the 2001 and 2008 income tax rebates affected consumer bankruptcy filings. The authors exploit the randomized timing of the rebate checks and estimate that the rebates caused a significant, short-run increase in consumer bankruptcies in both years, with larger effects in 2008 when the rebates were more generous and more widely distributed. Using hand-collected data from individual bankruptcy petitions, the authors document that the rebates caused an increase in the total liabilities and debt-to-income ratios of filers.
It is unlikely that many consumer bankruptcy attorneys would be surprised by a finding that the receipt of tax refunds often increases the filings of Chapter 7 bankruptcies. This paper extends that truism and finds that tax rebates in 2001 and 2008 increased Chapter 7 fillings, but had a small, negative effect on Chapter 13 filings.
Following the 2001 tax rebates, Chapter 7 filings increased by 2% and after the 2008 tax rebates, the increase was by roughly 7%. The greater increase following the 2008 rebates indicates that it was "driven by the larger average value of the rebate checks as well as the more severe recession, which likely increased the number of liquidity-constrained households."
The impact of tax rebates were, however, only a short-term affect, in essence making possible for Debtors to file bankruptcy sooner, not increasing the total number of bankruptcies in the longer-term.
As tax rebates are intended to stimulate the economy during a recession (or worse), this paper suggests that many households use tax rebates to file for bankruptcy and as households tend to increase short-run consumption after bankruptcy by a great deal more than the amount of the rebates themselves. "In this sense, reducing the barriers to bankruptcy may be a particularly effective economic stimulus, as the timely discharge of household debt may increase household consumption substantially."
This paper also makes the unsurprising suggestion that attorney’s fees are one of the primary delays for debtors filing bankruptcy and that a reduction of attorney’s fees and costs would beneficial for debtors.
The authors of the paper draw the conclusion that debtors would enjoy improved "social welfare" through the reduction of legal fees and cost. A unspoken premise for this conclusion is that attorney’s fees and court costs are "too high." Their data, however, actually would seem to support a more nuanced conclusion, namely that Debtors benefit from improved means for paying attorney’s fees and costs. This paper shows that one of way to have provide debtors (and everyone else) with tax rebates. Consumer bankruptcy attorneys are also well familiar with the rush of February, March and April filings after receipt of tax refunds.
There are, however, other means of making payment of attorneys’ fees easier. Included in this should be the growing number (even in the face of inexplicable Chapter 13 Trustee resistance) to attorney fee only ("AFO") Chapter 13 plans, where the costs of filing, including in some cases the filing fee, are paid overtime and after a debtor has received the initial benefit of the automatic stay.
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