Liquidity Constraints and Consumer Bankruptcy

Some households do not have the liquid assets that are needed to cover the costs of bankruptcy filing; receiving tax rebates provided the needed liquidity.

Over the past three decades, consumer bankruptcy rates have tripled. As of the late 1990s, nearly 10 percent of American households had declared bankruptcy. In the early years of the last decade, the annual rate of bankruptcy filing among American households was over 1.3 percent. In an attempt to slow the increase in bankruptcies, the 2005 Bankruptcy Abuse Prevention and Consumer Protection Act required that bankruptcy filers undergo mandatory credit counseling at their own expense and it raised the legal and administrative fees that households must pay in order to declare bankruptcy from an average of $921 before the reform to an average of $1,477 after the reform.

In Liquidity Constraints and Consumer Bankruptcy: Evidence from Tax Rebates (NBER Working Paper No. 17807), authors Tal Gross , Matthew Notowidigdo , and Jialan Wang exploit the variation in liquidity induced by the 2001 and 2008 income tax rebates in order to estimate the effect of a one-time, anticipated increase in liquidity on consumer bankruptcy filings. The rebates, which varied between $300 and $1200 per household, were randomly distributed to households over an approximately ten week period in both years.

The researchers find that the tax rebates led to a significant, short-run increase in consumer bankruptcies: total bankruptcies increased by roughly 2 percent after the 2001 rebates and by 7 percent after the 2008 rebates. The increase in bankruptcy filings was consistent with the presence of liquidity constraints for many households. Some households do not have the liquid assets that are needed to cover the costs of bankruptcy filing; receiving tax rebates provided the needed liquidity. The authors find no evidence that the increase in filings came from bankruptcies that would not have occurred otherwise. Instead, the rebates seem to have allowed households that would have filed for bankruptcy eventually to do so months earlier than they otherwise would have.

--Lester Picker