Liquidity Constraints and Consumer Bankruptcy: Evidence from Tax Rebates

Abstract

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. We 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, we document that the rebates caused an increase in the total liabilities and debt-to-income ratios of filers.