The Consumption Effects Associated with Filing for Personal Bankruptcy

Abstract

This article examines the response of food consumption to filing for personal bankruptcy in the spirit of previous work on the benefits of other social-insurance programs. Using the Panel Study of Income Dynamics (PSID), we find that an increase in the financial benefit to filing for bankruptcy increases the growth in food consumption. In addition, we find that filing under chapter 7 of the bankruptcy code provides consumption insurance, while filing under chapter 13 of the bankruptcy code provides no significant consumption benefits. Personal bankruptcy in the United States is part of the social-insurance structure provided by the federal and state governments. Other programs in this network include, but are not limited to, Unemployment Insurance (UI), Temporary Assistance to Needy Families (TANF), and food stamps. While these latter three programs are targeted to specific groups, the recently unemployed for UI and low-income households for TANF and food stamps, personal bankruptcy is not. Much like these other programs, though, bankruptcy reduces income uncertainty and reduces wealth uncertainty. Surprisingly little work has been done on the direct benefits to filing for bankruptcy. This is in contrast with the growing literature on the costs of bankruptcy.1 Fay, Hurst, and White (2002) estimate the financial benefit to filing for bankruptcy, which equals the debt forgiven minus any lost assets. This measure is a good predictor of whether the household files for bankruptcy, but it is not clear that the financial benefit is the true measure of the welfare gain from bankruptcy. In fact, the financial benefit is most likely an overestimate of the household's gain in the year it files for bankruptcy. Unlike UI or TANF, bankruptcy provides no increase in money income for that period but rather increases net-of-debt income. This change is felt over the household's lifetime, and filers will most likely smooth this effect over multiple years because households cannot file for bankruptcy again for six years. Further, using the financial benefit makes it difficult to compare results against the