Bankruptcy: "$400 per household"

As this debate goes forward, it is important for all to understand that according to some experts, a conservative estimate is that every American family pays about $400 a year in a hidden tax associated with bankruptcies, taxes they should not have to pay. I am told that others place the fair estimate of this hidden bankruptcy tax in the range of $550 per person per year. There are numerous examples of people who take advantage of loopholes today at the expense of everyone else tomorrow.
. . .
Bankruptcy abuse also hurts our Nation's small businesses. Without reforms from this bill, losses from bankruptcy abuse will continue to break the backs of the Nation's small businesses and retailers, which work with slim profit margins and have even smaller margins for error.

Senator Orrin Hatch, February 28, 2005
151 Cong. Rec. S1786

The roots of this widely cited figure [of $400 per household] as applied to bankruptcy are obscure, as there are no firm national figures on the amount of debt discharged in bankruptcy. Nevertheless . . . it is probably about right.

The Staten/Barron study indicated that chapter 7 debtors have an average of $41,228 in unsecured debt, and chapter 13 debtors report an average of $20,953 in unsecured debt. Assuming that these averages (based on a study of 3,798 personal bankruptcies filed in 13 cities during mid-1996) are fairly representative of all personal bankruptcies—a fairly big assumption—one can make a rough estimate of total unsecured debt nationwide in non-business cases. Applying these averages to FY 1997 non-business filings yields an estimate of approximately $46 billion in unsecured debt. The amount actually discharged would be reduced somewhat by the debts that are not discharged in the approximately 50 percent of chapter 13 cases that end up being dismissed, non-dischargeable debts and payments made through liquidation of assets in chapter 7 cases, chapter 13 plan payments, reaffirmations and other repayments. There are about 100 million households in the United States, so the $400 per household estimate is also in the right ball park.

Ed Flynn, March 1998
ABI Journal, Vol. XVII, No. 2

But Prof. Elizabeth Warren convincingly shows that the $400 per household number is not the correct number for analysis.

In 1997, when the "$400 fact" was released, there were about 101 million American families. That same year, about 1.3 million families filed for bankruptcy. [FN24] In order for the 1.3 million families to repay enough to produce the $44 billion that Tassey implied would be passed on to their fellow citizens, the families in bankruptcy would have to come up with about $33,800 apiece--plus transactions costs for collection and redistribution. For bankrupt debtors with a median pre-tax income of about $21,000, this would be problematic. [FN25]

How about squeezing the "abusers" harder? The credit industry hired its own researchers to estimate the number of debtors who might repay something. The research was discredited, as the General Accounting Office (GAO) sharply questioned the assumptions and methodology of the study. [FN26] But even the credit industry researchers could identify only 185,000 debtors who might be able to pay anything. [FN27] In order to raise the $44 billion Mr. Tassey promised, these 185,000 families would need to come up with about $237,839 apiece. [FN28] The numbers simply do not add up.

Prof. Elizabeth Warren, 2004
13 J. Bankr. L. & Prac. 2 Art. 4

So what we have now is that some tens of billions of dollars (say $40 billion) are discharged each year in personal bankruptcy. The optimistic estimate for collections from BAPCA is a few billions of dollars ($3 billion). The US economy, as measured by 2004 GDP, is some $11 trillion. If we only look at consumer credit, the total is some $2.1 trillion, which is 700 times the $3 billion estimated benefit from the means-testing provision.

I'm currently unconvinced that the Harm of "substantial losses" is a substantial problem worth addressing. Sure, finance is a world of basis points, but a solvency of 14 basis points (0.0014%) of payable-but-discharged debt is quite underwhelming.