State law is factor in bankruptcy, study finds

People have long considered how a state's bankruptcy rate reflects the demographics of its residents, but a new study by two BYU economists found state law and state bankruptcy court norms also contribute to a state's bankruptcy rate.

BYU professors Lars Lefgren and Frank McIntyre wrote in the study, published in the University of Chicago's Journal of Law and Economics, that about 70 percent of bankruptcy differences between the states can be explained by wage garnishment laws, the percentage of bankruptcies filed under Chapter 13 and demographics.

The authors looked at 28,000 bankruptcies in all 50 states from 1999 to 2001. During that time, Utah's bankruptcy rate was second-highest in the nation, after Tennessee, Lefgren said.

In 2005, Congress changed bankruptcy law to make it more difficult to file for bankruptcy, but Lefgren said that the conclusions of the study don't necessarily change because the authors looked at state laws and bankruptcy court norms.

Federal law allows creditors to garnishee up to 25 percent of a person's wages, if their income meets certain requirements. Some people declare bankruptcy because they are not taking home enough income after garnishments, Lefgren said.

But about half the states have garnishment laws that favor debtors. For instance, in North Carolina, creditors can garnishee 75 percent of a person's disposable income. "But their disposable income is a calculation after living expenses," Lefgren said, and people who make $100,000 a year can argue that 100 percent of their income goes to living expenses. The result is that in North Carolina, creditors don't bother garnisheeing wages, and as a result, North Carolina has one of the lowest bankruptcy rates in the United States.

In Utah, creditors can garnishee wages for six months. Then they have to get permission from a judge to renew garnishment.

"Utah falls on the relatively severe end in terms of debtors and what can be garnisheed," Lefgren said.

Chapter 13 bankruptcy is different than Chapter 7 bankruptcy because with Chapter 13, debtors are required to repay a portion of their debts to creditors in monthly installments. Chapter 7 bankruptcies result in the debtor selling assets and distributing proceeds among debtors. All unsecured debt vanishes, and most households don't have assets worth liquidating, Lefgren said.

But with Chapter 13 bankruptcies, the monthly installments can become too much and the debtors default. That can result in another bankruptcy filing.