PERSONAL

BANKRUPTCY

Analysis of Four

Reports on Chapter 7

Debtors’ Ability to Pay

United States General Accounting Office

GAO Report to Congressional Requestors

June 1999

GAO/GGD-99-103

United States

General Accounting Office

Washington, D.C. 20548

General Government Division

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GAO

June 21, 1999

The Honorable Charles E. Grassley

Chairman, Subcommittee on Administrative

 Oversight and the Courts

Committee on the Judiciary

United States Senate

Dear Mr. Chairman:

As you requested, this report compares and evaluates the methodologies

used by four reports on bankruptcy debtors’ ability to pay their debts—two

by Ernst & Young LLP (Ernst & Young) under the sponsorship of VISA

U.S.A. and MasterCard International,1

 one by Creighton University under

the sponsorship of the American Bankruptcy Institute (Creighton/ABI),2

and one by the Executive Office for U.S. Trustees (EOUST).3 These reports

address a major public policy issue—the amount of income that those who

file for personal bankruptcy have available to pay their debts. Specifically,

you requested that we evaluate and compare each report’s research

methodology for estimating the number of bankruptcy debtors who would

be able to pay a portion of their debts and the amount of debt such debtors

could repay. Last year, we reported on our evaluation of a similar report by

the Credit Research Center.4

Debtors who file personal bankruptcy petitions usually file under chapter 7

or chapter 13 of the bankruptcy code. Generally, debtors who file under

chapter 7 of the bankruptcy code seek a discharge of all their eligible

dischargeable debts.5

 Debtors who file under chapter 13 submit a

repayment plan, which must be confirmed by the bankruptcy court, for

paying all or a portion of their debts over a 3-year period, unless for cause

 

1

 Chapter 7 Bankruptcy Petitioners’ Ability to Repay: The National Perspective, 1997 (March 1998) and

Chapter 7 Bankruptcy Petitioners’ Repayment Ability Under H.R. 833: The National Perspective (March

1999).

2

 Marianne B. Culhane, J.D., and Michaela M. White, J.D., “Taking the New Consumer Bankruptcy

Model for a Test Drive: Means-Testing Real Chapter 7 Debtors ,” VII ABI L. Rev. 27 (March 1999).

3

 Gordon Bermant and Ed Flynn, Executive Office for U.S. Trustees, Incomes, Debts, and Repayment

Capacities of Recently Discharged Chapter 7 Debtors (January 1999).

4

 Personal Bankruptcy: the Credit Research Center Report on Debtors’ Ability to Pay (GAO/GGD-98-47,

Feb. 9, 1998).

5

 Eligible debts may be discharged in bankruptcy proceedings. A dischargeable debt is a debt for which

the bankruptcy code allows the debtor’s personal liability to be eliminated.
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the court approves a period not to exceed 5 years. Recent congressional

bankruptcy reform proposals would establish “needs-based” provisions for

personal bankruptcy in which a debtor who was determined to be able to

pay a specified portion of his or her debts would be required to file under

chapter 13 of the bankruptcy code.

Determining which of these four reports most accurately reflects what

would happen to chapter 7 debtors if “needs-based” bankruptcy reform

were enacted would depend on the details of the legislation eventually

enacted as well as which assumptions about debtors' income, expenses,

debts, and repayment capacity prove to be more accurate.

Each of the four reports represents a reasonably careful effort to estimate

(1) the percentage of chapter 7 debtors who would be required to enter a

chapter 13 debt repayment plan if a specific set of proposed “needs-based”

legislative provisions were enacted (the “can-pay” debtors) and (2) the

amount of debt such debtors could potentially repay over a 5-year

repayment period. “Can-pay” debtors were defined as those debtors whose

gross income met or exceeded a household income test and who could

potentially repay a specific minimum amount of unsecured nonpriority

debt over 5 years. The reports’ estimates of the proportion of “can-pay”

debtors in their respective samples were 15 percent (Ernst & Young,

March 1998; EOUST, January 1999); 10 percent (Ernst & Young, March

1999), and 3.6 percent (Creighton/ABI). The reports’ estimates of the

amount of unsecured nonpriority debt (such as credit card debt) that the

“can-pay” debtors could potentially repay over 5 years ranged from about

$1 billion to about $4 billion.

It is important to note that these repayment estimates do not necessarily

represent unsecured nonpriority creditors’ potential net gain from

implementing needs-based bankruptcy, compared with current practice. It

was not the objective of any of these reports to estimate the potential net

gain to creditors (secured or unsecured) under “needs-based” bankruptcy

and, consequently, none of the reports attempted to do so. Under current

bankruptcy law, many chapter 7 debtors already repay at least some of

their debt, either because they voluntarily reaffirm--that is, agree to repay--

some debts (usually home mortgage or vehicle loans) or because the debts

cannot be discharged in bankruptcy (such as most student loans).

Following the close of their bankruptcy cases, debtors remain financially

responsible for all debts that they reaffirm with the bankruptcy court and

all debts that cannot be discharged in bankruptcy.

Results in Brief
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To develop its percentage and dollar estimates, each of the reports made a

number of assumptions, which varied by report. Each of the reports

included three assumptions: (1) the data in debtors’ schedules on incomes,

expenses, and debts were accurate and could be used as the basis for

forecasting debtors’ income and expenses for a 5-year period; (2) debtors’

income and living expenses would not change over 5 years; and (3) all

debtors required to enter a 5-year repayment plan would complete that

plan. Proposed “needs-based” legislation specified the use of the second

and third assumptions for identifying “can-pay” chapter 7 debtors.

However, none of these three assumptions has been validated. For

example, about 36 percent of the more than 953,180 debtors who entered a

chapter 13 plan during calendar years 1980 through 1988 completed their

repayment plans.6

 If “needs-based” bankruptcy provisions were enacted,

the completion rate could be higher or lower than this. However, there is

no empirical basis for assuming that the completion rate would be 100

percent. To the extent that the completion rate is less than 100 percent, the

amount of debt repaid to creditors could be less than estimated in the

reports.

The reports reached different estimates of “can-pay” debtors principally

because each report used different and noncomparable samples of

debtors, different proposed “needs-based” legislative provisions, and

different methods and assumptions for determining debtors’ allowable

living expenses. A change in a single assumption could affect each report’s

results. For example, according to Ernst & Young, had its 1998 report used

the same median household income test as that used in the Creighton/ABI

report, the Ernst & Young report’s estimate of “can-pay” debtors would

have been 10 percent rather than 15 percent. Similarly, the Creighton/ABI

reported noted that had it used the two Ernst & Young reports’ method of

determining debtors’ transportation ownership allowance, its estimate of

can-pay debtors would have been 6.8 percent rather than 3.6 percent.

Personal bankruptcy filings have set new records in each of the past 3

years, reaching about 1.4 million in calendar year 1998, of which more than

1 million were chapter 7 filings. There is little agreement on the causes for

such high personal bankruptcy filings in a period of relatively low

unemployment, low inflation, and steady economic growth. Nor is there

agreement on the number of debtors who seek relief through the

bankruptcy process who have the ability to pay at least a portion of their

debts and the amount of debt such debtors could potentially repay.

 

6

 The cases of all 953,180 debtors had been closed by September 30, 1993.

Background
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Several bills were introduced in the 105th Congress that would implement

some form of “needs-based” bankruptcy for those who file for personal

bankruptcy under chapter 7 of the bankruptcy code.7

 The conference

report on the Bankruptcy Reform Act of 1998, H.R. 3150, passed the House

in October 1998, but did not reach a vote in the Senate. In the 106th

Congress, the conference report version of H.R. 3150 was introduced in the

House as H.R. 833, and a bill with somewhat different provisions, S.625,

was introduced in the Senate.

Each of these bills has included provisions for determining when a debtor

could be required to file under chapter 13 of the bankruptcy code, rather

than under chapter 7. Currently, the debtor usually determines whether to

file under chapters 7 or 13. Generally, these bills would require debtors

who filed under chapter 7 and whose gross monthly income met a

specified income threshold to undergo a detailed analysis of their income,

expenses, and debts to determine whether they could proceed under

chapter 7 or be required to file under chapter 13. Under chapter 13, debtors

enter into a repayment plan, which must be approved by the bankruptcy

court, to repay their debts over a period not to exceed 3 years, unless for

cause the bankruptcy court approved a period not to exceed 5 years. The

“needs-based” bankruptcy reform bills introduced in the 105th and 106th

Congress would generally mandate a 5-year repayment period for debtors

required to file under chapter 13, rather than under chapter 7. Generally,

the private panel trustee8

 would be responsible for making the initial

determination of whether a debtor would be permitted to proceed under

chapter 7.

Under the bankruptcy code, a debtor’s debts may be grouped into three

general categories for the purposes of determining creditor payment

priority: (1) secured debts, for which the debtor has pledged collateral,

such as home mortgage and automobile loans; (2) unsecured priority debt,

such as child support, alimony, and certain back taxes; and (3) unsecured

nonpriority debt, such as credit card debts, student loans, and other

unsecured personal loans. In analyzing debtors’ repayment capacity, the

four reports focused principally on the proportion of total unsecured

nonpriority debt that debtors could potentially repay. In general, “needs-

 

7

 The two bills on which the House and Senate, respectively, principally focused in the 105th Congress

were H.R. 3150 and S.1301.

8

 Panel trustees are individuals, usually attorneys, appointed by the U.S. Trustee, who are initially

responsible for reviewing debtors’ financial schedules and filing motions with the bankruptcy court

regarding whether a debtor has met the statutory qualifications to proceed under chapter 7. The

“needs-based” provisions of the various bankruptcy reform bills would change the standards the panel

trustee and bankruptcy court use to make this assessment.
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based” bankruptcy bills introduced in the 105th and 106th Congress would

require debtors to file under chapter 13 if the debtors met or exceeded a

specific income standard and could repay all their nonhousing secured

debts, all their unsecured priority debts, and a minimum specified amount

of their unsecured nonpriority debts over a 5-year period.

To evaluate and compare the four reports’ research methodologies, we

assessed the strengths and limitations, if any, of each report’s assumptions

and methodology for determining debtors’ ability to pay and the amount of

debt that debtors could potentially repay. The comments and observations

in this report are based on our review of the March 1998 and March 1999

Ernst & Young reports, the March 1999 Creighton/ABI report, and the

January 1999 EOUST report; some additional information we requested

from each report’s authors; independent analyses using the Creighton/ABI

report’s database; and our experience in research design and evaluation.

We reviewed specific aspects of each report’s methodology, including the

proposed legislation on which the report was based, how the bankruptcy

cases used in the analysis were selected, what types of assumptions were

made about debtors’ and their debt repayment ability, how debtors’

income and allowable living expenses were determined, and whether

appropriate data analysis techniques were used. We also assessed the

similarities and differences in the methodologies used in the four reports.

In addition to reviewing the reports, we had numerous contacts with the

reports’ authors. On March 16, 1999, we met with one of the authors of the

Creighton/ABI report, and on March 25, 1999, we met with the authors of

the two Ernst & Young reports to discuss our questions and observations

about each report’s methodology and assumptions. Following these

discussions, we created a detailed description of each report’s

methodology (see app.I), which we sent to the authors of each report for

review and comment. On the basis of the comments received, we amended

our methodological descriptions as appropriate. The authors of the

Creighton/ABI report responded to written questions we submitted. Ernst

& Young, Creighton/ABI, and EOUST provided additional details on their

methodologies and assumptions that were not fully described in their

reports. We did not verify the accuracy of the data used in any of these

reports back to the original documents filed with the bankruptcy courts.

However, the Creighton/ABI authors provided us with a copy of the

database used in their analysis. Ernst & Young declined to provide a copy

of their database, citing VISA’s proprietary interest in the data. (VISA

U.S.A. and MasterCard International sponsored the Ernst & Young

reports.) We received the EOUST report in early April and, because of time

constraints, did not request the database for the report. We reviewed the

Scope and

Methodology
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Creighton/ABI data and performed some analyses of our own to verify the

authors’ categorization of data used in their analyses. In our review, we

found that the Creighton/ABI researchers prepared and analyzed their data

in a careful, thorough manner.

The team that reviewed the reports included specialists in program

evaluation, statistical sampling, and statistical analysis from our General

Government Division’s Design, Methodology, and Technical Assistance

group. We did our work between February and May 1999 in Washington,

D.C., in accordance with generally accepted government auditing

standards. On May 18, 1999, we provided a draft of our report to Ernst &

Young, the authors of the Creighton/ABI report, and EOUST for comment.

Each provided written comments on the report. In addition, on May 28,

1999, we met with representatives from Ernst & Young to discuss their

comments on the draft report. Ernst & Young and Creighton/ABI also

separately provided technical comments on the report, which we have

incorporated as appropriate. The Ernst & Young, Creighton/ABI, and

EOUST written comments are summarized at the end of this letter and

contained in appendixes III through V.

Each of the reports found that at least some portion of chapter 7 debtors—

ranging from 3.6 percent to 15 percent--met the definition of “can-pay”

debtors as that term was defined in each report’s methodology. The

amount of unsecured nonpriority debt that each report estimated these

“can-pay” debtors could repay over 5 years ranged from about $1 billion to

about $4 billion.

It is important to note that these estimates do not necessarily represent

unsecured nonpriority creditors’ potential net gain from implementing

needs-based bankruptcy, compared with current bankruptcy practice. It

was not the objective of any of these reports to estimate the potential net

gain to creditors (secured or unsecured) under “needs-based” bankruptcy

and, consequently, none of the reports attempted to do so. Currently, many

chapter 7 debtors repay at least some of their debts. Debtors may

voluntarily reaffirm—that is, agree to repay—specific debts (most

commonly home mortgage or vehicle loans) or they may, in effect, be

required to repay others. Some debts, including such unsecured

nonpriority debts as most student loans, cannot be discharged in

bankruptcy. Following the close of their bankruptcy cases, debtors remain

financially responsible for all debts reaffirmed with the bankruptcy court

and all debts that cannot be discharged in bankruptcy.

Shared Characteristics

of the Four Reports
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In developing its estimates of “can-pay” debtors and the total amount of

debt such debtors could repay, each report made a number of

assumptions, which varied by report. Three of these assumptions were

used in all four reports: (1) the data in debtors’ schedules of current

estimated income, current estimated monthly expenses, and debts were

accurate and could be used as the basis for forecasting debtors’ income

and expenses for a 5-year period; (2) debtors’ income and allowable living

expenses would remain unchanged during the 5-year repayment period;

and (3) all debtors required to file under chapter 13 and enter a 5-year

repayment plan would complete that plan. The reports used the second

and third assumptions because proposed “needs-based” legislation

specified their use in identifying “can-pay” chapter 7 debtors. However,

none of these assumptions has been validated.

Each report’s data on debtors’ income, debts, and most living expenses

were from the financial schedules that debtors generally file at the same

time as their bankruptcy petitions.9

 The instructions for the income and

expense schedules specifically ask the debtors to enter their “estimated”

monthly income or expenses. Although these schedules are the only

source of detailed debtor financial data publicly available, the data in the

schedules are of unknown accuracy and reliability.

Both Ernst & Young and Creighton/ABI, for example, developed separate

methodologies for valuing the amount of unexpired vehicle leases because

the data debtors reported on the schedule for unexpired leases was

incomplete or inconsistent. In some cases, for example, debtors reported

the monthly lease payment rather than the total amount of the payments

due on the remainder of the lease. To the extent this occurred, it would

have understated the amount owed on the lease and, thus, overstated a

debtor’s repayment capacity. The National Bankruptcy Review

Commission’s October 1997 report noted that there had been no empirical

report of the accuracy of the financial data initially reported by bankruptcy

debtors, and it recommended random audits of such data.

Each report noted that the proposed legislation used in its analysis

required the use of the assumptions that all “can-pay” debtors who entered

a 5-year repayment plan would complete the plan without modification

and that such debtors’ income and expenses would remain stable during

the 5-year repayment period. All four reports noted that a debtor’s income

 

9

 Federal bankruptcy rule 1007 provides, among other things, that schedules and statements other than

the statement of intention shall be filed with the bankruptcy petitions in a voluntary case, or if the

petition is accompanied by a list containing the names and addresses of all the debtor’s creditors,

within 15 days thereafter.
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and/or expenses may change during the course of a 5-year repayment plan

and that any such changes could affect a debtor’s repayment capacity. The

Creighton/ABI and EOUST reports asserted that it was likely that many

debtors would experience a change in income, expenses, or both over the

5-year period that would reduce their ability to complete their repayment

plans.

Available evidence suggests that at least some percentage of debtors

would be unable to complete their chapter 13 repayment plans. A 1994

AOUSC report10 reviewed the outcomes of all 953,180 chapter 13 cases

filed between calendar years 1980 and 1988 and terminated by September

30, 1993. The report found that about 36 percent of debtors who

voluntarily entered a 3- to 5-year bankruptcy debt repayment plan under

chapter 13 were able to complete their repayment plans and obtain

discharges.11 Another 14 percent of these debtors were unable to complete

their chapter 13 plans and had their eligible debts discharged after their

cases were converted to chapter 7. About 49 percent had their cases

dismissed and did not receive a discharge of their eligible dischargeable

debts. The results of the AOUSC report caution against making broad

conclusions about debtors’ ability to maintain debt payments over a 5-year

period based on the data in the initial debtor financial schedules alone. If

needs-based bankruptcy provisions were enacted, at least some debtors

are likely to experience a change in their financial circumstances during a

5-year repayment period that could increase or decrease their repayment

capacity. Thus, at least some percentage of debtors who complete their

repayment plans are likely to have those repayment plans modified during

the 5-year repayment period. In addition, there is no empirical basis for

assuming that the completion rate would be 100 percent, as assumed in

each of these reports. To the extent that the completion rate was less than

100 percent, the amount of debt repaid to creditors could be less than

estimated in the reports.

The reports differed in their sampling methods, the calendar period from

which the sample of debtors was selected, the proposed legislation used as

the basis for their repayment capacity analyses, the income levels used to

screen debtors for further repayment analysis, the methods used to impute

interest for certain debts, and the assumptions used to estimate debtors’

 

10 Bankruptcy Statistical Trends: Chapter 13 Dispositions (October 1994).

11 This total included “hardship discharges.” A hardship discharge generally may be granted to a chapter

13 debtor who fails to complete the plan payments due to circumstances for which the debtor should

not justly be held accountable. An AOUSC official and EOUST said such chapter 13 discharges were

rare.

Differences in the Four

Reports
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allowable living expenses and debt repayments. Thus, the reports also

differed in the proportion of debtors—the “can-pay debtors--they

estimated would have sufficient income, after paying allowable living

expenses, to repay all of their nonhousing secured debts, all their

unsecured priority debts, and a specific minimum portion of their

unsecured nonpriority debts over a 5-year period. The different methods

and assumptions used in each report’s analysis are discussed in detail in

appendixes I and II.

The two Ernst & Young reports, the Creighton/ABI report, and the EOUST

report used different types of samples drawn from different populations of

bankruptcy petition filers. These differences limit the degree to which the

results of each report can be compared.

The Ernst & Young reports were based on a national probability sample of

about 2,200 drawn from all chapter 7 bankruptcy cases filed nationwide

during calendar year 1997. The cases were selected randomly from the

petitions filed in all federal bankruptcy districts, largely in proportion to

each district’s total chapter 7 filings. Consequently, the results of the Ernst

& Young reports can be generalized to all chapter 7 petitions filed

nationwide in calendar year 1997.

The Creighton/ABI report used randomly selected chapter 7 cases that met

certain qualifications from seven judgmentally selected bankruptcy

districts.12 The districts used in the report were originally chosen for a

different purpose—a report of debtors’ reaffirmations of their debts. The

report’s results can only be generalized to these seven districts. Therefore,

neither extrapolation of the Creighton/ABI results to the nation nor

comparison to the results of Ernst & Young’s March 1998 report is

supported by the methods used. The Creighton/ABI report’s authors

acknowledged that the two reports were based on different sample

designs. However, they still portrayed their results as comparable with

those of the Ernst & Young report. Nevertheless, we recognize that

statistically valid probability samples of less than national scope, such as

Creighton/ABI’s, are often mandated by limited resources. The results of

such samples, appropriately limited to the scope of the sample, can

provide useful information for policymakers.

 12 Those districts were the Northern District of California, the District of Colorado, the Northern

District of Georgia, the District of Massachusetts, the District of Nebraska, the Middle District of North

Carolina, and the Western District of Wisconsin.

Sampling Differences
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The EOUST report was based on a nonprobability sample of nearly 2,000

cases drawn from those chapter 7 cases designated as no-asset by the U.S.

Trustees in 84 of the 90 bankruptcy districts and closed in the first half of

calendar year 1998. The cases were selected in proportion to each district’s

chapter 7 filings during calendar year 1997. Cases from six bankruptcy

districts in Alabama and North Carolina were excluded from the report

because these districts do not have U.S. Trustees.13 Because statistical

probability sampling methods were not used to select the cases closed

within each district, standard statistical methods are not technically

applicable for making inferences from these results to the population of

no-asset chapter 7 cases from those 84 bankruptcy districts closed during

this period. However, treating such a sample as if it were a random sample

may sometimes be reasonable from a practical point of view. EOUST,

based on its subject matter expertise, asserts that these cases are as

random as those they would have obtained from a statistical random

sample of filings from each Trustee’s office. We have no basis to judge the

accuracy of that assertion.

Each of the four reports used different proposed legislation as the basis for

its analysis of debtor repayment capacity. The two Ernst & Young reports

and the Creighton/ABI report each used different proposed legislation

introduced in or passed by the House of Representatives in 1998 or 1999.

The EOUST report was based on a mix of the provisions in specific

versions of H.R. 3150 and S.1301, two bills Congress considered in 1998.

The basic similarities and differences in the “needs-based” provisions of

the proposed legislation used in the Ernst & Young, Creighton/ABI, and

EOUST reports are shown in table 1. Basic differences include the median

income thresholds used to select debtors for repayment capacity analyses

and the two key tests used to identify the “can-pay” debtors.

 

13 These six districts have bankruptcy administrators under the jurisdiction of the federal judiciary. U.S.

Trustees are employees of the Department of Justice. According to EOUST, about 2.4 percent of the

975,370 consumer chapter 7 cases filed nationally in the year ending March 31, 1998, were in the six

districts excluded from the EOUST sample.

Each Report’s Analysis Was

Based on Different

Proposed Legislation
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Ernst & Young

 (March 1998)

Creighton/ABI

 (March 1999)

Ernst & Young

 (March 1999)

EOUST

 (January 1999)

Proposed legislation used

in analysis

H.R. 3150 as

introduced in February

1998.

H.R. 3150 as passed by the

House in June 1998.

H.R. 833 as introduced

in February 1999

H.R. 3150 as passed by

the House, June 10,

1998, and S.1301 as

approved by Senate

Judiciary Commmittee.

Median income test

Annual gross median

household income threshold

used

Households of one

person

Median income for

one-person household.

Median income for oneperson household with one

earner.

Same as Creighton/ABI. Same as Creighton/ABI.

Households of two to

four persons

Median income for

households of two to

four.

Median income for family

households of two to four.

Same as Creighton/ABI. Same as Creighton/ABI.

Households of more than

four persons

Median income by

household size. In

tables used, median

income peaked at

families of four and

declined for families of

more than four.

Median income for family

household of four.

Median income for

family household of four

plus $583 annually for

each additional member

over four.a

Median income for family

household of four plus

$583 monthly for each

additional member over

four.b

Percent of median income

needed to pass income test

More than 75 percent

for household of same

size as debtor’s.

100 percent or more for

household of same size as

debtor’s.

Same as Creighton/ABI. Same as Creighton/ABI.

Debtor’s allowable living

expenses

Based on IRS

Collection Financial

Standards.

Same as 1998 Ernst &

Young, except interpreted

IRS transportation

allowance differently.

Same as 1998 Ernst &

Young.

Selected expenses—

taxes, business

expenses, child support

and alimony--were

deducted from that

portion of debtor income

over the national annual

median for household of

comparable size.

Minimum monthly income

test after paying allowable

living expenses and

repaying all nonhousing

secured debt and all

unsecured priority debt

over 5 years

More than $50. If $50

or less, debtor could

file under chapter 7.

Same as 1998 Ernst &

Young.

No specific income test.

Test based on amount

of unsecured nonpriority

debt that could

potentially be repaid.c

Any income remaining

from that portion of

debtor income above the

national median after

allowable monthly living

expenses and payment

on priority debt.d

Minimum percentage of

unsecured nonpriority

debt to be repaid

20 percent. If debtor

met this test and all

preceding tests, debtor

would be required to

file under chapter 13.

Same as 1998 Ernst &

Young.

$5,000 or 25 percent,

whichever was less. If

debtor met this test,

debtor would be

required to file under

chapter 13.

No specific minimum

used.

Table 1: “Needs-Based” Provisions in Congressional Bills As Used in Four Reports on Bankruptcy Debtors’ Repayment

Capacity
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a

For example, a family household of six would be assigned the national median income for a family

household of four plus $1,166 ($583 X 2).

b

For example, a family household of six would be assigned the national median income for a familiy

household of four plus $13,992 ($583 x 24).

c

Under H.R. 833 as introduced, a debtor could be required to file under chapter 13, regardless of

household income, if the debtor could potentially repay 25 percent of his or her unsecured nonpriority

debts or $5,000, whichever was less.

d

The EOUST report assumed that debtors would pay their monthly home mortgage payments and

payments on all nonhousing secured debt from that portion of their gross income that was below the

national median for a household of comparable size.

Source: GAO analysis of Ernst & Young, Creighton/ABI, and EOUST reports and the proposed

legislation used in each report's analysis.

Each report relied on annual household median income data as reported

by the U.S. Census Bureau to select debtors for further analysis of their

repayment capacity. Each debtor’s annual gross household income was

compared with the median national annual gross household income for a

household of comparable size—one person, two persons, and so forth.

However, in making this comparison, the reports used different national

median income thresholds from the Census Bureau and data for different

calendar years (1993, 1996, or 1997).14 These differences reflect the

different median income tests in the different proposed legislative

provisions used in various reports’ analyses and the different years from

which each report’s sample was drawn.

The Census Bureau reports annual gross median incomes for different

types of households by household size. Generally, for each household size,

incomes for nonfamily households of two or more are less than incomes

for family households of two or more. The Census Bureau table chosen for

analysis can also make a difference. For example, the 1997 annual gross

median income for a household with one earner was $29,780. This was

$11,018 more than the 1997 annual gross median income of $18,762 for a 1-

person household. The Census Bureau defines a household as all persons,

related and unrelated, occupying a housing unit. The Census Bureau

defines a family household as a group of two or more persons related by

birth, marriage, or adoption who reside together. Thus, the table chosen

for comparison can affect whether a debtor’s income is determined to be

above or below the national median for a household of comparable size.

To illustrate the effect of each report’s median household income test,

table 2 compares the median annual gross household incomes each report

would have used had all the reports used the 1997 Census Bureau tables.

For example, the 1998 Ernst & Young report determined median income

 

14 The Creighton/ABI report used 1993 data, the two Ernst & Young reports used 1996 data, and the

EOUST report used 1997 data.

Differences in

Determination of Debtors’

Median Income
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using household income by household size. Debtors would have been

selected for further repayment analysis if their incomes were more than 75

percent of the Census Bureau amounts shown in table 2. Thus, debtors in

four--person households would have been selected for further analysis if

their 1997 annual gross household incomes were more than $39,874 (75

percent of $53,165). In the other three reports, debtors in four-person

households would have been selected for further analysis if their 1997

gross annual incomes were at least $53,350—a difference of $13,476.

Ernst & Young

 (March 1998)

Creighton/ABI

(March 1999)

Ernst & Young

(March 1999)

Executive Office for U.S.

Trustees (January 1999)

Household

size

1997

Census

table

incomea

1997

income

threshold

usedb

1997

Census

table

incomec

1997

income

threshold

used

1997

Census

table

incomec

1997

income

threshold

used

1997

Census

table

incomec

1997

income

threshold

used

1 person $18,762 $14,072 $29,780 $29,780 $29,780 $29,780 $29,780 $29,780

2 persons 39,343 29,508 37,562 37,562 37,562 37,562 37,562 37,562

3 persons 47,115 35,337 46,783 46,783 46,783 46,783 46,783 46,783

4 persons 53,165 39,874 53,350 53,350 53,350 53,350 53,350 53,350

5 persons 50,407 37,806 51,101 53,350d 51,101 53,933e 51,101 60,346f

6 persons 46,465 34,849 45,473 53,350d 45,473 54,516e 45,473 67,342f

7 persons or

more 42,343 31,758 42,001 53,350d 42,001 55,099e 42,001 74,338f

a

Census Bureau table H-11 for median income by household size. The Census Bureau defines a

household as all people occupying a housing unit.

b

Based on the provisions of H.R. 3150 as introduced, Ernst & Young used an income threshold of 75

percent of the median. In this table, the results of that calculation have been rounded to the next

highest dollar. Debtors above this threshold would have been subject to further repayment capacity

analysis.

c

Used Census Bureau table H-12 (one-earner households) for households of one. Used Census

Bureau table F-8 for families of two or more members. The Census Bureau defines a family as a

group of two or more people related by birth, marriage, or adoption who reside together.

d

Based on the provisions of H.R. 3150 as passed by the House on June 10, 1998, used 100 percent

of the median income for households of one to four persons, and for households of more than four,

used 100 percent of the median income for a family household of four.

e

Based on the provisions of H.R. 833 as introduced, used 100 percent of the median income for

households of one to four persons, and for households of more than four, used 100 percent of the

median income for a family household of four plus $583 annually for each additional household

member over four.

f

Based on the higher of the provisions of H.R. 3150 as it passed the House on June 10, 1998, or

S.1301 as approved by the Senate Judiciary Committee, used 100 percent of the median income for

households of one to four persons; and for households of more than four, used 100 percent of the

median income for a family household of four plus $583 monthly for each additional household

member over four.

Source: 1997 Census Bureau tables for median annual household incomes and Ernst & Young,

Creighton/ABI, and EOUST reports.

Table 2: Census Bureau Tables and Actual Median Household Incomes, by Household Size, That Each Report Would Have

Used Had All Four Reports Used the 1997 Census Tables on Household Incomes
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As shown in table 2, in the Census Bureau tables, national median incomes

peak at households of four and decline for households of more than four.

Three of the reports made adjustments for this fact. Each used a different

method, based on the specific proposed legislative provisions used in its

analysis. For family households of four or more, the Creighton/ABI report

used the median income for a family of four. For each additional

household member over four, the 1999 Ernst & Young and EOUST reports

used the median income for a family of four, plus $583 annually (Ernst &

Young) or $583 monthly (EOUST) for each additional family household

member over four. Table 2 shows the difference these adjustments would

make. Had each report used the 1997 Census tables, the median income

used for a family of six would have ranged from $34,849 (1998 Ernst &

Young) to $67,342, (EOUST).

As would be expected, the higher the median household income used for

comparison, the lower the percentage of debtors whose household

incomes met or exceeded the income level used for comparison. Almost

half of the debtors in the 1998 Ernst & Young report sample passed the

median income test, while less than 20 percent passed the test in the 1999

Ernst & Young and EOUST reports (see table 3). Because the Ernst &

Young reports used the same debtor sample and 1996 median income data,

the different pass rates for the two reports reflect solely the different

median income thresholds used. For the Creighton/ABI and EOUST

reports, the different pass rates may reflect, to some degree, differences in

the debtors in each report’s sample and the each report’s use of median

income tables for different calendar years—1993 and 1997, respectively.
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Ernst & Young

 (March 1998)

Creighton/ABI

 (March 1999)

Ernst & Young

(March 1999)

EOUST

 (January 1999)

Median Income Test Gross income, adjusted

for household size,

exceeds 75 percent of

national median.

National median

household incomes

peaked at families of

four and declined for

families of more than

four.

Gross income,

adjusted for

household, size is 100

percent or more of

national median. For

family households of

more than four, used

income for family

households of four.

Gross income, adjusted

for household size, is 100

percent or more of

national median. For

family households of more

than four, added $583

annually for each family

member over four.a

Gross income, adjusted

for household size, is the

higher of median income

standard in H.R. 3150 or

S.1301. For family

households of more than

four, added $583 monthly

for each family member

over four.b

Percentage of debtors in

sample who passed median

income test

47% 24.2% 19% 17.7%

Percentage of debtors who

passed median income test

and have net monthly income

above $50c

17% 4.0% Not in proposed legislation 13.7%

Percentage of debtors who

passed median income test,

have net monthly income

above $50, and can repay 20

percent of unsecured

nonpriority debt over 5 years

15% 3.6% Not in proposed legislation 12.2%d

Percentage of debtors who

can repay at least $5,000 or

25 percent of unsecured

nonpriority debt (whichever is

less) over 5 years

Not in proposed

legislation

Not in proposed

legislation

10 % 13.4%

Percentage of debtors who

had any net income available

to pay unsecured nonpriority

debts.

Not in proposed

legislation

Not in proposed

legislation

Not in proposed

legislation

15%e

Total estimated unsecured

nonpriority debt that all “canpay” debtors could repay

over 5 years

$4 billion $870 million (national

projection from 7

districts)f

 $3 billion Less than $1 billion to $3.76

billiong

a

For example, a family of six would be assigned the national median income for a family of four plus

$1,166 ($583 X 2).

b

For example, a family of six would be assigned the national median income for a family of four plus

$13,992 ($583 X 24).

c

Net after deducting allowable living expenses and full repayment of nonhousing secured debt and

unsecured priority debt over 5 years.

d

EOUST provided estimates for repayment of 20 percent of unsecured nonpriority debt and

repayment of $5,000 or 25 percent of unsecured nonpriority debt, whichever was less. Both estimates

assumed that debtors would use 100 percent of net income available for payment of unsecured

nonpriority debt.

e

This is EOUST's maximum estimate. This estimate represents the percentage of debtors with any

available net monthly income that could be applied to the payment of unsecured nonpriority debts

after paying monthly allowable living expenses and payments for secured debts and unsecured

Table 3: Results of Four Reports Analyses of the Percentage of Chapter 7 Bankruptcy Debtors Who Could Pay A Substantial

Portion of their Unsecured Nonpriority Debts
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priority debts. This measure of debt repayment was not included in any of the proposed legislation

used in the analyses of these four reports.

f

The Creighton/ABI report included this estimate in its report, noting that the estimate was true if the

results for its seven judgmentally selected districts were true for all 90 bankruptcy districts. Although

the Creighton/ABI report provided this national estimate, the results of its analysis cannot be used for

national estimates.

g

The higher figure assumes that after allowable living expenses and payments on unsecured priority

debt, all remaining available income above the national median, no matter how small, would be used

for payment of unsecured nonpriority debts. The lower figure assumes that amount collected would be

reduced by (1) debtor attorney and chapter 13 trustee fees and (2) some portion of debtors whose

repayment capacity is reduced during the 5-year repayment period by such factors as divorce or

unemployment. The EOUST report noted that it considered the lower figure to be more realistic. The

EOUST report assumed that debtors would pay their home mortgages and all nonhousing secured

debt from that portion of their gross income that was below the national median for a household of

comparable size.

Source: Ernst & Young, Creighton/ABI, and EOUST reports.

Table 3 also shows the percentage of debtors in each report’s sample that

passed each major repayment capacity test. The final estimates of the

percentage of “can-pay” debtors in each sample ranged from 3.6 percent to

15 percent. EOUST provided three estimates—15 percent if debtors used

all their available net income, no matter how small, to pay their unsecured

nonpriority debt; 12.2 percent if the can-pay debtors paid at least 20

percent of their unsecured priority debt; and 13.4 percent if they paid

$5,000 or 25 percent, whichever was less.

Under the “needs-based” provisions used in these analyses, two principal

variables affected each report’s estimate of the percentage of debtors who

had sufficient income to pay the minimum specified percentage of their

unsecured nonpriority debts. These were the (1) total amount of the

debtor’s nonhousing secured and unsecured priority debts and (2) debtor’s

allowable living expenses. Under the “needs-based” provisions of the

proposed legislation used in the two Ernst & Young reports and the

Creighton/ABI report, payments on nonhousing secured debt and

unsecured priority debt plus allowable living expenses were deducted

from income to determine whether the debtor had any net income

available for payment of unsecured nonpriority debts. For debtors with the

same living expenses, the higher the payments on secured debt and

unsecured priority debt were relative to income, the less income the

debtor would have for payment of unsecured nonpriority debt. Conversely,

the lower such payments were relative to income, the greater the net

income available for payment of unsecured nonpriority debts. Further,

under the proposed needs-based legislation, debtors would be allowed

housing allowances in excess of the IRS standards if necessary for

payment of home mortgage debt. Thus, assuming that all other living

expenses were the same, debtors whose mortgage payments exceeded the

IRS housing allowance would be permitted higher living expenses than
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debtors whose mortgage payments were less than the IRS housing

allowance or who were renters.

The two Ernst & Young reports and the Creighton/ABI report used the IRS

collection financial standards as the basis for determining debtors’

allowable living expenses. These standards and their application in the

Ernst & Young and Creighton/ABI reports are discussed in more detail in

appendix I. EOUST did not use the IRS standards to determine debtors’

allowable living expenses, concluding that they were cumbersome and

difficult to apply consistently across debtors. The EOUST report assumed

that debtors would (1) pay their home mortgage and other secured debts

from that portion of their income that was at or below the national median

for a family of comparable size and (2) pay their unsecured priority and

unsecured nonpriority debts from that portion of their income that was

above the national median. The EOUST report’s methodology is described

in detail in appendix II.

The IRS uses its collection financial standards to help determine a

taxpayer’s ability to pay a delinquent tax liability. The IRS has established

specified dollar allowances for housing and utility expenses;

transportation expenses; and food, clothing, and other expenses. However,

the IRS has not established specific dollar allowances for “other necessary

expenses,” such as taxes, health care, court-ordered payments (e.g., child

support or alimony), child care, and dependent care. Since there are no

specific dollar standards, the IRS determines whether individual expenses

in this category are reasonable and necessary on a case-by-case basis. The

IRS guidance notes that some of these “other necessary expenses,” such as

taxes, health care, and court-ordered payments, are “usually considered to

be necessary.” However, the taxpayer may be required to substantiate the

amounts and justify expenses for other expense items, such as child care,

dependent care, and life insurance.

Each of the proposed “needs-based” bankruptcy bills used in the Ernst &

Young and Creighton/ABI analyses provided that debtors would be

permitted the IRS allowances for national and local necessary expenses

(housing and utilities; transportation; and food, clothing, and other

expenses), and for other necessary expenses. However, none of the

proposed bills specified how the discretionary allowances for “other

necessary expenses” were to be determined.

There are also other provisions of the IRS collection standards that are not

mentioned in the bills. For example, the IRS standards permit a taxpayer 1

Differences in Interpreting

the IRS Expense Standards

for Allowable Living

Expenses
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year in which to modify or eliminate excessive necessary or unallowable

conditional expenses, if the tax liability cannot be paid within 3 years.

The “needs-based” provisions of the proposed legislation used in the Ernst

& Young and Creighton/ABI reports provided that debtors’ monthly debt

repayment expenses were to include whatever amounts were necessary to

pay monthly mortgage payments and to pay in full over 5 years all

nonhousing secured debts (such as auto loans) and all unsecured priority

debts (such as child support and certain back taxes). Thus, by implication,

debtors were to be permitted expenses in excess of the maximum IRS

allowances where necessary to repay debt. For example, if a debtor’s total

monthly vehicle debt payment exceeded the maximum applicable IRS

transportation ownership allowance, the higher debt payment would be

used as the ownership allowance.

A basic description of the IRS collection financial standards is presented in

table 4. With the exception of debt repayment, both Ernst & Young reports

and the Creighton/ABI report generally used the IRS standards as expense

ceilings. The principal difference was in the methods used to determine

the debtors’ transportation allowances.
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IRS standard

National or local

standard

Description of expense category and IRS

guidelines

Housing and utilities Local, by county.

Dollar amount set

according to family

size. No difference

if taxpayer owns or

rents.

IRS standard is a cap—taxpayer allowed

amount actually spent or IRS allowance,

whichever is less. Includes mortgage or rent,

property taxes, interest, parking, necessary

maintenance and repair, homeowner’s or

renter’s insurance, homeowner dues,

condominium fees, and utilities.

Transportation

Ownership Applied nationally,

but IRS considers it

a local standard

IRS standard is a cap. Provides maximum

monthly allowance for the lease or purchase

of up to two automobiles—$372 for first

automobile, $294 for second automobile. No

ownership allowance is included if taxpayer

has no vehicle lease or purchase payments.

Operating and

public

transportation

Local, by census

region and

metropolitan

statistical area

IRS standard is a cap. Allowed in addition to

ownership allowance, if taxpayer has

payments for lease or purchase of vehicle. If

taxpayer has no vehicle lease or purchase

payment or no vehicle, only the operating

allowance is permitted. Includes such

expenses as insurance, normal maintenance,

fuel, and registration fees. One-person

household allowed one operating allowance;

two-person households usually allowed no

more than two unless taxpayer can

demonstrate that additional vehicles are

necessary for income production.

Food, clothing, other

expenses

National (except for

Alaska and

Hawaii), by income

and household

size.

National standard allowance is provided

regardless of amount actually spent. Food,

housekeeping supplies, apparel and services,

personal care products and services, and

miscellaneous. Adjusted for income and

number of persons in the household.

Other necessary

expenses

No standard other

than expense must

be necessary and

reasonable. Actual

amount allowed

determined on

individual basis by

IRS.

Includes such expenses as charitable

contributions, child care, dependent care,

health care, payroll deductions (e.g., taxes,

union dues), and life insurance.

Source: IRS internet site and IRS regulations.

Table 4: Basic Description of IRS

Collection Financial Standards
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The IRS transportation allowance is divided into two categories—

ownership costs and operating costs, which includes an allowance for

debtors with no vehicles. The IRS ownership allowance is a single national

standard15 for payments on leased or purchased vehicles—currently, $372

for the first car and $294 for the second car, with a maximum of two cars

allowed.16 According to the IRS, the “ownership costs provide maximum

allowances for up to two automobiles if allowed as a necessary expense.”

The operating portion of the IRS standard is derived from Bureau of Labor

Statistics (BLS) data. The operating allowance varies by census region and

metropolitan statistical area. The current allowance for Boston,

Massachusetts, for example, is $220 (no vehicles), $274 (one vehicle), or

$328 (two vehicles). IRS regulations describe the application of the

ownership and operating allowances as follows: “If a taxpayer has a car

payment, the allowable ownership cost added to the allowable operating

cost equals the allowable transportation expense. If a taxpayer has no car

payment, or no car, only the operating cost portion of the transportation

standard is used as the allowable expense.”

Each report used different methods to assign the ownership portion of the

transportation allowance. There were essentially two differences---secured

vehicle debt payments that were less than the IRS allowance and

ownership allowances for debt-free vehicles.

In effect, Ernst & Young did not use the IRS ownership allowances. It

interpreted H.R. 3150 and H.R. 833 to require the use of secured vehicle

debt payments as the ownership allowance. Ernst & Young totaled all

vehicle debt, added 10 percent for interest (equivalent to 9 percent for 2

years), and amortized the resulting total over 60 months. The resulting

monthly amount was used as the ownership allowance, whether it was

more or less than the maximum applicable IRS ownership allowance. In all

of the proposed “needs-based” bankruptcy bills, debt payments could

exceed the maximum applicable IRS housing and transportation

allowances.

For secured vehicle debt, Creighton/ABI totaled all vehicle debt, added 24

percent for interest (equivalent to 9 percent for 5 years), and amortized the

resulting total over 60 months. The resulting monthly vehicle debt payment

was used as the ownership allowance if it was equal to or more than the

 

15 In its description of the Collection Financial Standards, IRS notes that the “ownership cost portion of

the transportation standard, although it applies nationwide, is still considered part of the local

standards.”

16 The current allowances used in our examples were applicable as of October 15, 1998.

Differences Between the Ernst &

Young and Creighton/ABI

Interpretationsof the IRS

Transportation Allowances

Differences in the Ownership

Allowances Used
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maximum IRS ownership allowance for a household of the same size and

number of vehicles as the debtor’s. If the monthly secured debt payment

was less than the maximum IRS ownership allowance for a household of

the same size and number of vehicles as the debtor’s household,

Creighton/ABI added the difference to the debtor’s transportation

ownership allowance. For example, the IRS ownership allowance for a

one-vehicle household is a maximum of $372 a month. This allowance

applies to any one-vehicle household regardless of size. If a debtor in a

one-vehicle household had a monthly payment for secured vehicle debt of

$333, Creighton/ABI would have allowed an additional monthly allowance

of $39, for a total ownership allowance of $372. Both the IRS standards and

Ernst & Young would have allowed $333.

It is important to note that the IRS standards permit an ownership

allowance for vehicle lease payments. Similar to secured vehicle debt

payments, monthly lease debt payments that exceeded the IRS

transportation ownership allowances would be permitted under needsbased bankruptcy. However, both Ernst & Young and Creighton/ABI found

the data on vehicle leases to be inconsistently reported among the debtors

in their samples and sometimes inconsistently reported on the schedules

of an individual debtor. Debtors did not necessarily show on their

schedules the total amounts remaining to be paid on unexpired vehicle

leases or the amount of the monthly payments on such leases. Therefore,

neither report may have accurately captured the amount remaining to be

paid on unexpired leases and the monthly vehicle lease costs.

The other principal difference in the treatment of the transportation

ownership allowance was that the Creighton/ABI report provided an

ownership allowance for debt-free vehicles. The IRS standards would

include only an operating allowance for debt-free vehicles. Because there

were no secured debt payments for debt-free vehicles, Ernst & Young did

not include an ownership allowance for such cars. Creighton/ABI included

the maximum IRS ownership allowance for debt-free cars—one allowance

for one person households, one allowance for households of two or more

with one vehicle, and two allowances for households of two or more with

two or more vehicles.

Crieghton/ABI’s and Ernst & Young’s methods of assigning vehicle

operating allowances were the same except for households of two or more

persons with more than two vehicles. Under the IRS collection financial

standards, IRS’ normal practice is to limit vehicle operating allowances to

one for households of one and two for households of two or more, unless

the taxpayer can demonstrate that any additional vehicles are necessary

Differences in the Operating

Allowances Used
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for producing income. However, debtors are not required to provide

information on their bankruptcy financial schedules regarding whether any

or all of their vehicles are necessary for producing income.

Both Ernst & Young and Creighton/ABI determined the number of debtor

vehicles by using the larger of the number of vehicles shown on schedules

B17 or D.18 If a debtor reported no vehicles on either schedule, both Ernst &

Young and Creighton/ABI assigned one "no car” operating allowance. In

addition, both Ernst & Young and Creighton/ABI followed the general IRS

practice and limited households of one to one operating allowance. For

households of two or more, Crieghton/ABI also followed the general IRS

practice, limiting such households to a maximum of two operating

allowances. Ernst & Young placed no limit on the number of operating

allowances for households of two or more. It included operating

allowances for the larger of the number of cars listed on schedules B or D.

Ernst & Young stated it did so because data were not available on which

vehicles were necessary for producing income.

We found no evidence that the Ernst & Young reports or the Creighton/ABI

report double counted any portion of the transportation allowances used

in their reports. The similarities and differences in the Ernst & Young and

Creighton/ABI interpretations of the IRS transportation allowances are

discussed in more detail in appendix I. The Creighton/ABI report stated

that “we believe that a substantial part of the difference between Ernst &

Young’s results and our own results is due to the treatment of motor

vehicle expense.” The Creighton/ABI report noted that had it used Ernst

and Young’s interpretation of the transportation allowance under H.R.

3150, its estimate of “can-pay” debtors would have been about twice as

large--6.78 percent rather than 3.6 percent.

Despite the methodological differences in each report, and the different

years from which the samples were drawn, there is considerable similarity

in the characteristics of those debtors in each report’s sample who would

not be required to file under chapter 13 (see table 5). The amount of the

median income for these “can’t pay” debtors was $20,136 to $21,204.

Similarly, the median amount of unsecured nonpriority debts for the “can’t

pay” debtors was $20,303 to $23,570. The data for the “can-pay” debtors

was somewhat more varied. The median household income of the “can-

 

17 Schedule B—Personal Property.

18 Schedule D—Creditors Holding Secured Claims.

Similarities and Differences

in Incomes and Debts

Between “Can-Pay” and

“Can’t Pay” Debtors
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pay” debtors ranged from $44,738 and $52,080. The median amount of

unsecured nonpriority debt for these debtors ran from $30,813 to $39,085.

Debtor

characteristics

Ernst & Young

(March 1998)

Ernst & Young

(March 1999)

Creighton/ABI

(March 1999)

EOUST

(January 1999)

Year from which

sample of

debtors was

drawn 1997 filings 1997 filings 1995 filings

Cases closed in

first half of 1998

Debtor’s median

family income

All debtors in

sample

$22,290a $22,290a $21,264 $22,800b

Debtors who

would not be

required to file

under chapter 13

20,417 21,204 20,688 20,136

Debtors who

would be

required to file

under chapter 13

44,738 51,974 52,080 46,350

National median

household

income

35,492 35,492 40,611 35,492

Debtor’s median

unsecured

nonpriority debt

All debtors in

sample

24,611 24,405 20,581 23,190

Debtors who

would not be

required to file

under chapter 13

23,570 23,472 20,303 21,508c

Debtors who

would be

required to file

under chapter 13

30,813 39,085 33,526 34,680d

a

Not in published report; data separately provided to GAO.

b

Not in initial report; data separately provided to GAO.

c

Included debtors who fell below the median income thresholds set in both H.R. 3150 and S.1301.

d

Included the 300 debtors whose household incomes were above the median income thresholds set in

both S.1301 and H.R. 3150, after deducting business expenses, child support and alimony payments,

and day care expenses listed on schedule J, plus priority debt payments listed on schedule.

Source: Ernst & Young, Creighton/ABI, and EOUST reports and additional data provided by Ernst &

Young and EOUST.

The 1998 Ernst & Young report did not include any allowance for debtor

attorney fees or the costs of administering a chapter 13 repayment plan.

The Creighton/ABI report and the 1999 Ernst & Young report based their

attorney fee estimates on the same 1996 report that found that the average

total debtor attorney fee in chapter 13 cases was $1,281, of which $428 was

Table 5: Median Household Income and

Median Unsecured Nonpriority Debts of

Bankruptcy Debtors Who Would and

Would Not Be Required to File Under

Chapter 13, as Determined by Four

Reports on Debtor Repayment Capacity

Differences in Debtor

Attorney Fee and

Administrative Costs
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paid up front and the $800 balance through the repayment plan (subject to

the trustee’s percentage fee). Based on this report, the Creighton/ABI

report assumed that debtor attorney fees would add about $800, or $13 per

month, to the debtor’s monthly expenses. The 1999 Ernst & Young report

assumed that debtors who were required to file under chapter 13 would

incur an average attorney fee of $1,281. The report treated as an unsecured

nonpriority debt any difference between this total and the amount the

debtor indicated on the bankruptcy petition that he or she had already paid

an attorney. If no amount was indicated as already paid, Ernst & Young

assumed that the debtor owed $800—the same as Creighton/ABI.

The 1999 Ernst & Young report and the Creighton/ABI report both included

estimates of chapter 13 administrative expenses. Each report assumed that

administrative expenses could consume about 5.6 percent of debtor debt

payments under a chapter 13 plan—the 1995 average chapter 13 trustee

fees as a percentage of disbursements to creditors. However, each report

applied this percentage somewhat differently. The 1999 Ernst & Young

report included three different estimates of these costs—$92 million, $138

million, and $249 million--based on three different assumptions (see app.

I). The Creighton/ABI report assumed that administrative expenses would

be 5.6 percent of debtor payments on unsecured priority debts, unsecured

nonpriority debts, and secured debts (other than home mortgages and

other real estate claims of $20,000 or more).

The Ernst & Young, Creighton/ABI, and EOUST reports made a reasonably

careful effort to apply the provisions of proposed legislation as they

interpreted them and developed estimates of the percentage of chapter 7

debtors who could potentially repay a specific portion of their unsecured

nonprority debts. Based on the data available to us, the reports reached

different estimates of “can-pay” debtors principally because each report

used different and noncomparable samples of debtors, different proposed

“needs-based” legislative provisions, and different methods and

assumptions for determining debtors’ allowable living expenses. Together,

the reports illustrate how the different methods and assumptions used to

identify “can-pay” debtors can affect the results of the analysis.

The March 1998 and March 1999 Ernst & Young reports estimated that 15

percent and 10 percent, respectively, of chapter 7 debtors could be

required to file under chapter 13 rather than chapter 7. Both reports used

the same sample and the same method of determining debtors’ allowable

living expenses. The differences between the two estimate were the result

of two changes in the methodology used in the March 1999 report—both

resulting from the different “needs-based” provisions of H.R. 833 compared

Differences in

Proposed Legislation

and Methodologies

Used Yielded Different

Estimates of Debtor

Repayment Capacity
B-282761

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with those of H.R. 3150. The March Ernst & Young 1999 report used a

higher median income threshold to screen debtors and also used an

unsecured nonpriority debt repayment threshold of $5,000 or 25 percent,

whichever was less. The March 1998 report used a median income screen

of more than 75 percent of the median and an unsecured nonpriority debt

repayment threshold of 20 percent. The 1999 Ernst & Young report did not

discuss the contribution of each of these changes to the March 1999

report’s revised estimate of “can-pay” debtors, and because Ernst & Young

did not provide us their data, we had no basis for assessing the

contribution of each change to the 1999 report’s estimates.

The 1998 Ernst & Young and Creighton/ABI reports were based on

different versions of H.R. 3150. Ernst & Young used the H.R. 3150 as

introduced in early 1998, while Creighton/ABI used the version that passed

the House in June 1998. One of the differences between the two versions

of the bill was the median household income test used to screen debtors

for further repayment capacity analysis. The later version of H.R. 3150

used in the Creighton/ABI report (1) included different Census Bureau

tables with generally higher household incomes and (2) required that “canpay” debtors have at least 100 percent of the median household income

used for screening debtors. The version of H.R. 3150 used in the 1998 Ernst

& Young report required debtors to have household incomes of 75 percent

of the median income standards used for comparison.

Data provided by Ernst & Young and Creighton/ABI illustrate how a

change in just one variable can affect the estimates in the reports we

reviewed. According to Ernst & Young, using the higher income standards

in the June 1998 version of H.R. 3150 would have reduced its March 1998

report’s estimate of “can-pay” debtors from 15 percent to 10 percent.

Conversely, the Creighton/ABI report noted that if it had used the same

interpretation of the IRS transportation ownership allowance as Ernst &

Young, its estimate of “can-pay” debtors would have been 6.8 percent

rather than 3.6 percent.

Other changes may have a marginal effect, although they are important in

fully understanding the potential benefit to creditors of implementing

needs-based bankruptcy reform. For example, in its estimates, the 1998

Ernst & Young report did not include any allowance for debtor attorney

fees and chapter 13 administrative costs that accompany chapter 13

repayment plans. However, according to Creighton/ABI, including such

fees and costs had little effect on its estimate of “can-pay” debtors.
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The EOUST report represents an effort to simplify the analysis required to

identify “can-pay” debtors. EOUST has an interest in a simplified approach,

since it would be responsible for overseeing the implementation of a

needs-based approach to personal bankruptcy. EOUST’s estimate of the

percentage of “can-pay” debtors was closer to that of Ernst & Young than

to Creighton/ABI’s, but its estimate of the amount of debt that could

actually be repaid was closer to Creighton/ABI’s—about $1 billion. EOUST

also provided data to us that illustrated the impact of changed assumptions

on the estimate of “can-pay” debtors in a sample. The authors reported that

12.2 percent of the EOUST debtor sample had sufficient income, after

expenses and payments on unsecured priority debt, to pay 20 percent of

their unsecured nonpriority debt, and 13.4 percent of the sample could pay

$5,000 or 25 percent (whichever was less) of their unsecured nonpriority

debt. The EOUST report assumed that debtors would pay their unsecured

nonpriority debts from that portion of their gross income that was above

the national median.

EOUST agreed with Creighton/ABI that it was likely that substantially

fewer than 100 percent of the “can-pay” debtors would complete their 5-

year repayment plans due to job loss, divorce, or other events that affected

their income, expenses, or both. As a result, EOUST thought it likely that

the actual amount that could be collected from the “can-pay” debtors in its

sample was closer to $1 billion than $3.76 billion. The higher estimate

assumed that all of the “can-pay” debtors in the EOUST sample would

devote 100 percent of their available net monthly income, no matter how

small, to debt repayment over 5 years.

Each of the reports represents a reasonably careful effort to estimate the

percentage of chapter 7 debtors in their respective samples who had

sufficient income, after allowable living expenses, to pay a substantial

portion of their debts--100 percent of all outstanding debts except for

unsecured nonpriority debt and most home mortgages. However, each

report assumed that the “can-pay” debtors would continue to pay their

monthly mortgage payments, and included such payments in debtors’

allowable living expenses.

Each report’s analysis rests on three assumptions, which have not been

validated, about bankruptcy debtors’ reported financial data, future

income and expenses, and repayment plan completion rates. Although

proposed needs-based legislation specified the use of the second and third

assumptions for use in means-testing chapter 7 debtors, each of these

assumptions is open to question. Each report also used different methods

of analyzing debtors’ living expenses and debt repayment capacity.

Conclusions
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Together, these reports demonstrate the extent to which the estimates of

debtor repayment capacity are dependent upon the income selection

criteria and assumptions used in the analysis. Changes in only one variable

can have a notable effect on the results. Moreover, the Creighton/ABI and

EOUST reports discuss some of the potential variables that could affect

the actual amount paid to creditors under needs-based bankruptcy.

Because it was not their objective, none of the reports attempted to

estimate the potential net gain to creditors (secured and unsecured) under

needs-based bankruptcy.

Which report most accurately reflects what would happen under chapter 7

if needs-based bankruptcy reform were enacted is unknown. The actual

number of debtors who would be required to file under chapter 13, the

number who would complete their 5-year repayment plans as initially

confirmed by the bankruptcy court, and the amount of debt repaid will

depend upon the details of any legislation eventually enacted and its

implementation.

We met with Ernst & Young’s representatives, including Thomas Neubig,

National Director, Policy Economics and Quantitative Analysis, on May 28,

1999, to discuss their comments on the draft report. Mr. Neubig, on behalf

of Ernst & Young; Professors Marianne Culhane and Michaela White,

authors of the Creighton/ABI report; and Mr. Joseph Guzinski, Assistant

Director of EOUST, provided written comments on our report (see app. III

through V). Ernst & Young and the authors of the Creighton/ABI report

also separately provided technical comments on the report that we

incorporated as appropriate. EOUST stated that we had accurately

described its report and had no suggested changes for the report. The

specific comments of Ernst & Young and the authors of the Creighton/ABI

report are discussed and evaluated at the end of appendixes III and IV,

respectively. We focus here on Ernst & Young’s and the Creighton/ABI

authors’ major comments and our evaluation of those comments.

Ernst & Young’s written comments included five major points. First, they

stated that our draft report did not sufficiently focus on the similarities in

the findings of the four reports and, specifically, that each of the four

reports found that “tens of thousands of above-median income chapter 7

debtors could repay a significant portion of their debts under needs-based

bankruptcy proposals.” Second, Ernst & Young noted that our discussion

focused on the variables that could affect each report’s estimates rather

than on distinguishing which report’s estimates were based on reasonable

adherence to proposed legislation and reasonable assumptions. Third,

Ernst & Young asserted that we should have assessed the reports based on

Comments from the

Authors of the Four

Reports and Our

Evaluation

Ernst & Young’s Comments

and Our Evaluation
B-282761

Page 28 GAO/GGD-99-103 Personal Bankruptcy

which one(s) most closely modeled the “reasonable” impact of the

proposed legislation as drafted. Fourth, Ernst & Young said that we did not

make clear that the Creighton/ABI’s estimates cannot be projected

nationally and also criticized the Creighton/ABI method of determining

transportation ownership allowances. Finally, Ernst & Young provided

information on its sample of 1997 chapter 13 case filings that it said

showed that, when combined with the provisions of needs-based

bankruptcy, would probably result in a significantly higher repayment plan

completion rate for “can-pay” debtors.

With regard to Ernst & Young’s comment that we did not sufficiently

highlight the similarities in the reports, we believe our report fully

discusses the similarities and differences in the methodologies in the four

reports that affected their respective estimates. As we noted, a change in a

single assumption or variable could have a significant effect on each of the

report’s estimates. Although each report found that some portion of the

chapter 7 debtors in their samples were “can-pay” debtors, the reports did

not agree on whether these “can-pay” debtors could in fact repay the

specified minimum portion of their unsecured nonpriority debts over 5

years. The Creighton/ABI and EOUST reports specifically asserted that the

formula used to determine the amount of debts that “can-pay” debtors

could potentially repay was unrealistic and that the actual return to

unsecured nonpriority creditors would be less than the formula indicated.

With regard to our focus on the variables and assumptions used in each

report, we believe that the combined effect of the three assumptions used

in the “can-pay” formula may lead to a somewhat optimistic estimate of the

amount of debt “can-pay” debtors would repay. Two of these assumptions

were particularly important in each report’s analysis: (1) “can-pay”

debtors’ living expenses, as determined under the formula, would remain

unchanged for the entire 5-year repayment period, and (2) 100 percent of

the “can-pay” debtors would complete their repayment plans without

modification. These two assumptions were based on the means-testing

criteria specified in proposed legislation for use in identifying “can-pay”

debtors. However, there is no empirical basis for either assumption.

Historically, about 36 percent of chapter 13 debtors have completed their

repayment plans. There is no basis for assuming that the implementation

of needs-based bankruptcy would raise that rate to 100 percent. It seems

likely that the financial circumstances of at least some of the “can-pay”

debtors would change during the 5-year repayment period. These changes

could increase or decrease the debtor’s ability to pay his or her debts. At

least some debtors are unlikely to be able to complete their repayment
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Page 29 GAO/GGD-99-103 Personal Bankruptcy

plans for such reasons as death, divorce, or unemployment. Since many

economic factors can change in a debtor’s financial situation during 5

years, it would seem prudent to base any policy decisions on a wider range

of assumptions than the somewhat optimistic set of assumptions used for

the principal estimates in these reports. Therefore, we continue to believe

that any estimates based on these assumptions should be viewed with

caution.

Ernst & Young stated that we should have assessed each report with

regard to which report most closely modeled the “reasonable” impact of

proposed legislation as drafted, and that its reports meet that criterion.

The Ernst & Young statement is principally based on the differences

between its interpretation and Creighton/ABI’s interpretation of the IRS

transportation ownership allowance. Creighton/ABI’s interpretation led to

a lower estimate of “can-pay” debtors than did Ernst & Young’s

interpretation. This issue is fully discussed in our report, including

appendix I. We believe it is important that policymakers have the

information necessary to fully understand the methodologies of each

report and the effect the similarities and differences have on each report’s

estimates. Moreover, each report made assumptions that were not

specifically required by the underlying proposed legislation used in its

analysis. For example, Ernst & Young’s method of calculating interest on

secured debts was not specified in either H.R. 3150 or H.R. 833.

In addition, not every provision of proposed needs-based legislation that

could have affected each report’s analysis and estimates was found within

the needs-based formula itself. For example, H.R. 833 as drafted provides

in general that for personal property purchased within 5 years of filing for

bankruptcy, the amount of the secured creditor’s claim would not be less

than the total amount remaining to be paid under the terms of the loan

contract, including interest. This is the amount of the secured creditor’s

claim that would have to be paid in full under needs-based bankruptcy. Yet

this may not be the same amount as the amount affected debtors listed on

their financial schedules. To the extent that the amount of such debt listed

by any affected debtors did not include the remaining unpaid interest owed

under the contract, Ernst & Young would have understated the amount of

the secured claims for such debtors, understated secured debt payments

and, thus, overstated the amount of income available for payment of

unsecured nonpriority debts. Ernst & Young did not mention this provision

in its March 1999 report or its potential effect on the estimates in that

report.
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With regard to the Creighton/ABI sample, our report clearly states that the

sample cannot be used to make national estimates. However, contrary to

Ernst & Young’s statement in its comments, the Creighton/ABI sample is a

statistically valid probability sample from the seven districts used in its

analysis. Consequently, the results of the sample can be projected to the

population of cases in those seven districts. In this characteristic, the

Creighton/ABI sample is different from the Credit Research Center sample,

also mentioned in Ernst & Young’s comments. That sample was not a

statistically valid probability sample from the 13 districts used in the

sample.

With regard to Ernst & Young’s new data on chapter 13 cases and their

relevance to the likelihood that a “significantly higher” percentage of canpay debtors would complete their chapter 13 plans, we note that these

chapter 13 data had not been previously provided to us or publicly

available. Consequently, we have not had an opportunity to review them.

Ernst & Young stated that its data showed the median income of “can-pay”

debtors was substantially higher than that for the chapter 13 debtors in its

1997 sample. Ernst & Young states that this higher income, combined with

the “needs-based” restrictions on debtors’ ability to move from chapter 13

to chapter 7, would probably result in a “significantly higher” chapter 13

completion rate for “can-pay” debtors.

Although we have not had an opportunity to review these data, we have

two basic observations. First, current bankruptcy law provides that

chapter 13 repayment plans will be for 3 years unless for cause the

bankruptcy court approves a period not to exceed 5 years. The repayment

estimates of the four reports were based on a 5-year repayment plan, 2

years longer than is now the case unless extended for cause. This provides

2 additional years in which debtors could experience a change in financial

circumstances that could affect their ability to complete their repayment

plans.

Second, the Ernst & Young data do not alter our basic point—that the

percentage of “can-pay” debtors who complete their 5-year repayment

plans is unlikely to be 100 percent. There is no empirical basis for

assuming that debtors’ financial circumstances would remain unchanged

during the course of a 5-year repayment period, that none of the repayment

plans would need to be modified during that 5-year period, and that 100

percent of “can-pay” debtors would complete their 5-year repayment plans

(modified or not). No one knows why some debtors complete their

repayment plans and others do not. One reason could be variations in the

amount of debt that the repayment plans anticipate the debtors would
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repay. For example, in the historical study cited in our report, the

bankruptcy district with the highest completion rate—about 57 percent--

permitted debtors to enter into repayment plans in which they paid as little

as 5 percent of the debt owed to creditors. This is substantially less than

the percentage that would be required under needs-based bankruptcy. For

those debtors who fail to complete their plans, the return to creditors is

likely to be less than estimated in these four reports.

The Creighton/ABI authors made several points in their comments. First,

they discussed their sample of cases, noting that although theirs was not a

national sample, it was a random sample for the seven districts that

provided more information on the debtors in each district than did Ernst &

Young for the debtors in its individual districts. Moreover, they continued,

insistence on national samples for bankruptcy studies, which require

extensive collection of case file data, would limit participation in public

policy debate to those with the very deepest pockets. Second, the authors

stated that they had reweighted their sample based on updated

unpublished data we provided and noted that the reweighting had minimal

effect on the report’s weighted estimates. Third, they stated that their

method of calculating interest on secured claims, rather than Ernst &

Young’s, was the correct approach as a matter of law and bankruptcy

practice. Finally, they noted that reasonable people could differ over the

interpretation of H.R. 3150 and the use of the IRS transportation ownership

allowance. The authors noted that Ernst & Young’s interpretation provided

no allowance for leased vehicles, although the IRS expense allowances do

provide an ownership allowance for leased vehicles.

With regard to the Creighton/ABI sample, we agree that it is a statistically

valid probability sample whose results can be projected to the population

of all chapter 7 cases filed in 1995 in the seven districts from which the

sample was drawn. Although it is likely the Creighton/ABI’s sample

included more cases in each of its seven districts than did Ernst & Young’s

sample, both reports focused their analysis on estimates projected to their

respective populations, not to individual districts.

We agree that statistically valid probability samples of less than national

scope, such as Creighton/ABI’s, can be useful for policymaking. The

Creighton/ABI sample, based on data from a different year than Ernst &

Young’s, provides useful information. Moreover, it is possible to make

some comparisons to the Ernst & Young sample’s results. For example, the

median income of the “can’t pay” and “can-pay” debtors in the

Creighton/ABI sample and Ernst & Young sample are similar, although

their data are for different years. The principal limitation of this

Comments of Creighton/ABI

Report’s Authors and Our

Evaluation
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Page 32 GAO/GGD-99-103 Personal Bankruptcy

comparison is that one cannot statistically estimate whether the results for

the Creighton/ABI sample would be basically the same or different for the

1995 national population of chapter 7 debtors.

Second, with regard to the reweighting of the Creighton/ABI sample, we

agree that the results of the reweighting minimally affected the report’s

estimates. The reweighting changed Creighton/ABI’s original weighted

estimates by less than 0.1 percent.

With regard to Creighton/ABI’s assertion that the Ernst & Young method of

imputing interest on secured claims is incorrect, whether the Ernst &

Young method is incorrect depends upon the assumptions made about the

repayment of secured debt. As the Creighton/ABI authors noted in their

comments, under current bankruptcy law and practice the amount of

interest paid on secured claims depends on the length of time in which the

secured claim is repaid. Generally, the longer the repayment period, the

greater the interest paid on the secured claim. If under needs-based

bankruptcy, secured claims payments were spread over 60 months,

Creighton/ABI’s method is the appropriate one for imputing interest on

secured claims. Given that the needs-based “can-pay” formula amortizes

secured claims over 60 months, it is not unreasonable to assume that such

debts would be repaid over 60 months.

However, if under needs-based bankruptcy secured claims were generally

paid in less than 60 months, then the interest paid would be less.

Essentially, the Ernst & Young method assumed that most secured debts

would be paid in 24 months. This may or may not be true under needsbased bankruptcy. However, if it were true, the Ernst & Young method of

imputing interest on secured claims would be appropriate. The difference

in the two methods would have an effect on each report’s estimates.

Compared to the Creighton/ABI method of imputing interest for 60

months, the Ernst & Young method of imputing interest for 24 months

would have resulted in lower secured debt payments and thus greater

income available for unsecured nonpriority debt payments.

With regard to Creighton/ABI’s interpretation of the IRS transportation

ownership allowance under H.R. 3150, we have noted that the

Creighton/ABI method provided a higher ownership allowance than either

the IRS would permit or Ernst & Young permitted for debt-free vehicles

and for debtors whose vehicle debt payments are less than the applicable

IRS maximum allowance. We agree it is possible that adjustments may

need to be made in the 5-year repayment plans of debtors who incur major

vehicle repair or replacement costs. To the extent that this proves
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Page 33 GAO/GGD-99-103 Personal Bankruptcy

necessary, Ernst & Young underestimated the amount of debt that would

actually be repaid under needs-based bankruptcy. On the other hand, to

the extent that such major repair and replacement costs prove to be less

than those assumed in the Creighton/ABI report, that report would have

underestimated the amount of income that would be available for debt

repayment.

Finally, it not clear that either Ernst & Young or Creighton/ABI was able to

accurately capture vehicle lease costs because of the lack of consistent

data in the debtors’ schedules. The correct amount to include was the total

amount remaining to be paid on the lease. To the extent that the amounts

remaining to be repaid on unexpired vehicle leases were not listed on

debtors’ schedules of secured debt or unsecured priority debt, neither

Ernst & Young nor Creighton/ABI captured the amount remaining to be

paid on vehicle leases. As debt payments, the monthly lease payments

under needs-based bankruptcy could exceed the IRS maximum

transportation ownership allowances. In addition, neither Ernst & Young

nor Creighton/ABI would have captured the appropriate amount of the

unexpired lease where the debtor listed only the monthly lease payment on

the debt schedules. Therefore, it is not clear that either report was able to

accurately capture the amount of unexpired leases or the appropriate

monthly payments on such leases for those debtors who were leasing

vehicles at the time they filed for bankruptcy.

We are providing copies of this report to Senator Robert Torricelli,

Ranking Minority Member of your Subcommittee; Senators Orrin Hatch

and Patrick Leahy, Chairman and Ranking Minority Member of the Senate

Committee on the Judiciary; Representatives George Gekas and Jerrold

Nadler, Chairman and Ranking Minority Member of the Subcommittee on

Commercial and Administrative Law, House Committee on the Judiciary;
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Page 34 GAO/GGD-99-103 Personal Bankruptcy

and to the authors of the two Ernst & Young reports, the Creighton/ABI

report, and EOUST report. We will also make copies available to others

upon request.

Major contributors to this report are acknowledged in appendix VI. If you

have any questions about this report, please call me on (202) 512-8777.

Richard M. Stana

Associate Director, Administration

of Justice Issues
Page 35 GAO/GGD-99-103 Personal Bankruptcy
Page 36 GAO/GGD-99-103 Personal Bankruptcy

Contents

1 Letter

40

Three Assumptions Used in All Three Reports 40

Similarities and Differences in the Ernst & Young and

Creighton/ABI Reports

41

Appendix I

Methodological

Similarities and

Differences in Three

Reports on Bankruptcy

Debtors' Repayment

Capacity

64

EOUST Debtor Sample 64

Description of the EOUST Report’s Methodology 65

Appendix II

Description of

Methodology Used in

the Report by the

Executive Office for

the U.S. Trustees

69

GAO Comments 73 Appendix III

Comments From Ernst

& Young

80

GAO Comments 86 Appendix IV

Comments From the

Authors of the

Creighton/ABI Report

Appendix V 90

Comments From the

Executive Office for

U.S. Trustees
Contents

Page 37 GAO/GGD-99-103 Personal Bankruptcy

Appendix VI 91

GAO Contacts and

Staff

Acknowledgments

Table 1: “Needs-Based” Provisions in Congressional Bills

As Used in Four Reports on Bankruptcy Debtors’

Repayment Capacity

11

Table 2: Census Bureau Tables and Actual Median

Household Incomes, by Household Size, That Each

Report Would Have Used Had All Four Reports Used

the 1997 Census Tables on Household Incomes

13

Table 3: Results of Four Reports Analyses of the

Percentage of Chapter 7 Bankruptcy Debtors Who

Could Pay A Substantial Portion of their Unsecured

Nonpriority Debts

15

Table 4: Basic Description of IRS Collection Financial

Standards

19

Table 5: Median Household Income and Median

Unsecured Nonpriority Debts of Bankruptcy Debtors

Who Would and Would Not Be Required to File Under

Chapter 13, as Determined by Four Reports on Debtor

Repayment Capacity

23

Table I.1: Methodological Similarities and Differences in

the Two Ernst & Young Reports and the Creighton/ABI

Report on Bankruptcy Debtors’ Repayment Capacity

42

Table I.2: How the IRS, Ernst & Young, and

Creighton/ABI Would Have Determined the

Transportation Ownership Allowance for Hypothetical

Debtors in Boston, Massachusetts, Using the Current

IRS Collection Financial Standards Allowances

58

Tables

Abbreviations

AOUSC Administrative Office of the United States Courts

BLS Bureau of Labor Statistics

EOUSC

EOUST
Contents

Page 38 GAO/GGD-99-103 Personal Bankruptcy

IRS Internal Revenue Service
Page 39 GAO/GGD-99-103 Personal Bankruptcy
Appendix I

Methodological Similarities and Differences in

Three Reports on Bankruptcy Debtors'

Repayment Capacity

Page 40 GAO/GGD-99-103 Personal Bankruptcy

This appendix describes and discusses the methodological similarities and

differences in the March 1998 Ernst & Young, March 1999 Ernst & Young,

and March 1999 Creighton/ABI reports on bankruptcy debtors’ ability to

pay their debts. Because its methodology is distinctly different from the

methodologies of these three reports, the EOUST report is discussed

separately in appendix II.

In estimating the proportion of chapter 7 debtors who could pay a

substantial portion of their debts, all three reports used three assumptions

that have not been validated: (1) the information on debtors’ income,

expenses, and debts, as reported in the debtors’ financial schedules, was

accurate and could be used to project debtors’ income and expenses over

a 5-year period; (2) debtors’ income and expenses would remain stable

over a 5-year debt repayment period; and (3) all debtors required to enter a

5-year repayment plan under chapter 13 would successfully complete that

plan. Each report noted that the second and third assumptions were used

because the proposed “needs-based” legislation specified their use in

identifying “can-pay” debtors and estimating the amount of unsecured

nonpriority debt they could repay.

Although the data from debtors’ financial schedules were the only publicly

available data for assessing debtors’ repayment capacity, the accuracy of

the data in debtors’ financial schedules is unknown. Moreover, an AOUSC

study of about 953,000 debtors who voluntarily entered chapter 13 found

that only about 36 percent completed their repayment plans and received a

discharge from the bankruptcy court. The reasons for this low completion

rate are unknown.

Each report noted that a debtor’s financial circumstances could change

during a 5-year repayment period, and that any changes could affect a

debtor’s repayment capacity. Creighton/ABI and EOUST specifically

asserted that it was unrealistic to assume debtors’ income and expenses

would remain stable for 5 years, and that all debtors would complete their

repayment plans. If “needs-based” bankruptcy provisions were enacted,

the repayment plan completion rate for “can-pay” debtors could be higher

or lower than the rate found by AOUSC. However, there is no empirical

basis for assuming that the completion rate would be 100 percent. To the

extent that the completion rate is less than 100 percent, the amount of debt

that the “can-pay” debtors could repay may be less than that estimated in

the three reports. Moreover, to the extent that debtors who complete their

5-year repayment plans have them modified during those 5 years, the

amount of debt actually repaid could be more or less than that assumed in

these reports’ “needs-based” estimates. It would be more for those debtors

Three Assumptions

Used in All Three

Reports
Appendix I

Methodological Similarities and Differences in Three Reports on Bankruptcy Debtors'

Repayment Capacity

Page 41 GAO/GGD-99-103 Personal Bankruptcy

whose financial circumstances improve and could pay more than

anticipated. It would be less for those debtors’ whose financial

circumstances deteriorate and could pay less than anticipated.

The two Ernst & Young reports and the Creighton/ABI report attempted to

apply the “needs-based” consumer bankruptcy provisions of different

proposed bankruptcy bills to estimate the number of debtors in their

respective samples who would be required to file under chapter 13 rather

than chapter 7 and enter a 5-year repayment plan. The major steps in each

report’s analysis were the following:

• identify the debtors whose gross annual income, adjusted for household

size, meets or exceeds a specific median national household income for

households of the same size (all three reports);1

• for those debtors who passed the median income test, determine their

allowable living expenses using data from the debtors’ expense schedules

and the IRS collection financial standards (all three reports);

• for those debtors who passed the median income test, determine their

total nonhousing secured debts, total unsecured priority debts, and total

unsecured nonpriority debts (all three reports);

• for those debtors who passed the median income threshold, determine

whether they had more than $50 in projected net monthly income after

paying allowable living expenses and paying all of their nonhousing

secured debt and unsecured priority debt over 5 years (1998 Ernst &

Young and Creighton/ABI);

• for those debtors who passed both the median annual income test and the

monthly net income test, determine whether they could repay at least 20

percent of their unsecured nonpriority debt over 5 years if they devoted

100 percent of their projected net monthly income to the repayment of

their unsecured nonpriority debt (1998 Ernst & Young and Creighton/ABI);

• for those debtors with household incomes at or above the median income

threshold for households of comparable size, determine whether the

debtors had sufficient income, after paying allowable living expenses, to

pay all their nonhousing secured debt, all their unsecured priority debt,

and $5,000 or 25 percent, whichever was less, of their unsecured

nonpriority debt over 5 years (1999 Ernst & Young).

Table I.1 details the similarities and differences in the repayment capacity

methodologies used in each of the two Ernst & Young reports and the

 1

 Under H.R. 833 as introduced, debtors, regardless of household income, could be required to file

under chapter 13 if it was determined that they could pay 25 percent or $5,000 of their unsecured

nonpriority debt, whichever was less.

Similarities and

Differences in the

Ernst & Young and

Creighton/ABI Reports
Appendix I

Methodological Similarities and Differences in Three Reports on Bankruptcy Debtors'

Repayment Capacity

Page 42 GAO/GGD-99-103 Personal Bankruptcy

Creighton/ABI report. The EOUST report is not shown in table I.1 because

it did not use many of the steps described in the table. For example,

EOUST did not use the IRS collection financial standards to determine

debtors’ allowable living expenses. The EOUST report is discussed in

detail in appendix II.

Data used or calculation made Ernst & Young

(March 1998)

Ernst & Young

(March 1999)

Creighton /ABI

(March 1999)

Debtor sample used for analysis National probability sample of

debtors who filed under chapter 7

in calendar year 1997.

Same Probability sample of debtors who

filed under chapter 7 in calendar

year 1995 in each of seven

judgmentally selected districts.

Proposed legislation used in

analysis

H.R. 3150 as introduced in

February 1998.

H.R. 833 as introduced in

February 1999.

H.R. 3150 as passed by the

House of Representatives, June

10, 1998.

Determination of debtors’

gross income

Gross monthly income Estimated current monthly gross

income from schedule I.a

Same Same

Gross annual income Multiplied gross estimated

monthly income on schedule I by

12.

Same Same

Determination of family size used

for median income comparison

For debtors who filed as

individuals, added one, and for

debtors who filed jointly, added

two, to the number of dependents

listed on schedule I.

Same Same

Initial income screen used to

determine whether debtors

would be subject to further

analysis of their repayment

capacity

Debtors’ gross annual income

exceeded 75 percent of 1996

annual median national income

for households of comparable

size as reported by U.S. Census

Bureau.b

Debtors’ gross annual income

exceeded 100 percent of 1996

annual median national income

for a family household of

comparable size as reported by

U.S. Census Bureau.c

 For oneperson households, used

median income for households

with one earner.d

 Families of

more than four members were

assigned the Census Bureau

table’s annual median income

for a four-person family plus

$583 annually for each

additional family member.

Debtors’ gross annual income

was 100 percent or more of 1993

national median income for family

household of comparable size as

reported by U.S Census Bureau.

For one-person households, used

median income for households

with one earner. Families of more

than four persons were assigned

the median income for a fourperson family.

Determination of debtors’

allowable living expenses

Housing and utility expenses for

nonhomeowners

IRS standard housing and utility

allowance by county of

residence.e

Same Same

Table I.1: Methodological Similarities and Differences in the Two Ernst & Young Reports and the Creighton/ABI Report on

Bankruptcy Debtors’ Repayment Capacity
Appendix I

Methodological Similarities and Differences in Three Reports on Bankruptcy Debtors'

Repayment Capacity

Page 43 GAO/GGD-99-103 Personal Bankruptcy

Data used or calculation made Ernst & Young

(March 1998)

Ernst & Young

(March 1999)

Creighton /ABI

(March 1999)

Housing and utility expenses for

homeowners

Full mortgage payment (except

as noted below), home

maintenance expenses, utilities

(electricity, heating, water, sewer,

and telephone), property taxes,

and homeowner insurancef

 as

reported on schedule J.g

Same Full mortgage payment (included

property tax and insurance if not

included in mortgage payment;

excluded property tax and

insurance if included in mortgage

payment and listed elsewhere);

maintenance expenses and

utilities (excluding cable

television) as listed on schedule

J.

Adjustments to homeowner

housing and utility expenses

Used the full monthly mortgage

payment debtor listed on

schedule J unless either of the

following conditions applied:

(1) if 85 percent of the debtor’s

reported monthly mortgage

payment, multiplied by 60, was

more than 110 percent of the total

outstanding mortgage debt shown

on schedule D,h

 then determined

debtor’s monthly mortgage

payment by dividing 110 percent

of the total outstanding mortgage

debt by 60; or

(2) if the debtor’s income after

allowable living expenses

(excluding debt payments) was

insufficient to pay the entire

mortgage payment, then used all

available income remaining after

allowable expenses (excluding

debt payments).

For all debtors, the outstanding

mortgage debt, as shown on

schedule D, was increased by 10

percent to include estimated

interest costs.i

Same Used the full monthly mortgage

payment debtor listed on

schedule J unless the following

condition applied: 85 percent of

the debtor’s reported monthly

mortgage payment, multiplied by

60, was more than 110 percent of

the total outstanding mortgage

debt shown on schedule D.h

 In

such cases, determined debtor’s

monthly mortgage payment by

dividing 110 percent of the total

outstanding mortgage debt by 60.

Transportation expenses
Appendix I

Methodological Similarities and Differences in Three Reports on Bankruptcy Debtors'

Repayment Capacity

Page 44 GAO/GGD-99-103 Personal Bankruptcy

Data used or calculation made Ernst & Young

(March 1998)

Ernst & Young

(March 1999)

Creighton /ABI

(March 1999)

Monthly vehicle ownership

allowance

Used secured debt payment as

ownership allowance, with

exception of leased vehicles.

Motor vehicle debt for all vehicles

on which secured debt was owed

was totaled, 10 percent added for

estimated interest costs

(equivalent to 9 percent for 2

years), and the resulting total

amortized over 60 months to

determine monthly vehicle

secured debt payment. Thus, if

there was no secured debt, there

was no ownership allowance. In

the absence of consistent

information on schedule G,j

 debt

for leased vehicles was treated as

secured debt, unsecured priority

debt, or unsecured nonpriority

debt, depending on how the lease

costs were listed on the debtors’

schedules. For example, if listed

as secured debt or unsecured

priority debt, amount would have

been amortized over 60 months

to determine monthly payment. If

vehicle was listed on schedule B,k

but not D (that is, there was no

secured debt shown for the

vehicle), no ownership allowance

was included.

Same Used secured debt payment as

ownership allowance when

secured debt payment was at

least as much as maximum IRS

allowance for household of same

size and number of vehicles as

debtor’s. Motor vehicle debt for all

vehicles on which secured debt

was owed was totaled, 24 percent

added for estimated interest costs

(equivalent to 9 percent for 5

years), and the resulting total

amortized over 60 months to

determine monthly vehicle

secured debt payment. The

debtor was allowed the total

monthly vehicle secured debt

payment or the maximum

applicable IRS ownership

allowance (for one or two cars,

based on household size),

whichever was higher. Used

same method as Ernst & Young

for determining allowance for

leased vehicles, with one

exception. If vehicle was listed on

schedule B, but not D (that is,

there was no secured debt shown

for the vehicle), the vehicle was

considered to be debt-free and

treated like all other debt-free

vehicles. However, no ownership

allowance was included for

leased vehicles if the lease was

listed only on schedule G. For

debt-free vehicles, debtors were

given the maximum IRS

ownership allowance. Ownership

allowance was based on the

number of vehicles debtors’

reported on schedules B or D.

Except for estimating secured

debt payments, debtors with

household size of one were

allowed no more than one

ownership allowance; households

of two or more were allowed no

more than two ownership

allowances.
Appendix I

Methodological Similarities and Differences in Three Reports on Bankruptcy Debtors'

Repayment Capacity

Page 45 GAO/GGD-99-103 Personal Bankruptcy

Data used or calculation made Ernst & Young

(March 1998)

Ernst & Young

(March 1999)

Creighton /ABI

(March 1999)

Monthly vehicle operating

allowance

Based on IRS standards, which

are assigned by city or county of

residence. If debtor’s city of

residence (as reported on the

debtor’s bankruptcy petition) had

its own IRS allowance, used

allowance for that city; otherwise,

used allowance for IRS region in

which debtor’s county of

residence was located.

Operating allowance assigned

based on debtor’s reported

number of vehicles.l Debtors with

household size of one were

limited to one vehicle operating

allowance. Households of two or

more were assigned operating

allowances for the larger of the

number of vehicles listed on

schedules B or D.

Same Same for households of one and

households of two or more with

no more than two vehicles.

However, limited households of

two or more to two operating

allowances, regardless of the

number of vehicles listed on

schedules B or D.

Monthly public transportation

allowance

Based on IRS standards. For

debtors who listed no vehicles on

schedules B or D, gave debtor

one IRS vehicle operating

allowance for households with no

vehicle.m

Same Same

Other living expenses Used IRS national standard,

based on household’s gross

monthly income and family size,

for housekeeping supplies,

apparel and services, personal

products and services, food, and

miscellaneous items.

Same Same

Other necessary expenses Deducted from monthly gross

income (as determined by Ernst &

Young) the following expenses as

reported on debtors’ schedules I

and J: payroll deductions (payroll

taxes, Social Security, nonhealth

insurance, union dues); taxes

neither deducted from wages nor

included in home mortgage

payments;n

 alimony, charitable

contributions, child care, other

payments to dependents not

living at home; health insurance

and medical and dental

expenses.

Same Used the same deductions that

were used in the Ernst & Young

March 1998 report, except

disallowed debt payments

withheld from the paycheck,

transfers into savings plan,

nonmandatory pension

contributions, all payments for

dependents not at home (except

alimony and child support), and

tuition payments.

Business expenses Not allowed. Debtors allowed business

expenses as reported on

schedule J—but only if debtor

reported business income on

schedule I.

All business expenses listed on

schedule J were allowed (whether

or not they were supported by a

supplemental detail list). In

addition, work uniforms listed on

schedule I were allowed.
Appendix I

Methodological Similarities and Differences in Three Reports on Bankruptcy Debtors'

Repayment Capacity

Page 46 GAO/GGD-99-103 Personal Bankruptcy

Data used or calculation made Ernst & Young

(March 1998)

Ernst & Young

(March 1999)

Creighton /ABI

(March 1999)

Determination of total debts

owed

Home mortgage debt Total outstanding mortgage debt

as shown on schedule D was

increased by 10 percent to

include estimated interest costs

(e.g., $100,000 was converted to

$110,000).

Same Total outstanding home mortgage

debt as shown on schedule D.

Other secured debt Total secured debts (other than

mortgage on principal residence)

as shown on schedule D. Total

increased by 10 percent to

include estimated interest costs

(e.g., $30,000 was converted to

$33,000).o

Same Total secured debts (other than

mortgage on principal residence)

as shown on schedule D.

Unsecured priority debts Total of all debts as shown on

schedule Ep

 (except for student

loans);10 percent added to any

back taxes listed on the schedule.

The total value of all student

loans not entitled to priority status

that were listed on schedule E

were deducted and added to the

total of debts listed on schedule

F.q

Same Total of all debts shown on

schedule E (except for student

loans) and the nonpriority portion

of debts for which only a part of

the total value was listed on

schedule E as entitled to priority

status (such as some tax

liabilities).

Unsecured nonpriority debts Total of all debts as shown on

schedule F, plus the value of all

student loans deducted from the

total debts shown on schedule E.

Same Total of all debts as shown on

schedule F plus the value of the

debts listed on schedule E that

were not entitled to priority status

(such as student loans, or a

portion of some tax liabilities).

Determination of debtors’

capacity to repay unsecured

nonpriority debts

Home mortgage debt Assumed debtor would maintain

monthly mortgage payments as

listed on schedule J, except

where mortgage would be paid off

in less than 60 months or debtor’s

income after allowable living

expenses was insufficient to

make full mortgage payment. In

cases where mortgage debt

would be paid off in less than 60

months, determined debtor’s

monthly mortgage payment by

dividing 110 percent of the total

outstanding mortgage debt by 60

months.

Same Assumed debtor would maintain

monthly mortgage payments as

listed on schedule J, except

where mortgage would be paid off

in less than 60 months. In such

cases, determined debtor’s

monthly mortgage payment by

dividing 110 percent of the total

outstanding mortgage debt by 60

months.
Appendix I

Methodological Similarities and Differences in Three Reports on Bankruptcy Debtors'

Repayment Capacity

Page 47 GAO/GGD-99-103 Personal Bankruptcy

Data used or calculation made Ernst & Young

(March 1998)

Ernst & Young

(March 1999)

Creighton /ABI

(March 1999)

Other secured debt Assumed total debts, as adjusted

for interest, would be paid over 60

months. Total outstanding

nonmortgage secured debts were

increased by 10 percent

(equivalent to 9 percent interest

for 24 months) to include

estimated interest, and the

resulting total amortized over 60

months.

Same Assumed all nonprimary

residence real estate debts of

less than $20,000 and all non-real

estate secured debts, as adjusted

for interest, would be paid over

60 months. Nonprimary residence

real estate debts of less than

$20,000 and all non-real estate

secured debts were grossed up

by 24 percent (equivalent to 9

percent interest rate for 60

months) and the resulting total

amortized over 60 months.

For debts of $20,000 or more

secured by real property other

than the debtor’s primary

residence, monthly payments

were determined by amortizing

the outstanding debt shown on

schedule D over 15 years (or 180

months) at an interest rate of 9

percent per year.

Unsecured priority debts Assumed total debts (as

adjusted) paid over 60 months.

Back taxes increased by 10

percent (equivalent to 9 percent

interest for 24 months) to include

estimated interest.

Same Same, but no interest included for

any debts in this category.

Second income screen, if used,

for determining debtors’ capacity

to repay unsecured nonpriority

debts

Debtor had monthly net income of

more than $50, after allowable

living expenses (including any

monthly mortgage payments) and

repayment over 60 months of all

nonmortgage secured debt and

unsecured priority debt.

None. H.R. 833 includes no

such screen. Next step is to

determine debtor’s debt

repayment capacity.

Same as Ernst & Young March

1998 report.

Test used for repayment of

unsecured nonpriority debt

Debtors who passed initial and

second income screen and could

also repay at least 20 percent of

their unsecured nonpriority debt

over 60 months.

Likely debtors were those who

passed initial income screen

and who had sufficient income

after allowable living expenses

(including any monthly

mortgage payments) to repay

over 60 months all their

nonmortgage secured debt, all

their unsecured priority debt,

and at least $5,000 or 25

percent of total unsecured

nonpriority debts (whichever

was less).

Same as Ernst & Young March

1998 report.

Treatment of debtor attorney

fees and chapter 13 trustee

fees
Appendix I

Methodological Similarities and Differences in Three Reports on Bankruptcy Debtors'

Repayment Capacity

Page 48 GAO/GGD-99-103 Personal Bankruptcy

Data used or calculation made Ernst & Young

(March 1998)

Ernst & Young

(March 1999)

Creighton /ABI

(March 1999)

Debtor attorney fees Debtor attorney fees not included

in analysis.

Used data from same report as

ABI. Report found that chapter

13 incurred average fee of

$1,281 in chapter 13 cases.

Treated as an unsecured priority

debt the difference between this

average fee and the amount the

debtor indicated on the

bankruptcy petition that he or

she had paid the attorney prior

to filing the bankruptcy petition.

If no data in schedule on

amount already paid to an

attorney, used $800 as unpaid

amount and amortized it over 60

months.

Used data from report that

showed that chapter 13 debtors

had average unpaid attorney fee

of $800 at filing. Added total of

$800 to debtor expenses and

amortized it over 60 months.

The $800 was assumed to

cover chapter 13 attorney fees

paid through the plan plus the

chapter 13 trustee fee applied to

these attorney debt payments.

Chapter 13 trustee administrative

expenses

None in calculation of debtor’s

debt repayment capacity. The

debt repayment calculation was

independent of any trustee fees.

Needs-based test did not

incorporate trustee fees. Total

debt repayment estimates are

net of trustee fees, and based

on three different assumptions:

(1) Trustee would receive 5.6

percent of all debt payments by

the “can-pay” debtors identified

by the needs-based test,

excluding debtor payments on

mortgage debt in excess of

$20,000 (estimate of $249

million in trustee fees paid).

(2) Excluding all debtors who

could repay 100 percent of their

debts—secured nonmortgage,

unsecured priority, and

unsecured nonpriority (estimate

of $138 million in trustee fees

paid).

(3) Trustee would receive 5.6

percent of debtors’ payments on

unsecured debts—unsecured

priority and unsecured

nonpriority (estimate of $93

million in trustee fees paid).

Applied a 5.6 percent feer

 to

unsecured priority debts,

unsecured nonpriority debts,

and secured debt (other than

home mortgages and

nonprimary residence real

estate claims of $20,000 or

more).

a Schedule I--Current Income of Individual Debtor(s). The schedule includes such categories as

monthly gross wages, salary, and commission; payroll deductions; and income from nonwage

sources, such as interest and dividends, alimony, and Social Security. For joint filers, the debtor must

show the monthly gross income of both the debtor and his or her spouse. Line one of this form

indicates that the information to be provided is an "estimate of average monthly income."

b Used Census Bureau table H-11 for national median income by household size. In this table,

median income rises for households between one and four persons, peaks at households of four, and

declines for households of more than four persons. The Census Bureau defines a household as all

people occupying a housing unit.

c

 Used Census Bureau table F-8 for families with two or more members. In table F-8, median income

rises for families between two and four persons, peaks at families of four, and declines for families of

more than four persons. The Census Bureau defines a family as a group of two or more people

related by birth, marriage, or adoption who reside together. A household, in contrast, includes related

family members and all unrelated people, such as foster children, who share the housing unit.
Appendix I

Methodological Similarities and Differences in Three Reports on Bankruptcy Debtors'

Repayment Capacity

Page 49 GAO/GGD-99-103 Personal Bankruptcy

d Used Census Bureau table H-12 (one-earner households) for households of one.

e IRS Collection Financial Standards for 1997.

f Homeowners' property taxes and insurance, as shown on Schedule J, were included whether they

were (1) listed as included in the monthly mortgage payment, (2) listed separately on Schedule J, or

(3) both, in which case the expenses were potentially counted twice. To the extent this occurred, it

would have increased debtors' allowable expenses and decreased their debt repayment capacity.

g Schedule J--Current Expenditures of Individual Debtor(s). The schedule includes such expenses as

housing, utilities, food, clothing, medical and dental expenses, transportation, charitable contributions,

insurance, taxes (not deducted from wages or included in home mortgage payments), alimony, and

child support. The instructions for this form note: "Complete this schedule by estimating the average

monthly expenses of the debtor and debtor's family. Pro rate any payments made bi-weekly,

quarterly, semi-annually, or annually to show monthly rate."

h Schedule D--Creditors Holding Secured Claims.

i

According to Ernst & Young, this adjustment is equivalent to the remaining cumulative interest on

outstanding principle for an 8 percent, 30-year mortgage with a maturity of 2 to 3 years.

j Schedule G--Executory Contracts and Unexpired Leases. Contracts for leased motor vehicles would

be properly listed on this schedule, but debtors were not consistent with regard to the schedule on

which vehicle lease costs were noted. According to Ernst & Young, they reviewed a “quality” sample

of 193 debtor petitions. Of these 193 petitions, 9 percent included vehicle leases on schedule G; 5

percent also listed leases as secured debt on schedule D, and 2 percent listed leases as unsecured

nonpriority debt on schedule F. Of these 193 debtors, 6 percent identified leased vehicles on

Schedule B.

k Schedule B--Personal Property. The instructions for this schedule note: "Do not include interests in

executory contracts and unexpired leases on this schedule. List them in Schedule G--Executory

Contracts and Unexpired Leases.”

l The debtor's number of vehicles was determined by taking the larger of (1) vehicles identified on

schedule B (Personal Property) or (2) the number of secured debts identified on Schedule D

(Creditors Holding Secured Claims) as vehicle debt. Ernst & Young and Creighton/ABI excluded any

leased vehicles listed on Schedule G for debtors who did not also identify at least one vehicle on

schedules B or D.

m The IRS public transportation allowance is the vehicle operating allowance for households with no

cars. Ernst & Young and Creighton/ABI used this allowance for debtors who did not list any vehicles

on their financial schedules.

 n Back taxes may have been listed on both schedule J and schedule E (Creditors Holding secured

Priority Claims). According to Ernst & Young, it was not always possible to determine from the

schedules when this occurred. To the extent this occurred, back taxes would be listed (and counted)

twice--as a monthly expense on schedule J and as an unsecured priority debt on schedule E.

o

According to Ernst & Young, the 10 percent future accrued interest on nonmortage secured debt was

the ratio of the remaining cumulative interest to outstanding principal for a 9 percent, 4-year

automobile loan with 2 years to maturity.

p Schedule E--Creditors Holding Unsecured Priority Claims. This schedule includes such claims as

alimony, child support, and back taxes.

q Schedule F--Creditors Holding Unsecured Nonpriority Claims. This schedule includes credit card

debts, other unsecured personal loans, and student loans.

r

The 1995 national average chapter 13 trustee fee computed as a percentage of disbursements as

provided to Creighton/ABI by EOUST.

Source: GAO analysis of Ernst & Young and Creighton/ABI reports and additional information

provided by the authors of the Ernst & Young and Creighton/ABI reports.

The Creighton/ABI sample was drawn from a different population than the

population from which the sample in the two Ernst & Young reports was

drawn. The differences in the populations make it difficult to compare the

Creighton/ABI estimates with those of the March 1998 Ernst & Young

report, which is based on substantially the same proposed legislation as

Sampling Differences
Appendix I

Methodological Similarities and Differences in Three Reports on Bankruptcy Debtors'

Repayment Capacity

Page 50 GAO/GGD-99-103 Personal Bankruptcy

that used by Creighton/ABI. The principal difference—and a significant

one—is that the version of H.R. 3150 used in the Creighton/ABI report

included a higher median household income test than did the version of

H.R. 3150 used in the 1998 Ernst & Young repoert.

The Ernst & Young reports were based on a national probability sample of

about 2,200 drawn from all chapter 7 bankruptcy cases filed nationwide

during calendar year 1997. The cases were selected randomly from the

petitions filed in all federal bankruptcy districts largely in proportion to

each district’s total chapter 7 filings. Consequently, the results of the Ernst

& Young reports can be generalized to all chapter 7 petitions filed

nationwide in calendar year 1997.

The Creighton/ABI study used chapter 7 cases from seven judgmentally

selected bankruptcy districts.2

 The districts used in the study were

originally chosen for a different purpose—a study of debtors’

reaffirmations of their debts. A debtor who files for bankruptcy may

generally voluntarily choose to reaffirm—or agree to pay—one or more

debts. As mentioned previously, the sample was originally chosen for a

study of debtor reaffirmation practices in bankruptcy proceedings,

including the effect of different permissible reaffirmation practices on

debtors’ decisions to reaffirm some of their debts.3

The report states that petitions from these districts had to meet the

following four qualifications before being eligible for selection into the

study sample:

• the petition must have been filed in calendar year 1995;

• the petition must have been filed as or converted to a chapter 7 case;

• the petition must have been filed by an individual or a married couple (a

nonbusiness filing); and

• the case file had to include most schedules.

 

2

 These districts were the Northern District of California, the District of Colorado, the Northern District

of Georgia, the District of Massachusetts, the District of Nebraska, the Middle District of North

Carolina, and the Western District of Wisconsin.

3

 According to the Creighton/ABI report’s authors, the seven districts were selected to obtain data from

districts with relatively high and low proportions of chapter 13 filings; districts in which debtors who

wished to reaffirm debts were required to file a written reaffirmation agreement with the bankruptcy

court; and districts in which debtors could reaffirm debts by agreeing to continue their contractual

payments (e.g., auto loan payments) without filing a reaffirmation agreement with the bankruptcy

court.
Appendix I

Methodological Similarities and Differences in Three Reports on Bankruptcy Debtors'

Repayment Capacity

Page 51 GAO/GGD-99-103 Personal Bankruptcy

The authors randomly selected filings in each district that met these

qualifications.

The report states that the results were weighted to reflect the number of

nonbusiness chapter 7 cases filed in 1995 in each district; however, the

results should have been weighted to reflect the number of cases filed as

or converted to chapter 7 cases. The authors of the Creighton/ABI report

provided us with data, not included in the report, that indicated that 35 of

the 1,041 cases in the report’s sample were filed initially under another

chapter (mostly chapter 13), but were closed as chapter 7 cases.

Depending on the districts where the cases were filed, weighted

adjustments that account for their presence in the population could have

affected the report’s results. However, we were unable to determine the

effect of this error. We provided updated unpublished data to the report’s

authors, and they reweighted their estimates. The results of the

reweighting show minimal effect on the report’s estimates. The

reweighting changed the weighted estimates by less than 0.1 percent.

The report’s results can be projected to the population of total chapter 7

filings for these seven bankruptcy districts. However, it cannot be used to

make projections to the national population of chapter 7 cases filed in

1995. Consequently, neither extrapolation of the Creighton/ABI results to

the nation nor comparison with the results of Ernst & Young’s March 1998

report is supported by the methods used. Although the Creighton/ABI

report’s authors acknowledge that the two reports were based on different

sample designs, they nevertheless portrayed the results of their study as

comparable with those of the Ernst & Young report. For example, Part III

of their report contains a detailed description of the projected net gain

nationwide in the amount of money unsecured creditors would collect

based primarily on the assumptions in their study compared with the net

gain amount estimated in Ernst & Young’s March 1998 report.

Nevertheless, the Creighton/ABI sample provides useful information for

policymakers. For example, its results show that, for its seven districts, the

median household income and median unsecured nonpriority debts of its

“can’t pay” debtors are similar to those in the Ernst & Young and EOUST

samples.

The analyses of the two Ernst & Young reports and the Creighton/ABI

report were based on the “needs-based” bankruptcy provisions in different

versions of proposed federal bankruptcy legislation. In analyzing debtor

repayment capacity, each report attempted to apply the “needs-based”

provisions of the proposed legislation used in the analysis as they

interpreted those provisions. Thus, a number of differences in the reports’

Proposed Legislation Used

in the Three Reports
Appendix I

Methodological Similarities and Differences in Three Reports on Bankruptcy Debtors'

Repayment Capacity

Page 52 GAO/GGD-99-103 Personal Bankruptcy

methodologies reflect the different proposed legislative provisions used as

the basis for the analysis. The 1998 Ernst & Young report was based on the

provisions of H.R. 3150 as introduced in the House of Representatives. The

Creighton/ABI report was based on the provisions of H.R. 3150 as passed

by the House in June 1998. The 1999 Ernst & Young report was based on

the provisions of H.R. 833 as introduced in February 1999.4

Each report relied on annual gross median household income data as

reported by the U.S. Census Bureau to select debtors for further analysis

of their repayment capacity. Each debtor’s annual gross household income

was compared with the annual gross median household income for a

household of comparable size—one person, two persons, and so forth.

However, in making this comparison, the reports used different national

median income thresholds from the Census Bureau and data for different

calendar years (1993 and 1996). These differences reflect the different

median income tests in the different proposed legislation used in each

report’s analysis and the different years from which each report’s sample

was drawn.

The Census Bureau reports median household income in different ways. It

reports annual gross median income for one-person households and for

households with one earner. The median income for households with one

earner is higher. The Census Bureau also reports annual gross median

income for households of two or more and for family households of two or

more. Households are defined as all persons, related and unrelated,

occupying a housing unit. Family households are defined as all persons

related by birth, marriage, or adoption who reside together. Generally,

annual gross median incomes for family households exceed those of

nonfamily households. Thus, the table chosen for comparison can affect

whether a debtor’s income is determined to be above or below the national

median for a household of comparable size.

The 1998 Ernst & Young report used the lowest annual gross median

household incomes for households of one and households of four or more

for two reasons. First, it used Census Bureau tables that generally had

lower median household incomes than the tables used in the other two

reports. Second, based on its interpretation of H.R. 3150 as introduced, the

1998 Ernst & Young report selected for more detailed repayment analysis

all debtors whose household incomes were more than 75 percent of the

national median household income. In the other two reports, debtors were

 

4

 H.R. 833 is identical to the conference report provisions of the Bankruptcy Reform Act of 1998, H.R.

3150, which passed the House but not the Senate in the 105th Congress.

Similarities and Differences

in Determination of

Debtors’ Median Income
Appendix I

Methodological Similarities and Differences in Three Reports on Bankruptcy Debtors'

Repayment Capacity

Page 53 GAO/GGD-99-103 Personal Bankruptcy

subject to further repayment analysis if their household incomes were at

least 100 percent of the annual gross median household income for

households of the same size. This higher standard was based on the

median household income standards specified in the proposed legislation

used in the other two reports’ analyses.

An example, which assumes that all the reports used 1997 Census Bureau

income data, illustrates the differences. The median annual gross income

for a household of one in 1997—the measure used in the 1998 Ernst &

Young report--was $18,762. In contrast, the 1997 annual gross median

income for a household with one earner—the measure used in the other

two reports—was $29,780. To pass the median income test, the 1998 Ernst

& Young report required a one-person household to have income in excess

of $14,072 (more than 75 percent of $18,762). However, to pass the median

income test in the other three reports, the same debtor would have had to

have income of at least $29,780—100 percent of the higher median—or

more than double the amount required in the 1998 Ernst & Young report

(based on 1997 Census Bureau data).

The median incomes used for households of two to four persons were

similar in all three reports, although the national medians used in the 1998

Ernst & Young report were higher for households of two and three

persons. However, the incomes diverged again for families of more than

four. In all the Census Bureau tables, median household income peaks at

families of four and declines for families of five or more. The 1998 Ernst &

Young report used the incomes reported in the Census tables for

households of more than four. Thus, as family size increased above four,

the median income used in the analysis declined. For family households of

four or more, the Creighton/ABI report used the median income for a

family of four. For family households of more than four, the 1999 Ernst &

Young report used the median income for a family household of four, plus

$583 annually for each additional household member over four. Each of

these methods reflected the proposed legislation used in each report. Had

each report used the 1997 Census Bureau tables, the median income used

for a family of six would have been $34,849 (1998 Ernst & Young), $53,350

(Creighton/ABI), or $54,516 (1999 Ernst & Young).

The impact of these different median income thresholds was reflected in

each report’s “pass rate”--the percentage of debtors who passed each

report’s median income threshold test. The pass rates reported were 47

percent (1998 Ernst & Young), 24.2 percent (Creighton/ABI), and 19

percent (1999 Ernst & Young). However, only the different pass rates in

the two Ernst & Young reports reflect solely the effect of using different
Appendix I

Methodological Similarities and Differences in Three Reports on Bankruptcy Debtors'

Repayment Capacity

Page 54 GAO/GGD-99-103 Personal Bankruptcy

median income thresholds. Both reports were based on the same sample

of debtors and used 1996 Census data on annual gross median household

incomes. The different pass rates for the Creighton/ABI report and the

EOUST report may reflect not only the different median income thresholds

used, but also (1) differences in the annual household incomes of the

sample of debtors each report used for analysis and (2) use of median

household incomes for different years, 1993 and 1997, respectively.

However, Ernst & Young reported to us that had their 1998 report used the

same median income thresholds as those used by Creighton/ABI, the

percentage of “can-pay” debtors in their 1998 report would have been 10

percent rather than 15 percent.

The Ernst & Young and Creighton/ABI reports based their determination of

debtors’ allowable living expenses on the IRS Collection Financial

Standards. The IRS uses these standards to determine a taxpayer’s ability

to pay a delinquent tax liability. The EOUST report did not use the IRS

standards in its assessment of debtors’ allowable living expenses,

concluding that they were cumbersome and difficult to apply consistently

across debtors.

The IRS has established specified dollar allowances for housing and utility

expenses; transportation expenses; and food, clothing and other expenses.

However, the IRS has not established specific dollar allowances for “other

necessary expenses,” such as taxes, health care, court-ordered payments

(e.g., child support or alimony), child care, and dependent care. Since

there are no specific dollar standards, the IRS determines whether

individual expenses in this category are reasonable and necessary on a

case-by-case basis. The IRS guidance notes that some of these “other

necessary expenses,” such as taxes, health care, and court-ordered

payments, are “usually considered to be necessary.” However, the taxpayer

may be required to substantiate the amounts and justify expenses for other

expense items, such as child care, dependent care, and life insurance.

As previously noted, the Ernst & Young reports and the Creighton/ABI

report each used the needs-based provisions of different proposed

bankruptcy reform bills. Each of the proposed bills provided that the

debtors would be allowed the IRS allowances for the national and local

necessary expense standards (housing and utilities; transportation; and

food, clothing, and other expenses), and other necessary expenses.

However, none of the proposed bills used as the basis for analyses in the

three reports specified how the discretionary allowances for “other

necessary expenses” were to be determined.

Similarities and Differences

in Determination of

Debtors’ Allowable Living

Expenses
Appendix I

Methodological Similarities and Differences in Three Reports on Bankruptcy Debtors'

Repayment Capacity

Page 55 GAO/GGD-99-103 Personal Bankruptcy

There are also other provisions of the IRS collection standards that are not

mentioned in the bills. For example, the IRS standards permit a taxpayer 1

year in which to modify or eliminate excessive necessary or unallowable

conditional expenses, if the tax liability cannot be paid within 3 years.

The “needs-based” provisions of the proposed legislation used in the Ernst

& Young and Creighton/ABI reports provided that debtors’ monthly debt

repayment expenses were to include whatever amounts were necessary to

pay monthly mortgage payments, to pay in full over 5 years all nonhousing

secured debts (such as auto loans), and all unsecured priority debts (such

as child support and certain back taxes) as scheduled by the debtors on

their financial schedules. Thus, by implication, debtors were to be

permitted expenses in excess of the IRS allowances where necessary to

repay debt. Consequently, for example, if a debtor’s total monthly vehicle

debt payments exceeded the applicable IRS transportation ownership

allowance, the higher debt payment would be used as the ownership

allowance.

The Ernst & Young and Creighton/ABI reports divided debtors’ living

expenses into several categories, including housing and utility expenses

(separately for nonhomeowners and homeowners), transportation

expenses, other living expenses, other necessary expenses, and business

expenses. While the three reports used the IRS expense standards for

determining allowable living expenses in most of these categories, there

were differences in how some of these standards were interpreted. The

biggest difference was in how the two Ernst & Young reports and the

Creighton/ABI report interpreted the standards to determine the

transportation allowance.

The IRS standards include a single housing and utilities allowance for

homeowners and renters, regardless of existing mortgage or rental

payments. An allowance is set for each county in the United States. Within

each county, there are three levels, according to family size—two persons

or fewer, three persons, and four persons or more. The allowances are

derived from Census Bureau and Bureau of Labor Statistic (BLS) data. All

three reports used these standards for nonhomeowners (by county of

residence), but none of the three reports used these standards for

homeowners.

To determine housing and utility expenses for homeowners, the Ernst and

Young reports generally used the total of the full mortgage payment, home

maintenance expenses, utilities, property taxes, and homeowner insurance

Housing and Utility Expenses
Appendix I

Methodological Similarities and Differences in Three Reports on Bankruptcy Debtors'

Repayment Capacity

Page 56 GAO/GGD-99-103 Personal Bankruptcy

amount as reported on schedule J.5 If the debtor indicated on schedule J

that property taxes and insurance were included in the home mortgage

payment, but also listed these expenses separately on the schedule, Ernst

& Young would have counted these expenses twice. To the extent this

occurred, the Ernst & Young analysis would have overstated debtors’

homeowner expenses. The Creighton/ABI report also used the homeowner

expenses listed on schedule J to determine a homeowner’s housing and

utility allowance. However, property taxes and homeowner insurance, if

listed separately on schedule J, were included as expenses only where the

schedule indicated that such expenses were not included in the mortgage

payment. Thus, where property taxes and homeowner insurance were

listed on schedule J twice—as included in the mortgage payment and as

separate expenses elsewhere on the schedule--Creighton/ABI would have

used lower homeowner expenses than Ernst & Young.

The three reports made adjustments to homeowner housing and utility

expenses if certain conditions applied. In both Ernst & Young reports,

adjustments were made to the full monthly mortgage payment listed on

schedule J if 85 percent of the reported monthly mortgage payment,

multiplied by 60 months, was more than 110 percent of the total

outstanding mortgage debt shown on schedule D6

 or if the debtor’s income

after allowable living expenses (excluding debt payments) was insufficient

to pay the entire mortgage payment. The Creighton/ABI report made

adjustments to the reported full monthly mortgage payment if the first

condition listed above was found, but did not apply the second condition.

According to Ernst & Young and Creighton/ABI, the number of debtors in

their samples affected by either of these conditions was very small.

The IRS transportation allowance is divided into two categories—

ownership costs and operating costs, which includes an allowance for

debtors with no vehicles. The IRS ownership allowance is a single national

standard7

 for payments on leased or purchased vehicles—currently $372

for the first car and $294 for the second car, with a maximum of two cars

allowed.8

 IRS revised the ownership allowance in 1998 to base it on

Federal Reserve Board of Governors’ data on the 5-year average ownership

 

5

 Schedule J—Current Expenditures of Individual Debtor(s).

6

 Schedule D—Creditors Holding Secured Claims.

7

 In its description of the Collection Financial Standards, IRS notes that the “ownership cost portion of

the transportation standard, although it applies nationwide, is still considered part of the local

standards.”

8

 The current IRS collection financial standard allowances used in our examples became applicable on

October 15, 1998.

Transportation Expenses
Appendix I

Methodological Similarities and Differences in Three Reports on Bankruptcy Debtors'

Repayment Capacity

Page 57 GAO/GGD-99-103 Personal Bankruptcy

or leasing costs for new and used cars. Because they are based on IRS

standards prior to 1998, none of the three reports used the current

standard. The prior IRS standard was based on the monthly cost of a 5-

year lease or purchase of a vehicle at 8.5 percent, assuming a price of

$17,000 for the first car and $10,000 for the second car.

According to the IRS, the “ownership costs provide maximum allowances

for up to two automobiles if allowed as a necessary expense.” The

operating portion of the IRS standard is derived from BLS data. The

operating allowance varies by census region and metropolitan statistical

area. The current allowance for Boston, Massachusetts, for example, is

$220 (no vehicles), $274 (one vehicle), or $328 (two vehicles). IRS

regulations describe the application of the ownership and operating

allowances as follows: “If a taxpayer has a car payment, the allowable

ownership cost added to the allowable operating cost equals the allowable

transportation expense. If a taxpayer has no car payment, or no car, only

the operating cost portion of the transportation standard is used to come

up with the allowable expense.”

Ernst & Young and Creighton/ABI used different methods to assign the

ownership portion of the transportation allowance. There were essentially

two differences---secured vehicle debt payments that were less than the

applicable IRS maximum ownership allowance and ownership allowances

for debt-free vehicles. The similarities and differences in the Ernst &

Young and Creighton/ABI methods of determining debtor transportation

ownership allowances are shown in table I.2. Although in some cases

Creighton/ABI provided a higher ownership allowance than the IRS

standards or Ernst & Young, we found no evidence that the Ernst & Young

reports or the Creighton/ABI report doubled-counted any portion of the

transportation ownership allowance.
Appendix I

Methodological Similarities and Differences in Three Reports on Bankruptcy Debtors'

Repayment Capacity

Page 58 GAO/GGD-99-103 Personal Bankruptcy

Monthly allowance for each of 60 months

Vehicle debt at filing

by household size

IRS collection

standards Ernst & Young Creighton/ABI

Ownership allowance Ownership allowance

Ownership

allowance

Secured debt

paymenta

Add remainder of

maximum IRS

allowance, if any Total

Secured debt

paymenta

Add remainder of

maximum IRS

allowance, if any Total

Household of any

size with no vehicles

$0 $0 $0 $0 $0 $0 $0

Household of any

size with one vehicle

$0 0 0 0 0 0 372 372

$30,000 372 500 0 500 500 0 500

$20,000 333 333 0 333 333 39 372

Household of two or

more with two or

more vehicles

$0 0 0 0 0 0 666 666

$30,000 500 500 0 500 500 166 666

$20,000 333 333 0 333 333 333 666

Household of any

size with one leased

vehicle and no other

vehicles

Amount of unexpired

lease listed as

secured debt of

$5,000 on schedule Db

Monthly lease

payment of no

more than $372

for the remainder

of the lease.

83 0 83 83 289 372

Leased vehicle listed

on schedule Bc only.

Monthly lease

payment of no

more than $372

for remainder of

the lease

0 0 0 0 372 372

a

For purposes of focusing on the conceptual differences in the methods used to determine the

ownership allowances, the table's allowance for secured debt repayment does not include any interest

costs. Both Ernst & Young and Creighton/ABI added estimated interest to the amount of the

outstanding secured debt on vehicle loans, then amortized the total over 60 months.

b

Schedule D—Creditors Holding Secured Claims. This example assumes that only the total amount of

the unexpired lease is shown as secured debt on schedule D.

c

Schedule B--Personal Property. This example assumes that the leased vehicle would be shown only

on schedule B, which would also include debt-free vehicles. Ernst & Young stated that its review of

193 cases in its sample found that about 2 percent of chapter 7 debtors listed vehicles on schedule B

only.

Source: GAO analysis of Ernst & Young and Creighton/ABI reports and additional information

provided by the reports' authors.

Table I.2: How the IRS, Ernst & Young, and Creighton/ABI Would Have Determined the Transportation Ownership Allowance for

Hypothetical Debtors in Boston, Massachusetts, Using the Current IRS Collection Financial Standards Allowances
Appendix I

Methodological Similarities and Differences in Three Reports on Bankruptcy Debtors'

Repayment Capacity

Page 59 GAO/GGD-99-103 Personal Bankruptcy

Based on its interpretation of H.R. 3150 and H.R. 833, Ernst & Young in

effect did not use the IRS ownership allowances. It totaled all secured

vehicle debt, added 10 percent for interest (equivalent to 9 percent for 2

years), and amortized the resulting total over 60 months. The resulting

monthly amount was used as the ownership allowance, whether it was

more or less than the applicable IRS ownership allowance. Creighton/ABI

totaled all vehicle debt, added 24 percent for interest (equivalent to 9

percent for 5 years), and amortized the resulting total over 60 months.

Creighton/ABI used the resulting monthly vehicle debt payment as the

ownership allowance if it was equal to or more than the maximum IRS

ownership allowance for a household of the same size and number of

vehicles as the debtor’s. If the monthly secured debt payment was less

than the maximum IRS ownership allowance for a household of the same

size and number of vehicles as the debtor’s, Creighton/ABI added the

difference to the debtor’s transportation expenses. For example, the

maximum IRS ownership allowance for a one-vehicle household is $372 a

month. If a debtor in a one-vehicle household had a monthly payment for

secured vehicle debt of $333, Creighton/ABI would have allowed an

additional monthly allowance of $39 (see table I.2).

The other principal difference was the ownership allowance for debt-free

vehicles. Because there were no secured debt payments for debt-free

vehicles, Ernst & Young did not include an ownership allowance for such

cars. Creighton/ABI included the IRS ownership allowance for debt-free

cars—one allowance for one-person households, one allowance for

households of two or more persons with one vehicle, and two allowances

for households of two or more persons with two or more vehicles.

The Creighton/ABI report explained that its approach to the ownership

allowance was based on the fact that the proposed “needs-based”

provisions penalize debtors with little or no secured vehicle debt. Debtors

with older cars with little or no debt are allowed minimal or no ownership

allowance under the IRS standards. The Creighton/ABI report noted that

most of the cars in its sample were at least 5 model years old when the

debtor filed for bankruptcy, and that debtors owed secured debt on 82 cars

that were 10 or more years old. They observed that it was likely that such

cars would need either major repairs or replacement during a 5-year debt

repayment period, and that limiting the ownership allowance to secured

debt payment made no provisions for this probability. To the extent that,

during their 5-year repayment plans, debtors faced major vehicle repairs or

had to replace their vehicles, the Creighton/ABI method may provide a

somewhat more realistic measure of the actual return to unsecured

nonpriority creditors. However, to the extent these expenses do not occur
Appendix I

Methodological Similarities and Differences in Three Reports on Bankruptcy Debtors'

Repayment Capacity

Page 60 GAO/GGD-99-103 Personal Bankruptcy

during the 5-years, the Creighton/ABI method would understate the

amount of income debtors would have available for payments on

unsecured nonpriority debt.

The IRS standards include an ownership allowance for leased vehicles.

The Ernst & Young and Creighton/ABI reports generally treated costs for

leased vehicles similarly. Neither report used the information from

schedule G,9 where unexpired leases should be listed. The needed data on

the amount remaining to be paid on unexpired leases were rarely listed on

this schedule. Instead, each report treated leased vehicles as secured debt,

unsecured priority debt, or unsecured nonpriority debt, depending on how

the lease costs were listed on the debtors’ schedules.10 If the cost of a

leased vehicle was listed on schedule D,11 Ernst & Young and

Creighton/ABI treated the cost as any other nonhousing secured debt—the

amount of the debt was increased by the amount of estimated interest

costs and amortized over 60 months. The one difference occurred when

the leased vehicle was listed on schedule B12 only. In such cases,

Creighton/ABI would have included an IRS ownership allowance for the

vehicle (based on household size and the number of other vehicles

reported). Ernst & Young would not have included an ownership

allowance in such cases since there was no secured debt, and Ernst &

Young used amortized secured debt as the ownership allowance.

Because accurate data on the amount remaining to be paid on unexpired

leases were not available from the debtors’ schedules, Creighton/ABI and

Ernst & Young simply used the amount of leased debt as listed on

schedules D, E, or F. The amount listed may or may not have been the

actual amount remaining to be paid on the unexpired lease. In some cases,

debtors may have listed only the monthly lease payment on their

schedules. Thus, it is not clear that either Ernst & Young or Creighton/ABI

was able to accurately capture the amount of unexpired leases and the

 

9

 Schedule G—Executory Contracts and Unexpired Leases.

10 According to Ernst & Young, they reviewed a “quality” sample of 193 debtor petitions—about 10

percent of their total sample. Of these 193 debtors, 9 percent included vehicle leases on schedule G, 5

percent also listed leases as secured debt on schedule D, and 2 percent listed leases as unsecured

nonpriority debt on schedule F. Of these 193 debtors, 6 percent identified leased vehicles on schedule

B.

11 Schedule D—Creditors Holding Secured Claims. This schedule should include any creditor claims

that are secured by a lien.

12 Schedule B—Personal Property. The instructions for this schedule specifically note: “Do not include

interests in executory contracts and unexpired leases on this schedule.”
Appendix I

Methodological Similarities and Differences in Three Reports on Bankruptcy Debtors'

Repayment Capacity

Page 61 GAO/GGD-99-103 Personal Bankruptcy

appropriate amount of monthly payments for those debtors who were

leasing vehicles at the time they filed for bankruptcy.

Crieghton/ABI’s and Ernst & Young’s methods of assigning vehicle

operating allowances were different for households of two or more

persons with more than two vehicles. Under the IRS collection financial

standards, IRS’ normal practice is to limit vehicle operating allowances to

one for households of one and two for households of two or more, unless

the taxpayer can demonstrate that any additional vehicles are necessary

for producing income. However, debtors are not required to provide on

their financial schedules information on whether any or all of their

vehicles are necessary for producing income.

Both Ernst & Young and Creighton/ABI determined the number of debtor

vehicles by using the larger of the number of vehicles shown on schedules

B or D. If a debtor reported no vehicles on either schedule, both Ernst &

Young and Creighton/ABI assigned one "no car” operating allowance. In

addition, both Ernst & Young and Creighton/ABI followed the general IRS

practice of limiting households of one to one operating allowance. For

households of two or more, Crieghton/ABI also followed the general IRS

practice of limiting such households to a maximum of two operating

allowances. However, Ernst & Young placed no limit on the number of

operating allowances for households of two or more. It included operating

allowances for the larger of the number of cars listed on schedules B or D.

The IRS collection standards use a national standard for other living

expenses. Included in other living expenses are housekeeping supplies,

apparel and services, personal products and services, food, and

miscellaneous items. Although the IRS has established allowances for

each of the individual categories of expenses, the standard provides a

single total amount to each household based on income and size. For

example, the current allowance for a four-person household with total

monthly gross income between $2,500 and $3,329 would be $912.13 The

allowances for all categories except miscellaneous are based on the BLS

consumer expenditure survey and are to be updated annually as new data

become available. The IRS has set miscellaneous expenses at $100 for the

first person in the household and $25 for each additional person.

The IRS has no established national or local standards for these expenses.

IRS regulations note that the amounts must be necessary and reasonable in

 

13 The individual components of this total allowance would be food, $465; housekeeping supplies, $48;

apparel and services, $176; personal care products and services, $48; and miscellaneous, $175.

Other Living Expenses

Other Necessary Expenses
Appendix I

Methodological Similarities and Differences in Three Reports on Bankruptcy Debtors'

Repayment Capacity

Page 62 GAO/GGD-99-103 Personal Bankruptcy

amount, and that the IRS employee responsible for the case determines

whether these two criteria have been met.

The three reports used many of the same deductions from monthly gross

income to make allowances for other necessary expenses. The Ernst &

Young reports subtracted payroll deductions such as payroll taxes, Social

Security, nonhealth insurance, and union dues; taxes neither deducted

from wages nor included in home mortgage payments; alimony; charitable

contributions; child care; other payments to dependents not living at home;

and health insurance and medical and dental expenses. The Creighton/ABI

report used the same deductions with some exceptions. The Creighton/ABI

report did not allow deductions from monthly gross income for debt

payments withheld from the paycheck, transfers into a savings plan,

nonmandatory pension contributions, all payments for dependents not at

home (except alimony and child support), and tuition payments.

The three reports determined business expenses differently. While the

March 1998 Ernst & Young study did not allow business expenses, the

March 1999 study allowed business expenses as reported on schedule J,14

but only if business income was reported on schedule I.15 The

Creighton/ABI study allowed all business expenses that were listed on

schedule J, in addition to expenses for work uniforms listed on schedule I.

According to Ernst & Young, their database did not include information on

uniforms because it did not itemize miscellaneous expenses reported on

the schedules.

The March 1998 Ernst & Young report did not include any allowance for

debtor attorney fees or the costs of administering a chapter 13 repayment

plan. The Creighton/ABI report and the March 1999 Ernst & Young report

based their attorney fee estimates on the same 1996 study, which found

that the average total debtor attorney fee in chapter 13 cases was $1,281, of

which $428 was paid up front and the balance paid through the plan

(subject to the trustee’s percentage fee). Based on this study, the

Creighton/ABI report assumed that debtor attorney fees would add a total

of about $800, or about $13 per month over 60 months, to the debtor’s

monthly expenses. The March 1999 Ernst & Young report assumed that

 

14 Schedule J—Current Expenditures of Individual Debtor(s). The schedule includes such expenses as

housing, utilities, food, clothing, medical and dental expenses, transportation, charitable contributions,

insurance, taxes (not deducted from wages or included in home mortgage payments), alimony, and

child support. In completing the schedule, debtors are to estimate their average monthly expenses in

each category.

15 Schedule I—Current Income of Individual Debtor(s). The schedule includes such categories as

monthly gross wages, salary, commissions, and income from nonwage sources.

Business Expenses

Differences in Debtor

Attorney Fees and

Administrative Costs
Appendix I

Methodological Similarities and Differences in Three Reports on Bankruptcy Debtors'

Repayment Capacity

Page 63 GAO/GGD-99-103 Personal Bankruptcy

debtors who were required to file under chapter 13 would incur an average

attorney fee of $1,281. The report treated as an unsecured nonpriority

debt any difference between this total and the amount the debtor indicated

on the bankruptcy petition as already paid to his or her attorney. If the

debtor schedules included no information on the amount of the attorney

fee already paid, Ernst & Young assumed that the remaining fee would be

$800 and amortized this amount over 60 months.

The March 1999 Ernst & Young report and the Creighton/ABI report both

included estimates of chapter 13 administrative expenses. Each report

assumed that administrative expenses could consume about 5.6 percent of

debtor debt payments under a chapter 13 plan—the 1995 average chapter

13 trustee fees as a percentage of disbursements to creditors. However,

each report applied this percentage somewhat differently. The Ernst &

Young report included three different estimates of these costs, based on

three different assumptions (see table I.1). The Creighton/ABI report

assumed that administrative expenses would be 5.6 percent of debtor

payments on unsecured priority debts, unsecured nonpriority debts, and

most secured debts. The report assumed that debtors would pay creditors

directly for their home mortgages and any other real estate claims of

$20,000 or more, thus avoiding the trustee fee on such payments.
Appendix II

Description of Methodology Used in the

Report by the Executive Office for the U.S.

Trustees

Page 64 GAO/GGD-99-103 Personal Bankruptcy

The methodology of the report by the Executive Office for the U.S.

Trustees (EOUST) was substantially different from the methodologies

used in the Ernst & Young and Creighton/ABI reports. The EOUST report

differed from the other reports in the proposed legislative provisions used

in its analysis, its determination of debtor allowable living expenses, and

its method of determining the income that debtors had available for debt

repayment. The EOUST report’s sample, methodology, and its differences

from the other three reports are discussed in this appendix.

The EOUST report was based on a sample of chapter 7 no-asset cases1

closed during the first 6 months of 1998 in the 84 bankruptcy districts with

U.S. Trustees.2

 All of the cases in the sample had been designated by the

panel trustee as no-asset cases, and almost all of these cases had been filed

in late 1997 or early 1998. The number of sample cases in each district was

proportional to each district’s share of the national total of chapter 7 cases

filed in calendar year 1997. The sample used in the analysis included a total

of 1,955 cases.

Statistical probability sampling methods were not used to select the cases.

Instead, after determining the number of cases needed from each district,

EOUST requested that the Trustees for the districts send them the

districts’ sample quotas from among their most recently closed cases.

Because the sample procedure for selecting filings within districts was not

random, the characteristics of the filings selected may be influenced by the

judgmental selection of the sample cases by the Trustees. Therefore,

technically, standard statistical methods are not applicable for making

inferences from these results to the population of no-asset chapter 7 cases

from these 84 bankruptcy districts closed during this period. However,

treating such a sample as if it were a random sample may sometimes be

reasonable from a practical point of view. EOUST, based on its subject

matter expertise, asserts that these cases are as random as those it would

have obtained from a statistical random sample of filings from each

Trustee’s office. We have has no basis to judge the accuracy of that

assertion.

 

1

 No-asset cases are those cases in which the debtor has no nonexempt assets that can be liquidated

and the proceeds used to make payments to creditors. In bankruptcy, the debtor is permitted to retain

certain exempt assets.

2

 There are 90 bankruptcy districts. The sample did not include cases from the six bankruptcy districts

in Alabama and North Carolina that do not have U.S. Trustees. These six districts are served by

bankruptcy administrators who are under the supervision of the federal judiciary. According to

EOUST, about 2.4 percent of the chapter 7 cases closed in the first half of 1998 were in the districts

excluded from the EOUST sample. U.S. Trustees, who serve the remaining 84 bankruptcy districts, are

under the supervision of the Executive Office for U.S. Trustees, which is an agency of the Department

of Justice.

EOUST Debtor Sample
Appendix II

Description of Methodology Used in the Report by the Executive Office for the U.S. Trustees

Page 65 GAO/GGD-99-103 Personal Bankruptcy

The EOUST report was based on data from debtors’ financial schedules

(including any amended schedules). There are two principal differences

between the EOUST report and the other three reports we reviewed. First,

the EOUST report did not use the IRS financial collection standards to

determine debtors’ allowable living expenses. Second, the EOUSC report

assumed that debtors would pay their unsecured priority debts and

unsecured nonpriority debts from that portion of their total gross income

that was above the national annual median income for a household of

comparable size. The report assumed that debtors would make any

mortgage payments and pay all nonhousing secured debts from that

portion of their total annual gross income that was at or below the national

median. The report also used “needs-based” provisions from two separate

pieces of proposed legislation—H.R. 3150 as it passed the House on June

10, 1998, and S.1301 as reported by the Senate Judiciary Committee.

However, as discussed later, this appeared to have less impact on the

report’s estimates than the other two differences. The following section

describes the EOUST report’s method of estimating the percentage of

“can-pay” debtors in its sample and the total amount of unsecured

nonpriority debt these debtors could potentially repay.

The report determined each debtor’s gross annual income by multiplying

total monthly gross income, as reported on schedule I, by 12 months. In

determining a debtor’s total gross monthly income, as shown on schedule

I, the EOUST report included any reported earnings from a spouse,

whether the debtor filed individually or jointly with a spouse. Such income

was included under the assumption that this total income was available to

the household for expenses and debt payment. Spousal income was also

used because the report’s purpose was to include the upper range of

whatever was included in the House (H.R. 3150) or Senate (S.1301) bills.

The Senate bill required that the analysis of a debtor’s repayment capacity

include income from all sources. The House bill required that spousal

income be considered only when the debtor filed jointly. In the other three

reports, spousal income was included in the debtor’s gross income only if

the debtor filed jointly.

Much like the Ernst & Young and Creighton/ABI reports, the EOUST report

screened debtors to determine whether their gross annual household

income was above 100 percent of the national median income for a

household of comparable size as defined in H.R. 3150 and S.1301. The

report used whichever median income standard was higher for each

debtor household. For households of four or fewer, the median income

test used was the same as that used by 1999 Ernst & Young and

Creighton/ABI reports. For households of one, the report used the median

Description of the

EOUST Report’s

Methodology

Step 1: Determine Debtor’s

Gross Income

Step 2: Screen Debtors for

Median Household Income
Appendix II

Description of Methodology Used in the Report by the Executive Office for the U.S. Trustees

Page 66 GAO/GGD-99-103 Personal Bankruptcy

income for one-earner households (Census Bureau table H-12). For

households of two or more, the report used median family household

income from Census Bureau table F-8. In this table, median family income

peaks at family households of four and declines for families of more than

four. For families of five or more, the report used the median income for a

family household of four plus $583 monthly for each additional family

member—the median income standard used in S. 1301. The differences in

the household income standards used in each report are shown in table 2

of this report.

The EOUST report eliminated from further analysis all debtors whose total

gross annual income was less than or equal to the median income for a

household of the same size (using the previously discussed criteria). It was

assumed that these debtors would be eligible to file for chapter 7, if they

chose to do so. This step is similar to that used by both the 1998 Ernst &

Young and Creighton/ABI reports.

Of the 1,955 bankruptcy debtors in the sample, 347 had gross annual

household incomes above the national median for a household of

comparable size.

A small number of those debtors with gross annual incomes above the

national median reported business receipts as gross income on schedule I.

However, according to the EOUST report’s authors, it was not always

possible to tell from the schedule how much of the debtor’s gross income

was obtained from self-employment. If the debtor listed business expenses

on schedule J,3

 these expenses were deducted from the debtor’s reported

total gross income. Creighton/ABI also permitted business expenses listed

on schedule J. However, Ernst & Young permitted such expenses only if

the debtor also showed business income on schedule I.

For all 347 debtors with annual household incomes above the national

median, the report estimated the debtor’s net disposable income, after

taxes, on that portion of the debtor’s total annual gross income that was

above the national median. To do this, the report multiplied the amount of

annual gross income above the national median by 65 percent. For

example, if a debtor had gross annual income of $40,000 and the

appropriate national median income was $30,000, the debtor had $10,000 in

gross income that exceeded the national median for a household of the

debtor’s size. The report would have assumed that $3,500 of this $10,000

 

3

 The appropriate line from schedule J is entitled, “Regular expenses from operation of business,

profession, or farm (attached detailed statement).”

Step 3: Eliminate From the

Analysis Any Debtors With

Annual Gross Incomes

Below the Median

Threshold

Step 4: Deduct Business

Expenses From Gross

Income Above the National

Median

Step 5: Deduct Taxes From

Gross Debtor Income Above

the National Median
Appendix II

Description of Methodology Used in the Report by the Executive Office for the U.S. Trustees

Page 67 GAO/GGD-99-103 Personal Bankruptcy

would be used for taxes, leaving the debtor net disposable income of

$6,500.

The debtor’s net annual income above the national median was converted

to monthly income. Thus, a debtor who had $6,500 in net annual income

above the national median would be deemed to have $541.66 in monthly

income above the median. The report then deducted the following

expenses, as appropriate, from the net monthly income that was above the

national median:

• tax liabilities shown on schedule J,4

• child support and alimony payments shown on schedule J, and

• one-sixtieth of total priority debt on schedule E (with no interest).

Thus, a debtor with net monthly income of $541.66, and total deductible

expenses (as determined in the report) of $300, would have $241.66

monthly to devote to unsecured nonpriority debt repayment.

As a result of the calculations in steps 4, 5, and 6, 47 debtors no longer had

income above the national median. The remainder of the analysis focused

on those remaining 300 debtors who had any positive net annual income

above the national median.

The report estimated the total amount of unsecured nonpriority debt that

these 300 debtors could repay using four different assumptions. Debtors

would use 100 percent, 75 percent, 50 percent, or 25 percent of the income

available for payment of unsecured nonpriority debt to pay their

unsecured nonpriority debts. In our example, the debtor would use 100

percent, 75 percent, 50 percent, or 25 percent of the $241.66 in net monthly

income available for the payment of unsecured nonpriority debt. If the

“can-pay” debtors used 100 percent of their available net income to pay

unsecured nonpriority debt for 5 years, the report estimated that creditors

could receive a total of about $3.76 billion over 5 years. However, should

this prove optimistic, and not all “can-pay” debtors were able to devote 100

percent of their net income to unsecured debt payment for 5 years, the

report also provided a sensitivity analysis using three less favorable

assumptions about the amount of available net income that would be used

for debt repayment over 5 years. For the remaining assumptions, the

report estimated that using 75 percent, 50 percent, or 25 percent of

available net income over 5 years to pay unsecured nonpriority debt would

yield $3.22 billion, $2.49 billion, or $1.40 billion, respectively.

 

4

 Schedule J—Current Expenditures of Individual Debtor(s).

Step 6: Convert Remaining

Annual Gross Income to

Monthly Income, Then

Include Additional Selected

Deductions

Step 7: Eliminate Second

Set of Debtors From

Analysis; Estimate Debt

Repayment Capacity
Appendix II

Description of Methodology Used in the Report by the Executive Office for the U.S. Trustees

Page 68 GAO/GGD-99-103 Personal Bankruptcy

These debt repayment estimates assume that (1) debtors’ income and

expenses would remain unchanged over a 5-year repayment period; (2) all

debtors would complete their 5-year repayment plans; and (3) there would

be no cost to administering the repayment plans. However, each of the

three lower estimates of total debt repayment provide an estimate of what

could happen if the net effect of changes in these assumptions were to

reduce debtor unsecured nonpriority debt repayment capacity by 25

percent, 50 percent, or 75 percent.

The report notes that the actual amount of debt paid to creditors--secured

and unsecured--would depend upon a number of variables, including the

number of debtors who completed their repayment plans without

modification and the amount of trustee fees and other administrative

expenses incurred to administer the repayment plans. The report stated

that it was likely that many of these debtors would experience some type

of change, such as job loss or divorce, that would affect their repayment

capacity and their ability to complete their repayment plans. The report

also noted that it was not clear how the IRS collection standards should be

applied and that using the standards would be cumbersome, “conducive to

gaming,” and could add to bankruptcy litigation as creditors and debtors

sought to clarify the application of the standards. As a result of all these

factors, the report noted that the final return to unsecured nonpriority

creditors was likely to be less than $1 billion annually.
Appendix III

Comments From Ernst & Young

Page 69 GAO/GGD-99-103 Personal Bankruptcy

Note: GAO comments

supplementing those in the

report text appear at the

end of this appendix.

See comment 1.

See comment 2.
Appendix III

Comments From Ernst & Young

Page 70 GAO/GGD-99-103 Personal Bankruptcy

See comment 3.

See comment 4.
Appendix III

Comments From Ernst & Young

Page 71 GAO/GGD-99-103 Personal Bankruptcy

See comment 5.
Appendix III

Comments From Ernst & Young

Page 72 GAO/GGD-99-103 Personal Bankruptcy

See comment 6.
Appendix III

Comments From Ernst & Young

Page 73 GAO/GGD-99-103 Personal Bankruptcy

The following are GAO’s comments on specific issues included in the letter

dated, June 2, 1999, from Thomas Neubig, National Director, Policy

Economics and Quantitative Analysis, Ernst & Young. Other issues

discussed in the letter have been included in the report text.

1. Ernst & Young made several observations regarding our comparison of

the four reports and our discussion of the variables that could affect the

estimates in each report. First, Ernst & Young stated that our draft report

did not sufficiently highlight the similarities in the four reports, in

particular that all four reports found that “tens of thousands of abovemedian income Chapter 7 bankruptcy filers could repay a significant

portion of their debts under needs-based proposals.” Second, Ernst &

Young stated that our conclusion that the percentage of “can-pay” debtors

and the amount of debt they could repay were dependent on a number of

variables was not helpful to policymakers. It was noted that it would be

more helpful to policymakers if we had identified the “reasonable” impact

of the proposed needs-based legislation as drafted, rather than state that

nothing could be known with certainty. Ernst & Young noted that

estimates based on how the proposed law would have applied in the past,

or future estimates based on reasonable assumptions, are more useful than

waiting to validate every assumption.

With regard to the first comment, our report clearly states that each of the

reports found that some portion of chapter 7 debtors in their samples—

ranging from 3.6 percent to 15 percent—met all relevant means-testing

criteria, including the potential ability to repay a specific minimum amount

of their unsecured nonpriority debts. (see Results in Brief and table 3). We

also note that there is some similarity in the median household incomes

and median unsecured nonpriority debts of those debtors whom each

report determined were “can’t pay” and “can pay” debtors (table 5).

However, our report also notes that both the Creighton/ABI and EOUST

reports specifically asserted that the formula used to determine the

amount of debt that “can-pay” debtors could potentially repay was

unrealistic and that the actual return to unsecured creditors under needsbased bankruptcy would be less than the formula indicated.

With regard to our emphasis on the variables that could affect the

estimates in these four reports, we believe it is important that

policymakers be provided information that can help them to understand

and interpret the point estimates in these four reports. Whether there are

“tens of thousands” of “can-pay” debtors and what amount of debt such

GAO Comments
Appendix III

Comments From Ernst & Young

Page 74 GAO/GGD-99-103 Personal Bankruptcy

debtors could potentially repay are questions the answers to which are

critically dependent upon the assumptions used to develop the answers.

“Can-pay” debtors were defined in the proposed legislation used in the four

reports’ analyses as those debtors who (1) met a specific household

income test and (2) could potentially repay a specific minimum amount of

their unsecured nonpriority debt over 5 years. To determine whether the

debtor could repay this minimum amount of unsecured nonpriority debt,

each report used two assumptions based upon the means-testing criteria

specified in proposed needs-based legislation: (1) the debtor’s income and

allowable living expenses would remain stable for the 5-year repayment

period and (2) 100 percent of “can-pay” debtors would complete their 5-

year repayment plans. Based on these criteria, the reports calculated

whether the debtor’s net monthly income available for payment of

unsecured nonpriority debt multiplied by 60 months would be sufficient to

pay the minimum total amount of unsecured nonpriority debt specified in

the needs-based legislation used in the report’s analysis. If so, the debtor

was classified as a “can-pay” debtor. This same 60-month total was the

basis for estimating the total amount of unsecured nonpriority debt each

“can-pay” debtor could potentially repay.

The fact that these assumptions were specified in proposed legislation for

use in identifying “can-pay” debtors did not automatically validate them as

empirically based or realistic. There is no empirical basis for assuming that

debtors financial circumstances would remain unchanged during the

course of a 5-year repayment period, that none of the repayment plans

would need to be modified during that 5-year period, and that 100 percent

of debtors would complete their repayment plans (modified or not). No

one knows how many “can-pay” debtors will be able to complete their 5-

year repayment plans on the terms under which bankruptcy court initially

confirmed the plans. However, even if the completion rate were higher

than the 36 percent for the 953,180 debtors studied by the Administrative

Office of the U.S. Courts (AOUSC), it is unlikely to be 100 percent. For

those debtors who are unable to complete their repayment plans, the

return to creditors is likely to be less than estimated in the Ernst & Young

and Creighton/ABI reports, and less than the largest estimate in the

EOUST report.

2. Ernst & Young stated that its analyses were the only ones to apply the

proposed legislation (H.R. 3150 and H.R. 833) as written. Ernst & Young

suggested that we should have used “adherence to the legislative language

as a criterion for evaluating the reasonableness of the reports’

methodology.” Ernst & Young principally bases its assertion on the fact
Appendix III

Comments From Ernst & Young

Page 75 GAO/GGD-99-103 Personal Bankruptcy

that its interpretation of the IRS transportation ownership allowance more

closely followed the IRS Collection Financial Standards than did the

Creighton/ABI interpretation.

We clearly described the methodologies of each report, noted where they

differed, and discussed the impact of those differences on each report’s

estimates. The difference in the Ernst & Young and Creighton/ABI

interpretation of the IRS transportation allowances are fully discussed in

our report, including appendix I. We would only note here that

Creighton/ABI, not Ernst & Young, more closely followed IRS practice

with regard to the assignment of vehicle operating allowances for

households of two or more persons with more than two vehicles.

Moreover, all of the reports used some methods and assumptions that

were not specifically required by proposed needs-based legislation. For

example, neither H.R. 3150 nor H.R. 833, the bills used in Ernst & Young’s

March 1998 and March 1999 reports, specified any method of imputing the

interest on secured claims. Ernst & Young used a lower imputed interest

rate for secured debts (9 percent over 2 years) than did Creighton/ABI (9

percent over 5 years). Compared to Creighton/ABI’s method, Ernst &

Young’s method would have resulted in lower payments on secured

outstanding debts of the same amount. Consequently, the effect of Ernst &

Young’s method would have been to include more income than did

Creighton/ABI for the payment of unsecured nonpriority debts. The two

Ernst & Young reports offered no explanation for why both used a 2-year

rather than 5-year period of interest when secured debts were amortized

over 5 years in determining debtors’ repayment capacity.

Further, the proposed legislation did not require that the formula used to

identify “can-pay” debtors consider the potential net return to creditors

after administrative costs were deducted from debtors’ payments to

creditors. Yet this is an important policy consideration. Both the

Creighton/ABI report and the second Ernst & Young report included an

estimate of the total cost of administrative fees, such as debtor attorney

and chapter 13 trustee fees. Payments to creditors would be reduced by

the amount of such fees. The Ernst & Young report included estimates

using three sets of assumptions. This type of sensitivity analysis would

also have been useful in conjunction with the two Ernst & Young reports’

discussion of their estimates of “can-pay” debtors and the amount of debt

such debtors could potentially repay over 5 years.

Finally, Ernst & Young did not mention a provision of H.R. 833 that could

have affected its estimates of “can-pay” debtors and the amount of
Appendix III

Comments From Ernst & Young

Page 76 GAO/GGD-99-103 Personal Bankruptcy

unsecured nonpriority debt they could repay. Under H.R. 833, the amount

of the creditor’s secured claim for personal property purchased within 5

years of filing for bankruptcy would generally be not less than the total

remaining amount to be paid, including interest, under the terms of the

loan contract. Under current bankruptcy law, the amount of the secured

creditor’s allowed claim is generally the market value of the property,

which may be more or less than the total amount of principal owed under

the loan contract. If it is less, the secured creditor has two claims—(1) a

secured claim for the market value of the collateral and (2) an unsecured

nonpriority claim for the deficiency between the market value of the

collateral and the debt owed on the collateral.

Ernst & Young did not mention in its March 1999 report whether any of the

debtors in its sample would have been affected by this provision of H.R.

833. To the extent that the amount of secured nonhousing debt listed by

any affected debtors did not include the unpaid interest owed under the

terms of the contract, Ernst & Young would have understated the amount

of the secured claims for such debtors, understated secured debt payments

and thus overstated the amount of income available for payment of

unsecured nonpriority debts.

3. Ernst & Young offered a critique of the Creighton/ABI method of

determining debtors’ transportation ownership allowance.

We believe our report fully discusses this issue, clearly demonstrating

where the Creighton/ABI report’s transportation ownership allowances

would have varied from the amount that IRS would have provided under

its Collection Financial Standards.

4. Ernst & Young also observed that the Creighton/ABI sample is a

nonrandom sample whose results cannot be projected nationally.

Moreover, the sample could have a very large margin of error that could

well encompass Ernst & Young’s estimate that 10 percent of chapter 7

debtors were “can-pay” debtors.

Our report clearly states that the Creighton/ABI sample cannot be used for

national projections. However, the Creighton/ABI sample is a statistically

valid random sample for the seven districts used in its analysis. The results

of that sample can be projected to the population of 1995 chapter 7 filings

in those seven districts. We calculated that the estimates for the seven

districts in the Creighton/ABI sample are subject to an error margin of

about 1.8 percentage points.
Appendix III

Comments From Ernst & Young

Page 77 GAO/GGD-99-103 Personal Bankruptcy

5. Ernst & Young provided new data on a sample of chapter 13 cases filed

in 1997 and compared these data with those for its sample of chapter 7

debtors who would be required to file under chapter 13. Ernst & Young

stated that these new data, combined with provisions in the proposed

“needs-based” legislation, make it reasonable to expect that the percentage

of debtors who would complete a required 5-year repayment plan was

likely to be “significantly higher” than the 36 percent rate shown in

available historical data.

The data presented by Ernst & Young in its comments had not been

previously provided to us or available publicly. Therefore, we have had no

opportunity to review the analysis and data on which Ernst & Young’s

statements are based. However, we do have two observations on the

analysis presented.

First, current bankruptcy law provides that chapter 13 repayment plans

will be for 3 years unless for cause the bankruptcy court approves a period

not to exceed 5 years. The repayment estimates in the four reports were

based on a repayment period of 5 years, 2 years longer than provided for in

current bankruptcy law unless extended for cause. This provides 2

additional years in which debtors could experience a change in their

financial circumstances that could affect their ability to complete their

repayment plans.

Second, the Ernst & Young data do not alter our basic point—that the

percent of “can-pay” debtors who complete their 5-year repayment plans is

unlikely to be 100 percent. Ernst & Young noted that many current chapter

13 filers use chapter 13 as a temporary means of protecting their homes

from creditors and then drop out of chapter 13 after their homes are no

longer in danger. In our report, we stated that about 49 percent of chapter

13 cases filed between 1980 and 1998 were dismissed. Such cases would

include those debtors who temporarily filed under chapter 13 to protect

their homes from foreclosure. It is not clear that the proposed needs-based

legislation would necessarily increase or decrease the number of such

chapter 13 cases.

In addition, the AOUSC report we cited found that the district with the

highest completion rate—57 percent---permitted debtors to repay a very

low percentage of their outstanding debt, as little as 5 percent. This is

substantially less than the percentage required in any of the proposed

needs-based legislation used in the four reports we reviewed.
Appendix III

Comments From Ernst & Young

Page 78 GAO/GGD-99-103 Personal Bankruptcy

We agree with Ernst & Young that the characteristics of the “can-pay”

debtors required to file under chapter 13 may be different than those cited

in the AOUSC study of chapter 13 debtors, or of those who currently file

chapter 13 voluntarily. In addition, as we stated in our report, it is possible

that the percentage of debtors who complete their required chapter 13

repayment plans under needs-based bankruptcy could increase. However,

even if one assumes, for the reasons Ernst & Young states, that under

needs-based bankruptcy the percentage of debtors who complete their

chapter 13 plans were double to 72 percent—twice the rate found in the

AOUSC study—28 percent of debtors would not complete their plans. For

that 28 percent of debtors, creditors would receive less than Ernst &

Young’s reports estimated. The amount of the reduced return to creditors

would depend upon when within the 5-year period the court determined

the debtor could not complete the plan and the amount of debt remaining

to be repaid under the debtor’s repayment plan. For those debtors who do

complete their plans, creditors could receive more or less than these four

reports estimated. For those debtors whose financial circumstances

improve during the 5-year plan, creditors could receive more. For those

debtors whose financial circumstances deteriorate, creditors could receive

less. However, it is important to emphasize that there is no empirical

reason to base repayment estimates on the assumption that 100 percent of

those required to file under chapter 13 in a needs-based bankruptcy system

would complete their repayment plans.

6. In the conclusion to its comments, Ernst & Young states that other

organizations, such as the Congressional Budget Office, make reasonable

estimates about the expected impact of proposed legislation using

reasonable assumptions and available data. Ernst & Young concluded that

its reports provided Congress with important information about the

expected impact of the proposed legislation.

As we have stated in our report, we recognize that using the data from the

bankruptcy debtors’ financial schedules, despite such problems as

inconsistently reported data, was necessary for each report’s analysis. The

debtors’ schedules are the only publicly available source of data about

debtors income, expenses, and debts. However, it is equally important to

clearly state the limitations of the data used and the implications of the

assumptions used.

We believe that each of the four reports provided Congress with important

information about the potential impact of proposed “needs-based”

legislation. The Ernst & Young reports arguably provided an overall “bestcase” estimate of the results of needs-based consumer bankruptcy, if
Appendix III

Comments From Ernst & Young

Page 79 GAO/GGD-99-103 Personal Bankruptcy

enacted. The Creighton/ABI report provided a lower estimate, principally

because of its interpretation of the IRS transportation ownership

allowance. In discussing the rationale for its approach, the report

highlighted one of the potential problems that could reduce the amount of

unsecured nonpriority debt that would be repaid under needs-based

bankruptcy. For example, the older the debtors’ cars when they enter

chapter 13, the more likely it is that those cars will either need major

repairs or replacing (albeit not necessarily with a new car). Moreover, the

Creighton/ABI report’s description of the “can-pay” debtors in its sample

puts a “personal face” on needs-based bankruptcy, providing a partial

picture of the variety of debtors who could be affected by needs-based

bankruptcy. The EOUST report showed that a much simpler approach to

identifying “can-pay” debtors would result in about the same percentage of

“can-pay” debtors as the more complex method used by Ernst & Young

and Creighton/ABI.
Appendix IV

Comments From the Authors of the

Creighton/ABI Report

Page 80 GAO/GGD-99-103 Personal Bankruptcy

Note: GAO comments

supplementing those in the

report text appear at the

end of this appendix.
Appendix IV

Comments From the Authors of the Creighton/ABI Report

Page 81 GAO/GGD-99-103 Personal Bankruptcy
Appendix IV

Comments From the Authors of the Creighton/ABI Report

Page 82 GAO/GGD-99-103 Personal Bankruptcy

See comment 1.
Appendix IV

Comments From the Authors of the Creighton/ABI Report

Page 83 GAO/GGD-99-103 Personal Bankruptcy

See comment 2.
Appendix IV

Comments From the Authors of the Creighton/ABI Report

Page 84 GAO/GGD-99-103 Personal Bankruptcy

See comment 3.
Appendix IV

Comments From the Authors of the Creighton/ABI Report

Page 85 GAO/GGD-99-103 Personal Bankruptcy

See comment 4.

See comment 5.
Appendix IV

Comments From the Authors of the Creighton/ABI Report

Page 86 GAO/GGD-99-103 Personal Bankruptcy

The following are GAO’s comments on specific issues included in the letter

dated May 28, 1999, from Professors Marianne Culhane and Michaela

White, authors of the Creighton/ABI report. Other issues discussed in the

letter have been included in the report text.

1. The authors stated that, although theirs was not a national sample, it

nevertheless was randomly drawn within the seven districts used in the

sample. Moreover, the sample included districts across the country, from

rural and urban areas and from low-cost and high-cost areas. In addition,

the sample provided a more complete picture of the debtors within each

district used because it included a larger number of debtors from each

district than did Ernst & Young’s sample.

We agree that the Creighton/ABI sample is a random sample whose results

can be generalized to the population of chapter 7 cases in the seven

districts used in its analysis. The districts in its sample are diverse and

were initially chosen by the Creighton/ABI’s authors in part because of that

diversity. Although the Creighton/ABI sample may include more cases

within each district in its sample than did Ernst & Young ‘s sample, both

reports focused on the estimates for the entire population in their

respective samples.

2. The authors stated that they reweighted their results based on data that

we provided on converted chapter 7 cases. The results of this reweighting

had minimal effect on the report’s estimates.

As we indicated in our draft report, we were uncertain about the impact of

using only total cases filed initially under chapter 7 in each district as the

basis for weighting the Creighton/ABI report’s weighted estimates. The

Creighton/ABI sample also included some cases that had been filed under

chapter 13 but converted to and closed under chapter 7. We provided the

authors of the report with updated unpublished data on the total number

of cases in each district that had been filed in 1995 under chapter 7 and

had been converted to chapter 7 from chapter 13. Based on these data, the

authors reweighted their estimates. The new Creighton/ABI analysis

provided to us shows that the revised weighting had minimal effect on its

estimates. The reweighting did not change any of the report’s weighted

estimates by as much as 0.1 percent.

3. The authors state that Ernst & Young’s interest calculations on secured

debt are incorrect as a matter of law and practice, substantially overstating

debtors’ capacity to repay their unsecured nonpriority debts.

GAO Comments
Appendix IV

Comments From the Authors of the Creighton/ABI Report

Page 87 GAO/GGD-99-103 Personal Bankruptcy

The Ernst & Young method of calculating interest on secured debts (9

percent for 2 years) would have resulted in lower monthly payments on

the same amount of outstanding secured debt than would Creighton/ABI’s

method of calculating such interest (9 percent for 5 years). The effect of

the Ernst & Young method, compared with the Creighton/ABI method, is to

decrease secured debt payments and, thus, increase the amount available

for payment to unsecured nonpriority creditors. However, whether the

Ernst & Young’s method of imputing interest on secured claims was

incorrect depends upon the assumptions made about the repayment of

secured debt.

Under current bankruptcy law, the amount of the creditor’s allowed

secured claim is the market value of the collateral securing the claim. The

market value of the collateral may be more or less than the amount of the

secured outstanding debt. Also, under current bankruptcy law, the secured

creditor is entitled to the present value of the secured claim. Interest is

usually added to the market value of the secured claim to determine its

present value. As the authors of the Creighton/ABI study noted in their

comments, the amount of the interest paid on secured claims depends on

the length of the repayment period. Generally, the longer the repayment

period, the greater the imputed interest on secured claims. In determining

this interest on secured claims, Ernst & Young and Creighton/ABI differed

principally because they used different repayment periods for computing

interest on secured nonhousing claims.

The Creighton/ABI report assumed that secured nonhousing claims would

be repaid over 60 months, and computed interest for this entire period.

Given that the needs-based “can-pay” formula amortizes secured claims

over 60 months, it is not unreasonable to assume that such debts, including

interest, would be repaid over 60 months. If secured claims payments were

spread over 60 months—that is, the entire repayment plan period--then

Creighton/ABI’s method is the appropriate one for imputing interest on

secured claims. However, if it were assumed the secured claims would be

paid in less than 60 months, then it would be appropriate to compute

interest for a shorter period. Essentially, the Ernst & Young method

assumed that most secured debts would be paid in 24 months. This may or

may not be true under needs-based bankruptcy. However, if it were true,

the Ernst & Young method would be appropriate and correct.

4. The Creighton/ABI authors state that reasonable people can differ over

the interpretation of H.R. 3150 and how the IRS expense allowances were

to be interpreted within the context of the bill. The bill directed the use of

the IRS allowances “excluding payments of debts.” Ernst & Young
Appendix IV

Comments From the Authors of the Creighton/ABI Report

Page 88 GAO/GGD-99-103 Personal Bankruptcy

interpreted this to mean that secured vehicle debt payments were to be

used as the ownership allowance. Because vehicle lease payments are not

secured debt, the Ernst & Young method provided no allowance for

vehicle lease payments. Creighton/ABI gave the debtor the IRS ownership

allowance, less the amount of secured vehicle debt payments.

Our report states that the IRS ownership allowance is used by IRS as a

“cap.” The allowance includes monthly loan or lease payments for no more

than two purchased or leased vehicles. As we noted in our report, the

Creighton/ABI interpretation provided a higher transportation ownership

allowance than IRS would permit or Ernst & Young permitted for debtors

with debt-free vehicles or whose secured vehicle debt payments were less

than the maximum applicable IRS allowance.

The determination of actual lease payments was problematical for Ernst &

Young and Creighton/ABI because the data in Schedule G (unexpired

leases) were not generally useful for determining the amount remaining to

be paid on the vehicle lease. As we discussed in our report, neither

Creighton/ABI nor Ernst & Young found the data on leased vehicles in

their samples to be particularly consistent. Ernst & Young did not include a

transportation ownership allowance for vehicle lease payments unless

they were listed as secured debt. If the lease payments, or the amount

remaining to be paid on the lease, were listed as unsecured priority or

unsecured nonpriority debt, no ownership allowance was included.

We agree that it is possible that adjustments may need to be made in the 5-

year repayment plans of debtors who incur substantial major vehicle

repairs or are required to replace a vehicle. To the extent this occurs, the

actual amount the debtor repaid to creditors could be less than anticipated

at the beginning of the repayment plan, or in the “can-pay” formula as

interpreted by Ernst & Young. On the other hand, to the extent this need

does not arise, the Creighton/ABI method of determining transportation

ownership allowances would understate the amount of income that would

be available for debt repayment.

5. The authors stated that there are questions about the Ernst & Young

database that we did not address in our report. These include the high

percentage of asset cases in the chapter 7 debtor sample, the fact that the

sample was not strictly proportional to the chapter 7 filings in each

district, and that Ernst & Young excluded what appears to be a high

number of sample cases from its analysis.
Appendix IV

Comments From the Authors of the Creighton/ABI Report

Page 89 GAO/GGD-99-103 Personal Bankruptcy

Ernst & Young’s report did not discuss whether the asset cases in its

sample had a higher proportion of “can-pay” debtors than did the no-asset

cases in its sample. To be statistically valid, a sample need not be designed

so that sample sizes are strictly proportional to the sizes of known

subgroups within the population from which the sample was drawn.

However, if a sample design is intentionally disproportionate to the size of

known subgroups, projections to the population from which the sample

was drawn must be appropriately weighted. It appears that Ernst & Young

did such reweighting. Although the number of cases excluded from the

analysis was higher than Creighton/ABI experienced, it is not necessarily

an unusually high number of cases to exclude.
Appendix V

Comments From the Executive Office for U.S.

Trustees

Page 90 GAO/GGD-99-103 Personal Bankruptcy
Appendix VI

GAO Contacts and Staff Acknowledgments

Page 91 GAO/GGD-99-103 Personal Bankruptcy

Richard M. Stana, (202) 512-8816

William Jenkins, Jr. (202) 512-8757

In addition to those named above, David Alexander, Anne Rhodes-Kline,

Sidney Schwartz, Wendy Ahmed, and Geoffrey Hamilton made key

contributions to this report.

GAO Contacts

Acknowledgements
Page 92 GAO/GGD-99-103 Personal Bankruptcy
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