THE EFFECT OF UNEMPLOYMENT BENEFITS, WELFARE BENEFITS, AND OTHER INCOME ON PERSONAL BANKRUPTCY

I. INTRODUCTION Income is an important determinant of whether a household files for personal bankruptcy. Sullivan et al. (1998, p. 79) find that 68% of bankruptcy filers responded that job-related reasons were a primary contributor to their decision to file. In addition, Fay et al. (2002) find that increases in labor income decrease the likelihood of filing for bankruptcy. This focus on labor income seems reasonable because labor income is the main (if not sole) source of income for most households. What happens when an individual loses his or her job? Does income from other sources, such as government payments from Unemployment Insurance (UI) or welfare, have a similar affect on the probability of filing for bankruptcy? Early empirical research examined the interaction between bankruptcy and transfer programs (Buckley and Brinig 1996; Domowitz and Eovaldi 1993; Shephard 1984). This earlier empirical research, however, hypothesized that transfer programs encourage bankruptcy, which differs from the standard effect of income on bankruptcy. Income insurance arising either from explicit programs or from implicit ones, such as the option to file for bankruptcy, always creates two effects. Ex post, the presence of insurance makes negative shocks easier to bear. Ex ante, any insurance program encourages risk taking, especially one that provides the option to default on debt. Theory is ambiguous as to the relative strengths of these forces. Some progress can therefore emerge from a careful empirical study of the interaction of transfer programs and bankruptcy filings. The central innovation in the present work is to use disaggregated panel data to evaluate the joint impact of transfers and bankruptcy. Using the Panel Study of Income Dynamics (PSID), this article examines how income and its components affect the decision to file for bankruptcy, specifically looking at the effects of labor income, UI benefits, Aid to Families with Dependent Children (AFDC) benefits, child support, and all remaining income. (1) This does not represent the first to use the PSID (Elul and Subramanian 2002; Fay et al. 2002), but it is the first to include transfer benefits with the PSID. The results suggest that increases in UI benefits, labor income, and nonlabor income decrease the probability of bankruptcy. By presenting evidence that bankruptcy is a substitute with other government programs, the article provides insight to policy makers. For example, changes in one government policy or program often alter participation in other programs. Grogger (2003) finds that changes in the Earned Income Tax Credit (EITC) "explain 15.8 percent of the decline in welfare use over this time period [1993-1999]." Previous research had not accounted for the effect of the EITC on welfare use, but Grogger shows that doing so ignores an important interaction between two government programs. Analogously, one cannot examine bankruptcy without examining its potential interaction with other government programs, such as UI and AFDC. One final contribution of this article is to reconcile conflicting results regarding income. Some research has found income to be a negative and significant predictor of bankruptcy, whereas others find that income does not affect the bankruptcy decision. The results in this article suggest that it is different functional form assumptions that account for the differences. The article is laid out as follows. The next section provides an overview of bankruptcy laws, UI, and AFDC. In the third section, the empirical literature on the effect of income on the bankruptcy decision is discussed. The fourth and fifth sections present the empirical model and the results, and the sixth section discusses the policy implications. The last section concludes. II. DESCRIPTION OF PERSONAL BANKRUPTCY, UI, AND AFDC This section attempts to provide a clear and concise overview of personal bankruptcy, UI, and AFDC. …