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The steady and significant increase in consumer bankruptcies from 1980 to 2004 (and the extremely large amount of consumer debt discharged in those bankruptcy filings) generated a political backlash that resulted in the passage of the 2005 Bankruptcy Abuse Prevention and Consumer Protection Act (BAPCPA). A major component of the BAPCPA legislation was the imposition of an income-based “means test”, which forces bankrupts to file for protection under specific chapters of the U.S. Bankruptcy Code. A major (political) assumption underpinning the adoption of BAPCPA was that the means test would shift some debtors from Chapter 7 “Liquidations” to Chapter 13 “Wage Earner” plans. The Chapter 13 filing was seen as an attractive alternative to Chapter 7, since Chapter 13 provides some re-payment to creditors, as opposed to the almost certain and complete creditor losses under Chapter 7. Shifting some filers into Chapter 13 filings (who ostensibly repay some of their outstanding obligations to creditors), therefore, should lead to lower social welfare losses (since firms are not forced to absorb these losses or to recoup them by charging their customers higher prices) than simply allowing nearly all filers (as was the case under the pre-BAPCPA Bankruptcy Code) to file under Chapter 7 and have their existing debts discharged.
The success of this policy rests on several crucial assumptions. First, BAPCPA assumes that a significant number of individuals “do not pass” the means test and are shifted to a Chapter 13 filing. The effectiveness of the means test as a screening device is uncertain, and would vary between bankruptcy districts and intra-district as well, because of the policy of a statewide standard measure which does not provide for intra-state, county or district differences in family income averages.
Second, BAPCPA assumes that the means test shifts the “right individuals” (i.e., those who can and should repay some portion of their debts) to file under Chapter 13 of the Bankruptcy Code. To date, the literature provides little concrete evidence to suggest that this is (or is not) the case. The means test is based on a net income standard (i.e., an ability to repay) and attempts to set some concrete median income levels, adjusted by family size and the filer’s state of residence, which would presumptively identify debtors who could meaningfully fund a Chapter 13 repayment plan. The question of “who can fund a plan,” in essence, also answers the “who should fund a plan” question. The causes of debt accumulation, job loss or medical expenses versus poor financial management, are not considered when answering these questions (Sullivan, Warren and Westbrook, 2003; Hackney, McPherson and Friesner, 2010a).
Third, BAPCPA assumes that the means test not only shifts the “right” people into filing under Chapter 13 of the Bankruptcy Code, but that they actually repay a significant amount of their debts. But the actual process by which disposable income is calculated under the means test, and the ranking of priorities under which debts are (are not) repaid, make this assumption tenuous. For example, the filer’s attorney fees and trustee fees are typically paid before creditors (Norberg, 1999, 2006; Norberg & Compo, 2007). Secured creditors receive preferential treatment in that they must be paid if the filer wishes to retain the collateral, while unsecured creditors typically are paid only after some provision has been made for the first two groups.