April 10, 2005

The BR Means Test, Part 2: What’s Wrong with Its Definition of “Statewide Median Income”

Filed under: Bankruptcy & Reform — Tom @ 3:44 pm

UPDATE April 25 1PM ET: Welcome Volokh Conspirators in search of a deeper look at the Statewide Medians Todd Zywicki originally blogged on here and linked back to me in an update here.

Proponents of Bankruptcy “Reform” breezily cite the use of statewide median incomes by family size in its Means Test to demonstrate the bill’s “compassion.” In theory (but see the NOTE at the end of this post), if your family income is less than the state median for your family size, your filing will “automatically” be classified a Chapter 7 (liquidation and immediate discharge), and you have the “fresh start.” We are thus implicitly led to believe that half the population of every state will not be able to be forced into Chapter 13′s payment regimen if they file.

There are at least four reasons why this is not true, and why the percentage of the population in any state that is “automatically” eligible for Chapter 7 is will usually be closer to 40% than to 50%.

Let’s start by looking at how Bankruptcy “Reform” as passed by the Senate (WARNING: large HTML file) defines “Median Family Income”:

(A) the median family income both calculated and reported by the Bureau of the Census in the then most recent year; and

(B) if not so calculated and reported in the then current year, adjusted annually after such most recent year until the next year in which median family income is both calculated and reported by the Bureau of the Census, to reflect the percentage change in the Consumer Price Index for All Urban Consumers during the period of years occurring after such most recent year and before such current year;’.

A separate area of the bill states that the “Median Family Income” to be used is that of the person’s or family’s state of residence based on family size.

The definitions seems reasonable enough, until you learn or realize a number of things, which the rest of this post will address.

REASON 1: The only available data that complies with the law’s specific requirements is 5-plus years old.

    – There are no “then most recent year” (2004) figures by state by family size for Item (A). There are only statewide figures that do not take family size into account (with only one exception we will see later). The most recent available data by state for different family sizes is from 1999.
    – So to comply with Item (B) above, you have to apply five years of inflation to the 1999 state figures. This will greatly distort the calculated medians. Filers from states whose incomes have risen significantly faster than inflation will be penalized, since the calculated median will be lower than “true median” if it were known, meaning that people who would be Chapter 7s with current and accurate data will be unfairly (based on the bill’s supposed “intent”) thrown into 13. Filers in states whose incomes have fallen in comparison to inflation will benefit slightly because the calculated median will be lower than the “true median” if it were known.

REASON 2: Using inflation instead of income growth .

    But wait, it gets worse: The new law’s use of inflation instead of income growth, especially applied over a 5- year period, will cause the calculated medians to be significantly less than the “true medians.” That’s because annual income growth is usually 0.5% – 1.0% higher than inflation. This means that in EVERY state, fewer people will be below the calculated median than would be if the “true median” were known.

REASON 3: Time lag between data reporting and reality.

    It gets even worse: The median figures will lag reality by anywhere from 1-12 months, depending on what month the filing takes place, because the new law does not allow any partial-year inflation (or income growth) to be taken into account. For example: If, as expected, the law takes effect on October 20, 2005, an estimated 180 days after the president signs it, late-2005 filers will be forced to compare their income to a median that ignores the estimated 2.5% of inflation that will have occurred since January 1, 2005. January 2006 filers with near-median incomes would be smart to wait until the inflation results for December 2005 are released on about January 20 before they file; otherwise the median income comparison will ignore a full year of inflation.

To estimate the accumulated impact of all of these first three items, I created the spreadsheet below, following these steps:

    – I started with the 1999 Census Bureau state-by-state median incomes by family size, which were conveniently assembled HERE by the American Bankruptcy Institute (the median for one person is the set of “one worker” figures in the top table; scroll down about halfway to get to the figures for family sizes of 2 or more).
    – Though the Census Bureau does not publish annual state data for every family size, it does publish such data for a family size of four for the Low Income Home Energy Assistance Program (LIHEAP). The LIHEAP data for 4-person famililes is HERE, and the first column of data at the link represents the median income for 2003 (to be used for LIHEAP purposes in fiscal year 2006) that is in the spreadsheet below.
    – To estimate the average “reality lag” of inflation that would have occurred between the end of 2003 and any filings that would have occurred in 2004, I multiplied the 2003 “actual” LIHEAP median by 1.65%, which is half of the 2004′s inflation of 3.3% (most of 2004′s inflation actually occurred in the first half of the year, so we’re being a bit conservative).
    – I multiplied the 1999 state medians for 4-person families by 109.43%, which represents the inflation that occurred from the beginning of 2000 until the end of 2003 (4 years). This represents the formula that would be mandated by the Bankruptcy Reform (BR) means test had the law been in effect in 2004.
    – I compared the 2003 BR means test median to the “adjusted LIHEAP” (2003) median.

Here’s the spreadsheet documenting all of this for all 50 states and DC:

Here is how to read the results for your state:

    – Negative (bracketed) results in the last two columns for your state mean that the BR-calculated median that would have been used to evaluate 2004 bankruptcy filings had the law been in effect (the “Inflated 1999 Census”) was less than the reasonable estimate (the “Adjusted LIHEAP”) of what it “should have been” (expressed in dollars and as a percentage). Though it’s not possible to nail down how many people in your state would be affected, the larger the difference between the two medians, the fewer people in your state who would have qualified for “automatic” Chapter 7 bankruptcy consideration had they chosen to file.
    – Positive results in the last two columns mean that the BR-calculated median would have been higher than the “should have been used” estimate.

So what are the results?

    – You can see that the BR-calculated medians would have been lower (often much lower) in 44 of the states and DC, and higher (and never by as much as 2%) in just 6 states.
    – Nationwide, on a population-weighted basis (you don’t want to see that spreadsheet), the BR-calculated medians were more than 4% lower than they “should have been.”

But there’s one more factor, and it has to do with where bankruptcy filings are more likely to occur.

REASON 4: The use of statewide medians causes filers in urban areas, where per-capita income and per-capita filings are both higher, to have less of a chance (somtimes much less) of being eligible for an “automatic” Chapter 7 than filers in rural areas, where per-capita income and filings are lower.

The number of bankruptcy filings per capita is higher in urban areas than in rural ones. How much higher is difficult to get a handle on, but here are two examples:

    A comparison of 2001 per-capita bankruptcy rates and per-capita incomes in Michigan for different “groupings” (go to Page 26 at link) revealed the following:

    Both the per-capita filing rate and income of the urban and rural-urban areas combined (about 5.1 and $21,300, respectively) were significantly higher than those for the other areas (about 3.8 and $17,100), resulting in differences of about 33% and 25%.
    For 1999 in Pennsylvania, the state with largest rural population of any state in the US at the time, the rural filing rate per 1,000 was 2.85, and the urban rate was about 30% higher at 3.73 (go to Page 23 at link), while per-capita incomes were $22,453 and $30,287 (35% higher than the rural per-capita), respectively (at Page 28 of link).

    Based on these two examples from two of the larger states, it’s reasonable to believe that the nationwide urban-area bankruptcy filing rate is significantly higher than the nationwide rural-area rate.

    Because urban incomes are higher, quite a bit fewer than 50% of urban populations will be eligible for the “automatic” Chapter 7, and instead will be forced into Chapter 13 if they choose to file. The impact of this will be even further exaggerated because urban filing rates are higher.

    Here are some examples using data from the Bureau of Labor Statistics 2002-2003 Consumer Expenditure Survey for the Midwest, where median and average incomes are fairly uniform among the region’s various states in the region. Although metro-area average incomes are being compared to regional average income instead of medians being compared to medians (which would be ideal, but aren’t available), you’ll see my point:

    Average income before taxes–
    Entire region-$50,861
    St. Louis-$55,698
    Kansas City $57,460

    Average income is higher than the regional average in 6 of the 8 metro areas listed, in 2 cases by quite a bit, and in 2 other cases by more than 10%.

    Don’t try to do this for any other region if you don’t live in the Midwest. Other regional comparisons aren’t useful because of wide disparities in income between individual states in each region.

    * * * *

    What should have been done? The writers of the bill could have easily used individual metro-area averages, plus an average for all non-metro areas in each region for those not living in a Metro area, as the basis of comparison for the Means Test. The use of such averages corrected for a year or so of inflation would have made up for the reality lag factor (Reason 3 above), and would certainly have been more fair than the bill’s current use of statewide medians.

    But they didn’t do this. Why not? At the risk of sounding like a broken record: Statewide Median Income as defined in the bill is not about giving members of the bottom half of the population a chance for a new beginning–it’s about discouraging many of the very people who would be the most logical candidates for bankruptcy from filing, so supporters can claim “victory” when the bankruptcy stats go down; and, it’s about forcing the maximum number of poor souls who do file through the payment regimen of Chapter 13, while pretending to have “compassion.”

    Once again, the claim of bill supporters that they wish to give “a fresh start to those who need it” is revealed for what it truly is: a bald-faced, Grade-A lie.

    NOTE: I say “in theory” about the “automatic” nature of below-median income Chapter 7 filings because there is a great deal of disagreement as to whether the new law’s use of the term “abuse,” as opposed the current law’s threshold of “substantial abuse,” will cause Chapter 7 filers who appear to have money to partially pay their debts based on the Means Test to be forced to do so by creditor-pressured or hard-nosed trustees or administrators. If so, they will be arbitrarily moved into Chapter 13′s payment regimen.

    Creditors may claim that the mere availability of money to pay under the calculated Means Test constitutes an “abuse” when considering the “totality of the circumstances” (another term in the new law). Even if the creditors don’t make such a claim, the trustee or administrator may sometimes decide on his or her own that it is an abuse. Apparently such a determination would have to be brought up to a “United States Trustee” (with a capital “T”–as I understand it, there are 13 or so Trustees in the system, and trustees [with a small "t"] in every bankruptcy district). Again “in theory,” this means that an abuse determination based solely on Means Test money availability would rarely if ever occur. Unfortunately, there is no definitive answer to this controversy except to see how the law, if passed, gets applied in the real world.



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