Personal Bankruptcy: Analysis of Four Reports on Chapter 7 Debtors'
Ability to Pay (Letter Report, 06/21/1999, GAO/GGD-99-103).
This report compares and evaluates the methodologies used by four
reports on bankruptcy debtors' ability to repay their debts--two by
Ernst & Young LLP under the sponsorship of VISA and Mastercard, one by
Creighton University under the sponsorship of the American Bankruptcy
Institute, and one by the Executive Office for U.S. Trustees. These
reports focus on a major public policy issue--the amount of income that
those who file for personal bankruptcy have available to pay their
debts. GAO discusses 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.
--------------------------- Indexing Terms -----------------------------
REPORTNUM: GGD-99-103
TITLE: Personal Bankruptcy: Analysis of Four Reports on Chapter 7
Debtors' Ability to Pay
DATE: 06/21/1999
SUBJECT: Comparative analysis
Financial analysis
Bankruptcy
Proposed legislation
Income statistics
Debt
Debt collection
Personal liability (legal)
Statistical methods
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United States General Accounting Office GAO Report
to Congressional Requestors June 1999 PERSONAL BANKRUPTCY
Analysis of Four Reports on Chapter 7 Debtors' Ability to Pay
GAO/GGD-99-103 United States General Accounting Office GAO
Washington, D.C. 20548 General Government Division B-282761 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. Page 1
GAO/GGD-99-103 Personal Bankruptcy B-282761 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 Results in Brief 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. Page
2 GAO/GGD-99-103 Personal
Bankruptcy B-282761 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 Background 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. Page 3
GAO/GGD-99-103 Personal Bankruptcy B-282761 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. Page 4
GAO/GGD-99-103 Personal Bankruptcy B-282761 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 Scope and assessed the strengths and
limitations, if any, of each report's assumptions Methodology
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 Page 5
GAO/GGD-99-103 Personal Bankruptcy B-282761 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- Shared Characteristics ranging from
3.6 percent to 15 percent--met the definition of "can-pay" of the
Four Reports 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. Page 6 GAO/GGD-
99-103 Personal Bankruptcy B-282761 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. Page 7
GAO/GGD-99-103 Personal Bankruptcy B-282761 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 Differences in
the Four which the sample of debtors was selected, the proposed
legislation used as Reports 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. Page 8
GAO/GGD-99-103 Personal Bankruptcy B-282761 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 Sampling
Differences 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. Page 9
GAO/GGD-99-103 Personal Bankruptcy B-282761 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 Each Report's Analysis Was its analysis of debtor
repayment capacity. The two Ernst & Young reports Based on
Different and the Creighton/ABI report each used
different proposed legislation 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. Page 10
GAO/GGD-99-103 Personal Bankruptcy B-282761 Table 1: "Needs-Based"
Provisions in Congressional Bills As Used in Four Reports on
Bankruptcy Debtors' Repayment Capacity
Ernst & Young Creighton/ABI
Ernst & Young EOUST (March 1998)
(March 1999) (March 1999) (January
1999) Proposed legislation used H.R. 3150 as
H.R. 3150 as passed by the H.R. 833 as introduced H.R. 3150
as passed by in analysis introduced in February
House in June 1998. in February 1999
the House, June 10, 1998.
1998, and S.1301 as approved by Senate Judiciary Commmittee.
Median income test Annual gross median household income threshold
used Households of one Median income for
Median income for one- Same as Creighton/ABI. Same as
Creighton/ABI. person one-person household.
person household with one earner. Households of two to
Median income for Median income for family Same
as Creighton/ABI. Same as Creighton/ABI. four persons
households of two to households of two to four. four.
Households of more than Median income by Median
income for family Median income for Median income
for family four persons household size. In
household of four. family household of four household
of four plus tables used, median
plus $583 annually for $583 monthly for each income peaked at
each additional member additional member over families of four and
over four.a four.b declined for families of more
than four. Percent of median income More than 75 percent
100 percent or more for Same as Creighton/ABI. Same as
Creighton/ABI. needed to pass income test for household of same
household of same size as size as debtor's.
debtor's. Debtor's allowable living Based on IRS
Same as 1998 Ernst & Same as 1998 Ernst & Selected
expenses- expenses Collection Financial
Young, except interpreted Young. taxes,
business Standards. IRS transportation
expenses, child support allowance differently.
and alimony--were deducted from that portion of debtor income over
the national annual median for household of comparable size.
Minimum monthly income More than $50. If $50 Same
as 1998 Ernst & No specific income test. Any income
remaining test after paying allowable or less, debtor could
Young. Test based on amount from that
portion of living expenses and file under chapter 7.
of unsecured nonpriority debtor income above the repaying all
nonhousing
debt that could national median after secured debt and
all
potentially be repaid.c allowable monthly living unsecured
priority debt
expenses and payment over 5 years
on priority debt.d Minimum percentage of 20 percent. If
debtor Same as 1998 Ernst & $5,000 or 25
percent, No specific minimum unsecured nonpriority
met this test and all Young.
whichever was less. If used. debt to be repaid
preceding tests, debtor
debtor met this test, would be required to
debtor would be file under chapter 13.
required to file under chapter 13. Page 11
GAO/GGD-99-103 Personal Bankruptcy B-282761 aFor 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). bFor 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).
cUnder 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. dThe 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 Differences in
by the U.S. Census Bureau to select debtors for further analysis
of their Determination of Debtors' repayment capacity. Each
debtor's annual gross household income was Median Income
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. Page 12
GAO/GGD-99-103 Personal Bankruptcy B-282761 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. 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 Ernst & Young
Creighton/ABI Ernst & Young
Executive Office for U.S. (March 1998) (March
1999) (March 1999) Trustees
(January 1999) 1997 1997 1997
1997 1997 1997 1997
1997 Census income Census income
Census income Census income
Household table threshold table
threshold table threshold table
threshold size incomea usedb
incomec used incomec used
incomec 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 aCensus Bureau table H-
11 for median income by household size. The Census Bureau defines
a household as all people occupying a housing unit. bBased 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. cUsed 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. dBased 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.
eBased 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. fBased 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. Page
13 GAO/GGD-99-
103 Personal Bankruptcy B-282761 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. Page 14
GAO/GGD-99-103 Personal Bankruptcy B-282761 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 Ernst & Young Creighton/ABI
Ernst & Young EOUST (March 1998)
(March 1999) (March 1999)
(January 1999) Median Income Test Gross income,
adjusted Gross income, Gross income,
adjusted Gross income, adjusted for household size,
adjusted for for household size, is 100 for
household size, is the exceeds 75 percent of household,
size is 100 percent or more of higher of
median income national median. percent or more of
national median. For standard in H.R. 3150 or National
median national median. For family
households of more S.1301. For family household incomes
family households of than four, added $583
households of more than peaked at families of more than
four, used annually for each family four, added
$583 monthly four and declined for income for family
member over four.a for each family member families of
more than households of four.
over four.b four. 47% 24.2%
19% 17.7% Percentage of debtors in sample
who passed median income test Percentage of debtors who
17% 4.0% Not in proposed legislation
13.7% passed median income test and have net monthly income above
$50c Percentage of debtors who 15%
3.6% Not in proposed legislation
12.2%d passed median income test, have net monthly income above
$50, and can repay 20 percent of unsecured nonpriority debt over 5
years Percentage of debtors who Not in proposed
Not in proposed 10 %
13.4% can repay at least $5,000 or legislation
legislation 25 percent of unsecured nonpriority debt (whichever is
less) over 5 years Percentage of debtors who Not
in proposed Not in proposed Not in
proposed 15%e had any net income
available legislation
legislation legislation to pay unsecured
nonpriority debts. Total estimated unsecured
$4 billion $870 million (national $3
billion Less than $1 billion to $3.76 nonpriority debt that all
"can- projection from 7
billiong pay" debtors could repay
districts)f over 5 years aFor
example, a family of six would be assigned the national median
income for a family of four plus $1,166 ($583 X 2). bFor example,
a family of six would be assigned the national median income for a
family of four plus $13,992 ($583 X 24). cNet after deducting
allowable living expenses and full repayment of nonhousing secured
debt and unsecured priority debt over 5 years. dEOUST 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. eThis 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 Page
15
GAO/GGD-99-103 Personal Bankruptcy B-282761 priority debts. This
measure of debt repayment was not included in any of the proposed
legislation used in the analyses of these four reports. fThe
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. gThe 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 Page 16
GAO/GGD-99-103 Personal Bankruptcy B-282761 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 Differences in Interpreting collection
financial standards as the basis for determining debtors' the IRS
Expense Standards allowable living expenses. These standards
and their application in the for Allowable Living Ernst
& Young and Creighton/ABI reports are discussed in more detail in
Expenses 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 Page 17
GAO/GGD-99-103 Personal Bankruptcy B-282761 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. Page 18
GAO/GGD-99-103 Personal Bankruptcy B-282761 Table 4: Basic
Description of IRS National or local
Description of expense category and IRS Collection Financial
Standards IRS standard standard
guidelines Housing and utilities Local, by county. IRS
standard is a cap-taxpayer allowed Dollar amount set amount
actually spent or IRS allowance, according to family whichever is
less. Includes mortgage or rent, size. No difference property
taxes, interest, parking, necessary if taxpayer owns or
maintenance and repair, homeowner's or rents.
renter's insurance, homeowner dues, condominium fees, and
utilities. Transportation Ownership Applied
nationally, IRS standard is a cap. Provides maximum but IRS
considers it monthly allowance for the lease or purchase a local
standard 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 Local, by census IRS standard is a
cap. Allowed in addition to public region and
ownership allowance, if taxpayer has transportation
metropolitan payments for lease or purchase of vehicle.
If statistical area 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 National (except for National standard allowance
is provided expenses Alaska and
regardless of amount actually spent. Food, Hawaii), by income
housekeeping supplies, apparel and services, and household
personal care products and services, and size.
miscellaneous. Adjusted for income and number of persons in the
household. Other necessary No standard other
Includes such expenses as charitable expenses
than expense must contributions, child care, dependent care, be
necessary and health care, payroll deductions (e.g., taxes,
reasonable. Actual union dues), and life insurance. amount allowed
determined on individual basis by IRS. Source: IRS internet site
and IRS regulations. Page 19
GAO/GGD-99-103 Personal Bankruptcy B-282761 Differences Between
the Ernst & The IRS transportation allowance is divided into two
categories- Young and Creighton/ABI ownership costs and
operating costs, which includes an allowance for Interpretationsof
the IRS debtors with no vehicles. The IRS ownership
allowance is a single national Transportation Allowances
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." Differences in the Ownership Each report used
different methods to assign the ownership portion of the
Allowances Used 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. Page
20
GAO/GGD-99-103 Personal Bankruptcy B-282761 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 needs- based 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. Differences
in the Operating Crieghton/ABI's and Ernst & Young's methods of
assigning vehicle Allowances Used 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 Page 21
GAO/GGD-99-103 Personal Bankruptcy B-282761 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 Similarities and Differences years
from which the samples were drawn, there is considerable
similarity in Incomes and Debts in the
characteristics of those debtors in each report's sample who would
Between "Can-Pay" and not be required to file under
chapter 13 (see table 5). The amount of the "Can't Pay" Debtors
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. Page 22
GAO/GGD-99-103 Personal Bankruptcy B-282761 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.
Table 5: Median Household Income and Debtor
Ernst & Young Ernst & Young Creighton/ABI
EOUST Median Unsecured Nonpriority Debts of characteristics
(March 1998) (March 1999) (March 1999)
(January 1999) Bankruptcy Debtors Who Would and Year from
which Would Not Be Required to File Under sample of Chapter
13, as Determined by Four debtors was
Cases closed in Reports on Debtor Repayment Capacity drawn
1997 filings 1997 filings 1995 filings first half of
1998 Debtor's median family income All debtors in
$22,290a $22,290a $21,264
$22,800b sample Debtors who 20,417
21,204 20,688 20,136 would not be
required to file under chapter 13 Debtors who
44,738 51,974 52,080
46,350 would be required to file under chapter 13 National median
35,492 35,492 40,611
35,492 household income Debtor's median unsecured nonpriority debt
All debtors in 24,611 24,405
20,581 23,190 sample Debtors who
23,570 23,472 20,303
21,508c would not be required to file under chapter 13 Debtors who
30,813 39,085 33,526
34,680d would be required to file under chapter 13 aNot in
published report; data separately provided to GAO. bNot in initial
report; data separately provided to GAO. cIncluded debtors who
fell below the median income thresholds set in both H.R. 3150 and
S.1301. dIncluded 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 Differences in Debtor
attorney fees or the costs of administering a chapter 13 repayment
plan. Attorney Fee and The Creighton/ABI
report and the 1999 Ernst & Young report based their
Administrative Costs 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
Page 23
GAO/GGD-99-103 Personal Bankruptcy B-282761 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 Differences in careful effort to
apply the provisions of proposed legislation as they Proposed
Legislation interpreted them and developed estimates
of the percentage of chapter 7 debtors who could potentially repay
a specific portion of their unsecured and Methodologies
nonprority debts. Based on the data available to us, the reports
reached Used Yielded Different different estimates of "can-pay"
debtors principally because each report Estimates of Debtor
used different and noncomparable samples of debtors, different
proposed Repayment Capacity "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 Page 24
GAO/GGD-99-103 Personal Bankruptcy B-282761 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 "can- pay" 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. Page 25
GAO/GGD-99-103 Personal Bankruptcy B-282761 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 Conclusions
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. Page 26
GAO/GGD-99-103 Personal Bankruptcy B-282761 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, Comments
from the National Director, Policy Economics and
Quantitative Analysis, on May 28, Authors of the Four
1999, to discuss their comments on the draft report. Mr. Neubig,
on behalf of Ernst & Young; Professors Marianne Culhane and
Michaela White, Reports and Our authors of the
Creighton/ABI report; and Mr. Joseph Guzinski, Assistant
Evaluation 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 Ernst & Young's Comments stated that our draft
report did not sufficiently focus on the similarities in and Our
Evaluation 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 Page 27
GAO/GGD-99-103 Personal Bankruptcy B-282761 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 Page 28
GAO/GGD-99-103 Personal Bankruptcy B-282761 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. Page 29 GAO/GGD-
99-103 Personal Bankruptcy B-282761 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 can- pay 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 Page 30
GAO/GGD-99-103 Personal Bankruptcy B-282761 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, Comments of Creighton/ABI they discussed
their sample of cases, noting that although theirs was not a
Report's Authors and Our national sample, it was a random
sample for the seven districts that Evaluation
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 Page 31
GAO/GGD-99-103 Personal Bankruptcy B-282761 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 needs- based 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 Page 32
GAO/GGD-99-103 Personal Bankruptcy B-282761 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; Page 33
GAO/GGD-99-103 Personal Bankruptcy B-282761 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 34
GAO/GGD-99-103 Personal Bankruptcy Page 35 GAO/GGD-99-103
Personal Bankruptcy Contents 1 Letter 40 Appendix I
Three Assumptions Used in All Three Reports
40 Methodological Similarities and Differences in the
Ernst & Young and 41 Creighton/ABI Reports
Similarities and Differences in Three Reports on Bankruptcy
Debtors' Repayment Capacity 64 Appendix II EOUST
Debtor Sample
64 Description of Description of the EOUST Report's
Methodology 65 Methodology Used in the
Report by the Executive Office for the U.S. Trustees 69 Appendix
III GAO Comments
73 Comments From Ernst & Young 80 Appendix IV GAO
Comments
86 Comments From the Authors of the Creighton/ABI Report 90
Appendix V Comments From the Executive Office for U.S. Trustees
Page 36 GAO/GGD-99-103 Personal
Bankruptcy Contents 91 Appendix VI GAO Contacts and Staff
Acknowledgments Table 1: "Needs-Based" Provisions in Congressional
Bills 11 Tables As Used in
Four Reports on Bankruptcy Debtors' Repayment Capacity Table 2:
Census Bureau Tables and Actual Median
13 Household Incomes, by Household Size, That Each Report Would
Have Used Had All Four Reports Used the 1997 Census Tables on
Household Incomes Table 3: Results of Four Reports Analyses of the
15 Percentage of Chapter 7 Bankruptcy Debtors Who Could Pay A
Substantial Portion of their Unsecured Nonpriority Debts Table 4:
Basic Description of IRS Collection Financial
19 Standards Table 5: Median Household Income and Median
23 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 Table I.1:
Methodological Similarities and Differences in
42 the Two Ernst & Young Reports and the Creighton/ABI Report on
Bankruptcy Debtors' Repayment Capacity Table I.2: How the IRS,
Ernst & Young, and 58
Creighton/ABI Would Have Determined the Transportation Ownership
Allowance for Hypothetical Debtors in Boston, Massachusetts, Using
the Current IRS Collection Financial Standards Allowances
Abbreviations AOUSC Administrative Office of the United
States Courts BLS Bureau of Labor Statistics EOUSC
EOUST Page 37 GAO/GGD-99-
103 Personal Bankruptcy Contents IRS Internal Revenue
Service Page 38 GAO/GGD-99-103
Personal Bankruptcy Page 39 GAO/GGD-99-103 Personal Bankruptcy
Appendix I Methodological Similarities and Differences in Three
Reports on Bankruptcy Debtors' Repayment Capacity 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 Three Assumptions
substantial portion of their debts, all three reports used three
assumptions Used in All Three that have not been validated: (1)
the information on debtors' income, expenses, and debts, as
reported in the debtors' financial schedules, was Reports
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 Page 40
GAO/GGD-99-103 Personal Bankruptcy Appendix I Methodological
Similarities and Differences in Three Reports on Bankruptcy
Debtors' Repayment Capacity 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 Similarities and
apply the "needs-based" consumer bankruptcy provisions of
different Differences in the proposed bankruptcy bills
to estimate the number of debtors in their respective samples who
would be required to file under chapter 13 rather Ernst & Young
and than chapter 7 and enter a 5-year repayment plan.
The major steps in each Creighton/ABI Reports 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. Page 41
GAO/GGD-99-103 Personal Bankruptcy Appendix I Methodological
Similarities and Differences in Three Reports on Bankruptcy
Debtors' Repayment Capacity 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. Table I.1: Methodological Similarities and
Differences in the Two Ernst & Young Reports and the Creighton/ABI
Report on Bankruptcy Debtors' Repayment Capacity Data used or
calculation made Ernst & Young
Ernst & Young Creighton /ABI (March 1998)
(March 1999) (March 1999) Debtor sample
used for analysis National probability sample of Same
Probability sample of debtors who debtors who filed under chapter
7 filed under chapter 7 in
calendar in calendar year 1997.
year 1995 in each of seven judgmentally selected districts.
Proposed legislation used in H.R. 3150 as introduced in
H.R. 833 as introduced in H.R. 3150 as passed by the
analysis February 1998.
February 1999. House of Representatives, June
10, 1998. Determination of debtors' gross income Gross monthly
income Estimated current monthly gross Same
Same income from schedule I.a Gross annual income
Multiplied gross estimated Same
Same monthly income on schedule I by 12. Determination of family
size used For debtors who filed as Same
Same for median income comparison individuals, added one, and
for debtors who filed jointly, added two, to the number of
dependents listed on schedule I. Initial income screen used to
Debtors' gross annual income Debtors' gross annual income
Debtors' gross annual income determine whether debtors
exceeded 75 percent of 1996 exceeded 100 percent of 1996
was 100 percent or more of 1993 would be subject to further
annual median national income annual median national
income national median income for family analysis of their
repayment for households of comparable for a family
household of household of comparable size as capacity
size as reported by U.S. Census comparable size as reported
by reported by U.S Census Bureau. Bureau.b
U.S. Census Bureau.c For one- For one-person households, used
person households, used median income for households
median income for households with one earner. Families of more
with one earner.d Families of than four persons were
assigned more than four members were the median income for a four-
assigned the Census Bureau person family. table's annual
median income for a four-person family plus $583 annually for each
additional family member. Determination of debtors' allowable
living expenses Housing and utility expenses for IRS standard
housing and utility Same Same
nonhomeowners allowance by county of
residence.e Page 42
GAO/GGD-99-103 Personal Bankruptcy Appendix I Methodological
Similarities and Differences in Three Reports on Bankruptcy
Debtors' Repayment Capacity Data used or calculation made
Ernst & Young Ernst & Young
Creighton /ABI (March 1998) (March 1999)
(March 1999) Housing and utility expenses for Full mortgage
payment (except Same Full
mortgage payment (included homeowners as
noted below), home
property tax and insurance if not maintenance expenses, utilities
included in mortgage payment; (electricity, heating, water, sewer,
excluded property tax and and telephone), property taxes,
insurance if included in mortgage and homeowner insurancef as
payment and listed elsewhere); reported on schedule J.g
maintenance expenses and utilities (excluding cable television) as
listed on schedule J. Adjustments to homeowner Used the
full monthly mortgage Same Used
the full monthly mortgage housing and utility expenses payment
debtor listed on
payment debtor listed on schedule J unless either of the
schedule J unless the following following conditions applied:
condition applied: 85 percent of (1) if 85 percent of the debtor's
the debtor's reported monthly reported monthly mortgage
mortgage payment, multiplied by payment, multiplied by 60, was
60, was more than 110 percent of more than 110 percent of the
total the total outstanding
mortgage outstanding mortgage debt shown
debt shown on schedule D.h In on schedule D,h then determined
such cases, determined debtor's debtor's monthly mortgage
monthly mortgage payment by payment by dividing 110 percent
dividing 110 percent of the total of the total outstanding
mortgage outstanding mortgage
debt by 60. 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 Transportation expenses Page 43
GAO/GGD-99-103 Personal Bankruptcy Appendix I Methodological
Similarities and Differences in Three Reports on Bankruptcy
Debtors' Repayment Capacity Data used or calculation made
Ernst & Young Ernst & Young
Creighton /ABI (March 1998) (March 1999)
(March 1999) Monthly vehicle ownership Used secured debt
payment as Same Used secured
debt payment as allowance ownership
allowance, with
ownership allowance when exception of leased vehicles.
secured debt payment was at Motor vehicle debt for all vehicles
least as much as maximum IRS on which secured debt was owed
allowance for household of same was totaled, 10 percent added for
size and number of vehicles as estimated interest costs
debtor's. Motor vehicle debt for all (equivalent to 9 percent for
2 vehicles on which secured
debt years), and the resulting total
was owed was totaled, 24 percent amortized over 60 months to
added for estimated interest costs determine monthly vehicle
(equivalent to 9 percent for 5 secured debt payment. Thus, if
years), and the resulting total there was no secured debt, there
amortized over 60 months to was no ownership allowance. In
determine monthly vehicle the absence of consistent
secured debt payment. The information on schedule G,j debt
debtor was allowed the total for leased vehicles was treated as
monthly vehicle secured debt secured debt, unsecured priority
payment or the maximum debt, or unsecured nonpriority
applicable IRS ownership debt, depending on how the lease
allowance (for one or two cars, costs were listed on the debtors'
based on household size), schedules. For example, if listed
whichever was higher. Used as secured debt or unsecured
same method as Ernst & Young priority debt, amount would have
for determining allowance for been amortized over 60 months
leased vehicles, with one to determine monthly payment. If
exception. If vehicle was listed on vehicle was listed on schedule
B,k schedule B, but not D (that
is, but not D (that is, there was no
there was no secured debt shown secured debt shown for the
for the vehicle), the vehicle was vehicle), no ownership allowance
considered to be debt-free and was included.
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. Page 44
GAO/GGD-99-103 Personal Bankruptcy Appendix I Methodological
Similarities and Differences in Three Reports on Bankruptcy
Debtors' Repayment Capacity Data used or calculation made
Ernst & Young Ernst & Young
Creighton /ABI (March 1998) (March 1999)
(March 1999) Monthly vehicle operating Based on IRS
standards, which Same Same
for households of one and allowance are
assigned by city or county of
households of two or more with residence. If debtor's city of
no more than two vehicles. residence (as reported on the
However, limited households of debtor's bankruptcy petition) had
two or more to two operating its own IRS allowance, used
allowances, regardless of the allowance for that city; otherwise,
number of vehicles listed on used allowance for IRS region in
schedules B or D. 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. Monthly public transportation
Based on IRS standards. For Same
Same allowance debtors who listed no
vehicles on schedules B or D, gave debtor one IRS vehicle
operating allowance for households with no vehicle.m Other living
expenses Used IRS national standard, Same
Same based on household's gross monthly income and family size,
for housekeeping supplies, apparel and services, personal products
and services, food, and miscellaneous items. Other necessary
expenses Deducted from monthly gross Same
Used the same deductions that income (as determined by Ernst &
were used in the Ernst & Young Young) the following expenses as
March 1998 report, except reported on debtors' schedules I
disallowed debt payments and J: payroll deductions (payroll
withheld from the paycheck, taxes, Social Security, nonhealth
transfers into savings plan, insurance, union dues); taxes
nonmandatory pension neither deducted from wages nor
contributions, all payments for included in home mortgage
dependents not at home (except payments;n alimony, charitable
alimony and child support), and contributions, child care, other
tuition payments. payments to dependents not living at home;
health insurance and medical and dental expenses. Business
expenses Not allowed.
Debtors allowed business All business expenses listed on
expenses as reported on schedule J were allowed (whether
schedule J-but only if debtor or not they were supported by a
reported business income on supplemental detail list). In
schedule I. addition, work uniforms listed on
schedule I were allowed. Page 45
GAO/GGD-99-103 Personal Bankruptcy Appendix I Methodological
Similarities and Differences in Three Reports on Bankruptcy
Debtors' Repayment Capacity Data used or calculation made
Ernst & Young Ernst & Young
Creighton /ABI (March 1998) (March 1999)
(March 1999) Determination of total debts owed Home mortgage debt
Total outstanding mortgage debt Same
Total outstanding home mortgage as shown on schedule D was
debt as shown on schedule D. increased by 10 percent to include
estimated interest costs (e.g., $100,000 was converted to
$110,000). Other secured debt Total secured debts
(other than Same Total secured
debts (other than mortgage on principal residence)
mortgage on principal residence) as shown on schedule D. Total
as shown on schedule D. increased by 10 percent to include
estimated interest costs (e.g., $30,000 was converted to
$33,000).o Unsecured priority debts Total of all debts as
shown on Same Total of all debts
shown on schedule Ep (except for student
schedule E (except for student loans);10 percent added to any
loans) and the nonpriority portion back taxes listed on the
schedule. of debts for which
only a part of The total value of all student
the total value was listed on loans not entitled to priority
status schedule E as entitled to
priority that were listed on schedule E
status (such as some tax were deducted and added to the
liabilities). total of debts listed on schedule F.q Unsecured
nonpriority debts Total of all debts as shown on
Same Total of all debts as shown on
schedule F, plus the value of all
schedule F plus the value of the student loans deducted from the
debts listed on schedule E that total debts shown on schedule E.
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 Same
Assumed debtor would maintain monthly mortgage payments as
monthly mortgage payments as listed on schedule J, except
listed on schedule J, except where mortgage would be paid off
where mortgage would be paid off in less than 60 months or
debtor's in less than 60
months. In such income after allowable living
cases, determined debtor's expenses was insufficient to
monthly mortgage payment by make full mortgage payment. In
dividing 110 percent of the total cases where mortgage debt
outstanding mortgage debt by 60 would be paid off in less than 60
months. months, determined debtor's monthly mortgage payment by
dividing 110 percent of the total outstanding mortgage debt by 60
months. Page 46
GAO/GGD-99-103 Personal Bankruptcy Appendix I Methodological
Similarities and Differences in Three Reports on Bankruptcy
Debtors' Repayment Capacity Data used or calculation made
Ernst & Young Ernst & Young
Creighton /ABI (March 1998) (March 1999)
(March 1999) Other secured debt Assumed total
debts, as adjusted Same
Assumed all nonprimary for interest, would be paid over 60
residence real estate debts of months. Total outstanding
less than $20,000 and all non-real nonmortgage secured debts were
estate secured debts, as adjusted increased by 10 percent
for interest, would be paid over (equivalent to 9 percent interest
60 months. Nonprimary residence for 24 months) to include
real estate debts of less than estimated interest, and the
$20,000 and all non-real estate resulting total amortized over 60
secured debts were grossed up months.
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
Same Same, but no interest
included for adjusted) paid over 60 months.
any debts in this category. Back taxes increased by 10 percent
(equivalent to 9 percent interest for 24 months) to include
estimated interest. Second income screen, if used, Debtor had
monthly net income of None. H.R. 833 includes no
Same as Ernst & Young March for determining debtors' capacity more
than $50, after allowable such screen. Next step is to
1998 report. to repay unsecured nonpriority living expenses
(including any determine debtor's debt debts
monthly mortgage payments) and repayment capacity. repayment over
60 months of all nonmortgage secured debt and unsecured priority
debt. Test used for repayment of Debtors who passed initial
and Likely debtors were those who Same as Ernst & Young
March unsecured nonpriority debt second income screen and
could passed initial income screen 1998 report.
also repay at least 20 percent of and who had sufficient
income their unsecured nonpriority debt after allowable
living expenses over 60 months. (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). Treatment of debtor attorney fees and
chapter 13 trustee fees Page 47
GAO/GGD-99-103 Personal Bankruptcy Appendix I Methodological
Similarities and Differences in Three Reports on Bankruptcy
Debtors' Repayment Capacity Data used or calculation made
Ernst & Young Ernst & Young
Creighton /ABI (March 1998) (March
1999) (March 1999) Debtor attorney fees
Debtor attorney fees not included Used data from same report as
Used data from report that in analysis.
ABI. Report found that chapter showed that chapter 13
debtors 13 incurred average fee of had average unpaid
attorney fee $1,281 in chapter 13 cases. of $800 at
filing. Added total of Treated as an unsecured priority $800 to
debtor expenses and debt the difference between this amortized it
over 60 months. average fee and the amount the The $800 was
assumed to debtor indicated on the cover chapter
13 attorney fees bankruptcy petition that he or paid
through the plan plus the she had paid the attorney prior
chapter 13 trustee fee applied to to filing the bankruptcy
petition. these attorney debt payments. If no data in
schedule on amount already paid to an attorney, used $800 as
unpaid amount and amortized it over 60 months. Chapter 13 trustee
administrative None in calculation of debtor's Needs-
based test did not Applied a 5.6 percent feer to
expenses debt repayment capacity. The
incorporate trustee fees. Total unsecured priority debts,
debt repayment calculation was debt repayment
estimates are unsecured nonpriority debts, independent
of any trustee fees. net of trustee fees, and based
and secured debt (other than on three different assumptions:
home mortgages and (1) Trustee would receive 5.6
nonprimary residence real percent of all debt payments by estate
claims of $20,000 or the "can-pay" debtors identified
more). 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). 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. Page 48
GAO/GGD-99-103 Personal Bankruptcy Appendix I Methodological
Similarities and Differences in Three Reports on Bankruptcy
Debtors' Repayment Capacity 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. iAccording
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. oAccording 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. rThe
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 Sampling Differences
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 Page 49
GAO/GGD-99-103 Personal Bankruptcy Appendix I Methodological
Similarities and Differences in Three Reports on Bankruptcy
Debtors' Repayment Capacity 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. Page
50
GAO/GGD-99-103 Personal Bankruptcy Appendix I Methodological
Similarities and Differences in Three Reports on Bankruptcy
Debtors' Repayment Capacity 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 Proposed Legislation Used report were based on
the "needs-based" bankruptcy provisions in different in the Three
Reports 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' Page 51
GAO/GGD-99-103 Personal Bankruptcy Appendix I Methodological
Similarities and Differences in Three Reports on Bankruptcy
Debtors' Repayment Capacity 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 Similarities and Differences
reported by the U.S. Census Bureau to select debtors for further
analysis in Determination of of their repayment
capacity. Each debtor's annual gross household income Debtors'
Median 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. Page 52
GAO/GGD-99-103 Personal Bankruptcy Appendix I Methodological
Similarities and Differences in Three Reports on Bankruptcy
Debtors' Repayment Capacity 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 Page 53
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Similarities and Differences in Three Reports on Bankruptcy
Debtors' Repayment Capacity 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 Similarities and Differences debtors' allowable living expenses
on the IRS Collection Financial in Determination of
Standards. The IRS uses these standards to determine a taxpayer's
ability Debtors' Allowable Living to pay a delinquent tax
liability. The EOUST report did not use the IRS Expenses
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. Page 54
GAO/GGD-99-103 Personal Bankruptcy Appendix I Methodological
Similarities and Differences in Three Reports on Bankruptcy
Debtors' Repayment Capacity 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. Housing and
Utility Expenses 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 Page 55
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Debtors' Repayment Capacity 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. Transportation
Expenses 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. Page 56
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Similarities and Differences in Three Reports on Bankruptcy
Debtors' Repayment Capacity 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. Page 57
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Similarities and Differences in Three Reports on Bankruptcy
Debtors' Repayment Capacity 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 Monthly allowance for each of 60 months
Vehicle debt at filing IRS collection by household size
standards Ernst & Young
Creighton/ABI Ownership allowance
Ownership allowance Add remainder of
Add remainder of Ownership Secured debt maximum IRS
Secured debt maximum IRS allowance paymenta
allowance, if any Total paymenta
allowance, if any Total Household of any
$0 $0 $0 $0
$0 $0 $0 size with no
vehicles Household of any size with one vehicle $0
0 00 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 00 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 Monthly lease
83 0 83 83
289 372 lease listed as payment of no secured
debt of more than $372 $5,000 on schedule Db for the
remainder of the lease. Leased vehicle listed Monthly lease
00 0 0 372 372 on
schedule Bc only. payment of no more than $372 for remainder
of the lease aFor 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. bSchedule 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. cSchedule
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. Page 58
GAO/GGD-99-103 Personal Bankruptcy Appendix I Methodological
Similarities and Differences in Three Reports on Bankruptcy
Debtors' Repayment Capacity 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 Page 59
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Debtors' Repayment Capacity 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." Page 60
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Similarities and Differences in Three Reports on Bankruptcy
Debtors' Repayment Capacity 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. Other Living Expenses 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. Other Necessary
Expenses 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. Page 61
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Similarities and Differences in Three Reports on Bankruptcy
Debtors' Repayment Capacity 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. Business Expenses 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 Differences
in Debtor debtor attorney fees or the costs of administering a
chapter 13 repayment Attorney Fees and plan. The
Creighton/ABI report and the March 1999 Ernst & Young report
Administrative Costs 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. Page 62
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Similarities and Differences in Three Reports on Bankruptcy
Debtors' Repayment Capacity 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. Page 63
GAO/GGD-99-103 Personal Bankruptcy Appendix II Description of
Methodology Used in the Report by the Executive Office for the
U.S. Trustees 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 EOUST Debtor Sample 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. Page 64
GAO/GGD-99-103 Personal Bankruptcy Appendix II Description of
Methodology Used in the Report by the Executive Office for the
U.S. Trustees The EOUST report was based on data from debtors'
financial schedules Description of the (including any
amended schedules). There are two principal differences EOUST
Report's between the EOUST report and the other
three reports we reviewed. First, the EOUST report did not use the
IRS financial collection standards to Methodology
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 Step 1: Determine Debtor's total monthly gross
income, as reported on schedule I, by 12 months. In Gross Income
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 Step
2: Screen Debtors for screened debtors to determine whether
their gross annual household Median Household Income 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 Page 65
GAO/GGD-99-103 Personal Bankruptcy Appendix II Description of
Methodology Used in the Report by the Executive Office for the
U.S. Trustees 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 Step 3: Eliminate From the
gross annual income was less than or equal to the median income
for a Analysis Any Debtors With household of the same size
(using the previously discussed criteria). It was Annual Gross
Incomes assumed that these debtors would be eligible
to file for chapter 7, if they Below the Median
chose to do so. This step is similar to that used by both the 1998
Ernst & Young and Creighton/ABI reports. Threshold 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 Step 4: Deduct Business national median
reported business receipts as gross income on schedule I. Expenses
From Gross However, according to the EOUST report's
authors, it was not always Income Above the National
possible to tell from the schedule how much of the debtor's gross
income Median 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 Step 5: Deduct Taxes From median, the
report estimated the debtor's net disposable income, after Gross
Debtor Income Above taxes, on that portion of the debtor's total
annual gross income that was the National Median
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)." Page
66
GAO/GGD-99-103 Personal Bankruptcy Appendix II Description of
Methodology Used in the Report by the Executive Office for the
U.S. Trustees 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 Step 6: Convert Remaining
to monthly income. Thus, a debtor who had $6,500 in net annual
income Annual Gross Income to above the national median
would be deemed to have $541.66 in monthly Monthly Income, Then
income above the median. The report then deducted the following
Include Additional Selected expenses, as appropriate, from the net
monthly income that was above the national median: Deductions *
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
Step 7: Eliminate Second income above the national
median. The remainder of the analysis focused Set of Debtors From
on those remaining 300 debtors who had any positive net annual
income Analysis; Estimate Debt above the national
median. Repayment Capacity 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). Page 67
GAO/GGD-99-103 Personal Bankruptcy Appendix II Description of
Methodology Used in the Report by the Executive Office for the
U.S. Trustees 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. Page 68
GAO/GGD-99-103 Personal Bankruptcy Appendix III Comments From
Ernst & Young Note: GAO comments supplementing those in the
report text appear at the end of this appendix. See comment 1. See
comment 2. Page 69 GAO/GGD-99-103 Personal Bankruptcy Appendix
III Comments From Ernst & Young See comment 3. See comment 4. Page
70 GAO/GGD-99-103 Personal Bankruptcy
Appendix III Comments From Ernst & Young See comment 5. Page 71
GAO/GGD-99-103 Personal Bankruptcy Appendix III Comments From
Ernst & Young See comment 6. Page 72
GAO/GGD-99-103 Personal Bankruptcy Appendix III Comments From
Ernst & Young 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 GAO Comments 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 above- median 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 needs- based 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 Page 73 GAO/GGD-
99-103 Personal Bankruptcy Appendix III Comments From Ernst &
Young 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 Page 74
GAO/GGD-99-103 Personal Bankruptcy Appendix III Comments From
Ernst & Young 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 Page
75 GAO/GGD-99-103 Personal
Bankruptcy Appendix III Comments From Ernst & Young 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. Page 76
GAO/GGD-99-103 Personal Bankruptcy Appendix III Comments From
Ernst & Young 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. Page 77
GAO/GGD-99-103 Personal Bankruptcy Appendix III Comments From
Ernst & Young 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 "best- case" estimate of the
results of needs-based consumer bankruptcy, if Page 78
GAO/GGD-99-103 Personal Bankruptcy Appendix III Comments From
Ernst & Young 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. Page 79
GAO/GGD-99-103 Personal Bankruptcy Appendix IV Comments From the
Authors of the Creighton/ABI Report Note: GAO comments
supplementing those in the report text appear at the end of this
appendix. Page 80 GAO/GGD-99-103 Personal Bankruptcy 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 See comment 1. Page 82
GAO/GGD-99-103 Personal Bankruptcy Appendix IV Comments From the
Authors of the Creighton/ABI Report See comment 2. Page 83
GAO/GGD-99-103 Personal Bankruptcy Appendix IV Comments From the
Authors of the Creighton/ABI Report See comment 3. Page 84
GAO/GGD-99-103 Personal Bankruptcy Appendix IV Comments From the
Authors of the Creighton/ABI Report See comment 4. See comment 5.
Page 85 GAO/GGD-99-103
Personal Bankruptcy Appendix IV Comments From the Authors of the
Creighton/ABI Report 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 GAO Comments 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. Page 86
GAO/GGD-99-103 Personal Bankruptcy Appendix IV Comments From the
Authors of the Creighton/ABI Report 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 Page 87
GAO/GGD-99-103 Personal Bankruptcy Appendix IV Comments From the
Authors of the Creighton/ABI Report 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. Page 88
GAO/GGD-99-103 Personal Bankruptcy Appendix IV Comments From the
Authors of the Creighton/ABI Report 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. Page 89
GAO/GGD-99-103 Personal Bankruptcy 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
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Sidney Schwartz, Wendy Ahmed, and Geoffrey Hamilton made key
contributions to this report. Page 91
GAO/GGD-99-103 Personal Bankruptcy Page 92 GAO/GGD-99-103
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