Tax Problems #1 Cause of Bankruptcy
Todd Zywicki of The Volokh Conspiracy fingers tax liabilities as the #1 cause of bankruptcies:
An interesting thing briefly suggested here is the extent to which tax problems force people into bankruptcy (usually, however, not because they just "forgot" to pay their taxes). There aren't many good studies on this, but some have concluded that as much as 10% of bankruptcy filings are caused by tax liabilities (and that doesn't count those who would have alot more money available to pay their debts but for having to pay their taxes or pay their taxes because they are generally nondischargeable in bankruptcy). For those keeping score at home, this exceeds the number of bankruptcies traditionally thought to be caused by health problems, death in the family, college expenses, and gambling.
Given that most lawyers I talk to report that they often see tax problems as a primary cause of consumer bankruptcy, it certainly would be useful if someone had access to data to look at this question. For some reason, however, empirically-minded bankruptcy scholars seem to be largely uninterested in investigating the extent to which bankruptcies are caused by tax liabilities or excessive tax burdens.
(Thanks to InstaPundit for the tip.)
Comments (23)
Half Sigma
People only have high tax liabilities if they made a lot of money.
Tax time may be the time of year they decide to file for bankruptcy, but it's certainly not the root cause.
Published: April 25, 2005 1:14 PM
Dick Clark
"People only have -high- tax liabilities if they made a -lot- of money."
Your choice of rather vague quantifiers doesn't do much for your position here. Someone who has an income just high enough to incur tax liability may make a mistake (i.e. underpayment) and accrue additional penalties that seem pretty substantial relative to that person's income.
As for your flat-out assertion that "tax time" is not the "root cause" of bankruptcy (which misses the mark as far as a refutation of this article, which was about "taxation" itself, not "tax time")... well, I don't think that anyone was attempting to assess taxation as a "sufficient" cause for any particular bankruptcy. Rather, bankruptcy was cited as the "#1 cause." Therefore the taxation that allegedly caused the bankruptcy might be a contributing (perhaps even "necessary") factor, but not a wholly sufficient one.
Published: April 25, 2005 1:55 PM
James W. Fogal, CFP
Dear Half Sigma:
Not everyone with large tax bills are high income earners. My sister and brother-in-law are 21/22 years of age -- he worked for a church in 2004 which did not withhold any taxes (including social security/medicare). No one told him to save or send-in quarterly payments in preparation of this tax bill. Although they are in a low tax bracket (marginal federal tax bracket of 10%), they owed a very large social security tax bill since he was classified as self-employed. If they didn't have a moral repugnance to bankruptcy (and have a child on the way), they likely would file bankruptcy to discharge their other debts. They will be paying this tax bill for a long time.
Also, many middle-income taxpayers get caught with the Alternative Minimum Tax. If they don't have much surplus cash flow, getting caught with this tax can be quite difficult in making payments.
In addition, just because a person makes "a lot of money" doesn't mean they won't file for bankruptcy. Many celebrities and others who earn millions file for bankruptcy, if their spending is more than their earnings. It happens more often than one would realize. According to "The Millionaire Next Door," many high income earners have little to no net worth. Getting clobbered with a large tax bill only makes matters worse.
Published: April 25, 2005 2:28 PM
Vache Folle
Another trap for the small businessman is employee withholding tax. In times of bad cash flow, there is the temptation to spend this money, and this subjects the employer to a 100% penalty for which he may be made personally liable. Another problem arises in the case of the self employed individual who must set aside 15% of his gross as self employment tax and pay taxes on his income as well. With customary bad recordkeeping, taxes assesed are often way out of whack to actual earnings.
Published: April 25, 2005 2:42 PM
David Heinrich
Aside from my general opinion on bankruptcy as being a crime by natural law, I think it particularly disgusting when billionares (like Donald Trump) or millionares (like M.C. Hammer) declare bankruptcy.
Published: April 25, 2005 4:09 PM
Mark D. Fulwiler
While I believe that people are morally obliged to pay off their debts to the extent that it is reasonable to do so, the fact is that nobody is compelled to loan out money, and that in this imperfect world a creditor always takes a risk of getting stuck with an uncollectable debt.
And is one really obliged to pay off ~all~ debt? Suppose, in a moment of foolishness, that you borrow a dollar and agree to pay it back with a million dollars in interest. In one obliged to go into indentured servitude for life?
Published: April 25, 2005 4:44 PM
Lisa Casanova
True, no one is compelled to loan money. But my understanding of bankruptcy is that it pretty much eliminates whatever contract you made with the borrower stipulating the terms of the loan you're giving them, and replaces it with the decision of the bankruptcy court. So, I can make a contract with you (and as many other people as I want) to get a loan, and then file bankruptcy and leave you with no way to collect from me, even if I might have the means to repay you eventually. That seems an injustice.
Published: April 25, 2005 5:12 PM
James W. Fogal
Mark:
If a lender and borrower make a contract, it is wrong for the government to step-in and nullify the contract. If the borrower cannot fulfil the contract, there needs to be a mutual settlement (apart from government's bankruptcy laws).
In the absence of Chapter 7 bankruptcy, borrowers will be much more careful in their lending.
Maybe I am old-fashioned in my thinking, but I believe that a person should keep a promise. Chapter 7 bankruptcy encourages irresponsibility.
Published: April 25, 2005 5:18 PM
todd yarling
I don't know about "natural law" but in God's law, bankruptcy is commanded every 7 years.
Yes a shadow and a type but especially since this money is play money off a printing press, go go backrupters... or is it bankruptees... err uh
Published: April 25, 2005 5:45 PM
James W. Fogal
A few comments from Dr. Murray N. Rothbard:
(pp. 180-181 of Man, Economy, and State with Power and Market)
"This analysis provides the clue to the treatment of defaulting debtors on the free market. If a creditor decides to forget about the debt and not press charges, he in effect grants a gift of his
property to the debtor, and there is no further room for enforcement of contract. What if the creditor insists on keeping his property? It is clear that if the debtor can pay the required amount but refuses to do so, he is guilty of pure fraud, and the enforcing agency would treat his act as such. Its prime move would be to make sure that the debtor’s assets are transferred to their rightful owner, the creditor. But suppose that the debtor has not got the property and would be willing to pay if he had it? Does this entitle him to special privilege or coerced elimination of the debt, as in the case of bankruptcy laws? Clearly not. The prime consideration in the treatment of the debtor would be his continuing and primary responsibility to redeem the property of the creditor. The only way by which this treatment could be eliminated would be for the debtor and the creditor to agree, as part of the original contract, that if the debtor makes certain investments and fails to have the property at the date due, the creditor will forgive the debt; in short, he grants the debtor the rights of a partial co-owner of the property."(Emphasis added by poster)
This book can be viewed at:
Mises.org/rothbard/mes.asp
or purchased at:
Mises.org/store/product1.asp??SID=2&Product_ID=177
Published: April 25, 2005 5:58 PM
James W. Fogal
Todd:
It is true that Jews of the Old Testament law did have a provision for forgiveness of debts every seven years.
BUT, the Bible has other things to say about non-payment of valid debts:
"Pay what you vow! It is better that you should
not vow than that you should vow and not pay� (Ecclesiastes 5:5).
Psalm 37:21 says,
“The wicked borrows and does not pay back, but the righteous is gracious and gives.�
The Bible is not as clear-cut as you suggest.
Published: April 25, 2005 6:48 PM
James W. Fogal
Todd:
It is true that Jews of the Old Testament law did have a provision for forgiveness of debts every seven years.
BUT, the Bible has other things to say about non-payment of valid debts:
"Pay what you vow! It is better that you should
not vow than that you should vow and not pay� (Ecclesiastes 5:5).
Psalm 37:21 says,
“The wicked borrows and does not pay back, but the righteous is gracious and gives.�
The Bible is not as clear-cut as you suggest.
Published: April 25, 2005 6:49 PM
Pete Canning
I don't have my copy of The Ethics of Liberty on me, but is there not specific reference to a debtor's prison?
Published: April 25, 2005 6:55 PM
Half Sigma
James, if people have to file bankruptcy because they forgot to save for tax time, that's their OWN STUPIDITY.
Now normally, it's libertarians who say that people should be allowed to suffer for their own stupidity.
Published: April 25, 2005 9:24 PM
Lisa Casanova
Half Sigma,
Maybe, maybe not. Either way, the government has no business making anybody suffer.
Published: April 25, 2005 9:49 PM
Roger
Hello, I am self employed and have to pay quarterly tax payments and 15.3% social security tax on gross income. Scrapping by each year to pay the bills, and taking care of a family. Thanks to God no medical bills or other mishaps that can wipe a person out. I see other families with extreme medical bills and old people on fixed incomes, I don't know how they make it. God bless them and care for them.
Roger
Published: April 25, 2005 10:46 PM
Andy D.
Half Sigma:
If the cost of living is 70% of your income, and the government taxes 35% of your income, how is that not the govenment taxing you into bankruptcy? Should you lower your standard of living to conform to socialism or should the government conform to the people? How many of these government programs do the majority of Americans use? Not very much, and that is precisely why socialist progs can barely scrape by.
Normally its libertairians who say that people shouldn't be oppressed. Oppression means the use or threat of violence to deny a human freedom.
Published: April 26, 2005 2:11 AM
Paul D
Half Sigma:
I'm a self-employed low earner, and I usually don't earn enough to pay income tax. I do have the government demanding social security and medical taxes from me, though.
In trying to improve my business, support my wife, and save for one or two important (yet meager) goals, I can't even afford these simple taxes. I'm *frequently* tempted to just declare bankruptcy and get rid of my debts; only my conscience prevents me from doing so.
I suppose you think I'm stupid or something for not having enough money to afford this. Why don't you stop spouting nonsense and go find a tax-collector to hug?
Published: April 26, 2005 5:07 AM
James W. Fogal
Pete:
Thank you. I forgot that Rothbard has an excellent quote in The Ethics of Liberty (pp.143-146). He says:
"Would bankruptcy laws be permissible in a libertarian legal system? Clearly not, for the bankruptcy laws compel the discharge of a debtor's voluntarily contracted debts, and thereby invade the property rights of the creditors. The debtor who refuses to pay his debt has stolen the property of the creditor. If the debtor is able to pay but conceals his assets, then his clear act of theft is compounded by fraud. But even if the defaulting debtor is not able to pay, he has still stolen the property of the creditor by not making his agreed-upon delivery of the creditor's property...Bankruptcy laws, which discharge the debt in defiance of the property rights of the creditor, virtually confer a license to steal upon the debtor...."
There is more to this section on bankruptcy. I encourage you to read Chapter 19 at:
http://mises.org/rothbard/ethics/ethics.asp
Published: April 26, 2005 9:58 AM
Michael A. Clem
It's not "play money". The fact that the government controls the printing press allows them to devalue the dollar, but those dollars still represent tangible goods and assets that creditors are denied by bankruptcy. The borrower got something tangible from the borrowed money, did they not?
Published: April 26, 2005 12:24 PM
Half Sigma
Paul, if bankrupcty would reduce your debts, then file for it. It's not immoral, it's an implicit part of every lending contract.
Published: April 26, 2005 3:22 PM
Andy D.
LoL Sigma! The only reason bankruptcy exists is becuase the government puts a gun in the face of the lenders and says that they can't go after you! Is that not immoral? If you lend me 500 bucks and I say I can't pay you back, that isn't immoral?? The purpose of the contract is so that you REPAY, the GOVERNMENT BREAKS the contract. Wow, you have an econoblog?
Published: April 26, 2005 4:30 PM
Kelton Baker
--Published: December 28, 2006 7:37 PM