Do fiscal payments reduce personal bankruptcy?

A central policy question for dealing with financially distressed individuals is whether exogenous income increases (e.g. fiscal cash transfers) will help these individuals avoid default. If, for example, a financially distressed individual uses the fiscal cash transfer to pay down debt then bankruptcy may become less likely. However, if the individual uses the fiscal cash transfer for consumption then the probability of bankruptcy may not decline. We examine this issue empirically, by exploiting a politically motivated, one time only, fiscal cash transfer paid to every resident of one Canadian province in one specific year (the so-called "Ralphbucks" payments to every resident of Alberta in 2006) but not to any other Canadians.

We explore the impact of this Alberta specific income shock on every Canadian bankruptcy as measured by data provided to us by the Canadian bankruptcy regulator, the Office of the Superintendent of Bankruptcy (OSB). These OSB data are the result of special runs of the OSB data extraction system conducted specifically for this project. These data contain counts of every Canadian bankruptcy filing in all Canadian six-character postal codes in every year. Canadian six-character postal codes are extremely small geographic spaces containing only 15 households on average (often less than a city block). We can thus capture the impact of this exogenous income shock, using a difference-in-difference specification, where Alberta in 2006 is the treatment group, and all other provinces in all other periods are the control group. We also include a large number of control variables to account for observable shocks. A key advantage of our data is that our basic unit of analysis is insolvency filing counts measured at the 6 character postal code level. We can thus match these geographic data with other income shock data measured at various larger levels of geographic aggregation. We exploit characteristics of the insolvency system in Canada to construct falsification tests. Specifically, we find that the positive income shock from the 2006 Alberta fiscal cash transfer lowered consumer bankruptcies in our treatment group (Albertan postal codes in 2006) by about 9 % compared to consumer bankruptcies in our control group (all Canadian postal codes not in Alberta in 2006, and all postal codes in all other years).

This paper is of importance in the context of the theoretical debate on the causes of bankruptcy. The income shock explanation for bankruptcy (that negative income shocks e.g. divorce, job loss, health shocks etc. should lead to increases in bankruptcy filings) is at the center of a longstanding theoretical debate over whether it, or various alternative explanations such as strategic default, financial benefits or stigma, are the main causes of bankruptcy (see e.g., Fay, Hurst and White 2002, Gross and Souleles, 2002, White 2011 and many others). The main premise behind the income shock hypothesis is that negative shocks will reduce debt repayments and thus increase the probability of bankruptcy. We find that fiscal payments significantly reduced personal bankruptcies, which is consistent with the income shock hypothesis for bankruptcy.