U.S. Jerey Traczynski. October 6, University of Wisconsin-Madison. Department of Economics. Oce: 7310 Social Science. Oce Phone: (608)

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1 Divorce Rates and Bankruptcy Exemption Levels in the U.S. Jerey Traczynski October 6, 2010 University of Wisconsin-Madison Department of Economics Oce: 7310 Social Science Oce Phone: (608) Abstract While raising bankruptcy exemption levels protects consumers from negative asset shocks, an unintended consequence of this policy that remains unexplored is the eect on divorce rates. This eect arises from reducing benets of marital risk sharing. I establish conditions under which increases in exemptions lead to more divorce and investigate using data from the Vital Statistics of the United States. I estimate that exemption increases between 1989 and 2005 resulted in over 200,000 additional divorces during this period and that the eect on divorce rates in 2005 is comparable in magnitude to the introduction of unilateral divorce laws from Wolfers (2006). I would like to thank Karl Scholz, Jane Cooley, Chris Taber, Ben Cowen, Shannon Mok, Mai Seki, Kamil Sicinski, Caleb White, Alex Yuskavage, and participants in the UW-Madison Public Finance research seminar for their useful comments and suggestions. All remaining errors are my own. Department of Economics, University of Wisconsin-Madison, Madison, WI 53706; traczynski@wisc.edu.

2 1 Introduction In 2007, there were approximately 1.1 million divorces and 850,000 bankruptcy lings in the U.S. 1 Researchers have devoted signicant attention to the negative eects of divorce on the nancial and psychological health of both adults and children (Clark-Stewart and Brentano, 2006) and to how bankruptcy declarations under dierent sets of laws aect consumer welfare (Livshits et al., 2007). Generous bankruptcy laws can be helpful in shielding individuals from negative income or asset price shocks, just as marriage allows individuals to share risk by pooling resources. Since both institutions oer some of the same benets in the form of insurance, changes in bankruptcy laws may have unforeseen consequences for divorce rates. This tradeo has yet to be explored in either the divorce or bankruptcy literature. In personal bankruptcy, individuals may keep any assets that t under predetermined exemption levels. These exemptions allow individuals to retain some property to begin the fresh start that U.S. bankruptcy law oers. By guaranteeing a minimum amount of assets that debtors may keep, exemptions are an important part of bankruptcy's protections for individuals against misfortune. The size and allowable categories of exemptions have been central to the debate surrounding every federal bankruptcy law revision since Previous papers have exploited variation in exemptions both across states and over time to determine the various ways in which exemptions aect consumers' ability to obtain loans and the interest rates that banks oer (White, 1987; Gropp et al., 1997; Lin and White, 2001). This paper quanties the specic eect of bankruptcy exemption levels on divorce rates. I use a simple model of divorce in which individuals only obtain a divorce if there is no possible outcome from bargaining within marriage that makes both partners better o. This model suggests a way to test whether variation in bankruptcy exemption levels aects state divorce rates. Intuitively, bankruptcy oers more insurance against negative income and 1 Total number of divorces from author's calculations. Divorce calculation includes the assumption that states that do not report total divorces have a divorce rate equal to the national rate. See Section 4 and Table 2 for more information on divorce data availability. The total number of bankruptcies was obtained from 1

3 asset shocks when exemption levels increase, so I use exemption levels as a measure of the insurance oered by bankruptcy. I investigate empirically whether increases in exemption levels lead to increases in the divorce rate using state level panel data from the Vital Statistics of the United States, which covers the vast majority of divorces in the U.S. over the period , along with data on state bankruptcy exemption levels. The empirical analysis exploits variation within states over time. I nd evidence that increases in the total exemption amount available to debtors are associated with increases in the divorce rate. I estimate that over the sample period, increases in exemption levels resulted in over 200,000 additional divorces and that, by 2005, the magnitude of the increase in divorce rates is comparable to the short run eect of introducing unilateral divorce as estimated by Wolfers (2006). Overall, the eect of changes in bankruptcy exemption levels on the divorce rate is a large unintended consequence. 2 Previous Literature and Background 2.1 Divorce Various studies attempt to pin down economic factors inuencing the divorce rate. Conger et al. (1990) demonstrate that couples with self-reported economic hardships are more likely to divorce, while Sweezy and Tiefenthaler (1996) show that a number of state level variables, such as mandatory separation requirements before divorce and AFDC and food stamp payments, have no signicant eect on the divorce rate. Neither paper focuses on the role of social insurance in marital dissolution: this paper is the rst to examine the eect of changes in bankruptcy exemption levels on divorce rates. Much of the debate on determinants of divorce rates has centered on the eects of unilateral divorce laws. Becker (1981) uses the Coase Theorem to argue that unilateral divorce should have no eect on divorce rates, while Clark (1999) presents a model in which introducing unilateral divorce may have a positive, negative, or no eect on divorce. Both models 2

4 analyze how resource allocation within marriage and property division in divorce change in response to changes in divorce laws, altering an individual's nancial position and optimal divorce decision. In empirical work, Peters (1986, 1992) nds that the introduction of unilateral divorce in a state does not aect the probability that a woman in that state gets divorced, while Allen (1992) and Gruber (2004) nd the opposite. Using the same state level data employed in this paper, Friedberg (1998, p. 626) claims that the widespread adoption of unilateral divorce laws between 1968 and 1988 accounts for 17% of the overall increase in the divorce rate during this period. However, Wolfers (2006, p. 1814) revisits Friedberg's results and nds that unilateral divorce laws explain only a very small fraction of the dramatic rise in divorce. Previous work analyzes the correlation between being divorced and declaring bankruptcy. In a 1991 survey described by Sullivan et al. (2000), 22.1% of bankruptcy lers reported divorce as a major cause of their decision to le, and a 1999 survey discussed in Jacoby et al. (2000) ranks divorce as the third leading cause of bankruptcy lings behind job loss and medical expenses. Since a single person is more susceptible to income shocks from job loss and unforeseen medical bills than a married person, these surveys may understate the full eect of divorce on bankruptcy decisions. Nonetheless, they establish the general pattern that a single person has a higher probability of declaring bankruptcy than one who remains married. Domowitz and Sartain (1999, p. 413) estimate that a single individual is approximately twice as likely as a married individual to le for bankruptcy, while Fay et al. (2002) shows that individuals are more likely to le for bankruptcy if they become divorced in the previous year and Edmiston (2006, p. 78) claims that a one percentage point higher share of the population being divorced would lead to 7.8 additional bankruptcies per 1000 households each year. These papers focus on the choice to declare bankruptcy after divorce, while this study uses changes in the asset protection oered by bankruptcy law to examine the decision to divorce. The recent decline of U.S. home prices provides an example of an asset shock that married 3

5 couples can withstand better than singles. Stories about couples who can't leave their current situation because the nancial costs are too great and because it's too dicult to sell their house (Romans, 2009) and end up reluctantly staying together until the housing market turns around (Armour, 2009, p. 2B) have appeared in national media such as CNN and USA Today. 2 These stories oer anecdotal evidence of couples facing nancial uncertainty choosing not to divorce. In this paper, I show how changes in bankruptcy exemption levels can aect the risk sharing motive for marriage. Since dierent divorce laws provide dierent rules for property division, I test whether changes in bankruptcy exemptions have dierent eects on divorce across legal regimes. 2.2 Bankruptcy In the past thirty years, the United States has had three major reforms to its bankruptcy laws: the Bankruptcy Reform Act of 1978 (BRA78), the Bankruptcy Reform Act of 1994 (BRA94), and the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (BAPCPA). BRA78 was a comprehensive reform that replaced the Bankruptcy Act of Unlike all previous bankruptcy law changes, BRA78 was not a response to an economic recession, but rather designed to meet the demands of present technical, nancial, and commercial activities (Tabb, 1995, p. 33). BRA78 established a uniform national set of exemptions while allowing states to opt out and set their own exemption levels if desired. Every state set their own exemptions by 1987, though several allowed debtors the option of using the federal exemptions. 3 White (1987) shows that higher state exemption levels are associated with a high number of bankruptcy lings. Many dierent categories of exemptions are available to debtors in bankruptcy. The largest in dollar terms is the homestead exemption, which allows debtors to prevent creditors from seizing part of their housing equity during bankruptcy. Smaller exemptions are 2 See also Lloyd (2008) in the San Francisco Chronicle and Leland (2008) in the New York Times. 3 Posner (1997) oers an excellent discussion of the political background leading up to the passage of BRA78. 4

6 also available for a wide variety of personal property, ranging from cars and furniture to ceremonial guns and wedding rings. Some states list maximum exemption amounts for each type of good separately, while others oer wildcard exemptions that allow debtors to retain any personal property of their choice up to a specied dollar amount. Both BRA94 and BAPCPA were intended to alter the relationship between bankruptcy and divorce settlements; in fact, these alterations were a goal of BRA94. 4 Under BRA78, a debtor's obligations to a former spouse were divided into two categories: support debts and property division debts. Support debts include alimony, maintenance payments, and child support payments, while property division debts result from the decision of a judge to divide the equity that the married couple held in a large item, usually the marital home. In a typical divorce, a judge awards the home to one partner and orders that the other spouse be paid half the value of the home, so whomever gets the house also receives a large debt. In bankruptcy, property division debts were considered dischargeable, while support debts were not. Since bankruptcy courts applied this distinction strictly when determining dischargeability, a former spouse unhappy with the divorce settlement had the opportunity to use bankruptcy courts to try to obtain a more favorable division of property and debts. 5 Such litigation was suciently prevalent and, occasionally, high-prole that judges began to push Congress for bankruptcy reform. 6 One case, Farrey v. Sanderfoot, reached the Supreme Court in 1991 and prompted a dissenting lower court judge to remark that the debtor was using bankruptcy laws to steal from his former wife. 7 BRA94 instructed bankruptcy courts not to discharge any debts resulting from a divorce settlement that would result in a benet to the debtor that outweighs the detrimental consequences to a spouse, 4 Johnson (1997) contains a detailed discussion of changes under BRA94 and their motivations. 5 Alexander (1994, p. 360): The advantage for the debtor arises because Congress clearly intended, in drafting the Code, to provide debtors with a fresh nancial start. 6 Bello (1993, p. 645). Bello (1993) also provides contemporary analysis of the legal environment surrounding marital support cases. 7 Farrey v. Sanderfoot (In re Sanderfoot), 899 F. 2d 598, 607 (7th Cir. 1990) (Posner, J., dissenting), revised, 500 U.S. 291 (1991). This case was almost certainly the most publicized of all divorce cases involving bankruptcy - see Margolick (1991) for a contemporary newspaper article. 5

7 former spouse, or child of the debtor. 8 BRA94 also roughly doubled the previous federal exemption levels and prompted a number of states that had opted out of the federal statute to increase their own exemption levels in response. BAPCPA declared that under Chapter 7 bankruptcy, any debt incurred by the debtor in the course of a divorce or separation or in connection with a separation agreement, divorce decree or other order of a court of record would not be considered dischargeable and limited a debtor's ability to engage in prebankruptcy planning by empowering judges to reverse any asset transfers between exemption categories made shortly before the bankruptcy ling. 9 3 Model I develop a simple one-period framework, building on the work of Kotliko and Spivak (1981), to describe the eects of changes in bankruptcy exemption levels on the utility of being divorced relative to remaining married. 10 All individuals begin married. 11 Utility functions are strictly increasing and strictly concave in both consumption, c i, and match quality with spouse θ i, i = (h, w). Match quality is a random variable with known distribution. At the beginning of the period, each partner receives a realization of match quality and decides whether to declare divorce. After making this decision, individuals learn Y i, the present value of their assets and income in that period. A household consists of either two married partners or one divorced individual. All married households carry debt with present value 2T and may declare bankruptcy at no cost, keeping any assets below exemption level βe, where E is the exemption level available to a single individual and 1 β 2 is a multiplier representing the fact that the exemptions available to married households are higher in many states. Following the empirical results of Gropp et al. (1997) and Lin and White (2001), I assume 8 11 U.S.C. Ÿ523(a)(15)(A), U.S.C. Ÿ523(a)(15)(5), There are also many bargaining models of marriage, with the Nash bargaining models of Manser and Brown (1980) and McElroy and Horney (1981) being among the most prominent. Using a Nash bargaining model does not change the intuition of the results presented here. 11 This assumption ignores the potential eect of exemption levels on the probability of getting married. I address this issue in Section 6 below. 6

8 that the amount of debt that a household can carry is a function of the state exemption level, so T = T (βe). For simplicity, I assume that there are only two possible asset levels, so Y i { Y L, Y H}, where βe < Y L < Y H. I further assume that a divorced household will declare bankruptcy if it receives a low asset value while a married household will only declare bankruptcy if both spouses receive low asset values, so 2Y L 2T < βe < Y L + Y H 2T. I denote the probability of receiving each asset value by p j, j = (H, L). Within marriage, I assume that asset transfers are costless. This implies that the couple will always consume on the Pareto frontier of possible utility values for each partner, with the exact point determined by relative bargaining power of the spouses within the marriage. This also means that divorce will only occur when there is no point on the frontier that oers both partners a utility level higher than they would receive in divorce. Thus, a married household solves max c h,c w if it does not declare bankruptcy and U h (c h, θ h ) + αu w (c w, θ w ) s.t. c h + c w Y h + Y w 2T max c h,c w U h (c h, θ h ) + αu w (c w, θ w ) s.t. c h + c w βe otherwise, where α > 0 represents the relative bargaining power of the two married individuals. Let ( ) c NB h, c NB w denote the solution if the couple does not declare bankruptcy and ( ) c B h, c B w denote the solution if they do. If either spouse chooses divorce, then each former partner solves the trivial problem max c i U i (c i, 1) s.t. c i Y i T if the individual does not declare bankruptcy and max c i U i (c i, 1) s.t. c i E 7

9 otherwise. 12 Here, it is clearly optimal for the individual to consume Y i T if not declaring bankruptcy and E otherwise. 13 Now consider the eect of an increase in E, the bankruptcy exemption level, on the utility values of divorce and marriage. For i, the value of being married with a given match quality θ i is given by m i = p 2 L U i ( c B i, θ i ) + ( 1 p 2 L ) Ui ( c NB i, θ i ) (1) while the value of being divorced is given by d i = p L U i (E, 1) + (1 p L ) U i (Y i T, 1). (2) E appears in both explicitly in d i and implicitly in the value of marriage through its eect on ( c B h, cb w). For concreteness, I assume that each individual's utility function is a standard Cobb-Douglas function of the form U i (c i, θ i ) = c γ i i θ1 γ i i with 0 < γ i < 1. Under this assumption, taking the derivative of Equations 1 and 2 with respect to E yields m ( i E = ( ) ) p2 L γ i c B γi 1 i θ 1 γ i i β cb i E (3) and d i E = p L (γ i E γ i 1 ) (1 p L ) (γ i (Y i T ) γ i 1 ) β T E, (4) which we can compare to determine how changes in bankruptcy exemption levels aect divorce rates. Specically, if d i E value of marriage whenever E increases. > m i, then the value of divorce increases relative to the E With less joint surplus available for a married 12 I normalize the distribution of the match quality parameter such that θ i > 0 and for single individuals, θ i is set to I ignore here any issues raised by property division laws by assuming that each individual keeps only his or her own assets after getting divorced and that all debts of the married households are joint. I address this concern in Section 6 below. 8

10 couple to divide, there are now a greater range of θ i values that will cause the partners to prefer divorce. In the context discussed above, a low asset value realization can be thought of as a fall in home prices and the risk-sharing motive for remaining married is rendered less important by the higher guaranteed level of consumption oered by the higher exemption level. Determining which derivative is larger and whether marriages become more fragile when bankruptcy exemption levels increase is thus an empirical question. Comparing Equations 3 and 4, d i > m i E E implies p L (γ i E ) γ i 1 (1 p L ) (γ i (Y i T ) ) γ i 1 β T ( E > ( ) ) p2 L γ i c B γi 1 i θ 1 γ i i β cb i E or ( ) 1 γi 1 > p L β cb i E E ( θi c B i ) 1 γi ( ) (1 pl ) β + p L (Y i T ) 1 γ i T E. (5) From previous empirical estimates, I assume that T E < 0.14 It can be shown that 0 < cb i E < In Equation 5, all three terms grow smaller when E increases, taking into account changes in the equilibrium values of c B i, T, cb i T, and. Equation 5 is also consistent with E E the eects of the housing market decline under the interpretation of p L as the probability of getting a low house price. As p L increases, it is more likely that d i E more likely to stay together as E increases. < m i, so couples are E If the inequality in Equation 5 is satised, then the value of divorce increases relative to the value of staying married in response to an increase in exemption levels. This inequality can be tested in the data by determining if divorce rates increase when exemption levels rise. This simple model captures the most salient elements of the interaction between uncertain asset values, exemptions, and the divorce decision. 14 See Lin and White (2001, p. 155) and Gropp et al. (1997, p. 220) for empirical evidence supporting this assumption. 15 See Appendix for a discussion of the properties of cb i E. 9

11 4 Empirical Model and Data The reduced-form model I estimate is given by divrate it = α + δ T otalexemption it + κ (T otalexemption it ) 2 + π X it + µ t + η i + ζ i T rend + ξ i T rend 2 + ɛ it (6) Here, divrate is the number of divorces in state i during year t per 1000 married persons. TotalExemption is the sum of the real homestead and nonhome exemptions available to married couples under the assumption that doubling of exemptions is allowed unless specically prohibited measured in units of $10,000 and adjusted to constant 2007 dollars using CPI data from the Bureau of Labor Statistics. X it represents other control variables discussed below. µ t is a year xed eect and η i is a state xed eect, while ζ i T rend and ξ i T rend 2 are state-specic linear and quadratic time trends. This regression form is similar to those used by Friedberg (1998) and Wolfers (2006) to analyze the impact of unilateral divorce laws on the divorce rate and by Berkowitz and Hynes (1999) to study the eect of bankruptcy exemptions on mortgage rates. Under this empirical model, identication of the eect of the bankruptcy exemption levels comes from variation within individual states over time. If there were no changes in bankruptcy exemption levels, the vector of exemption levels would be perfectly collinear with the state xed eects. Thus, the state xed eects control for dierences between states in exemption levels, while the exemption variables control for the eects of changes within states in exemption levels. The state xed eects also control for any state specic characteristics that may aect divorce rates and are constant over time, including separation and residency requirements, while year xed eects capture any unobserved national changes in divorce propensity To check the appropriateness of using this estimation strategy for this analysis, I also estimate a version of Equation 6 including leads and lags of bankruptcy exemption levels to determine if state divorce rates respond to future exemption levels. I nd that only past and contemporaneous exemption levels signicantly aect the divorce rate, which I interpret as evidence in favor of this research design. Results are available 10

12 I choose the sample period, 1989 to 2005, to avoid complications created by changes in bankruptcy laws that raise potential issues of policy endogeneity or alter the nature of bankruptcy. Hynes et al. (2004) claim that a state's decision to opt out of the federal exemption levels may be correlated with a number of other variables such as the state bankruptcy ling rate and the generosity of the state's assistance programs for the poor, which is potentially problematic for this study given the relationship between income transfers to the poor and the willingness of individuals to leave a risk sharing arrangement such as marriage. I begin my sample in 1989 since no state opts out after this time. Similarly, if there are substantial changes in how debtors may use exemptions in the bankruptcy process, then the level of insurance oered by exemptions is not well captured by their dollar amount. The 2005 BAPCPA reform made pre-bankruptcy planning more dicult, so consumers are less able to move assets between exemption categories after this time. Since this change makes the assumption of fungibility of assets less viable, I end the sample for analysis in Another potential concern is that divorce rates and bankruptcy exemption levels may be jointly determined by a third factor, such as the rate of bankruptcy lings in the state, or that policymakers change exemption levels in response to changes in the state divorce rate. Hynes et al. (2004, p. 31) examine potential determinants of state exemption levels from , including the state divorce rate and bankruptcy ling rate, and nd that the only robust predictor of exemption levels... was historic levels of exemptions. 18 Fay et al. (2002, p. 709) argue that exemption levels should be treated as exogenous with respect to bankruptcy ling rates because states change their exemption levels only rarely - mainly to correct nominal exemption levels for ination, and this intuition also applies for why exemption levels can be considered exogenous with respect to divorce rates. Over , there were upon request. 17 See Edmiston (2006, pp ) for a summary of relevant changes brought about by BAPCPA. This sample period does contain BRA94, which altered the types of debts that result from divorce that may be discharged in bankruptcy. As this was a national law change, much of the eect of the reform will be captured by year xed eects included in the regression. I examine one potential source of cross-state variation in the eect of this provision of BRA94 on state bankruptcy laws in Section 6 below. 18 I conrm in my sample that the state divorce rate, including lagged values, is not a statistically signicant predictor of the state's exemption level. Results are available upon request. 11

13 a total of 112 changes in the nominal total value of state exemption levels, an average of 6.6 changes per year. Since it does not appear that exemption levels are determined directly by the divorce rate nor through a third factor such as bankruptcy lings per capita, I treat exemption levels as exogenous with respect to the divorce rate. I obtained data on state bankruptcy exemption levels from state statutes for the years The homestead exemption is simply the amount listed in each year, which is unlimited in some states. I ignore any conditions on lot size or location for the homestead. I construct the total nonhome exemption level by adding together all allowable exemptions for cars, personal possessions, tools of trade, bank deposits, and wildcard exemptions. I omit any explicit exemption amounts for clothing or household goods, as well as any insurance, burial plot, or pension exemptions. These items are not subject to value limits in many states or have specic beneciary requirements and therefore do not have easily quantiable changes in value over time. This formulation of the nonhome exemption is comparable to that used by Gropp et al. (1997) and Berkowitz and Hynes (1999). Table 1 lists both the homestead and nonhome exemption levels for singles in nominal terms for all states in 1989, 1995, and These years mark the beginning and end of the sample as well as the year immediately following the passage of BRA94. In most states in this sample the homestead and nonhome exemption levels rise over time, both in nominal and real terms. Since the model presented above relies on the inuence of bankruptcy exemptions on divorce values, I calculate the available exemptions in three dierent ways. Many states have laws explicitly allowing married couples to exempt a larger amount than a single person, while others have expressly disallowed married couples to double the available exemptions. In other cases, there is no specic court ruling determining whether a couple may double an exemption. I therefore calculate the exemption level in a state under the assumption that all exemptions may be doubled unless explicitly disallowed. 19 Table 1 lists whether a state 19 As a sensitivity check, I also calculate exemption levels under the assumption that only exemptions explicitly allowed may be doubled and exemptions levels as they apply to single individuals, ignoring any possible doubling. In the context of the theoretical model, these alternative calculations allow for changes in β. The results below are qualitatively unchanged under these alternative measures of exemption levels, 12

14 allowed married couples a larger homestead exemption than singles in I then create the total exemption level by combining the total amounts of the homestead and nonhome exemptions under the assumption that assets are generally fungible across the two categories. Many states, including Georgia, Nebraska, New Mexico, New York, North Dakota, Vermont, and Virginia, oer substantial cash or wildcard exemptions that can be used in place of a homestead exemption, or follow the federal exemptions in allowing a debtor to claim any unused portion of the homestead exemption as a wildcard, possibly up to some predetermined dollar limit. 20 Even in states without such explicit rules, Bello (1993, p. 655) supports the legal validity of the assumption that exemptions may be combined, claiming that pre-petition planning that enables a debtor to convert property into the type of property that will be exempt... is generally allowed. I obtained data on the number of divorces within a state from the Vital Statistics of the United States and the percentage of the population over age 15 currently married from March Current Population Survey supplements for years for all fty states and the District of Columbia. While using individual level data that contains divorce information might be preferable due to the availability of other characteristics thought to be correlated with divorce rates such as education, age at marriage, or presence of children, I use state level data to avoid potential problems including the possibility that getting divorced is correlated with dropping out of the panel and the small sample sizes in most available panel data sets. Figure 1 shows the federal divorce rate during this period. Due to irregularities in state reports, not all states have an ocial divorce rate in all years. Table 2 lists the average divorce rates per 1000 married persons for each state from I also list the years for which divorce data are available for each state. 21 In and in no case is the point estimate of the eect of exemption levels outside the 95% condence interval of any other point estimate. The results in Table 3 use the highest eective value of β and are the most conservative estimates of the eect of changes in bankruptcy exemption levels on divorce rates. 20 See Elias et al. (2005) for an exhaustive list of state exemptions and the conditions under which they may be combined. 21 If data do not exist for a state for some years within an interval, I report the average divorce rate of the years for which data exist. 13

15 general, the divorce rate is falling over this sample period in the vast majority of states, as is the national average. Several states have unlimited household exemptions. Since the majority of the states with unlimited household exemptions are adjacent to the Mississippi River, I present results for samples using only states with dened homestead exemptions and the full sample of all states. I do this to control for possible policy endogeneity, as individuals have a limited ability to select more favorable divorce or bankruptcy laws by satisfying residency requirements. 22 Since it is easier to satisfy such requirements in neighboring states, the choice of each state to continue to oer an unlimited exemption may be related to the decision of neighboring states. I assign a nominal value of $500,000 for the homestead exemption in states with unlimited exemptions, following the precedent established by Berkowitz and Hynes (1999). 23 In states that allow their residents to choose between using state exemptions and federal exemptions, I assume that individuals choose the federal exemptions if the total value of the federal exemptions (homestead plus nonhome) exceeds that of the state exemptions. To control for contemporaneous economic conditions in each state, I include real personal income as obtained from the Bureau of Economic Analysis, along with the state unemployment rate from the BLS and the real median state house price from the Census Housing Tables and Federal Housing Financial Agency's all-transactions index. 24 I also include the state homeownership rate, reported by the Census Bureau, as a measure of economic wealth and because exemption levels are generally higher for homeowners. I then add each state's population percent black, percent Hispanic, and percent between ages 15 and 64 as demo- 22 For divorce laws, Nevada's very low residency requirements and high divorce rate suggests that individuals do exhibit some selection across states. The main results presented are robust to the exclusion of Nevada. For bankruptcy laws, see Topolnicki and Macdonald (1993) for examples of individuals attempting to use dierent bankruptcy laws to skirt repaying creditors. 23 Berkowitz and Hynes (1999) try several dierent values for the homestead exemption in unlimited states, including $1,000,000, $750,000, $500,000, and $250,000. Using these alternative values does not substantively change the results presented here. I present results using a dummy variable for unlimited exemption states in Section 6. Also note that when determining the exemption level available to married couple, I do not double the nominal amount in unlimited homestead states. 24 The BEA denes personal income as income received by persons from participation in production, from government and business transfer payments, and from government interest. (Ruser et al., 2004, p. 1) 14

16 graphic controls. To capture state laws that may aect divorce rates, I add dummy variables for whether a state has child custody guidelines, whether judges are permitted to consider marital fault when determining property division or maintenance payments, and whether a state allows covenant marriage. Each of these variables is taken from the year-end review of family law changes in Family Law Quarterly and has been considered as a possible determinant of divorce rates in the literature. 25 I include other measures of each state's social insurance programs designed to assist individuals with low income. I use the real maximum AFDC/TANF payment as reported in the Green Book of the U.S. House Committee on Ways and Means and real maximum earned income tax credit calculated from NBER TAXSIM and the Brookings Institution Tax Policy Center. All control variables measured in dollars are adjusted for ination to constant 2007 dollars using the CPI. 5 Empirical Results Table 3 reports the estimation results from Equation 6 using the exemption levels available to married couples assuming that all exemptions available to singles may be doubled unless specically disallowed. Specications (1)-(4) use a sample of states with dened homestead exemptions while (5)-(8) are estimated over the full panel of states. All estimates are performed using weighted least squares, where each observation is weighted by the contemporaneous married population of the state. The weights ensure that the changes in bankruptcy exemptions that aect the most people are given the most importance in the estimation. Since changes in state bankruptcy exemption levels can be prompted by changes at the federal level, estimates from the weighted specication may be more relevant to federal policymakers. In both the dened homestead and full samples, the coecients on the bankruptcy exemptions decline in absolute value as additional controls are added, but no 25 For more information on the laws, see Elrod and Spector (2006) and previous years. Nixon (1997) explores the link between divorce and child support payments, which are determined in part by custody decisions. Brinig and Buckley (1998) look at the eect of no-fault settlements on divorce rates, while Matouschek and Rasul (2008) discuss covenant marriages as part of a marriage contract. 15

17 set of estimates of the exemption coecients is outside the condence interval of any other set of estimates. Thus, the estimates are robust to the inclusion of a variety of additional control variables. In all specications, the coecient on the total exemption value is positive and the coecient on its square is negative, indicating that increases in exemption levels lead to increases in the divorce rate with a diminishing marginal eect. Table 4 provides context for the magnitude of these estimates. Weighting each state's exemption level by its married population, the mean total exemption level for states with a dened homestead exemption was $53, in 1989 and $79, in 2005, while the mean for all states was $106, in 1989 and $160, in 2005 when unlimited exemptions are set to $500,000. Using the estimates from column (4) of Table 3, these results indicate that if a state with a dened homestead exemption increased its total exemption level from $53, to $79, between 1989 and 2005, this would lead to an increase of in the 2005 divorce rate. Since the national divorce rate in 2005 was 6.38 divorces per 1000 married persons, the mean increase in bankruptcy exemption levels is associated with a 1.46% increase in the mean divorce rate. Turning attention to the full sample of states and using the coecients from column (8) of Table 3, I estimate that increasing exemption levels from $106, to $160, between 1989 and 2005 leads to an increase of in the 2005 divorce rate, a 2.37% increase. This eect size is approximately the same as Wolfers (2006, p. 1814) attributes to unilateral divorce laws a few years after their introduction. While the eect of the introduction of unilateral divorce laws on the divorce rate has decreased over time, continual increases in bankruptcy exemption levels make the estimates of the eect size larger as time passes. Over the sample period, I estimate that more than 200,000 additional divorces have occurred in the U.S. as an unintended consequence of increases in bankruptcy exemptions. As I have used the specications with the smallest estimated coecients, this should be interpreted as a conservative estimate. Overall, the results presented in Table 3 and subsequent analysis show that increases in bankruptcy exemption levels over the sample period led to increases in the divorce rate and a sizable number of additional divorces. 16

18 6 Sensitivity Analysis As noted above, the model oers other testable implications and ignores several potentially important aspects of the divorce decision, including the inuence of dierent property division laws and the eect that exemptions have on the initial choice to marry. These omitted features may bias the estimates of the impact of exemption levels. To investigate these alternatives, I use the general regression form divrate it = α + δ T otalexemption it + κ (T otalexemption it ) 2 + ψ T otalexemption it Dummy i + φ (T otalexemption it ) 2 Dummy i (7) + π X it + µ t + ν t Dummy i + η i + ζ i T rend + ξ i T rend 2 + ɛ it where Dummy i is a dummy variable equal to 1 if state i has a particular characteristic of interest. Specically, I use dummies for states with community property laws, unlimited homestead exemptions, and unilateral divorce laws. Under this specication, ψ and φ estimate the dierence between the eect of a given variables in states with a specic characteristic and states without. I determine whether these dierences are signicant using F-tests on the hypothesis that the bankruptcy interaction coecients ψ and φ are jointly 0. I report all results for all sensitivity checks in Table Community Property Laws In the context of bankruptcy, one particularly important aspect of a divorce is the division of marital assets. In a state with community property laws, all assets and debts acquired during a marriage are considered to be equally the property of both spouses. In addition, most property that individuals owned prior to the marriage is considered community property after a specic period. Upon divorce, community property states are more likely to award spouses equal shares of marital assets than other states. This aects the value of divorce for both partners directly by changing their income levels and indirectly by making income 17

19 levels more or less certain. If a judge has great latitude in dividing the equity in the marital home, then both spouses face additional risk in declaring divorce as they are less able to predict their asset levels after divorce. Community property laws have a theoretically ambiguous eect on the divorce rate, as changing the division of marital assets will increase the utility of divorce for one partner while lowering it for the other relative to another legal regime. However, the division of property after divorce is more predictable, as judges have less discretion when deciding settlements. As in the theoretical model, the newly single individuals still face uctuations in asset values after divorce. With a more accurate estimate of their asset levels after divorce, individuals can better assess how much insurance is oered by exemption levels. For example, an individual who knows he will receive so many assets that declaring bankruptcy is a remote possibility will not be oered much insurance by exemption levels, while someone who knows he will receive few assets may nd exemption levels very relevant to his divorce decision. In this sense, exemption levels are a cleaner measure of available social insurance when uncertainty has been removed from marital asset division. Community property states also provide an opportunity to evaluate the importance of the divorce debt reforms included in BRA94. As discussed above, BRA94 restricted the ability of debtors to use bankruptcy to discharge debts acquired in divorce settlements. Since the division of debts between spouses is dierent in community property states than in others, this provision of BRA94 may have a dierent eect in community property states. If so, there should be a signicant coecient on the interaction between the year dummy and the community property dummy in the years after BRA94. Table 1 lists the states with community property laws. I dene CP i to be 1 if a state has community property laws and present results in columns (1) and (2) of Table 5. In states with dened exemption levels, the hypothesis that the coecients on the interactions are jointly zero is rejected and the marginal eects of changes in bankruptcy exemptions on divorce rates are larger in community property states than states without such laws. In the 18

20 sample of all states, I nd no dierential eect in community property states, and the point estimates on the interaction variables falls by roughly half. Across both regressions, of all the interactions between year dummies and the community property dummy, only the 1992 interaction is statistically signicant. As there appears to be no dierential eect in the year dummies after passage of BRA94, I interpret this as evidence that the divorce debt provisions of this law did not meaningfully alter the relationship between divorce rates and bankruptcy exemptions levels. The signicance of the interaction between community property laws and bankruptcy exemption levels shows that individuals do nd exemption levels relevant after an even division of all marital assets, so the results in this paper are not driven by the relevance of state exemption levels to divorce settlements that leave one spouse with a very small asset level. I interpret the lack of statistical signicance and smaller estimated interaction eects when including the unlimited exemption states as evidence that in unlimited exemption states, the additional insurance provided by the equality of distribution is small compared to the large size of the available exemptions. For dened exemption states, the larger estimated eect of exemption levels on divorce rates in community property states is evidence that exemption levels aect divorce rates by changing the amount of available social insurance, a substitute for the insurance oered by marriage. 6.2 Unlimited Homestead Exemptions In the main results, states with unlimited homestead exemptions were assigned a nominal value for the homestead exemption, and changing this value does not qualitatively alter the main results. However, the main results also suggest that the marginal eect of changes in exemption levels on divorce rates falls as the exemption level rises, and this result may be sensitive to the nominal value assigned to unlimited homestead states. To test whether the marginal eects of increases in exemption levels are dierent in states with unlimited homestead exemption than in states with dened homestead exemptions, I dene UnlimHome i 19

21 to be 1 if a state has an unlimited homestead exemption and present results in column (3) of Table 5. This approach also has the benet of producing estimates of the eect of increases in exemption levels on divorce rates that do not require a specic choice of the nominal exemption value assigned to unlimited homestead states. With the additional controls included, the coecients on the interacted exemption variables are not signicant. This indicates that changes in bankruptcy exemption levels do not have a signicantly dierent eect on the divorce rate in states with unlimited homestead exemptions. This result also provides evidence that the estimated diminishing marginal effect of exemption level increases on the divorce rate is not sensitive to the nominal value assigned to unlimited homestead exemptions. 6.3 Unilateral Divorce The model in Section 3 assumes that the decision to divorce can be made unilaterally by either spouse, a potentially restrictive feature of the model. To investigate whether the presence of unilateral divorce laws alters the extent to which bankruptcy exemption levels aect divorce rates, I use Unilat i, a dummy equal to 1 if divorce in a state requires the consent of only one spouse and is granted on no-fault grounds based on the coding in Friedberg (1998, p. 613). 26 Columns (4) and (5) of Table 5 contain the results. Under both specications, I reject the hypothesis that the marginal eect of an increase in exemption levels is dierent in unilateral divorce states. This result shows that the estimated eect of bankruptcy exemption levels on divorce rates is not aected by a prominent characteristic of state divorce laws. 26 While there is some debate as to how to properly dene unilateral divorce, Wolfers (2006) shows that estimates of the eect of unilateral divorce laws on the divorce rate are similar across seven dierent coding schemes. 20

22 6.4 Marriage Rates One hypothesis not captured by the model is that if individuals are suciently forward looking to consider the possibility of declaring bankruptcy after divorce, these same individuals would likely consider this possibility before entering marriage. This yields a potential alternative explanation for the results presented here: if increases in exemption levels are associated with increases in the marriage rate, then these marginal marriages might be especially vulnerable to match quality shocks, resulting in a higher divorce rate. If this alternative is true, then the data should show that an increase in marriage rates is associated with an increase in bankruptcy exemption levels. I test this hypothesis using marriage data from the Vital Statistics of the United States over by replacing the divorce rate per 1000 married persons with the marriage rate per 1000 total population as the dependent variable in Equation 6 and present results in columns (6) and (7) of Table 5. In both specications, the coecients on the bankruptcy exemption levels fail to be signicantly dierent from zero at any conventional level. 27 Thus, I nd no evidence that changes in exemption levels are associated with changes in marriage rates and thereby aect the divorce rate. 7 Conclusion This paper investigates the eect of bankruptcy exemption levels on divorce rates, exploring the relative level of insurance oered by marriage as a determinant of divorce not previously considered in the literature. I present a simple theoretical model of divorce decisions and uncertain asset values in which marriage allows individuals to share risk. My empirical strategy identies the eect of increases in exemption levels on divorce rates by exploiting exogenous within-state variation in exemption levels over time. Under the assumption that debtors can plan before bankruptcy to take full advantage of both homestead and nonhome 27 As marriages are measured by state of occurrence, not state of residence of those getting married, I also run these regressions excluding Nevada, which has an extremely high marriage rate due to lax marriage laws. The results in Table 5 are robust to the exclusion of this outlier. 21

23 exemptions by moving assets between the two categories and that married debtors can double any exemption level they are not specically prohibited from doing so by law, I nd that increases in exemption levels are associated with increases in divorce rates and estimate that exemption increases across the U.S. between 1989 and 2005 led to approximately 200,000 additional divorces over this period. I perform a variety of sensitivity tests on this specication to address aspects of the divorce decision neglected by the theoretical model, showing the dierential eects that changes in bankruptcy exemptions can have under various divorce laws and that the divorce debt provisions of BRA94 did not meaningfully aect the estimated relationship. I also show that bankruptcy exemptions do not aect the divorce rate by altering the marriage rate. Ultimately, I nd that the cumulative eect of the increases in exemption levels over this sample is to raise the divorce rate per 1000 married persons approximately percentage points, a 2.37% increase over its 2005 level, with the magnitude growing larger each year. This eect size is similar to that of other changes in divorce laws thought to be more immediately relevant to divorce rates, such as the introduction of unilateral divorce. As such, the increase in the divorce rate is a sizable unintended consequence of the changes in bankruptcy exemption levels. 22