Bad Data, Bad Bankruptcy Law?

Flawed statistics underpin the new bankruptcy legislation that takes effect in October.
Stephen TaubJuly 7, 2005

How often do small-business owners file for bankruptcy? And how have those figures — which vary considerably — affected U.S. bankruptcy law?

Official U.S. government data found that about 37,000 small businesses filed for bankruptcy in 2003, according to the Ewing Marion Kauffman Foundation, which supports entrepreneurial education. And since 1986, those data show, business bankruptcies began to decline as a percentage of all bankruptcy filings, dropping to a low of 2.3 percent for the 12 months ended June 30.

And according to The New York Times, Congress wrote the Bankruptcy Abuse Protection and Consumer Protection Act of 2005 based on that very decline in business bankruptcy filings.

In reality, however, owners of small businesses filed an estimated 260,000 to 315,000 bankruptcies in 2003, according to a new research study conducted by professors at Harvard Law School and the University of Nevada, Las Vegas, with support from the Kauffman foundation.

Flawed statistics, the study maintains, underpin the bankruptcy law, which is scheduled to take effect in October. The new law, added the Kauffman report, will unintentionally hurt entrepreneurs more than the intended target: consumers who are unable to pay their credit card bills. As a result, the report continued, the new legislation may deter would-be entrepreneurs from taking risks to start new businesses.

The Kauffman study attributed the government’s undercounting to a computing error. In the mid-1980’s, when the bankruptcy court began to computerize its records, the default setting on the most common software programs counted bankruptcy filers as individuals, according to the Times.

“The data suggest that much of the measurement of the small business economy is simply wrong, and that errors affect every assessment of the strength, number and role of entrepreneurial businesses in the United States,” said Elizabeth Warren, a co-author of the study and a professor at Harvard Law School. “Our economic system needs to encourage entrepreneurs to make new investments. Sometimes these investments will fail through no fault of their owners, and when that happens, the owners need to be able to move to other businesses and create new jobs and investment opportunities.”

Carl Schramm, president and chief executive officer of the Kauffman Foundation, added that “entrepreneurs deserve to know that they will have adequate support and information in all their activities-including the death and rebirth of their enterprises. We need to appreciate the enormous risks that entrepreneurs take on, and the number of times many of them must try, fail, and try again until they hit the right idea at the right moment.”

Many individuals who file for bankruptcy, observed the report, are, in reality, small-business owners using their personal credit to launch or sustain their businesses. “It’s doesn’t divide so neatly into consumer and business bankruptcies,” Jay L. Westbrook, a business law professor at the University of Texas at Austin, told the Times. As many as 20 percent of “consumer” filings may really be business bankruptcies, Westbrook added.

“The model that Congress used for writing the bankruptcy law — a growing number of consumers and a rapidly shrinking number of entrepreneurs and small-business owners — was simply wrong,” Professor Warren told the paper. “It’s bad policy on lots of levels.”

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