Personal Bankruptcy and Wage Garnishment

Contrary to Chapter 7 bankruptcy in the U.S., many European bankruptcy regimes are stricter and force bankrupts to repay some outstanding debt through wage garnishment. Since wage garnishment raises the efective marginal tax rate, it distorts labor supply. Explicitly modeling the garnishment period and endogenizing labor supply, this paper examines the optimal garnishment regime for Germany: optimal garnishment rates are 18 percentage points lower and the garnishment du-ration increases from six to ten years. Consequently, repayment during bankruptcy increases and interest rates fall. Welfare improves by 3.3%. Low-income households gain the most due to better access to cheaper credit.