California leads the nation in household debt. According to the Federal Reserve’s most recent Quarterly Report, the average level of debt in California for an individual with a credit history is over $70,000. Most of this debt consists of home mortgage loans, but about $10,000 per person consists of unsecured loans such as credit card debt and student loans.
Individuals and families who are struggling to make ends meet prioritize their mortgage and rent payments in order to avoid foreclosure and eviction. As a result, the amount of delinquent debt—for which payments are 30 days or more late—is closely related to the amount of unsecured debt. When workers fall behind on their unsecured debt, creditors can obtain a court order to deduct loan payments directly from a worker’s paycheck. In this weak economy, thousands of workers face such wage garnishments.
To protect low-income workers, federal law exempts from garnishment the first $217.50 of earnings a week ($11,000 annually). This is the federal minimum wage for a thirty-hour workweek. But this leaves very little income for an individual, much less a family, to purchase even the most basic necessities. The 2012 federal poverty level for an individual is $11,170 a year and estimates by the Bureau of Economic Analysis suggest that that the cost of living in California is at least 20% higher than the national average.
A bill on wage garnishment, AB 1775, recently signed into law by Governor Brown, gives California workers some much-needed relief. The new law increases the amount of a worker’s paycheck that is exempted from garnishment to $320 a week. This is the amount that a minimum wage worker would earn in California in a forty-hour workweek. The bill was sponsored by the Western Center for Law and Poverty and was introduced by Assembly member Bob Wieckowski, a former bankruptcy attorney. The California Association of Collectors and the California Bankers Association opposed it.
Opponents argued that debtors should take personal responsibility for their obligations or declare bankruptcy. But these critics are mistaken in their view that the law removes a worker’s contractual obligations. Raising the exemption level does not forgive a penny of debt. It only provides a more humane schedule of repayment.
Raising the exemption level makes good economic sense. Opponents claimed that an increase in the exemption level would reduce the availability of credit, but a modest increase is unlikely to significantly affect the price or availability of credit. The magnitude of the increase is comparable to a California cost of living adjustment to the federal rule.
Raising the exemption level has the benefit, for debtors and creditors alike, of forcing fewer debtors into bankruptcy. A study of credit card debt by researchers at the University of Maryland compared states that follow the federal rule to states such as Texas that ban wage garnishment. In states that ban garnishment, the gains to creditors from lower bankruptcy rates more than offset losses from nonpayment. A similar study by researchers at the Federal Reserve Bank of Chicago found that state garnishment exemptions had no effect on credit card repayments from households with low credit scores.
Raising the exemption level also helps to sustain employment. As of July 2012 California’s unemployment rate stood at 10.7 percent, the third highest in the country. In such an economy, policies that penalize the additional earnings of low-income workers make little sense. A wage garnishment, like most taxes, discourages workers from earning more. Raising the exemption, by contrast, allows low-income workers to take home a larger fraction of their pay.
The new law is not without flaws. It preserves a particularly harsh and unwise feature of federal law. For workers who make more than the exempted amount but below $427 a week, every additional dollar earned goes toward debt collection. There is no reason for such a punitive garnishment schedule in this income range. For example, we all believe an individual should pay his or her taxes, but few believe that a tax rate of 100% on every additional dollar earned is appropriate for a billionaire, much less a low-income worker. Future legislation should modify this punitive schedule
Despite this drawback, the ethics and economics of the new law are squarely on the side of California’s indebted workers. Conflicts over the state and national debt will continue to dominate the political scene, but wage garnishment teaches us several important lessons. Household debt overhang presents a large obstacle to our economic recovery. Debt can be rescheduled so that a greater fraction of repayment occurs when the economy recovers. It serves neither justice nor prosperity to demand repayment faster than is necessary.
(Disclosure: I provided written and oral testimony in support of the bill to the CA Senate Judiciary Committee and the Governor’s office on behalf of the bill’s sponsors.)
[Editor’s note: This is the first in a series of posts designed to expand The Network beyond student-generated content. Professor Krishnamurthy joined the Berkeley Law faculty in 2010. He graduated from Yale Law School and holds an M.A. and Ph.D. in economics from UC Berkeley. His research interests include financial regulation, antitrust and competition policy, law and development, and distributive justice.]