Debtor protection, credit redistribution and income inequality

A debtor-friendly personal bankruptcy regime reallocates credit by reducing its availability, particularly for low-asset individuals. We show that increasing the amount of asset protection in bankruptcy leads to higher income inequality. The rise in inequality is amplified in industries with high credit needs and is triggered by an increased income gap among self-employed individuals. We also find an increase in income inequality among salaried workers, which is explained by a drop in the wages and working hours of unskilled workers. Debtor protection thus creates an imbalance in economic opportunities among business owners that reduces the aggregate demand for unskilled labor.