Credit Unions Can't Be Taxed If They Don't Exist

After enduring months of salvos from the banking industry, credit unions are fighting back.

This video from the Credit Union National Association, one of the industry’s two major trade groups, launches credit unions’ campaign to enlist their 96 million members nationwide to beat back lobbying efforts by the American Bankers Association and the Independent Community Bankers of America that would strip them of their tax-exempt status.

Credit unions have been exempt from the federal income tax ever since it was created in 1916 by the 16th Amendment, on grounds that they are “organized and operated for mutual purposes and without profit.”

This reliance on community bonds and mutual interest has allowed credit unions to serve populations that historically have had difficulty accessing bank credit, whether it be immigrants and other individuals of more modest means (highlighted in CUNA’s video by the striking fact that, though 40% of Americans belong to a credit union, they hold only 6% of the country’s financial assets) or particular small business niches that banks have tended to eschew (in recent years, credit unions have had notably strong penetration among organic farms and taxi drivers, for instance.)

And for as long as credit unions have enjoyed their exemption, banks have been lamenting it as an “unfair” advantage. The charge does not stand up to scrutiny. An April report from Yang Liu and Richard Anderson of the Federal Reserve Bank of St. Louis examined whether credit unions’ tax exemption offered them a competitive advantage over banks, and found that the “evidence does not permit any sharp conclusions.”

Over the past two decades, Liu and Anderson found, the number of banks and credit unions have both declined and their total assets have both increased. Moreover, the relative proportion of assets held by credit unions has remained steady, even following federal legislation in 1998 to loosen membership requirements. The economists did find evidence that member business lending by credit unions displaced some bank lending, but also noted that “credit union lending has been steadier through business cycles, including the recent financial crisis.”

Nonetheless, with Congress engaged in a seemingly endless round of budget “crises” – both real and manufactured – and with the leadership of both of Congress’ tax-writing panels publicly committed to working on a major tax reform package, credit unions’ tax exemption is back on the table.

A May 6 report to the House Ways and Means Committee that aggregated comments from the various tax reform working groups included commentary on the credit union exemption from two of those groups, one dealing with financial services and the other with charitable and exempt organizations. Both working groups noted the preponderance of comments appeared to favor maintaining the tax exemption for state and federal credit unions, but the working groups also heard input from a number of interested parties who favor scrapping it.

The biggest of these, of course, is the ABA. The bankers launched their offensive earlier this year, with a billboard campaign in the Washington, D.C. area and print ads like this one that appeared in Politico. The ad reads:

Today credit unions are a $1 trillion industry that pays no income tax. That’s nearly $2 BILLION every year that could help shrink the federal deficit. Now, credit unions want even more perks. Enough is enough. It’s time to end credit unions’ indefensible and outdated special treatment.

The $2 billion figure is the ABA’s own invention, and far overstates what federal officials have found as the purported “cost” of the tax exemption. President Barack Obama’s proposed Fiscal Year 2014 budget estimates the cost of the exemption at $1.44 billion in 2012, which is by far the largest estimate from any independent agency.

In April, the Government Accountability Office released its annual corporate tax expenditures report, which put the exemption at $1.1 billion.  Meanwhile, the Joint Committee on Taxation finds the revenue lost because of the exemption to be just $500 million in both 2012 and 2013.

Of course, in order to tax credit unions, they have to continue to exist. The federal reports all operate from the baseline assumption that taxation would have relatively small impacts on the number of credit unions or their total assets. Part with that baseline assumption, and the analysis is quite different.

Thus a September 2012 report from the National Association of Federal Credit Unions found that eliminating the credit union tax exemption would actually cost the federal government $15 billion in lost tax revenue over the next decade, in addition to costing the U.S. economy $148 billion in lost gross domestic product and 1.5 million in lost jobs.

NAFCU’s analysis is premised on their estimate that credit unions benefit consumers by $10 billion annually. And it’s not just their own members who benefit; bank customers likewise benefit from lower fees, lower interest on loans and higher interest on savings, thanks to the competition that credit unions provide.

CUNA calculates similar (albeit somewhat more modest) effects. According to CUNA’sestimates, credit union members enjoyed $6 billion of benefits in 2012, while the moderating impact of credit union competition benefited bank customers by roughly $2 billion. All told, CUNA says, for every $1 in new credit union taxes, the government wipes out $10 in credit union benefits

Even if one is skeptical of the trade groups’ calculations, there can be no question that taxing credit unions would force most to reconsider the value of continuing to be organized as not-for-profit institutions. It is likely that many would convert to banks, and among those who did not, there are any number of ways for a mutually owned company to reduce “income” simply by increasing member benefits.

For credit unions with more than $1 billion in assets – that is, those who operate most like banks already – conversion would simply make financial sense, and many of these institutions already have at least considered conversion or have conversion plans drawn up as a contingency. Small credit unions are also likely to consider conversion, but for an entirely different purpose. Just like thousands of small banks already do, small credit unions could reorganize under Subchapter S charters, and thus continue to be exempt from federal income taxes.

If any group is likely to remain chartered as not-for-profit credit unions, it is the group of mid-sized institutions that historically have been most committed to serving lower-income consumers. Given the overwhelming research about the difficulties this segment of the population faces in finding appropriate financial services – a recent Pew reportestimates 12 million U.S. borrowers spend $7.4 billion on payday loans each year – it truly would be unfortunate to add new burdens on those institutions that offer them the best alternatives.

There is, of course, another way to settle the issue: Scrap the corporate income tax altogether. But that’s an argument for another day.