In 1934, the Federal Credit Union Act set the foundation for the organization of federal credit unions. A federal credit union was defined as a “cooperative association organized…for the purpose of promoting thrift among its members and creating a source of credit for provident or productive purposes.” The Act also established the basis of government for the federal credit union system. The Bureau of Federal Credit Unions was the supervising body until the National Credit Union Administration (NCUA) replaced it in 1970.
The Act, and periodic amendments throughout the past 80 years, allowed credit unions to form under either state or federal law, and exempted credit unions from income taxation by United States, state or local authorities, due to their status as not-for-profit, member-owned cooperatives, without capital stock. While the U.S. Attorney General declared state-charted unions exempt from federal taxation in 1917, it was not until 1937 that an amendment to the Federal Credit Union act established complete tax-exempt status for federal credit unions and most state-chartered credit unions (some states choose to apply the state corporate tax to state-chartered credit unions).
The Federal Credit Union Act was put into law amidst a major expansion of credit unions. Consumers seeking short-term personal loans looked to credit unions for relatively cheap credit. As decades passed, credit unions, including the newly established federally chartered credit unions, diversified their offerings to include certificates, credit cards and other banking products. With the transition to the National Credit Union Administration in 1970 came the establishment of the National Credit Union Share Insurance Fund, which was created with the support of credit union funds and provides deposit insurance for the members of insured credit unions. Rapidly growing membership interest through the 70’s and 80’s encouraged a loosening of credit union membership criteria. In 1998, Congress passed the Credit Union Membership Access Act, which confirmed that credit unions “are exempt from Federal and most State taxes because they are member-owned, democratically operated, not-for-profit organizations generally managed by volunteer boards of directors and because they have the specified mission of meeting the credit and savings needs of consumers, especially persons of modest means.”
The law established three criteria for credit union membership:
- Single Common-Bond – a bond by occupation or association.
- Multiple Common-Bond – multiple groups bound by occupation or association.
- Community – members within a defined neighborhood, community or district.
The tax-exemption issue that has arisen recently is a direct result of the ongoing Congressional review of government spending and taxation.
Why is this relevant to the credit union taxation issue? The May 6th Joint Committee on Taxation report presented an array of suggestions for potential tax reform in many industries, specifically noting that, “While significant differences between the rules under which credit unions and banks operate have existed in the past, most of those differences have disappeared over time.” The report included proposals presented to the Committee to repeal credit unions’ tax exemption, in order to take advantage of the added revenue.
- Credit unions don’t pay income taxes. Credit unions do pay other taxes, including payroll, sales and property taxes.
- Credit union members pay taxes on their interest earnings.
- Credit unions have a cap on business lending of 12.25% of their assets, as a result of the Credit Union Membership Access Act. There are currently proposals in both the House (H.R. 688) and the Senate (S.968) to raise the business-lending limit to 27.5% of assets.
- Some banks are classified under S-Corporation status, which removes them from corporate taxation. That responsibility is passed on to the shareholders, who are taxed at the individual level, far below the corporate. S-Corporation bank customers—like credit union members—pay taxes on their interest earnings.
A letter to Max Baucus, the Chairman of the Finance Committee of the Senate, written on July 15 by Frank Keating, CEO of the American Bankers Association (ABA) estimated the cost of credit union tax-exemption to be nearly $10 billion over the next five years. Going off of Baucus’ “blank slate” proposal (a vague plan to eliminate current tax exemptions, credits and deductions, and judge any new proposals on three criteria: if they grow the economy, if they make the tax code fairer, or if they effectively promote other important policy objectives), Keating suggests that credit union tax exemption does not meet the necessary criteria for exemption and should be eliminated.
The basis of this argument is the opinion that most credit unions are currently operating as untaxed banks. Since many credit unions have wide membership policies, they are in direct competition with banks. Keating argues that the public no longer distinguishes between credit unions and banks, which gives the untaxed credit unions an unfair advantage. Credit unions often use their earnings to offer better interest rates on deposit accounts and loans than banks can offer. Keating goes on to say that credit unions have diverged from their original goal of helping low- or moderate-income people by widening their membership to higher-income people.
The Independent Community Bankers of America (ICBA) point to the repeal of mutual savings banks’ tax exemption in 1951 as a precedent for credit unions to lose their tax exemption, due to a similarly advantageous situation where mutual savings banks were competing with banks that were being taxed. Mutual savings banks are member-owned financial institutions without capital stock, like credit unions, but they lack credit unions’ strict membership requirements.
In their own letter to Chairman Baucus, the ICBA reiterate Keating’s points concerning looser membership restrictions and increasing levels of higher-income members, and cite the Joint Committee on Taxation’s Estimates Of Federal Tax Expenditures For Fiscal Years 2012-2017, which states that “the tax exemption for noncharitable organizations that have a direct business analogue or compete with for-profit organizations organized for similar purposes is a tax expenditure.” The ICBA argues that the credit union tax exemption falls under this category.
The ICBA also calls into question the Credit Union Membership Access Act’s decision to allow multiple common bond membership requirements, which they say is in direct conflict with the original Federal Credit Union Act.
The Don’t Tax My Credit Union coalition, lead by the Credit Union National Association, and groups like the National Association of Federal Credit Unions (NAFCU) argue that repealing the tax exemption would put undue financial stress on consumers by raising interest rates on loans and lowering yields on savings accounts. Credit unions would be forced to resort to increasing fees to make up for the increase in taxation. The NAFCU says credit unions would “lose their identity” as member-driven cooperatives if the exemption was removed.
A report prepared for the NAFCU by Drs. Robert M. Feinberg and Douglas Meade, titled “Economic Benefits of the Credit Union Tax Exemption to Consumers, Businesses and the U.S. Economy”, estimates a $15 billion cost to the federal government should the tax exemption be removed. Consumers would lose approximately $10 billion per year in personal income benefits, which would also severely impact the U.S. GDP at a rate of about $14.8 billion per year. These losses would be in addition to an estimated 150,000 jobs lost per year.
Credit unions are not-for-profit, member-owned institutions. Every credit union member is awarded a vote. At some mutual financial institutions, members also get a vote, but it tends to be dependent upon the size of their deposits. More importantly, credit union’s not-for-profit status is due to the fact that they do not issue capital stock; earnings are either used to build capital or instituted as improved interest rates for members.
The Filene Institute argues that while banks reduced business lending during the recent economic crisis, credit unions maintained positive loan issuing rates, despite their 12.25% business-lending limit. In the aftermath of the 2008 financial crisis, bank loan growth fell to near -20%, while credit union loan growth fell to near 0%, an outcome that Filene attributes to the lending cap for credit unions. Credit union also demonstrated much lower delinquency and net charge-off rates during the same period. Credit unions were able to contribute to the stabilization of the economy post-recession.
More importantly, banks (including the biggest banks) have a much larger market share than all credit unions combined. CUNA’s “Commercial Banks & Credit Unions: Facts, Fallacies & Recent Trends” report puts total bank assets at $14.45 trillion and credit union assets at $1.03 trillion, as of 2012. While 67% of banks had $100 million in assets, only 20% of credit unions were comparable. Credit unions cannot accumulate capital as quickly as banks, which limits their growth potential.
The debate currently rages on between bankers and credit unions, but Congress’s focus has been taken up by larger budget concerns. We may not see an end to the tax reform issue until 2014. Until then, here are three possible outcomes for credit union tax exemption:
- Tax exemption remains.
- Tax exemption is removed.
- Tax exemption is widened. R Street has proposed a plan to allow mutual savings banks, cooperatives and other institutions to reclaim the tax-exempt status they lost in 1951. Credit union trade groups have publicly supported additional tax benefits for community banks and, as many on the banking side of the argument claim that the debate is about community banks, this solution would allow for a more level playing field. This provides tax benefits to the financial institutions that, along with credit unions, are most directly helping the lower-income population.