Subsidyscope

Exemption of Credit Union Income

All text from: Congressional Research Service (CRS). “Tax Expenditures: Compendium of Background Materials on Individual Provisions.” December 2008. GPO: Washington DC.

Description

Credit unions without capital stock, organized and operated for mutual purposes, and without profit are not subject to Federal income tax.

Impact

Credit unions are the only depository institutions exempt from Federal income taxes. If this exemption were repealed, both federally chartered and State chartered credit unions would become liable for payment of Federal corporate income taxes on their retained earnings but not on earnings distributed to depositors.

For a given addition to retained earnings, this tax exemption permits credit unions to pay members higher dividends and charge members lower interest rates on loans. Over the past 25 years, this tax exemption may have contributed to the more rapid growth of credit unions compared to other depository institutions.

Opponents of credit union taxation emphasize that credit unions provide many services free or below cost in order to assist low-income members. These services include small loans, financial counseling, and low-balance share drafts. They argue that the taxation of credit unions would create pressure to eliminate these subsidized services. But whether or not consumer access to basic depository services is a significant problem is disputed.

Rationale

Credit unions have never been subject to the Federal income tax. Initially, they were included in the provision that exempted domestic building and loan associations — whose business was at one time confined to lending to members — and nonprofit cooperative banks operated for mutual purposes. The exemption for mutual banks and savings and loan institutions was removed in 1951, but credit unions retained their exemption. No specific reason was given for continuing the exemption of credit unions.

In 1978, the Carter Administration proposed that the taxation of credit unions be phased in over a five-year period. In 1984, a report of the Department of the Treasury to the President proposed that the tax exemption of credit unions be repealed. In 1985, the Reagan Administration proposed the taxation of credit unions with over $5 million in gross assets. In the budget for fiscal year 1993, the Bush Administration proposed that the tax exemption for credit unions with assets in excess of $50 million be repealed. On March 16, 2004, Donald E. Powell, Chairman of the Federal Deposit Insurance Corporation, stated that “credit unions ought to pay taxes.” On November 3, 2005, the House Ways and Means Committee held a hearing on “Review of Credit Union Tax Exemption.” In the first session of the 110th Congress, the U.S. Treasury published two major studies concerning corporate tax reform: “Business Taxation and the Global Competitiveness,” and “Approaches to Improve the Competitiveness of the U.S. Business Tax System for the 21st Century.” Both of these studies recommended broadening the corporate tax base by repealing various business tax breaks including the tax exempt status of credit unions. Officials of the credit union industry argued that these Treasury reports were in conflict with a 2004 letter from President Bush stating his support for the credit union tax exemption.

Assessment

Supporters of the credit union exemption emphasize the uniqueness of credit unions compared to other depository institutions. Credit unions are nonprofit financial cooperatives organized by people with a common bond, which is a unifying characteristic among members that distinguishes them from the general public.

Credit unions are directed by volunteers for the purpose of serving their members. Consequently, the exemption’s supporters maintain that credit unions are member-driven while other depository institutions are profit- driven. Furthermore, supporters argue that credit unions are subject to certain regulatory constraints not required of other depository institutions and that these constraints reduce the competitiveness of credit unions. For example, credit unions may only accept deposits of members and lend only to members, other credit unions, or credit union organizations.

Proponents of taxation argue that deregulation has caused extensive competition among all depository institutions, including credit unions, and that the tax exemption gives credit unions an unwarranted advantage. Proponents of taxation argue that depository institutions should have a level playing field in order for market forces to allocate resources efficiently.

Selected Bibliography

• Bickley, James M. Should Credit Unions be Taxed? Library of Congress, Congressional Research Service Report 97-548. Washington, DC: Updated January 28, 2008.
• Jolly, Robert W., Gary D. Koppenhaver, and Joshua D. Roe. Growth of Large-Scale Credit Union in Iowa: Implications for Public Policy. Ames, Iowa: Department of Economics, Iowa State University, Working Paper #04031, November 2004.
• U.S. Congress, Congressional Budget Office. Budget Options. Washington, DC: U.S. Government Printing Office, February 2007, p. 294.
• U.S. Government Accountability Office, Issues Regarding the Tax- Exempt Status of Credit Unions, Testimony before the House Committee on Ways and Means, November 3, 2005.
• - . Greater Transparency Needed on Who Credit Unions Serve and on Senior Executive Compensation Arrangements, November 2006.
• Tatom, John. Competitive Advantage: A Study of the Federal Tax Exemption for Credit Unions. Washington, DC: Tax Foundation, 2005.

All text from: Congressional Research Service (CRS). “Tax Expenditures: Compendium of Background Materials on Individual Provisions.” December 2008. GPO: Washington DC.