Credit unions should remain tax exempt

 

Reducing wasteful government spending has been on the minds of many recently, and rightly so. However, reducing the deficit and making sensible tax reforms requires discerning which spending is fat, from which spending ultimately produces benefits that far outweigh the costs.

One example is a misaligned notion that credit unions, being tax-exempt nonprofit organizations, should pay federal income taxes. According to estimates, imposing taxes on credit union earnings could generate an additional $2.8 billion into the federal coffers. The reality is that the benefits provided by credit unions to consumers significantly exceed the taxes foregone from the exemption.

Understanding this point requires some background.

There are 4,600 credit unions serving 140 million Americans. These financial institutions tend to be much smaller in size, on average, than banks and account for about 7% of the market share compared to much larger banks. In fact, the assets of the 10 largest credit unions account for less than 5% of the assets of the 10 largest banks.

Credit unions do pay state and local taxes but do not pay federal taxes on their earnings. They are member-owned nonprofit institutions, meaning they give their members every dollar of earnings back by providing them lower interest rates on loans, like mortgages and car loans, and higher rates on deposits and investments like CDs. This means credit union customers save more money on loans and make more money on investments compared to bank customers.

One study estimated that these favorable interest rate differentials provide consumers $23 billion annually. Others cite the consumer benefits as high as $35 billion yearly. In other words, by exempting these financial institutions for $2.8 billion in federal taxes, consumers get between 10 and 16 times the benefit. That is not a bad deal for taxpayers. Alternatively, eliminating the tax exemption will mean consumers will lose these benefits.

The economic benefits don’t stop there. Considering that these additional consumer benefits will stimulate the economy with multiplier effects exceeding a factor of two, the result pumps even more money into the economy, generating additional tax revenue. The tax revenue from this additional economic activity likely exceeds the cost of the exemption. In short, imposing additional taxes could curtail other federal revenue streams.

There are other factors to consider. For instance, banks exist to make a profit for their shareholders and lavishly pay their board of directors, and that’s fine. However, credit unions have no shareholders and are served by volunteer boards. Since credit unions make no profits, there is nothing to tax once earnings return to members. Once income is earned by credit union members, it is taxed at the same rate as income earned by bank customers.

However, the proposed elimination of nonprofit status would mean that credit union members are taxed twice: the first would tax credit unions on the retained earnings that would have gone to benefit the credit union’s members through better interest rates; and the second would apply to the members’ personal income taxes.

The push to end the tax exemption is not about lowering the deficit and cutting waste; it is solely about preventing credit unions from competing with much larger “too big to fail” banks.

Ironically, after several taxpayer bailouts over the years, the banks are calling for the taxation of credit unions. Being too big to fail, these banks are truly the double dealers of government reliance — taking government bailouts on the one hand and then calling for government intervention to double-tax credit union members on the other.

Credit unions are a reasonable alternative to big banks, and they tend to lend substantially more to consumers than businesses. They also tend to serve more rural areas, compared to big banks. With more than 90 percent of the lending market share, banks do not strike me as needing protection from competition.

The evidence suggests that credit unions provide significantly more consumer benefits than they cost taxpayers. Specifically, eliminating the nonprofit status of credit unions would cost consumers $16 for every $1 of tax saved. Sticking consumers with much higher costs for a minimal tax benefit is a bad choice all the way around.

A better approach would be to encourage competition that maximizes consumer benefits. When tightening the budget, Congress needs to weigh the costs and benefits. Based on the empirical evidence and for the sake of consumers, the credit union tax exemption should be retained.

Steve Pociask is president and CEO of the American Consumer Institute. He wrote this for InsideSources.com.