If you’re one of the 115 million credit union members, you may not even realize it but your credit union doesn’t pay federal income taxes. Federal law recognizes that credit unions operate in unique ways and so, on the principle that credit unions provide financial services in a democratic, not-for-profit and cooperative manner, many years ago Congress exempted credit unions from taxes. While you may wonder whether credit unions continue to merit tax exemption, less obvious is what happens if the tax exemption is removed.
Credit unions have been exempt from the federal income tax since the Great Depression, to increase their ability to provide credit to lower-income families. And while the financial sector has evolved over the last several decades, with credit unions growing and changing over time, they still operate in the unique way that granted them the tax exemption in the first place.
Unlike the for-profit banks, which have private investors and pay dividends to stockholders, credit unions are member-owned institutions that have no shareholders, have no equity investors, and are served by volunteer boards. Since credit unions make no profits, there is nothing to tax. As nonprofit entities, credit unions are required to give surplus revenue to their members through benefits such as higher interest yields on deposits or lower rates on loans.
Yet, what is less obvious is that credit unions, although exempt from the federal income tax, they do pay many taxes and fees, among them payroll and property taxes. Only in 2017, credit unions generated about $12.2 billion in federal taxes and $7.4 billion in state taxes through employer, excise and property taxes. Their members also paid about $1.5 trillion in federal and state taxes on both the proceeds distributed and interest earned on their accounts.
The growth of credit unions and whether they still merit tax exemption have been under increasing scrutiny, with several proponents, including banks “too big to fail,” advocating for the end of the federal income tax exemption.
But evidence suggests, eliminating the tax exemption would have important ramifications that go beyond the scope of credit unions’ activities.
Banks comprise more than 90 percent of the lending market share, and while credit unions make up only a small percentage of the financial services industry, stripping the tax exemption will likely negatively affect competition and curtail credit.
First, it would affect tax revenue and the cost of banking. More specifically, ending the tax exemption and nonprofit status of credit unions would impose double taxation on members, to the point where it would cost consumers $16 for every $1 of taxes saved.
Second, it could turn counterproductive in terms of revenue. According to a 2017 report from the National Association of Federal Credit Unions, removing the tax exemption “would actually cost the federal government $38 billion in lost income tax revenue over the next 10 years, while GDP would be reduced by $142 billion, and nearly 900,000 jobs would be lost over the course of the next decade.” The same report estimates a 50 percent reduction in the credit union market share would cost bank customers “an estimated $6.9 billion to $15.7 billion per year in higher loan rates and lower deposit rates.”
Third, terminating the exemption would put greater burden on taxpayers by further reducing credit access and lending to those who need it most. Evidence suggests that taxpayers, whether members or not, benefit from the presence of credit unions in the marketplace, as credit union competition helps keep bank and savings and loan prices lower.
This is corroborated by academic research. A 2011 study by James Wilcox from the University of California at Berkeley, for example, found that the rise in loans by credit unions helped offset declines in business loans by banks during periods of macroeconomic stress, with credit unions offsetting 4 percent of the reduction in small business loans and 7 percent of the reduction in total business loans by banks.
The U.S. Treasury Department also reported that the expanded use of credit unions “benefit savers, borrowers, insurance funds, taxpayers and the financial system.”
Specifically, credit unions offer higher interest rates to savers, lower interest rates to borrowers, less credit rationing during periods of financial turmoil, lower size-adjusted failure rates, lower insurance fund loss rates, and a reduction in incentives to become “too big to fail.”
Further extensive evidence not listed here suggests that credit unions provide substantially more benefits for consumers than costs for taxpayers. As such, the push to end tax exemption and treat credit unions more like banks would not make the allocation of credit better, cheaper and more efficient. Instead, it would reduce competition and limit credit, affecting mostly the underserved population.