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Saturday, May 15, 2010

Should Credit Unions Be Taxed?

James M. Bickley
Specialist in Public Finance

Credit unions are financial cooperatives organized by people with a common bond; they are the only depository institutions exempt from the federal corporate income tax. As financial cooperatives, credit unions only accept deposits of members and make loans only to members, other credit unions, or credit union organizations. Many Members of Congress advocate a reliance on market forces rather than tax policy to allocate resources. Furthermore, some Members of Congress are interested in additional sources of revenue in order to either reduce the deficit, offset the cost of higher federal outlays, or make up for tax cuts elsewhere. Consequently, the exemption of credit unions from federal income taxes has been questioned. If this exemption were repealed, both federally chartered and state-chartered credit unions would become liable for payment of federal corporate income taxes on their retained earnings but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 FY2010 (October 1, 2009, through September 30, 2010), the Joint Committee on Taxation estimates that federal taxation of credit unions would yield revenue of approximately $1.6 billion. 

Credit unions differ in some aspects from other providers of financial services, but financial deregulation continues to lessen these differences. Deregulation has resulted from new legislation and decisions of regulatory agencies. Proponents of the taxation of credit unions argue that deregulation has led to vigorous competition between credit unions and other depository institutions. They maintain that the tax exemption gives credit unions an unfair competitive advantage over other depository institutions, and there is no market failure that justifies government intervention with a tax subsidy. Supporters of the tax exemption claim that, despite deregulation, credit unions are still unique depository institutions. They assert that the purpose of credit unions is to serve the financial needs of their members rather than to maximize profits. They argue that taxation would eliminate this service character of credit unions. 

In the 111th Congress, as of May 7, 2010, no legislation specifying the elimination or curtailment of the tax-exempt status of credit unions has been introduced. In the 111th Congress, legislation has been introduced to expand credit unions' ability to make business loans. Banking trade associations argue that the proposed expansion of credit unions' lending authority further reduces the distinction between banks and credit unions, and consequently lessens the justification for the tax-exempt status of credit unions. 

In the future, technological change and regulatory changes may further increase competition between credit unions and other depository institutions. The income tax exemption for credit unions, therefore, may be the subject of further debate.

Date of Report: May 7, 2010
Number of Pages:20
Order Number: 97-548
Price: $29.95

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