If you act like a bank, you should be taxed like one

Scott Hodge President, Tax Foundation
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The debate over how to reform the nation’s tax code – which means, among other things, eliminating wasteful tax breaks – is having the predictable effect of smoking out those industries who benefit from these tax subsidies.

Today, it’s the credit unions saying “not me.”

In a September 26, 2013 Daily Caller piece, the credit union industry again came to the defense of its tax exemption. The piece did not offer a coherent policy rationale for its privileged tax status other than to state the self-serving proposition that requiring these previously tax-exempt businesses to pay any income tax at all would be a “new tax”.

Hardly. Extending the current corporate income tax to an industry that has enjoyed tax-free status for 76 years is not a new tax. It’s a correction of flawed tax policy set in motion in 1937.

This was the major finding of a 2005 Tax Foundation study that estimated the tax loss to the federal Treasury over ten years to be $31.3 billion. Moreover, while credit unions were given their tax exempt status to help them serve the poor, our study found that “there is no solid evidence that credit unions have turned the subsidy into service for low-income people.”

Our study concluded that:

Today credit unions continue to grow faster than banks, have little practical limitations on membership, and make business loans that increasingly have no limits on who can borrow, how much or for what purpose. Even the limits that Congress has imposed, as they otherwise removed limits on credit union markets and competition, have broad loopholes and remain under serious challenge by the credit union industry. Today the principal justification for the tax exemption would seem to be that it already exists and, therefore, removing it could adversely impact thousands of institutions and their customers.

Credit unions were granted federal tax exemption on the strength of three promises: (1) That they would help lower-income people who don’t have bank accounts; (2) That they would restrict their customer base to groups of people with a common bond, enabling the credit union to specialize in their financial needs; and, (3) That they would avoid high-risk, high-return investments in favor of safe, lower-interest investments.

Have they delivered on any of their promises? No.

They have marketed their services mostly to middle- and upper-middle income people who would be profitable for taxpaying banks to serve, leaving low-income people to use check-cashing centers and title loan charlatans.

Credit unions and their regulators have “interpreted” the common-bond requirement to mean, for example, anyone living in Los Angeles County. Some common bond!

And rather than avoid high-risk investments, the financial meltdown taught us that many credit unions were invested in the same risky subprime junk that avowed risk-takers in the taxpaying financial sector got burned on.

Credit unions push back by saying that their benefit to the economy is much greater than their cost to the federal Treasury. A 2012 study commissioned by the National Association of Federal Credit Unions suggests that the benefit to consumers — both credit union members and bank customers —  of having a credit union presence in the financial marketplace is nearly $10 billion per year.

Indeed, their lower-cost products are a boon to consumers. The study estimates that “credit union rates on new and used car loans are 26 percent lower than bank rates, on average,” while “credit card rates are 9 percent lower and unsecured loan rates are 14 percent lower at credit unions.”

Rather than supporting their case, what the study actually illustrates is the built-in cost to consumers of taxing for-profit financial institutions. We know that the real economic cost of business taxes fall either on consumers through higher prices, workers through lower wages, or owners through lower share prices. In the case of financial institutions, the FAFCU study would indicate that the bulk of the benefits of removing the income tax would flow largely to consumers.

In other words, if a small tax exemption for credit unions benefits consumers and the economy many times over, then imagine the benefit to consumers and the economy if we were to exempt all financial institutions from the corporate income tax.

Put simply, the credit unions know that their exemption from corporate income taxes gives them a competitive advantage or they would not fight so hard to keep it. So there are really only two ways to level the playing field — eliminate their exemption or extend the exemption to all financial institutions.

Credit Unions can’t have it both ways. Sound policy demands that if you are going to behave as a commercial enterprise, you should be taxed like one.

Scott Hodge