- The tax-exempt status of credit unions has been challenged time and time again by traditional banks who believe the status provides a competitive advantage.
- Studies have shown that the tax-exempt status of credit unions has not provided a competitive advantage, with their market share remaining constant for the past quarter-century.
- Credit unions serve an important role in providing financial services to working- and middle-class families, where their interest is with their members and not shareholders.
In 1996, the North Dakota Bankers Association passed out bumper stickers that read, “YOU pay income taxes. Why don’t credit unions?” The marketing campaign was part of a larger effort by several state banking associations to question the tax-exempt status of credit unions. On tax day, April 15th, the effort culminated with banking association members sending postcards to their congressional representatives questioning the policy. This was the first of many calls to challenge credit unions’ tax status.
The battle by banks to usurp the exemption status of the credit union model has continued for decades. More recently, Republican Senator Orrin Hatch of Utah challenged the tax-exempt status of credit unions in 2018. His argument detailed that some larger credit unions were operating more like banks than following credit union charters. Senator Hatch rekindled the bank’s interest in diminishing the market share of competing credit unions.
Today’s New Challenge
A recent article from the National Taxpayers Union summarizes the banking industry’s position. The Union argues that the 1934 Federal Credit Union Act established credit unions as local institutions to serve lower-income constituencies with a common bond, such as a shared location or a shared occupation. The Act afforded credit unions a tax-exempt status, as not-for-profit institutions serving their members.
The NTU argues that credit unions have grown to become a $1.5 trillion industry. An industry that now has several larger unions with over $1 billion in assets. At the same time, some credit unions have loosened the requirements for membership by going beyond local associations and inviting the populations of entire states to join.
The Union would argue that the tax-exempt status gives credit unions a significant advantage in the financial market. They cite cases where credit unions have made purchases for-profit local banks, a practice that removes tax revenue from the government. They also claim that credit unions benefit from the Unrelated Business Income Tax Exemption. They can own and operate businesses outside of their charter without having to pay taxes on the income.
Credit Unions Respond
In response to Senator Hatch’s challenge, credit union representatives reminded him about the purpose and benefits of federal credit unions. Although credit unions provide some of the same financial services of competing banks, they operate with a fundamentally different model and purpose. Large banks are for-profit institutions. They seek to generate income for shareholders and sell publicly traded stocks. Credit unions are privately owned institutions, democratically operated, and not-for-profit.
The federal government established credit unions to serve their members and their communities – not the interest of shareholders. A credit union cannot issue stock and is therefore restricted on the opportunity to grow its presence. In most cases, credit unions also operated with a voluntary board of directors.
Most importantly, however, the tax-exempt status allows credit unions to distribute their profits to their member-owners through higher savings account dividends, lower loan rates, and minimal banking fees. For example, the national average interest rate on a three-month CD was 0.4 percent at credit unions, as opposed to 0.27 percent at banks in March of 2020.
With respect to the competitive advantage, banks assert credit unions gain through their tax-exempt status, market share statistics do not support their claim. For more than the past quarter-century, depository assets held by credit unions have stayed between six and seven percent. Additionally, banks can change their charter and move to a credit union model if they choose to do so, under federal law. If the advantages of operating as a credit union were so high, it would be expected that more banks would make the shift. Instead, only two banks have done this in recent history.
Consumer Choice Matters
The loss of the federal tax exemption would be a serious blow to consumers and credit union members. These institutions are designed to serve the financial needs of working-class people. If credit unions had to pay more taxes, they would also have to increase fees and loan rates. This would make goals like homeownership or entrepreneurship less accessible to the general public. It would also mean lower dividends on savings deposits, which goes against the credit union’s mission of encouraging thrift.
In addition, the tax revenue generated by taking away the tax-exempt status of credit unions does not justify the cost to the local communities they benefit. According to one study, the revenue from all credit unions in 2017 would only have provided 0.07 percent of annual federal spending. An amount so infinitesimal, the impact nationally would be nothing more than a whisper.
Advocating for Members
While statistics show a credit union’s tax-exempt status is not a competitive advantage, credit unions do indeed have a step on banks. Credit unions exist to serve their members, not shareholders. A bank’s Achilles’ heel has always been when stock price matters more than their customer’s experience.
An example is the recent passage of the
Because larger banks see federal credit unions as competition, it can be expected they will continue to criticize them. Although there has been bipartisan support for credit unions, banks will look for leaders who are sympathetic to their cause. The struggle to maintain tax-exempt status is far from over.