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Should Credit Unions Be Taxed?

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Abstract:

Credit unions are financial cooperatives organized by people with a common bond; they are the only depository institutions that are 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 If this exemption were repealed, both federally chartered and state-chartered credit unions would become liable for payment of federal corporate income taxes on their retained earnings but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 FY2006 (October 1, 2005 through September 30, 2006), the Department of the Treasury estimates that federal taxation of credit unions would yield revenues of approximately $1.39 billion. For FY2007 (October 1, 2006 through September 30, 2007), the Joint Committee on Taxation estimates that federal taxation of credit unions with assets of $10 million or more would yield revenue of approximately $1.3 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 109th Congress, as of May 23, 2005, no legislation concerning the tax exempt status of credit unions has been introduced. Treasury Secretary John Snow has made statements that appear to indicate that the Bush Administration supports the tax exemption for credit unions. In the future, technological change and deregulation will likely further increase competition between credit unions and other depository institutions. The income tax exemption for credit unions, therefore, likely will be the subject of further debate.

This report is a broad examination of the issues underlying proposals to tax credit unions. It does not track specific legislative proposals. The report will be updated, however, in the event of significant legislative activity.