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A Chance for Tax-Exemption Redemption

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A Chance for Tax-Exemption Redemption

September 21, 2017

This piece originally appeared on U.S. News & World Report

Congress and the Administration are working together to pass fundamental tax reform before the end of the year.  The goals of tax reform include lowering rates and broadening the base to stimulate economic growth.  One principle of taxation is treating similar businesses in a similar manner.

While this is true of many American businesses, it is not true of banks and credit unions. Today, however, large credit unions function in a similar matter to banks, which are taxed. This makes no sense.

Credit unions were set up in the 1930s as small community organizations, when many people had limited access to capital. In the Federal Credit Union Act of 1934, Congress restricted credit unions to “groups having a common bond of occupation or association, or to groups within a well-defined neighborhood, community or rural district.” To encourage their role in community service, they were exempt from federal income tax in 1937.

Credit Unions remained tax exempt under the idea of their “Common bond” until the National Credit Union Administration allowed the creation of “Multiple-Group federal credit unions… that do not have common bonds.” The American Bankers Association along with several smaller North Carolina banks challenged this in the Supreme Court in 1998, and it was ruled that credit unions had to be limited “to individuals within a single company, community or occupation” as originally stated in the Federal Credit Union Act of 1934.

Congress reacted by passing the Credit Union Membership Act in 1998, which grandfathered all pre-court ruling Credit Unions and allowed for future Multiple-Group Credit Unions. This paved the way for additional expansion of credit unions.

Now 281 credit unions have assets of over $1 billion .  Even though these credit unions account for four percent of the total of credit unions, these entities take up about three quarters of the tax benefit.

One reason for the tax-exempt status was for credit unions to return funds to members.  Some are using the funds for this purpose.  Others, however, are using them for mass marketing and aggressive growth that do not necessarily give a return back to members.

For instance, Golden 1 Credit Union in California bought the exclusive naming rights for the Sacramento Kings NBA Arena for $120 million. The $81.5 billion Navy Federal Credit Union were a sponsor of ESPN’s Monday night football. These are advertising tactics that similar to for-profit corporations such as Best Buy, Dunkin Donuts, and Toyota.

Another reason for the tax-exempt status was to enable credit unions to provide lower-cost loans and credit to low- and moderate-income households.  This does not appear to be the case.  A GAO Analysis has found that credit unions when compared to banks served a slightly lower proportion of households with low or moderate incomes, with 31 percent of low to moderate households using credit unions exclusively compared to 41 percent with banks. Laws such as the Community Reinvestment Act encourage banks to make a certain proportion of loans to low-income individuals.

Some loans are aimed at upper-income individuals. In Minnesota, the $4.5 billion Wings Financial Credit Union on its website advertises that it gives loans for "toys" such as private aircraft and boats. The $2.2 billion Technology Credit Union in California underwrites mortgages up to $8 million dollars underwrites mortgages up to $8 million dollars and provides portfolio manager services.

In order to take advantage of the discrepancy in the tax status, credit unions are buying banks. In the past 18 months, Credit Unions Bought Seven Banks . In 2015, the Florida Achieva Credit Union bought a bank, and even set up a service to advice other credit unions on how to merger with banks.

Credit unions were originally given tax exempt status so that they would service lower-income individuals, because banks were not doing so.  The situation has now changed, and the tax law should change with it.  As Congress proceeds with tax reform, members should consider leveling the playing field between financial institutions.  

Diana Furchtgott-Roth (@FurchtgottRoth) is a senior fellow at the Manhattan Institute and an adjunct professor of economics at George Washington University.

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