Credit Unions May Face a Taxing Dilemma
The country's fiscal woes may force credit unions to meet the tax man more often.
As the nation's budget deficit continues to grow, the government may be looking for new sources of revenue. Therefore, formerly sacred cows such as credit unions' tax-exempt status may go the way of VCRs and rotary phones.
A bipartisan commission established by President Obama to make recommendations on ways to cut the deficit is scheduled to issue its report after the election. The commission is considering an array of spending reductions and tax increases. In Washington parlance, tax increases are often euphemistically described as revenue enhancements.
Congress must give the panel's recommendations an up or down vote and cannot make amendments to them. Even if a tax on credit unions isn't part of the commission's recommendations, Congress could still include it in subsequent legislation.
It's clearly on the mind of policymakers. President Obama's Economic Recovery Board raised the possibility in a report issued this summer on ways to simplify the tax system and raise revenue.
"Unlike other financial institutions like banks and thrifts, credit unions do not pay corporate taxes on their income," the report notes. "Eliminating this exemption would raise revenue and level the playing field but would clearly raise taxes on credit unions."
CUNA and NAFCU are both promising to fight any effort to include a tax on credit unions. Their position is reminiscent of every interest group's efforts to preserve their special tax status.
The late Senate Finance Committee Chairman Russell Long (D-La.) famously described that attitude as: "Don't tax you, don't tax me, tax that man behind the tree."
Nobody knows for certain how much revenue such a tax would raise.
When the Treasury Department did an analysis in 2005, it estimated the annual revenue at $1.39 billion, while Congress's Joint Committee on Taxation estimated $1.30 billion.
The Tax Foundation, in a study funded by the Independent Community Bankers of America, concluded during that same year that that the annual revenues from such a tax could be as high as $3 billion.
Of course, credit unions already do pay taxes on certain transactions, such as the UBIT levied on certain products sold by state-chartered credit unions.
Credit unions contend that having their income exempt from income taxes allows them to serve underserved communities that are often overlooked by other financial institutions. That has been their major argument whenever the issue is raised on Capitol Hill or among regulators.
Taxing credit unions hasn't been a major source of discussion since a 2005 hearing of the House Ways and Means Committee and ultimately there was no action taken.
However, to quote the sage philosopher and noted financial expert Bob Dylan, "The times, they are a-changin'."
Part of the problem credit unions face is that, rightly or wrongly, banks have successfully portrayed them as being no different than banks, except with a tax-exempt status.
Even supporters such as Senate Banking Committee Chairman Christopher Dodd (D-Conn.) have expressed concern that credit unions were engaging in "mission creep."
Banks therefore argue if it looks like a proverbial duck, walks like a duck, and quacks like a duck, it's a duck.
In addition, when credit unions ask to offer more services, such as raising the cap on member business loans, this could have the effect of blurring the distinction between banks and credit unions. It is as if they want to be like banks in some ways, yet still be distinct.
Bert Ely, an Alexandria, Va.-based financial services consultant, puts it more colorfully.
"Credit unions want to have their cake and eat it too. With some pie on the side, maybe a la mode," he said.
In response to a question from Rep. Brad Sherman (D-Calif.) last February, Federal Reserve Chairman Ben S. Bernanke said because of credit unions' tax-exempt status, "the banks would complain, obviously, that if credit unions are allowed to do everything banks can do, why are they tax favored? I think that's the trade-off Congress has to consider."
In addition, the problems of the corporate credit unions, which required a loan from the U.S. Treasury and a hefty annual assessment to be paid by credit unions through 2021, have provided fodder to the banking lobby. Those trade associations are on a never-ending quest to tax credit unions and push for other steps to limit their growth.
While credit unions and the NCUA are rightly noting that this isn't a bailout and that the industry is solving its own problems, the battle for public perception may be an uphill one.
Ely noted that the NCUA's actions, coupled with the severe capital shortages facing some credit unions that could trigger more conversions to mutual banks, could weaken credit unions' position in the tax fight.
The Independent Community Bankers of America already smells blood. Earlier this month, it wrote Treasury Secretary Timothy Geithner that the NCUA's rescue plan for the corporates should "cast doubt on the wisdom and the fairness of their [credit unions'] tax-exempt status."
CUNA and NAFCU quickly responded by noting that it wasn't a bailout and criticizing banks for taking TARP money.
CUNA President/CEO Bill Cheney noted that the tax exemption guarantees that consumers have a choice beyond commercial banks and wrote Geithner that it is "one of the highest yielding investments the government has made."
NAFCU Executive Vice President Dan Berger wrote that the government should examine the tax-exempt status of banks that are subchapter S corporations "that continue to drink at the trough of TARP and the American taxpayer."
The fight is reminiscent of one combatant in a sandbox fight telling the teacher, "He hit me first." After that, the other child replies, "Did not." Then the first one retorts, "Did too."
That may be what the battle over credit union taxation will look like.
Let the sand throwing and name calling begin.