IDEAS home Printed from https://ideas.repec.org/p/pra/mprapa/4398.html
   My bibliography  Save this paper

Competitive advantage: a study of the federal tax exemption for credit unions

Author

Listed:
  • Tatom, John

Abstract

This study evaluates the federal tax exemption for credit unions. It reviews the industry’s history, its unique exemption, the motivation behind this tax treatment, the eroding case for special treatment, the size of the tax break and its effects on credit unions, their competitors, and their members. The nation’s credit unions always have been exempt from federal income taxation. Federally chartered credit unions are even exempt from state and local income taxation. Saving and loan associations, also originally largely exempt from taxation, lost their exemption on 1951 and calls for tax reform, including those of former Presidents Jimmy Carter and Ronald Reagan, included provisions to end the special exemptions of credit unions. But the credit union tax exemptions have survived. At least in part, these exemptions arose from the cooperative nature of credit union ownership and limits on their ability to compete because of their legal “field of membership” restrictions, which limited who could be a depositor and borrower from a credit union. Nonetheless, credit unions have competed with other financial institutions, especially banks, with a major cost advantage, the tax exemption. Tax exemption has allowed credit unions to grow much more rapidly than banks. Unusual growth was also fostered by steady erosion of limits on credit union membership over the past two decades. In 1998, the US Supreme Court struck down the liberalization of membership rules, but the US Congress promptly passed new legislation overriding the court. As a result the processes of consolidation, merger and broadening of geographic markets accelerated while credit unions were allowed to keep their tax exemptions. Thus, Congress created new tensions by weakening the case for tax exemption without addressing its continuing legitimacy. Today credit unions continue to grow faster than banks, have little practical limitations on membership, make business loans that increasingly have no limits on who can borrow, how much or for what purpose. Even the limits that Congress 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. The tax loss to the federal Treasury is estimated here to be $2 billion and to be growing rapidly. Indeed, the tax loss over the five years, 2004-2008 is estimated to be $12.6 billion and reaches $31.3 billion over the ten-year window 2005-2014. The size of the tax loss is substantially higher than estimates prepared by official arbiters including the Office of Management and Budget or the Congressional Budget Office. The annual loss in tax revenue could accrue to several different credit union constituencies: members, as depositors (higher “dividends,” or interest rates, on their “shares,” or deposits), borrowers (lower interest rates on loans), or shareholders (through greater retained earnings). The benefits of the tax break could also accrue to management, workers or other suppliers through inflated costs or inefficient operations. Based on other studies of differences between credit unions and banks and on direct and indirect evidence gathered for this study, it is found that the principal effect of the tax break is to enlarge the retained earnings or equity of the credit union industry. A higher ratio of equity to assets has made possible a larger and faster growing industry than would otherwise have been possible. There is some evidence that certain type loans have lower rates at credit unions. These are for loans that have become less profitable and less available at banks, such as auto loans. There is also some evidence that part of the tax advantage is absorbed by higher costs than they would have in a taxed, or more competitive, environment. Overall the dominant effect is to boost the equity ratio. Over the past ten years, credit unions have had an equity ratio, the ratio of equity to total assets that is more than 25 percent larger than that of banks. This is about the size of effect predicted by economic theory if the dominant effect of the tax break is to raise this measure. The equity ratio is a cushion against losses in asset value that could threaten the solvency of a financial institution. It is also a constraint on growth because a relatively safe institution cannot allow its assets to grow faster than its equity if it is holding its desired equity ratio. Despite the fact that the risk of credit union assets, largely shorter term consumer loans and consumer mortgages, is much smaller than the risks of bank assets, which are largely business loans and securities, credit unions hold a higher cushion against risk. These unusually large holding of equity cannot be realized through stock sales by the owners/members of credit unions and they do not yield competitive risk-adjusted yields on assets that they would have to earn if credit unions were subject to the same taxes as banks. Removing the tax exemption would level the playing field, reducing the excessive growth and relative size of credit union assets. It would also raise about $2 billion in tax revenue, either directly from credit unions or from more profitable and more highly taxed banks, where credit union deposits and assets would migrate if the tax exemption were ended. Finally it would raise the rate of return on some $65 billion of capital that is squirreled away in credit unions, earning lower rates of return than would be the case at taxed banks. Some analysts have argued that small institutions (under $10 million in assets) should continue to be tax exempt because of their special character and, perhaps, innate inefficiencies. But the corporate income tax already takes smallness into effect by taxing low-income firms at lower tax rates (15%, instead of up to 35% for large firms, or up to 39 percent for mid-sized corporations).

Suggested Citation

  • Tatom, John, 2005. "Competitive advantage: a study of the federal tax exemption for credit unions," MPRA Paper 4398, University Library of Munich, Germany.
  • Handle: RePEc:pra:mprapa:4398
    as

    Download full text from publisher

    File URL: https://mpra.ub.uni-muenchen.de/4398/1/MPRA_paper_4398.pdf
    File Function: original version
    Download Restriction: no
    ---><---

    References listed on IDEAS

    as
    1. Robert Tokle & Joanne Tokle, 2000. "The Influence of Credit Union and Savings and Loan Competition on Bank Deposit Rates in Idaho and Montana," Review of Industrial Organization, Springer;The Industrial Organization Society, vol. 17(4), pages 427-439, December.
    2. William R. Emmons & Frank A. Schmid, 2000. "Bank competition and concentration: do credit unions matter?," Review, Federal Reserve Bank of St. Louis, vol. 82(May), pages 29-42.
    3. Amel, Dean F. & Hannan, Timothy H., 1999. "Establishing banking market definitions through estimation of residual deposit supply equations," Journal of Banking & Finance, Elsevier, vol. 23(11), pages 1667-1690, November.
    4. Fried, Harold O. & Knox Lovell, C. A. & Eeckaut, Philippe Vanden, 1993. "Evaluating the performance of US credit unions," Journal of Banking & Finance, Elsevier, vol. 17(2-3), pages 251-265, April.
    5. Robert M. Feinberg, 2001. "The Competitive Role Of Credit Unions In Small Local Financial Services Markets," The Review of Economics and Statistics, MIT Press, vol. 83(3), pages 560-563, August.
    6. Jeffery W. Gunther & Robert R. Moore, 2004. "Small banks' competitors loom large," Southwest Economy, Federal Reserve Bank of Dallas, issue Jan, pages 1,9-13.
    Full references (including those not matched with items on IDEAS)

    Citations

    Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.
    as


    Cited by:

    1. Goddard, John & McKillop, Donal G. & Wilson, John O.S., 2023. "Who consumes the credit union subsidies?," Journal of Financial Stability, Elsevier, vol. 69(C).
    2. Regmi, Madhav & Featherstone, Allen Merril, 2018. "Differential Taxation In Agricultural Credit Market," 2018 Annual Meeting, February 2-6, 2018, Jacksonville, Florida 266692, Southern Agricultural Economics Association.
    3. McKillop, Donal & French, Declan & Quinn, Barry & Sobiech, Anna L. & Wilson, John O.S., 2020. "Cooperative financial institutions: A review of the literature," International Review of Financial Analysis, Elsevier, vol. 71(C).
    4. David L. Stowe & John D. Stowe, 2018. "Credit union business models," Financial Markets, Institutions & Instruments, John Wiley & Sons, vol. 27(5), pages 169-186, December.

    Most related items

    These are the items that most often cite the same works as this one and are cited by the same works as this one.
    1. Bauer, Keldon, 2008. "Detecting abnormal credit union performance," Journal of Banking & Finance, Elsevier, vol. 32(4), pages 573-586, April.
    2. Javier Gómez‐Biscarri & Germán López‐Espinosa & Andrés Mesa‐Toro, 2022. "Drivers of depositor discipline in credit unions," Annals of Public and Cooperative Economics, Wiley Blackwell, vol. 93(4), pages 849-885, December.
    3. Pat McGregor, 2005. "Credit Unions and the Supply of Insurance to Low Income Households," Annals of Public and Cooperative Economics, Wiley Blackwell, vol. 76(3), pages 355-374, September.
    4. Robert Feinberg, 2002. "Credit Unions: Fringe Suppliers or Cournot Competitors?," Review of Industrial Organization, Springer;The Industrial Organization Society, vol. 20(2), pages 105-113, March.
    5. Jordan van Rijn & Shuwei Zeng & Paul Hellman, 2021. "Financial institution objectives and auto loan pricing: Evidence from the survey of consumer finances," Journal of Consumer Affairs, Wiley Blackwell, vol. 55(3), pages 995-1039, September.
    6. Robert M. Feinberg, 2003. "The Determinants of Bank Rates in Local Consumer Lending Markets: Comparing Market and Institution‐Level Results," Southern Economic Journal, John Wiley & Sons, vol. 70(1), pages 144-156, July.
    7. David Ely & Kenneth Robinson, 2009. "Credit Unions and Small Business Lending," Journal of Financial Services Research, Springer;Western Finance Association, vol. 35(1), pages 53-80, February.
    8. William R. Emmons & Frank A. Schmid, 2004. "When for-profits and not-for-profits compete: theory and empirical evidence from retail banking," Supervisory Policy Analysis Working Papers 2004-01, Federal Reserve Bank of St. Louis.
    9. Chien-Min Kang & Ming-Chieh Wang & Lin Lin, 2022. "The Dynamic Typology in the Development Process of Credit Union Movements," IJFS, MDPI, vol. 10(2), pages 1-21, April.
    10. Goddard, John & McKillop, Donal & Wilson, John O.S., 2008. "The diversification and financial performance of US credit unions," Journal of Banking & Finance, Elsevier, vol. 32(9), pages 1836-1849, September.
    11. Christian Weller, 2010. "Have Differences in Credit Access Diminished in an Era of Financial Market Deregulation?," Review of Social Economy, Taylor & Francis Journals, vol. 68(1), pages 1-34.
    12. Kazumine Kondo, 2017. "Do credit associations compete with each other in Japanese regional lending markets?," Journal of Economics and Finance, Springer;Academy of Economics and Finance, vol. 41(1), pages 195-210, January.
    13. John Goddard & Donal McKillop & John Wilson, 2009. "Which Credit Unions are Acquired?," Journal of Financial Services Research, Springer;Western Finance Association, vol. 36(2), pages 231-252, December.
    14. Reka Sundaram-Stukel & Steven C Deller, 2021. "Locational Factors in the Competition between Credit Unions and Banks after the Great Recession," Papers 2110.07611, arXiv.org, revised Jul 2022.
    15. Timothy H. Hannan, 2003. "The impact of credit unions on the rates offered for retail deposits by banks and thrift institutions," Finance and Economics Discussion Series 2003-06, Board of Governors of the Federal Reserve System (U.S.).
    16. Robert Feinberg, 2008. "Explaining the Credit Union Entry Decision, and Implications for Performance," Review of Industrial Organization, Springer;The Industrial Organization Society, vol. 33(1), pages 81-91, August.
    17. Kondo, Kazumine, 2014. "Do Credit Associations Compete with Each Other in Japanese Regional Lending Markets?," MPRA Paper 56669, University Library of Munich, Germany.
    18. Feinberg, Robert M. & Rahman, A. F. M. Ataur, 2001. "A causality test of the relationship between bank and credit union lending rates in local markets," Economics Letters, Elsevier, vol. 71(2), pages 271-275, May.
    19. Andrew M. Cohen & Michael Mazzeo, 2004. "Market structure and competition among retail depository institutions," Finance and Economics Discussion Series 2004-04, Board of Governors of the Federal Reserve System (U.S.).
    20. Goddard, John & McKillop, Donal G. & Wilson, John O.S., 2023. "Who consumes the credit union subsidies?," Journal of Financial Stability, Elsevier, vol. 69(C).

    More about this item

    Keywords

    Credit Union; tax incidence; tax subsidy;
    All these keywords.

    JEL classification:

    • H25 - Public Economics - - Taxation, Subsidies, and Revenue - - - Business Taxes and Subsidies
    • H22 - Public Economics - - Taxation, Subsidies, and Revenue - - - Incidence
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:pra:mprapa:4398. See general information about how to correct material in RePEc.

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a bibliographic reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: Joachim Winter (email available below). General contact details of provider: https://edirc.repec.org/data/vfmunde.html .

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service. RePEc uses bibliographic data supplied by the respective publishers.