Tax reformers have declared that they are combing through the tax code for “special interest tax breaks” to repeal as offsets for deep tax rate cuts. Yet each tax break they seek to eliminate has a constituency, and those constituencies are typically willing to fight hard to retain their special tax treatment.
Among the tax preferences most dramatically illustrating those competing interests is the credit union exemption.
Critics of the exemption contend that it serves as a clear example of what a special interest tax break looks like by unfairly subsidizing a narrowly targeted base and putting similar businesses, like community or regional banks, at a competitive disadvantage. They also argue that the original purpose of the credit unions’ federal and state income tax exemption — to use their tax-advantaged status to serve low-income borrowers and depositors — has since been supplanted by the rise of “mega-credit unions” that operate far outside of the boundaries of their purported mission.
Credit union advocates argue that the size of the credit union is irrelevant and that the criteria for eligibility for the federal and state income tax exemption, which was established in the 1930s, remains the same. They say that while eliminating the exemption might raise revenue for tax reform, the tax increase would in turn be passed on to consumers, many of whom are low-income.
“It’s symbolic,” Tax Foundation President Scott Hodge, a critic of the exemption, told Tax Analysts. Repealing the credit union exemption wouldn’t be as politically charged as eliminating the mortgage interest deduction, but “it’s an example of how distortions can get built into the code, such that they create favored industries that then latch onto their preference and will do everything possible to keep it,” he said.
Although there’s been no explicit indication from policymakers that the credit union exemption is on the chopping block, credit union advocates preemptively took aim at the idea of repeal during an August 22 meeting with Treasury Secretary Steven Mnuchin. According to the Credit Union Journal, a delegation of credit union representatives presented Mnuchin with a study concluding that repealing the credit union exemption would have effects that work against economic growth.
Still, GOP leaders have emphasized that no provision is safe in the coming tax overhaul, repeating the mantra “all options are on the table” at every opportunity. And with that uncertainty in the air, both critics and supporters of the exemption are canvassing Washington to make their case.
Credit Union National Association Chief Advocacy Officer Ryan Donovan said his group is in “information sharing mode” with both lawmakers and administration officials and aims to ensure that policymakers understand why the exemption is in the law.
Meanwhile, Alejandro M. Sanchez, president and CEO of the Florida Bankers Association, said his group has made trips to Washington throughout the summer and will be returning this month to make the case that Congress needs to “close this loophole for one of the biggest tax-evading industries.”
If It Walks Like a Duck . . .
“Leveling the playing field between similar types of enterprises is a really important part of tax reform,” Hodge said. “Essentially, what we’ve created over the years with this subsidy is a tax-exempt successful industry that is competing directly with a taxed industry providing similar products, and that’s just simply wrong.”
Credit unions have pushed the limits on their “fields of membership” and are “unfairly competing directly with commercial banks,” Hodge said. He cited as an example the membership page on the website of Golden 1 Credit Union, based in Sacramento, California, which reads: “We offer the same products, services, and stability you’d find at a traditional bank.”
Sanchez made a similar argument: “Government should not be picking winners and losers in the free enterprise system . . . and that’s what we’re doing with credit unions.” He also placed the exemption in the context of tax fairness and paying for the country’s fiscal needs, accusing Navy Federal Credit Union, which extends membership eligibility to members of the military and veterans (and their families), of “not paying for the defense of this country . . . because you don’t pay state and federal corporate income taxes and you’re a $60 billion financial institution.”
Sanchez also held up Golden 1 Credit Union as an example of an abuser of the tax exemption, noting that it recently paid approximately $120 million for the naming rights of the NBA’s Sacramento Kings arena. “Is that what Congress intended for a not-for-profit?” Sanchez asked. “I think they’re just abusing the privilege and smacking Congress in the face, saying, ‘I dare you, tax me.’”
“Just like Congress said in the 1950s to the savings and loans [companies], ‘Hey wait a minute, you walk like a bank, and you talk like a bank? Aren’t you really a bank? Why are you tax exempt?’ And guess what? They took their tax-exempt status away. And that needs to be done again,” Sanchez concluded.
Hodge said it was important to look at repealing the exemption in the context of overall tax reform. The current tax reform discussion appears to favor a corporate rate drop into the lower 20s, which would lessen the impact of a sudden change in tax-exempt status. Tax reformers have also considered repealing the deduction for net interest expenses, and “the combination of those two policies . . . would bring these two industries closer together on a tax basis,” Hodge said.
“So it would not be dramatically disruptive to the [credit union] industry,”Hodge added, “and if they couldn’t manage it, then they are not strong enough to survive anyway.”
Argument for Status Quo
Credit union advocates, meanwhile, argue that the size of a credit union is irrelevant, because its purpose and structure remain the same as always.
“You can put the talking points that the bankers were using in the 1930s next to the talking points that they’re using in 2017. There’s not much difference, because the dynamics haven’t changed, and so there’s no reason to change the credit union tax status,” Donovan said.
The credit unions’ structure as not-for-profit financial cooperatives and their congressionally established mission to promote thrift and provide access remains constant regardless of whether a credit union has $10 million or $10 billion in assets, Donovan said.
He also defended Golden 1 Credit Union’s decision to spend $120 million on naming rights for the Sacramento arena, saying, “It’s important for credit unions to be able to get their name out to the community and to show they’re supportive of the community.” Naming an arena is “one way to do it,” he said. “It’s not the only way to do it.”
Donovan also argued that repealing the exemption would violate Republicans’ basic tax reform principle of cutting taxes on middle-income Americans. “We’re not aware of anybody on Capitol Hill . . . that thinks it’s a good idea to raise taxes on 110 million Americans,” Donovan said.
How Much Is at Stake?
With tax reformers scouring the tax code for base-broadening revenue raisers, how much revenue stands to be gained from repealing the exemption depends on who you ask.
According to January 2017 estimates from the Joint Committee on Taxation, the exemption will cost $14.4 billion over a five-year period, with the annual revenue loss trending higher over time — starting at $2.6 billion in 2016 and ticking up to $3.2 billion in 2020.
John A. Tatom of Johns Hopkins University, who authored a 2005 report on the exemption that projected it would lose $31.3 billion between 2004 and 2013, said the 2008 financial crisis “severely affected” credit unions, blunting the rapid increase in the revenue loss he had predicted in 2005.
“With pre-2008 interest rates, bank earnings and the tax exemption allowed more rapid growth of credit union equity, and this supported faster growth of credit union assets compared with banks — and also some slightly better interest rates on credit cards and, to a lesser degree, auto loans,” Tatom told Tax Analysts. “In today’s low interest rate environment, the credit union tax advantage has been less valuable for them as a source of growth.”
Still, Tatom now estimates that the 10-year revenue loss between 2017 and 2026 would total $35.3 billion.
Credit union advocates have a starkly different take.
The study credit union advocates presented to Mnuchin — which was commissioned by the National Association of Federally-Insured Credit Unions — asserts that if most credit unions disappeared as a result of repealing the credit union exemption, it would cost the government $38 billion in federal income tax revenue over a decade. Further, almost 900,000 jobs would be lost over that period, and GDP would be $142 billion less than it otherwise would have been, the study found.
Alan Viard of the American Enterprise Institute was skeptical that repealing the exemption would lose the government revenue, calling it a “demand-side version of the ‘typical tax cut pays for itself’ argument.” He added, “As usual, the JCT revenue estimate is better.”
Hodge likewise called the finding that nearly 900,000 jobs would be lost “preposterous.” For comparison, he said, the Tax Foundation’s macroeconomic models have found that a major tax increase, like raising capital gains tax rates to match ordinary income tax rates, would mean a $1.5 trillion tax increase but would cost the economy only 700,000 jobs over a decade. At $3 billion per year, eliminating the credit union tax exemption “would hardly show a blip in the macroeconomy,” Hodge said.
‘That’s Pretty Fair’
If repeal of the credit union exemption does come up as a revenue raiser, most observers agree that full repeal is unlikely and that a partial repeal would emerge as the more likely compromise.
Outright repeal would be politically challenging because of the perception that credit unions are owned and managed by consumers mainly for the benefit of low-income individuals, Tatom said. Further, many credit unions are tied to highly unionized employee groups, like teachers or government workers, making stand-alone repeal of the exemption unlikely.
However, if it were “packaged as part of a larger overall reform plan, so that consumers might see that there are offsetting gains, the possibility for credit union tax reform would be improved and could tilt the balance for reform,” Tatom explained.
Hodge said that he would support full repeal, arguing that credit unions “have matured as an industry and no longer need a tax subsidy,” but he acknowledged that politically, at least, a compromise solution “is probably the way to go.”
Even a vehement critic of the exemption like Sanchez says that his goal isn’t to eliminate the exemption altogether for “mom and pop” credit unions. He said only the large credit unions, based on their size or activities, should be taxed — “which still leaves out 80 to 90 percent of credit unions.”
“That’s pretty fair, I think,” he added.
One former House Republican tax counsel agreed that there is a “valid point to be made” about limiting the scope of the exemption so that credit unions are “more focused on what their purported mission is, which is to provide banking to the unbanked.” The counsel recommended using section 512, for example, which imposes a tax on unrelated business income earned by tax-exempt organizations. Under that model, income derived from products and services consistent with the credit union’s mission would be exempt, but streams of income outside the bounds of that mission would be taxed.
The credit union tax exemption was a topic of interest when former House Ways and Means Committee Chair Dave Camp drafted his 2014 tax reform draft, but the bill ultimately left the exemption untouched.
The former Republican tax counsel told Tax Analysts that while Camp and his staff didn’t spend a lot of time looking at the exemption, several Ways and Means Committee members asked if they were going to do anything about it. “I was fairly surprised there was a level of interest in the issue on a committee level other than just, ‘Fear the credit unions,’” the counsel said, adding that “there were definitely members willing to take on that fight after talking to community bank presidents in their districts.”
The counsel also said that the roughly $30 billion the JCT estimated would have resulted from repealing the exemption is not too small to be worth spending political capital on: “In fact, it’s a pretty good number.”
Credit union advocates won the last battle over the exemption, and they say they’re even more ready this time.
Donovan said that they made a push to mobilize credit union support when Camp began drafting his tax reform proposal. “But now we have even more fully developed our grassroots capabilities,” he added. And although he isn’t aware of any particular lawmaker or administration official who aggressively wants to repeal the exemption, “we’re going to be very engaged, not because anyone’s out to get us, but because we want to protect credit unions and their members,” he said.
Donovan pointed to the preservation of the credit union exemption in Camp’s plan as evidence that it will likely be preserved in the coming tax reform negotiations, since tax reformers have said they are using Camp’s plan as a model from which to pull base-broadening ideas. He reasoned that if the exemption wasn’t changed in Camp’s proposal, tax reformers today are unlikely to give it much attention.
“The spirit of [Camp’s] proposal has been the universe of the conversation right now, which is good,” he said.
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