Are Credit Unions an Example of Bad Tax Policy?

This week in Politico, a food fight broke out with banks tossing some volleys at credit unions.  The banks claim that credit unions are the beneficiaries of unfair tax treatment, and that this tax treatment should be eliminated as part of comprehensive tax reform.  Are they correct?

How are credit unions taxed?  Credit unions, unlike banks, are not set up as for-profit entities.  They are organized in specific areas, or for specific workforces, etc. as a type of non-profit.  There are 7000 credit unions with just under 100 million members.  Because they are non-profit, credit unions don't face entity level taxation.

So does that mean credit unions escape taxation?  No.  Credit unions plow their earnings back as benefits to members. That means credit union members get higher interest paid to them on savings deposits, and lower interest rates quoted to them for mortgages, car loans, and other debt.

In turn, the members end up paying more taxes on the interest received, and lose out on deductions for mortgage interest and business loans compared to their banking neighbors.  The net effect for federal coffers is pretty close to a wash.

In a way, credit unions are to flow-through businesses (partnerships, S-corporations, etc.) as banks are to C-corporations. 

So the question is not whether or not taxes get paid, but merely the incidence.  Banks face tax incidence primarily at the source level.  Credit unions face taxation primarily at the customer level.  It's simply two different business models with two different ways of imposing taxes.

How much does the government say it loses in taxes by not taxing credit unions at the entity level?  According to the "tax expenditure" report cited in the news article, this is about $2 billion per year.

That's probably over-stating it.  Almost certainly, the government is not counting the higher-than-bank-customer taxes paid by credit union members for the reasons stated above.

But even ignoring this, $2 billion is simply not a large tax item.  The context is that there are $1.2 trillion (with a "t") in annual tax preference items.  It's a small fraction of a percent of what's at play.

Why did such a small and arguably policy-correct tax item end up in the press?  Simple.  Businesses in Washington, DC like to publicly throw each other under the bus to gain a perceived advantage.  That's clearly what banks are doing here.