howardnlby Howard Stephenson
The Utah Legislature is wading into one of the most controversial issues in years: The question of taxing large credit unions which compete head to head with for-profit financial institutions. Before deciding the issue, policymakers need to understand the history behind the tax exemption and what has changed since the exemption was first given near the beginning of the last century.
Credit unions were originally created to allow people of “small means” to pool their resources and lend money to each other. Since these groups were underserved and were unable to obtain credit through normal means, an income tax exemption was established to increase access to credit for people of small means. This exemption enabled credit unions to economically serve their limited membership with very basic savings accounts and consumer loans. Traditionally, any earnings were used to provide better savings and borrowing rates, or were distributed back to the members of the credit union in the form of dividends.
Today, these tax exemptions are a significant economic benefit. For example, an exemption from today’s state and federal income tax rates of 5% and 35%, respectively on a credit union’s retained earnings, gives credit unions a marked competitive advantage over banks whose profits are taxable.
In qualifying for the exemption, credit union membership was to be limited to members who shared a common bond, typically workers in the same company or industry. As a consequence of the common bond requirement, credit unions spent very little on marketing or expansion and did not recruit membership from the general public. Since credit unions had one primary purpose – providing credit to underserved populations-prior to 1970 credit unions did not offer a full range of financial services and therefore did not compete with other taxable financial institutions.
Deposit Insurance and Expansion of Services Stimulated Credit Union Growth

In 1971 the National Credit Union Share Insurance Fund was established. This deposit insurance gave the public greater confidence in the financial security of credit unions, similar to the earlier Federal Deposit Insurance Corporation (FDIC) for banks. Prior to credit union share insurance, the safety of each member’s deposit depended on knowing the character and reliability of credit union members applying for loans. By reducing the risk to members of both federal and state credit unions through share insurance, members made larger deposits in their credit union savings accounts. At the same time, the common bond became less important and credit unions began to grow more rapidly.
However, credit union members still tended to use both credit unions and banks because, by design, not all financial services were available at their credit unions. They used credit unions for savings and personal loans and banks for checking accounts and other loans. But in 1978 and 1980 Congress authorized credit unions to offer mortgage loans and transaction (checking) accounts.
Credit unions quickly began to look like full-service financial institutions. As share insurance eliminated the need for credit unions to personally know each member and as credit unions added more services, credit union membership grew rapidly and the size of some credit unions began to rival that of many banks. Tax advantages have helped credit unions grow rapidly by allowing tax-free capital accumulation. Today’s credit unions offer credit cards, ATMs, money market accounts, mutual funds, home equity lines of credit, discount brokerage services and insurance.
The Court Ruled That Credit Unions Were Acting Outside the Law
Following the availability of share insurance in 1970 and then in 1980 due to the avilability of transaction (checking) accounts and a full range of financial services Utah state chartered credit union assets expanded rapidly. State regulators began to liberalize or ignore the common bond requirements that had previously justified the non-taxability of credit union retained earnings. In the mid 1980s the lack of enforcement of the limited field of membership for state chartered credit unions produced almost exponential growth in state chartered credit union assets. Banks brought a court challenge to enforce the field of membership limitations but it took a decade and a half for a final determination. Utah courts ruled in 1998 that the State Department of Financial Institutions had inappropriately administered the state’s credit union law for more than 15 years. During that time, a few Utah credit unions took advantage of their tax-exempt status to grow rapidly. Three credit unions are now among the financial institutions in Utah which operate well beyond what was once envisioned for state or federally chartered credit unions. These largest credit unions are now far larger than most Utah banks, are free to provide services to most of the state’s population, and are clearly in direct competition with tax-paying financial institutions.
Because the court appeared unable to “put the genie back in the bottle,” in 1999 the Utah Legislature partially reigned-in what had become a wide open field of membership. At the same time, while federal credit union regulators strictly enforced field of membership restrictions, federal credit union assets in Utah remained quite flat.
Tax-Free Growth
Most Utah credit unions have changed significantly over the years, but nearly all of them are still relatively small institutions that serve a limited field of membership. However, there is a handful of credit unions which have used their tax exemption to enable them to expanded rapidly and compete head-to-head with banks. These credit unions are larger than most banks and serve geographic boundaries that include most of the population of the state. They offer nearly every banking service provided by other taxpaying financial institutions. They have expanded rapidly, spending millions of dollars on mass media advertising and political initiatives, and they retain millions of dollars in earnings, which they use to expand their presence in the marketplace, rather than to serve a specific group of members.
Some state charted credit unions in Utah today advertise their services to the general public. It is questionable whether some large credit unions today primarily serve people of “small means” which originally justified the credit union tax exemption. In fact, the Credit Union National Association (CUNA) 2002 National Member Survey Report stated that credit union “. . . members have higher average household incomes than do nonmembers.” The report also noted “. . . credit unions’ relatively low member penetration level among lower-income consumers.” The report also disclosed that the remedy to a “shortage in peak borrowers” is “to attract more members and/or get more loans into the hands of existing members.” The CUNA membership survey report disclosed that “. . . credit union members, compared to nonmembers are more likely to be employed full-time, less likely to be retired, more likely to have a college degree, and more likely to own their home,” hardly a discription of people of small means.
It should be remembered that savings and loans, mutual savings banks and cooperatives lost their tax-exempt status in 1951 when Congress decided these institutions had become more like other profit-seeking financial institutions. It is clear that the large, full-service credit unions that exist today were not envisioned when the tax exemption was written into law. Many large credit unions today closely resemble mutual savings banks which are now taxable.
Additionally, Canada began taxing credit unions in 1972 and credit unions in that country have continued to prosper. Two U.S. Presidents, Carter and Reagan unsuccessfully called for congress to repeal the credit unions’ tax exemption. Additionally, the states of Alabama, Florida, Indiana, Maryland, Missouri, Nebraska and Oklahoma impose state income or franchise taxes on credit unions.
Putting the Genie Back In the Bottle — Creating Tax Equity
The Resolution Alliance, headed by former U.S. Senator Jake Garn (Republican) and former Salt Lake Mayor Ted Wilson (Democrat) has been formed to find a solution to the growing inequity of a few very large, untaxed credit unions competing with taxable financial institutions. The Utah Taxpayers Association and others have also called for a resolution to the inequity. The Asociation argues that the first principles of tax policy require that similarly situated persons or businesses be treated equally. Absent fundamental fairness in tax policy, citizens and business owners will quickly lose confidence in government while decisions in the marketplace will be distorted.
The question then, is whether banks should be given a similar tax exemption or large credit unions should lose their exemption. Given the current budget climate, extending the exemption to banks would probably not be politically feasible. Thus, taxing large, competitive credit unions may be the only viable way to provide equity. However, since Utah Taxes are already 9th highest among the fifty states, I believe any revenues raised through this equalization must be used to lower overall taxes, not grow government.
It is incumbent upon the Utah Legislature and Congress to re-establish equity between credit unions and taxable financial institutions. The competitive activity of credit unions must be limited, or they must be subject to the same state and federal tax obligations as their taxable competitors.