Banks Regularly question the legitimacy of credit unions’ exemption from federal taxes. The casual observer may wonder why credit unions, which take deposits and make loans, are treated differently for taxes purposes than are banks which perform like services. The justification comes from unique functions performed by credit unions.

The exemption from taxation was explained by the IRS in 1979. Credit unions are expected to help unbanked, lower-income people; they are required to restrict their customer base to members with a common bond, and they should avoid high-risk, high-return investments. These peculiar functions still have strong value for consumers and they are not available through banks.

The Joint Committee on Taxation estimates that in 2018, the tax expenditure for credit unions will cost $2.9 billion in lost income tax revenue, but the credit union industry has saved $15.6 billion per year for consumers over the last decade. Consumers and presumably, elected officials, would welcome other tax expenditures producing an annual 538% return. The important thing is that since credit union’s operate as a coop, its customers are the owners. In effect, these customers already pay personal income taxes on their interest, so taxing credit unions would amount to double taxation.

Also, credit unions are geared to serving the needs of groups with a common bond, and especially consumers of modest income. “Modest” is a slippery term that changes with geography and context. In Seattle, an income of $36,000 in 2018 for a single person may be regarded as modest, but most would agree that modest could also apply to those with even higher incomes.

About 14% of households encounter cash flow needs that lead to use of “non-bank credit” (payday lenders, pawn shops, rent-to-own contracts or tax refund anticipation loans). These people may be of modest means, some may be college educated and a few may earn more than $75,000. About one in five of those using non-bank credit could not get a small loan from their bank.

For modest income people, credit unions are a preferred source for small personal loans because the terms of credit union loans are more favorable than those from other non-bank credit sources. For example, Blue Federal Credit Union offers interest on car loans from as low as 3.89% and personal loans from 8.25%. Car loans are about 35% of credit unions’ portfolio. Their loan offers will beat the terms offered by typical pay day lenders.

The common bond requirement for membership in a credit union does not come with a headcount limit. The 1.7 million professional members of the American Federation of Teachers (AFT) is a large potential customer group, but they are undeniably linked by the common bonds of skill and work. Likewise, the 1.37 million active members of the US military are linked by skill and work, and the diversity of their physical locations does not erode their common bond.

Subsets of these groups may elect to affiliate as smaller groups (e.g. Denver Federation of Teachers, an affiliate of the AFT) who share their common bond, but that does not invalidate the common bond of the larger group who prefer affiliation with the national group.

If credit unions had strayed from their intended functions and resemble other financial institutions, the tax exemption could be an unjustified treatment disparity. However, for the 110 million members of 5,684 credit unions, the evidence shows credit unions remaining true to their unique requirements of serving modest income people connected by a common bond, while offering affordable rates on loans and attractive interest on deposits. When a program works that well, there is no reason to rescind the tax exemption.