Banks and Credit Unions: The Unlevel Playing Field

Who wouldn’t love to "have his cake and eat it too"? In the financial industry, credit unions come pretty close to achieving this coveted position. Federally chartered credit unions are exempted from federal and state income taxes and operate without being subjected to many costly regulations that now swamp their competitors in the banking industry.

As the old saying goes, if it looks like a duck and quacks like one too, it’s a duck. The fact is that even though large community credit unions are indistinguishable these days from banks, the law treats them very differently. Imagine if you had to pay income taxes but your neighbor across the street in a similar house and with a job and income just like yours didn’t have to pay a dime. If you think that would be unfair, you now know how bankers feel when it comes to dealing with credit unions as competitors.

How and why did this competitive playing field become uneven, and what difference does it make to consumers of financial services in Michigan and around the country?

The first state credit union was chartered in New Hampshire in 1909, and received an exemption from federal taxation in 1917. Federally chartered credit unions date back to 1934 and are exempt from both state and federal income taxation. The rationale for such favorable tax treatment comes from the concept of "common bond," which denotes a homogeneous group from which a credit union may draw patrons. These depositors become owners of the accumulated reserves (retained earnings) in proportion to their share of deposits.

Initially, there were two conditions attached to this special tax-exempt status:

  • First, membership in a credit union was confined to employees of the same company or occupation class across various firms, or to a social or civic group sharing common loyalties, mutual interests and benefits.

  • The second condition imposed on credit unions involved servicing citizens in their locale who had little access to or who could not afford basic financial services, such as checking accounts and money orders.

However, the world is not static. Regulations and definitions become obsolete and counterproductive, thanks to evolving technology and demographic shifts. For example, by 1982, "commonly bonded" groups began joining together, without regulatory intervention. In fact, on July 24, 2004, the National Credit Union Administration approved a "community" charter for a credit union whose "field of membership" is the 10.1 million residents of Los Angeles County!

Credit unions also do not confront a significant disadvantage foisted on the banking industry in the form of the immense costs of requirements under the Community Reinvestment Act. This legislation compels expanding banks to place resources (chiefly branches and loans) in high risk areas. Banks have been audited relentlessly for decades in order to ensure compliance, whereas credit unions have had no such oversight to interrupt their expansion objectives.

As a result, banks, especially small and mid-sized community banks, have been consistently losing market share to credit unions because the latter enjoy status as nonprofit financial cooperatives for tax purposes, though they are often organized with privileges as corporations for legal purposes.

In the 21st century, credit unions have largely expanded their markets to include virtually any "membership" of their choosing, and can match or approximate financial product offerings of the banking industry. For this reason, it is long overdue that the tax and regulatory playing field among equals be leveled.

It makes no economic sense to apply radically different tax and regulatory policies to two similar entities within the same industry. And aside from the obvious issues of unfairness and market distortions, this divergence raises a responsibility question too: Is it responsible for credit unions to want to behave just like banks and benefit from the same services of state and local government while their direct competition bears burdens and bills that the credit unions don’t?

The best solution is one that augments consumer choice, while strengthening the long-term viability and safety of the financial industry as a whole. In this case, policy reform should either remove federal income taxation altogether or converge tax rates and regulatory burdens between banks and credit unions.


David L. Littmann, a retired senior vice president and chief economist of Comerica Bank, is senior economist at the Mackinac Center for Public Policy, a research and educational institute headquartered in Midland, Mich. Permission to reprint in whole or in part is hereby granted, provided that the author and the Center are properly cited.


Federally chartered credit unions enjoy significant tax and regulatory advantages over their competitors in the banking industry. Policy reform should attempt to level the playing field between these essentially similar businesses.

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