Straight Talk – A Sub S credit union?

Credit unions have been beating up on banks for decades; they certainly don't need any help from the Federal Reserve. That's why I am so disappointed by an article appearing in the April edition of the Regional Economist, a publication of the Federal Reserve Bank of St. Louis..Economist Richard Anderson and research associate Yang Liu pen an article called "Banks and Credit Unions: Competition not going away." The title is inviting, suggesting an analysis of the competitive landscape in the financial services world. The Federal Reserve is a highly-qualified, trusted authority on financial services. The authors provide particulars including key historical facts, consolidation trends in both industries, and a good look at credit union "field of membership" rules..But the authors make a gross error in their discussion of taxation. While they correctly note that state-chartered credit unions gained an exemption from state income taxes in 1917 and federally-chartered credit unions became tax exempt in 1935, they go askew with this sentence:."Although the exemption reduces credit unions' cost of capital by approximately 40 percent relative to a fully taxed environment, several thousand small and medium-size banks are organized for tax purposes as Subchapter S corporations and are similarly exempt from federal income taxes.".Wow. There's an argument taken right out of the credit union industry playbook, and indeed, a footnote attributes the point to the Credit Union National Association. But the argument only works on people who don't know any better. A Federal Reserve economist should see right through this. .Subchapter S businesses, of course, produce income tax revenue; credit unions do not. To suggest that a subchapter S bank enjoys the same tax benefit of a credit union is dead wrong. Sub S incorporation just means the owners of the bank pay income tax at the personal rate rather than the corporation rate – but they still pay. There is not a sub S business owner in America who thinks their sub S status exempts them from paying taxes. I know a banking industry attorney who once invited credit union trade group execs to prove their point by seeking sub S tax treatment for their members. None of the credit union advocates thought that was a good idea..It is important that organizations such as the Federal Reserve Bank of St. Louis get this argument right. Legislation has just been reintroduced in the U.S. Senate to expand business lending by credit unions. In order to consider these matters appropriately, we have to get the tax implications right – considering both the letter of the law and the practical reality of the law. The Fed should know better.