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BANKS, CREDIT UNIONS SQUARE OFF

March 20, 2003

When your author was a boy in Illinois, he often visited his credit union. Not to tend vast wealth, mind you; the credit union was in our uncle's basement. It was great fun to play with the cool mechanical passbook posting machine, and Uncle Jay would sometimes let us press the button to update a real account (after he pressed all the preparatory buttons, of course).

We still have our credit union account, with a three-digit account number and a three-digit balance. But the credit union is no longer in his basement, and there are now more than 999 accounts. Instead of serving only Warren Township, it has over $145 million in assets and offices in three fast-growing counties in two states. It's not our uncle's credit union anymore.

TAXATION OF CREDIT UNIONS

Community banks have watched uneasily as credit unions have morphed from little credit pools to institutions that look an awful lot like banks. It can be hard to tell the difference, until you look at the tax returns. Banks are subject to federal income tax and the Iowa 5% "franchise tax" on bank income � to the tune of over $29 million in the state's most recent fiscal year.

Credit unions, by contrast, are generally exempt from federal income tax on earnings retained in the business. Iowa only subjects credit unions to a "moneys and credits" tax of .005% on excess reserves over $40,000. The total receipts under this tax apparently are too small to be broken out separately on the Iowa Department of Revenue and Finance annual report; as best we can tell, they are lumped in a $1.2 million "miscellaneous" category along with, for example, the marijuana stamp tax.

Iowa banks naturally don't relish tax-free competition, particularly from the biggest credit unions. About seven years ago, banks began to push for a tax on large credit unions. The proposal got nowhere until this year.

Things changed when the University of Iowa Community Credit Union attempted to buy Hawkeye State Bank in Iowa City. The idea that credit unions could accumulate enough capital tax-free to actually buy a bank got the attention of state legislators, and a credit union tax proposal has advanced out of committee in both houses.

THE PROPOSAL

The proposal would impose a 5% tax on increases in retained earnings of credit unions with over $150 million in assets. The effect would be to tax large credit unions to the extent they do not distribute their earnings to members. This would discourage the accumulation of earnings that credit unions might otherwise use to, well, buy banks. As a practical matter, only six of Iowa's 189 credit unions would be subject to the proposed tax (1).

By contrast, there are 370 Iowa banks with assets under $150 million whose earnings � retained or not � are subject to federal income tax and the 5% franchise tax. The legislature will decide in the coming weeks whether big credit unions can continue to compete with them tax-free.

(1) John Deere Community Credit Union in Waterloo; Collins Credit Union in Cedar Rapids; Dupaco and Du Trac in Dubuque; the Greater Iowa Credit Union in Ames; and the University of Iowa Credit Union.