Credit unions have historically occupied a unique niche among financial institutions. Credit unions differ from other depository institutions because they are (1) not-for-profit entities that build capital by retaining earnings (they do not issue capital stock), (2) member-owned cooperatives run by boards elected by the membership, and (3) tax- exempt. Like banks and thrifts, credit unions have either federal or state charters. Federal charters have been available since 1934, when the Federal Credit Union Act was passed. States have their own chartering requirements. As of December 2004, the federal government chartered about 62 percent of the slightly more than 9,000 credit unions and states chartered the remainder. Both federally and state-chartered credit unions are exempt from federal income taxes, with federally chartered and most state-chartered credit unions also exempt from state income and franchise taxes. Another distinguishing feature of credit unions is that they may serve only an identifiable group of people with a common bond. More specifically, credit union membership may be based on one of three types of common bond: single, multiple, or community. For example, a group of people that share a single characteristic, such as a common profession, could constitute the “field of membership” for a single-bond credit union. Field of membership is used to describe all the individuals and groups, including organizations, which a credit union is permitted to accept for membership. More than one group having a common bond could constitute the membership of a multiple-bond credit union. And, persons or organizations within a well-defined community, neighborhood, or rural district could form a community-bond credit union. Further, credit unions can offer members additional services made available by third-party vendors and by certain profit-making entities with which they are associated, referred to as credit union service organizations (CUSO). The tax-exempt status of credit unions originally was predicated on the similarity of credit unions and mutual financial institutions; however, while Congress did not always cite its reasons for continuing this exemption, recent legislation mentions the cooperative structure and service to persons of modest means as reasons for reaffirming their exempt status. The Revenue Act of 1913 exempted domestic building and loan associations (now called “savings and loans”), and mutual savings banks not having a capital stock represented by shares, from federal income tax. Further, the Revenue Act of 1916 exempted from taxation cooperative banks without capital stock organized and operated for mutual purposes and without profit. However, credit unions were not specifically exempted in either of these acts. Their tax-exempt status was addressed directly for the first time in 1917, when the U.S. Attorney General determined that credit unions closely resembled cooperative (mutual savings) banks and similar institutions that Congress had expressly exempted from taxation in 1913 and 1916. The Federal Credit Union Act of 1934 authorized the chartering of federal credit unions. The stated purpose of the act was to “establish a further market for securities of the United States and to make more available to people of small means credit for provident purposes through a national system of cooperative credit, thereby helping to stabilize the credit structure of the United States.” The 1934 act did not specifically exempt federal credit unions from taxation. In 1937, the act was amended to exempt federal credit unions from federal tax and limit state taxation to taxes on real and tangible personal property. Two reasons were given for the exemption: (1) that credit unions are mutual or cooperative organizations operated entirely by and for their members; and (2) that taxing credit unions on their shares, much as banks are taxed on their capital shares, places a disproportionate and excessive burden on the credit unions because credit union shares function as deposits. The Revenue Act of 1951 amended section 101(4) of the 1939 Internal Revenue Code to repeal the tax-exempt status for cooperative banks, savings and loan societies, and mutual savings banks, but it specifically provided for the tax exemption of state-chartered credit unions. While the act’s legislative history contains extensive discussion of the reasons why the tax-exempt status of the other mutual institutions was revoked, it is silent regarding why the tax exempt status of credit unions was not also revoked. The Senate report accompanying the Revenue Act of 1951 stated that the exemption of mutual savings banks was repealed in order to establish parity between competing financial institutions. According to the Senate report, tax-exempt status gave mutual savings banks the advantage of being able to finance growth out of untaxed retained earnings, while competing corporations (commercial banks) paid tax on income retained by the corporation. The report stated that the exempt status of savings and loans was repealed on the same grounds. Moreover, it stated that savings and loan associations were no longer self-contained mutual organizations, for which membership implied significant investments over time, risk of loss, heavy penalties for cancellation of membership or early withdrawal of shares, and in which members invested in anticipation of becoming borrowers at some time. Instead, investing members were simply becoming depositors who received relatively fixed rates of return on deposits that were protected by large surplus accounts, and borrowing members dealt with savings and loans in the same way as other mortgage lending institutions. Credit unions, unlike many other participants in the financial services market, are exempt from Federal and most State taxes because they are member-owned, democratically operated, not-for-profit organizations generally managed by volunteer boards of directors and because they have the specified mission of meeting the credit and savings needs of consumers, especially persons of modest means. At various times, the executive branch has proposed taxing credit unions, generally endorsing the creation of a “level playing field” among financial institutions in which organizations engaged in similar activities would be taxed similarly. Proponents of taxation contend that larger credit unions compete with banks in terms of the services they provide. Proponents also have questioned the extent that credit unions have remained true to their historical mission of providing financial services to persons of modest means. In response, opponents of the taxation of credit unions have argued that credit unions remain distinct organizationally and operationally from other financial institutions, providing their membership with services they would not receive from other institutions. Opponents also have argued that taxation would hinder the ability of credit unions to build capital (which is restricted to retained earnings), jeopardizing their safety and soundness. Finally, opponents have argued that other depository institutions, particularly smaller banks, also have opportunities for tax and regulatory relief such as S-corporation status. Some studies have attempted to quantify potential tax revenue from repealing the tax exemption, with estimates ranging from $1.2 billion to $3.1 billion, depending on the fiscal year considered, tax rates used, and other underlying assumptions. Unlike income retained by most other financial institutions, income retained by credit unions is not taxed until it is distributed to members. Thus, tax exemption allows credit unions to utilize untaxed retained earnings to finance expansion of services. Proponents of taxing credit unions claim that this ability to use untaxed retained earnings provides credit unions with a competitive advantage over banks and thrifts. In 1978, the Carter administration proposed that the tax-exempt status of credit unions be gradually eliminated to mitigate this advantage and establish parity between credit unions and thrift institutions. The administration also argued that the relaxation of rules regarding field of membership criteria, the expansion of credit union powers, and the rising median income of credit union members indicated that credit unions were no longer true mutual institutions serving low-income workers excluded from banking services elsewhere. In 1984, the Department of the Treasury (Treasury) report to the President included a proposal to repeal the tax exemption of credit unions, which also argued that the exemption gave credit unions a competitive advantage over other financial institutions and its repeal would “eliminate the incentive for credit unions to retain, rather than distribute, current earnings.” In 1985, the Reagan administration proposed taxing credit unions with more than $5 million in gross assets, but would have maintained the exemption on credit unions with less than $5 million of gross assets, since it was reasoned that taxing small credit unions would significantly increase the administrative burden for a relatively small revenue increase. Similarly, in the budget for fiscal year 1993 the first Bush administration proposed taxing credit unions with assets of more than $50 million. More recent arguments for the taxation of credit unions note the strong growth rates among large credit unions, which tend to offer a wider array of services. As a result, taxation proponents argue that larger credit unions compete with banks in terms of the services they provide and the households to which they provide these services. They question both the extent to which credit unions serve people of modest means and pass on their tax subsidy to members. While limited data are available to evaluate the income of credit union members—which precludes any definitive conclusion— some studies, including one of our own, indicate that credit unions serve a slightly lower proportion of households with low and moderate incomes than banks. We discuss this issue in more detail later in this statement. Arguments against repealing the tax exemption for credit unions assert that the exemption does not offer competitive advantages and that it is justified by the unique services credit unions offer and by their capital structure. As we reported in 1991, credit unions as organizations are exempt from federal and state income taxes. However, the income that their members receive is taxed. Members who receive dividends on share accounts are taxed on that income, just as depositors at commercial banks are taxed on interest income from savings or checking accounts. If credit unions distribute all income to shareholders and do not retain earnings at the entity level, all income will be taxed at the individual level. In this case, credit unions would have little tax advantage relative to taxable mutual financial institutions, whose income is taxed once at either the individual or entity level.