Skip to content

Reviewing Business Tax Expenditures: Credit Union Tax Exemption

14 min readBy: Erica York

Key Findings

  • Policymakers should carefully analyze taxA tax is a mandatory payment or charge collected by local, state, and national governments from individuals or businesses to cover the costs of general government services, goods, and activities. expenditures before categorizing one as a loophole—some tax expenditures are important structural elements of the tax code while others are unsound.

  • Generally, if a provision is broadly available and helps to eliminate the double taxationDouble taxation is when taxes are paid twice on the same dollar of income, regardless of whether that’s corporate or individual income. of saving, or broadly contributes to a consumption taxA consumption tax is typically levied on the purchase of goods or services and is paid directly or indirectly by the consumer in the form of retail sales taxes, excise taxes, tariffs, value-added taxes (VAT), or an income tax where all savings is tax-deductible. base, it is sound and should remain in the tax code.

  • On the other hand, if a provision is narrow and confers special treatment to specific industries or companies, or attempts to engineer decision-making through the tax code, it is generally unsound.

  • The exemption for credit union income is a worthy case study. The credit union exemption is a narrow benefit provided to a single subindustry that results in an inefficient allocation of resources and a tax advantage over banks that offer similar financial services.

  • Eliminating the credit union exemption could increase federal revenue with minimal harm to long-term economic output because much of the subsidy results in economic inefficiency.

  • Similarly, other business tax expenditures unrelated to cost recoveryCost recovery is the ability of businesses to recover (deduct) the costs of their investments. It plays an important role in defining a business’ tax base and can impact investment decisions. When businesses cannot fully deduct capital expenditures, they spend less on capital, which reduces worker’s productivity and wages. , deferral, or international tax ruleInternational tax rules apply to income companies earn from their overseas operations and sales. Tax treaties between countries determine which country collects tax revenue, and anti-avoidance rules are put in place to limit gaps companies use to minimize their global tax burden. s could be eliminated and the resulting revenue used to further improve the corporate tax baseThe tax base is the total amount of income, property, assets, consumption, transactions, or other economic activity subject to taxation by a tax authority. A narrow tax base is non-neutral and inefficient. A broad tax base reduces tax administration costs and allows more revenue to be raised at lower rates. or pay for new spending.


Tax expenditureTax expenditures are a departure from the “normal” tax code that lower the tax burden of individuals or businesses, through an exemption, deduction, credit, or preferential rate. Expenditures can result in significant revenue losses to the government and include provisions such as the earned income tax credit (EITC), child tax credit (CTC), deduction for employer health-care contributions, and tax-advantaged savings plans. s are provisions in the tax code that deviate from a “normal income tax structure.” They generally favor a specific industry or activity. Eliminating such provisions could help broaden the tax base, and thus raise more revenue while improving the structure of the tax code. But diagnosing which tax expenditures are unsound policies that should be eliminated, as opposed to a structural element of the tax code worth retaining, is not always straightforward.

What Is a Loophole or Tax Expenditure?

The Congressional Budget and Impoundment Control Act of 1974 defines tax expenditures as “revenue losses attributable to provisions of the Federal tax laws which allow a special exclusion, exemption, or deduction from gross incomeFor individuals, gross income is the total pre-tax earnings from wages, tips, investments, interest, and other forms of income and is also referred to as “gross pay.” For businesses, gross income is total revenue minus cost of goods sold and is also known as “gross profit” or “gross margin.” or which provide a special credit, a preferential rate of tax, or a deferral of tax liability.” [1] That contrasts with provisions that are the “normal structure” of income taxes.[2] Many tax expenditures can generally be likened to spending programs or subsidies administered through the tax code, rather than through the normal appropriations process.

Whether a provision is viewed as a deviation from a normal tax structure depends on what tax definition is viewed as normal.[3]

Using the definition of income developed by economists Robert Haig and Henry Simons, income is defined as one’s consumption plus change in net worth.[4] But that definition is not necessarily the best way to structure a tax base because a change in one’s net worth usually becomes consumption later.[5] As a result, building the tax base on a Haig-Simons definition of income can lead to multiple layers of tax on saving and investment.

Alternatively, the tax base could be built on a cash flow definition of income, which would define taxable incomeTaxable income is the amount of income subject to tax, after deductions and exemptions. For both individuals and corporations, taxable income differs from—and is less than—gross income. as revenue less all the costs of earning the revenue, leading to only one layer of tax on saving and investment.

The structure of the current U.S. tax system is a hybrid of the two definitions, but the Joint Committee on Taxation (JCT) generally uses a Haig-Simons income tax definition to determine what constitutes a tax expenditure.[6] Even there, the JCT must make some compromises due to various measurement difficulties and policy choices, resulting in an even more subjective list of tax expenditures.

For instance, several tax expenditures relate to depreciationDepreciation is a measurement of the “useful life” of a business asset, such as machinery or a factory, to determine the multiyear period over which the cost of that asset can be deducted from taxable income. Instead of allowing businesses to deduct the cost of investments immediately (i.e., full expensing), depreciation requires deductions to be taken over time, reducing their value and discouraging investment. deductions. When a business makes a capital investment, such as purchasing a machine, the value of the cash spent on that investment is transferred to the value of the physical asset. In the immediate period, the business’s net worth has not changed; instead, it has been transferred from cash to a physical asset, but over time, as the asset wears out or becomes obsolete, the business’s net worth drops.

Under the Haig-Simons definition of income, the tax code would need to allow deductions for normal wear and tear, i.e., “economic depreciation.” The Alternative Depreciation System (ADS) is thought to approximate economic depreciation, but it is not necessarily scientifically determined nor accurate for every type of asset and the varying intensities with which assets are used—perhaps the more explanatory reason for why it’s viewed as normal is that it was in place when tax expenditures were invented as a concept.[7]

The JCT categorizes as a tax expenditure any depreciation deduction in excess of what would be allowed under ADS. This diverges from the cash flow approach, where what matters is the amount of cash earned and spent each year by the firm. Capital investments, like other business costs including employee wages and utility bills, would be fully and immediately deductible when they are made under a cash flow definition of income. While economic depreciation can be useful for accounting purposes, for tax purposes it is quite arbitrary, and it creates unintended consequences that bias the tax code against investment.

This illustrates that the general determination of tax expenditures can be rather subjective—not every tax expenditure should be viewed as spending through the tax code, but instead, some may be important elements for properly structuring the tax code so that it does not distort decision-making.

A few rules of thumb can help determine whether a tax expenditure is good or bad policy, or somewhere in between, depending on its purpose and structure.

  • Generally, if a provision is neutral, broadly available, and helps to eliminate the double taxation of saving, or broadly contributes to a consumption tax base, it is sound and should remain in the tax code.
  • On the other hand, if a provision is narrow and confers disparate treatment to specific industries or companies, or attempts to engineer decision-making through the tax code, it is generally unsound.
  • Some provisions fall in the middle—they could be justified on certain grounds, but the effects or interactions within the current tax system might deserve further scrutiny.

Examining the Credit Union Tax ExemptionA tax exemption excludes certain income, revenue, or even taxpayers from tax altogether. For example, nonprofits that fulfill certain requirements are granted tax-exempt status by the Internal Revenue Service (IRS), preventing them from having to pay income tax.

We can apply the rules of thumb to the exemption of credit union income from the corporate income taxA corporate income tax (CIT) is levied by federal and state governments on business profits. Many companies are not subject to the CIT because they are taxed as pass-through businesses, with income reportable under the individual income tax. , a provision that the JCT categorizes as a tax expenditure, to analyze whether it is a sound policy. The rules of thumb indicate that the credit union exemption is a narrow benefit provided to a single subindustry that results in an inefficient allocation of resources and a tax advantage over banks that offer similar financial services. As such, eliminating the credit union exemption could increase federal revenue with minimal harm to long-term economic output because much of the subsidy results in economic inefficiency.

Credit unions are nonprofit financial cooperatives that accept deposits, make loans, and offer other types of financial services to their members. Federal chartering of credit unions began during the Great Depression with the Federal Credit Union Act of 1934. Prior to this, many states had passed laws allowing for state-chartered credit unions.

Today, both state-chartered and federal credit unions are exempt from the federal corporate income tax, while federal and most state-chartered credit unions are also exempt from state-level taxes except for real and tangible personal property taxA property tax is primarily levied on immovable property like land and buildings, as well as on tangible personal property that is movable, like vehicles and equipment. Property taxes are the single largest source of state and local revenue in the U.S. and help fund schools, roads, police, and other services. es.

Why the Exemption?

The original purpose of credit unions shows that they generally have three distinguishing characteristics to justify their exemption from federal income taxes: 1) help unbanked, lower-income individuals, 2) restrict their customer or membership base, and 3) avoid high-risk, high-return investments.[8] As explained by Federal Reserve of Richmond researchers:[9]

In the 1998 Credit Union Membership Access Act, Congress reiterated that credit unions are exempt from federal income tax “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.” Today, the Federal Credit Union Act still states that its purpose is to “make more available to people of small means credit for provident purposes through a national system of cooperative credit.”

In other words, the mission of credit unions is to create a national system for lower-income people who otherwise would not be able to access credit or savings options. Additionally, credit unions face certain restrictions that other financial institutions do not, such as limitations on loan interest rates and on aggregate loan amounts.[10]

A policy change that occurred in 1951 also provides insight into the basis for granting credit unions an exemption from federal income taxes. In 1951, Congress revoked the tax-exempt status of certain types of financial institutions, including mutual savings banks. Like credit unions, mutual savings banks are member-owned and established to serve members of modest means, encourage thrift, and provide safe and convenient facilities to care for savings. Yet in 1951, Congress found mutual savings banks to be in active competition with commercial banks and so their tax exemption was revoked.[11] At the time, the exemption for credit unions was retained, but an Internal Revenue Service (IRS) report from that period stated that if Congress felt in 1951 that credit unions had “resembled taxable financial institutions,” it “seems probable” that Congress would have removed their tax-exempt status as well.[12]

Evolution of the Industry

In the time since the exemption was granted, both the financial sector and the credit union industry have evolved. Evidence indicates that many credit unions now resemble other financial institutions that are subject to the corporate income tax, suggesting the tax subsidy for credit unions is nonneutral. And other changes in the marketplace mean that lower- and middle-income consumers now have plentiful access to credit.[13]

Credit unions’ distinguishing characteristics and restrictions have been loosened over time, meaning that credit unions often compete directly with banks for the same customers. For example, the field of membership, or common bond requirements, have been relaxed to the extent that several news articles report that there are credit unions where “anyone can join.”[14] Further, in 2017, new rules took effect that loosened restrictions on business and commercial lending, paving the way for more credit unions to increase business lending activities in competition with banks.[15]

While credit unions do retain semblances of their distinguishing characteristics and still face certain restrictions on some of their activities, “[t]he credit union industry has evolved over time such that many of the financial services that credit unions now provide are similar to those offered by banks and savings associations.”[16]

What Is the Effect of the Subsidy?

Economists have tried to determine where the subsidy flows as well as the income characteristics of credit union customers.

A 2019 paper from Robert DeYoung of the University of Kansas and others found that credit unions are more inefficient than similarly-sized banks by an “economically substantial” difference and that credit unions misallocate the subsidy. The authors attribute about half of the efficiency difference to “mandated inefficiencies,” while the other half is due to inefficient management practices compared to banks. For example, credit unions hire more workers than needed for efficient operations and receive below-market returns on their investments compared to similarly sized banks. Further, the authors find that credit unions are misallocating a large portion of their tax exemption by providing above-market prices such as higher deposit rates, rather than using it to provide greater access to financial services. They conclude with three implications:[17]

First, these findings buttress arguments that the tax exemption provides credit unions with an unfair competitive advantage over commercial banks. Second, credit union members are receiving fewer benefits than intended by the legislation that established the tax exemptions (Revenue Act of 1916, Federal Credit Union Act of 1934). And third, taxpayers’ funds are being misallocated because federal and state government ‘tax expenditures’ are being diverted away from their intended beneficiaries.

As summarized by DiSalvo and Johnston, DeYoung’s research raises the question of whether even the amount of the subsidy passed through to customers through prices fulfills the intended role of credit unions because many credit union customers are not low-income or disadvantaged.[18]

That question is answered by a majority of studies that indicate credit unions are less likely than banks to serve lower-income customers.[19] For example, a 2017 paper from the Federal Reserve Bank of Richmond summarizes:[20]

Regardless of how researchers interpret the concept of modest means, however, the majority of studies that have been conducted suggest that credit unions are in fact less likely than banks to serve this subset of members. …the average household income of credit union members exceeds that of nonmembers by 20 percent. Furthermore, results from the Federal Reserve’s 2004 Survey of Consumer Finances indicate that 31 percent of credit union members were low-to-moderate income individuals compared to 41 percent at commercial banks. Moreover, according to a 2009 study by William Kelly Jr., then of Grinnell College, 89 percent of the benefits that flow to members in the form of lower loan rates and higher deposit rates are going to middle- and upper-class consumers.

Likewise, a study by the Government Accountability Office (GAO) using Federal Reserve survey data from 2001 and 2004 found that “credit union customers had a higher median income than bank customers” and that “credit unions served a lower proportion of households of modest means (low- and moderate-income households, collectively) than banks.”[21]

Together, these studies suggest that the credit union exemption is a narrow benefit provided to a single subindustry that results in an inefficient allocation of resources and a tax advantage over banks that offer similar financial services. Furthermore, the credit union falls short of the congressional mandate to serve lower-income people who lack access to banking services.

Repealing the Credit Union Exemption

The U.S. Department of Treasury estimates that exempting credit unions from taxation will reduce federal tax revenue by $24.56 billion across the 10 fiscal years from 2021 through 2030, reaching about $2.8 billion in fiscal year 2030.[22] In the context of the entire U.S. economy, the exemption is small, representing less than 0.01 percent of GDP per year.

Using the Tax Foundation General Equilibrium model, we estimate that repealing the credit union exemption would have a negligible long-run effect on the economy, wages, and jobs. The macroeconomic effect of repeal is small for two reasons: first, the exemption is small in the context of the entire U.S. economy and corporate tax base, and second, much of the subsidy results in economic inefficiency. Specifically, we estimate that long-run economic output, American incomes, the capital stock, and wages would fall by less than 0.05 percent because of repeal.

Table 1. Economic Effect of Repealing the Credit Union Exemption
GDP Less than -0.05%
GNP Less than -0.05%
Capital Stock Less than -0.05%
Wages Less than -0.05%
Full-Time Equivalent Jobs -1,000

Source: Tax Foundation General Equilibrium Model, July 2021.

Repealing Business Tax Expenditures Not Related to Deferral, Cost Recovery, or International Taxation

The Tax Foundation General Equilibrium model can also show the effect of eliminating all tax expenditures not related to deferral, cost recovery, or international taxation—more than 50 benefiting corporations and nearly 50 benefiting noncorporate businesses.[23]

Tax expenditures related to deferral, cost recovery, and international taxation are structural elements of the tax code that are broadly available. For example, accelerated depreciation provisions like 100 percent bonus depreciationBonus depreciation allows firms to deduct a larger portion of certain “short-lived” investments in new or improved technology, equipment, or buildings in the first year. Allowing businesses to write off more investments partially alleviates a bias in the tax code and incentivizes companies to invest more, which, in the long run, raises worker productivity, boosts wages, and creates more jobs. , capital gains taxA capital gains tax is levied on the profit made from selling an asset and is often in addition to corporate income taxes, frequently resulting in double taxation. These taxes create a bias against saving, leading to a lower level of national income by encouraging present consumption over investment. treatment, and provisions that deal with overseas income of multinational corporations are designed as moves toward a domestic consumption tax base, rather than special tax treatment for a specific sector of the economy.

Tax expenditures not related to deferral, cost recovery, or international taxation include tax creditA tax credit is a provision that reduces a taxpayer’s final tax bill, dollar-for-dollar. A tax credit differs from deductions and exemptions, which reduce taxable income, rather than the taxpayer’s tax bill directly. s for specific industries, exemption of credit union and other types of income, regional development tax incentives, and health and education tax incentives, among others.

While elimination of preferential tax expenditures would increase marginal tax rates on corporate and noncorporate businesses, the economic effect would be limited as some expenditures are already scheduled to expire within the budget window, and others lead to inefficiencies as they distort economic decision-making as illustrated by the credit union exemption. Long-run GDP would fall by 0.2 percent, and federal revenue would increase by $985.6 billion over 10 years on a conventional basis.[24]

Table 2. Economic Effect of Eliminating Various Business Tax Expenditures
GDP -0.2%
GNP -0.2%
Capital Stock -0.4%
Wage Rate -0.2%
Full-Time Equivalent Jobs -33,000

Source: Tax Foundation General Equilibrium Model as cited in TF’s Options for Reforming America’s Tax Code 2.0 (Washington, D.C., 2021).


While eliminating loopholes is a common turn of phrase when discussing business taxation, determining what constitutes a loophole is not necessarily an easy task. Lawmakers should carefully analyze tax expenditures before eliminating them, being sure to retain provisions that are broadly available and reduce the tax penalty on saving and investment.

Some provisions, however, such as the exemption for credit union income, clearly distort economic activity by narrowly targeting tax preferences on one industry. Tax expenditures like the credit union exemption could be reformed, and the resulting revenue used to further improve the corporate tax base or pay for new spending.

Stay informed on the tax policies impacting you.

Subscribe to get insights from our trusted experts delivered straight to your inbox.


[1] Congressional Research Service, “Tax Expenditures: Compendium of Background Material on Individual Provisions,” December 2020,

[2] Ibid.

[3] See discussion in Alex Muresianu, “How the CARES Act Shifted the Composition of Tax Expenditures Towards Individuals,” Tax Foundation, Mar. 24, 2021,

[4] Henry C. Simons, Personal Income Taxation: The Definition of Income as a Problem of Fiscal Policy (Chicago: University of Chicago Press, 1938). See also Robert M. Haig, “The Concept of Income—Economic and Legal Aspects,” in Robert M. Haig, The Federal Income Tax (New York: Columbia University Press, 1921).

[5] Milton Friedman, A Theory of the Consumption Function (Princeton, NJ: Princeton University Press, 1957),

[6] The Joint Committee on Taxation, “Estimates of Federal Tax Expenditures for Fiscal Years 2020-2024,” Nov. 5, 2020.

[7] Robert Bellafiore, “Tax Expenditures Before and After the Tax Cuts and Jobs Act,” Tax Foundation, Dec. 18, 2018,

[8] See Erica York, “Repealing the Credit Union Exemption,” Tax Foundation, Oct. 16, 2019,

[9] Liz Marshall and Sabrina R. Pellerin, “Credit Unions : A Taxing Question,” Econ Focus (Federal Reserve Bank of Richmond), Second Quarter 2017,

[10] Congressional Research Service, “Introduction to Financial Services: Credit Unions,” Jan. 4, 2021, Credit unions do make loans to other credit unions and credit union corporations, and they can accept deposits and make loans to nonmembers under certain conditions. See John A. Tatom, “Competitive Advantage: A Study of the Federal Tax Exemption for Credit Unions,” Tax Foundation, Feb. 28, 2005,

[11] Senate Report No. 781, 1951-2 C.B. 476 and 478 as cited in Marples, “Taxation of Credit Unions: In Brief,” Congressional Research Service, Mar. 31, 2016.

[12] Ibid.

[13] Robert DeYoung, John Goddard, Donal G. McKillop, and John O.S. Wilson, “Who Consumers the Credit Union Tax Subsidy?” Queens Management School Research Paper Series, July 10, 2019,

[14] Marples, “Taxation of Credit Unions: In Brief.”

[15] James DiSalvo and Ryan Johnston, “Credit Unions’ Expanding Footprint,” Federal Reserve Bank of Philadelphia, First Quarter 2017, 22,

[16] Marples, “Taxation of Credit Unions: In Brief.”

[17] Robert DeYoung, John Goddard, Donal G. McKillop, and John O.S. Wilson, “Who Consumers the Credit Union Tax Subsidy?” Queens Management School Research Paper Series, July 10, 2019,

[18] DiSalvo and Johnston, “Credit Unions’ Expanding Footprint.”

[19] The study cited above from DiSalvo and Johnston finds that within residential real estate lending, small banks and credit unions primarily make loans to middle-income tracts, evidencing the idea that they compete for the same customers. The same study also shows that a slightly larger portion of credit union loans go to lower- and moderate-income tracts than small banks, but also reject a larger portion of loans in these areas than small banks, suggesting credit unions may have more stringent credit standards. Overall, the majority of evidence suggests most credit union customers are not low-income or disadvantaged.

[20] Marshall and Pellerin, “Credit Unions: A Taxing Question.”

[21] Government Accountability Office, “Credit Unions: Greater Transparency Needed on Who Credit Unions Serve and on Senior Executive Compensation Agreements,” Nov. 30, 2006, 51-53,

[22] U.S. Department of Treasury, “Tax Expenditures FY2022,” June 2021,

[23] Ibid.

[24] Tax Foundation, Options for Reforming America’s Tax Code 2.0 (Washington, D.C., 2021),