Who Consumes the Credit Union Tax Subsidy?

Abstract

Credit unions are exempt from paying income taxes, and these tax savings are supposed to subsidize the provision of financial services to credit union members. In this paper, we investigate whether the entire credit union tax subsidy is being passed along to credit union members — in the form of increased quantities of financial services and/or better-than-market interest rates — or whether some of the credit union tax subsidy is being consumed by inefficient credit union operations. We estimate a structural model of profit inefficiency for US commercial banks between 2005 through 2017, and use the estimated parameters to evaluate the relative performance of US credit unions and commercial banks. When inputs and outputs are valued in terms of market prices, profit inefficiencies at credit unions exceed those at similar commercial banks by an economically significant order. About half of this inefficiency gap can be attributed to legally mandated credit union activities — such as producing loans and issuing deposits — while the remainder can be attributed to operational inefficiencies at credit unions relative to banks. When inputs and outputs are valued in terms of the prices that credit unions actually pay, our results suggest that over nine-tenths of the tax subsidy is simply passed through to credit union members in the form of higher deposit interest rates.