Efforts that have surfaced in several states to tax credit union retained earnings could have such a negative effect on credit union net worth that Congress would have to revisit and change federal Prompt Corrective Action (PCA) law, according to NCUA Chairman Dennis Dollar.
Dollar made that point in remarks before the annual meeting of the Utah League of Credit Unions. Utah's legislature had considered a tax on the state's largest credit unions, but has tabled the proposal to study the idea for two years. (Dollar was scheduled to speak prior to the tax proposal announcement.) The state has passed a cap on member business lending. A tax proposal remains before the Iowa legislature, and similar proposals have been made in other states.
While acknowledging tax policy is the domain of state legislatures, Dollar told Utah's credit unions that the negative effects of such proposals must be examined before further moves are made.
"I recognize and respect the rights of each state to apply its own laws and regulations to institutions chartered under state law, including taxation," Dollar told the meeting. "However, no state should lightly enter into the taxation of credit union retained earnings without recognizing that there are net worth considerations, which are mandated by federal law for all federally insured credit unions-whether they are state or federal charters. These statutory net worth provisions, established under the PCA statute, cannot be disregarded when taxation is put on the table."
Dollar reminded the audience that the federal tax exemption is based on the structure of credit unions as not-for-profit financial cooperatives, which can build net worth only through retained earnings. Congress granted federal credit unions an exemption from corporate income taxes in 1934. Most states then followed.
"If credit unions are restricted in their ability to retain earnings sufficient to meet statutory reserve requirements," Dollar said, "the statutory requirements of PCA to be well-capitalized would need to be seriously re- evaluated by Congress. Taxation significantly alters the net-worth dynamic for credit unions and therefore has ramifications."
Dollar pointed out that had the 35% tax rate proposed at one point in Utah been in effect for credit unions nationwide the past 10 years, the average net worth ratio for all federally insured credit unions in the U.S. today would be about 8.42%, rather than its present level of 10.71%, NCUA estimates.
"Since a credit union's net worth ratio is the only buffer the National CU Share Insurance Fund (NCUSIF) has to protect against losses and since that insurance fund is the buffer protecting the taxpayers from credit union losses," Dollar observed, "it is incumbent on legislators and policy makers to weigh the impact of taxing the retained earnings of these not-for-profit financial cooperatives that have no other means of building net worth."
Taxation "would definitely result in reduction of their net worth, net worth required by federal law that they must maintain at a specified level."
Under federal PCA law, a credit union insured by NCUSIF must have a minimum net worth ratio of 7% to be considered well-capitalized.