Wrong Question Being Asked Over CU Taxation
"Should credit unions be taxed?" Shouldn't the question really be, "Why are banks taxed?"
What if banks and credit unions under $10 billion in assets were not taxed, and depositories over $10 billion in assets and up to $50 billion were taxed at the current 30% rate, and mega-financial institutions over $50 billion in assets were double-taxed to fund systemic risk?
Would this increase job growth, stimulate the economy and penalize the inefficient?
The Senate wants to surcharge big banks as a solution for Too Big To Fail, which has the support of the Federal Reserve. Congress is discussing tax reform to aid in the reduction of a growing $16-trillion deficit. So the age-old question will come up again: should credit unions be taxed?
Instead of the ongoing fight by credit unions and banks over taxation of credit unions, it would appear that tax reform of depositories would be a better solution.
What could be the goal of financial institution tax reform? Stimulate the economy by creating jobs, and establish a fund to avoid TARP legislation or Congress aiding Too Big To Fail institutions.
The Federal Reserve under Chairman Bernanke has studied where jobs are created and found more than 67% come from small businesses, especially those business employing fewer than 50 workers. Who is the "banker" to small business? It is not the mega-banks or Wall Street institutions; it is Main Street institutions: community banks, thrifts and credit unions.
Outgrowth of Outmoded Legislation
Joe the Plumber doesn't go to Chase, Wells Fargo or Bank of America to finance his business. He goes to community banks, thrifts and credit unions. Why? In congressional testimony one mega-bank CEO said his bank loses money on loans of less than $100,000 and even needs to make business loans upward of $1 million to make a reasonable return. Yet the size of the loan Joe the Plumber needs is below $1 million. Too Big To Fail is an outgrowth of legislation to protect deposits, the Bank Act of 1933 and a subsequent amendment madded the tool of "saving" a failing instituions. The government (Treasury, Fed, FDIC or NCUA) saves a failing institution to avoid the risk to the entire system of endangering confidence or trust by depositors.
Saving a depository means a depository is allowed to grow well beyond its optimal operating cost. Growth at all costs is the prime directive.
Economy of Scale (EOS) was first defined by Adam Smith in The Wealth of Nations more than 200 years ago. It represents the optimal level of cost, revenue, size and productivity. EOS for depositories has four phases: 1) a growth phase up to about $500 million in deposits; 2) the EOS efficiency phase from about $500 million to $10 billion; 3) the diseconomy phase beyond $10 billion in assets, and 4) systemic risk or Too Big To Fail phase.
The Economy of Scale then becomes the key to tax reform for depositories, economic stimulus for job creation and the end of Too Big To Fail or systemic risk.
Coming to the Aid of Joe the Plumber
The current tax position of all financial institutions is shown in Table One. What if the credit unions were taxed? This would raise $2.2 billion, which would only increase prices to Joe the Plumber and not be enough to save even one TBTF institution.
Also, note each of the asset ranges for financial institutions has the assigned economy of scale phase. The growth and EOS efficiency phases are separate, and the diseconomy phase is split between those who are becoming inefficient and those who are a full systemic risk or Too Big To Fail.
How could this tax position, shown in the table, be changed to aid Joe the Plumber create jobs and put an end for Too Big To Fail?
Don't tax those financial institutions that aid small businesses while growing to their economy of scale. Don't tax those depositories that have achieved their EOS and are able to maintain their EOS position.
Increase taxes on those institutions beyond their EOS to establish a fund to aid the government to shrink but not close the depositories that are Too Big To Fail. This tax increase would not impact the efficient and those growing to their EOS, but would tax those who are beyond their EOS and are Too Big To Fail:
The additional $33.6 billion raised each year would go to a fund run by the Federal Reserve for aid to mega-institutions that fail, thus in the long run avoiding TARP legislation.
What are the consequences of this proposed tax reform? Main Street FIs would aid Joe the Plumber to grow and add jobs to the economy. Financial Institutions larger than $10 billion would downsize to avoid taxes and extra taxes. Too Big To Fail would end. Executive pay would be a non-issue, since senior officials would earn lower pay but efficiency bonuses. Mega-banks would move to do what they do best: trading desk, M&A, merchant banking, currency exchange, etc.
And, the question "Should credit unions be taxed?" would be solved.
Michael Moebs is the CEO and Economist of Moebs $ervices in Lake Bluff, Ill. The firm specializes in pricing and is hosting The Pricing Institute in Philadelphia April 29th to May 2, 2013.