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December 16, 2012

Corporate tax treatment should be equal

(Continued)

A general tax policy principle is “if it walks like a duck, and quacks like a duck, it’s a duck.” The IRS taxes based on the substance of the transaction, not the form of corporate organization. The substance of mutual financial companies is little different than the traditional financial intermediation of community banks, led by boards of local citizens and designed to serve the needs of households and their commercial enterprises in the community.

I sit on a community bank board, and I had been a credit union member most of my life. Both organizations do great work in their communities and have similar missions. But, credit unions are afforded a tax advantage that holds small and community banks at a disadvantage. Banks live by the spread between what they receive in lending and what they pay out to depositors, with any residual going first to overhead, then to the IRS, and finally to shareholders. Corporate income taxes take a big slice from the spread. Mutual savings banks and credit unions are exempt from these same taxes.

While they continue to grow in management sophistication, community banks function much like they have promised their neighbors for a century. Meanwhile, despite the tax-exemption advantage, credit unions and mutual banks have been increasingly expanding their portfolio of services they provide to their community, including recent forays into commercial lending and residential mortgages.

Mutual financial institutions were granted their tax-exempt status in a sweep of Great Depression banking regulation. They probably could not successfully argue for their tax-exempt status based on the principles of the modern tax code. These tax-exempt organizations have also managed to escape many of the regulatory burdens placed on community banks arising as Congress reacts to the economic perils of U.S.banks too-big-to-fail. Tax-exempt financial institutions have gone unscathed by arguing they were different, even as they made great strides to become similar to, and compete side by side with, community banks.

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