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Tax battle: Banks on offensive against credit unions

Protest against banks and in favor of credit unions.
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Protest against banks and in favor of credit unions.

Congressional lawmakers currently working on tax reform are caught in a war of words between banks and credit unions.

At issue is the longtime federal tax exemption for credit unions: The credit unions want to keep it, while the banking industry wants it to end.

"Credit unions offer the same products as banks, and yet they get a tax exemption that costs taxpayers $2 billion a year," said James Ballentine, chief lobbyist for the American Bankers Association, an industry trade group.

"It's just fairness for the banking community and the taxpayers to stop the exemption," he said.

The ABA has been pushing to end the tax exemption for years, but in the past few weeks, with tax reform talks on Capitol Hill, it has stepped up its efforts with lawmakers to include a media blitz of radio and print ads in the Washington, D.C., area.

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"We're doing all we can to educate Congress on the issue," Ballentine said.

'We don't want to be like them'

So too are the credit unions.

"We're dealing with his head-on and getting our message out," said Dan Berger, president and CEO of the National Association of Federal Credit Unions, which is spearheading an email and call-in effort to lawmakers this week.

"Congress knows the value of credit unions," he said. "We were the only group lending to small businesses during the financial crisis. Our not-for-profit status shows that for us, it's not about stockholders, but about our members."

"If we lost the exemption, we'd be just like the banks," Berger said. "We don't want to be like them."

Credit unions, unlike banks, are not-for-profit, member-owned cooperatives. They have no shareholders and elect their boards of directors using a one-person, one-vote system, regardless of the amount individuals have invested.

Though products can vary, most credit unions are set up to offer more competitive interest rates and credit than banks and provide services like no-fee checking. Many are set up to directly support community development.

Only members of the credit union can deposit or withdraw funds, and the members usually, but not always, belong to a labor union, religious group or are employees of one company. Credit unions differ in terms of size and asset value.

(Read more: Now it's the 43 percent: Fewer paying no income tax)

It was under a 1934 law called the Federal Credit Union Act—and partly due to the devastating national bank collapse from the Great Depression—that credit unions got a federal tax exemption because "credit unions are mutual or cooperative organizations operated entirely by and for their members." They still must pay state and local taxes.

Though their numbers have been historically small, credit union membership has seen dramatic growth. It surged to 95.7 million by March of this year, an increase of 2.7 million from the start of 2012. That growth over five financial quarters was more than the previous 11 quarters, according to SNL Financial.

Credit unions are now a $1 trillion industry. They hold 6 percent of all financial assets in the U.S., compared with banks' 93 percent.

"Banks are trying to have it all and drive credit unions out of business with this push to end the tax exemption," said Tony Cherin, a professor of finance at San Diego State University and a board member of the USE Credit Union in San Diego.

"They've seen the growth of membership as a result of the recession, and they're crying in their beer," he said. "They don't like the idea that credit unions can offer lower rates."

"That's not true," said the ABA's Ballentine. "We welcome the competition. Banks compete against each other every day. What we want is a level playing field."

Selling points and accusations

Both sides can point to statistics that back up their views.

In a 2010 report on tax reform commissioned by President Barack Obama, an advisory board said that eliminating the federal tax exemption for credit unions would raise $19 billion in Treasury revenue over 10 years.

But a study commissioned by the NAFCU in 2012 countered that, saying that removing the tax exemption would cost credit union consumers about $10 billion a year through higher fees and interest rates on loans. And it would cost the federal government some $1.5 billion in lost tax revenue, due to loss of income, if the exemption was eliminated.

And both sides needed financial help from the Great Recession.

Some $245 billion was given to U.S. banks through the Troubled Asset Relief Program, with more than $169 billion paid back. Credit unions borrowed around $30 billion from the Treasury to stabilize two failed corporate credit unions—sort of central banks for credit unions—in 2009.

The credit unions are still in the process of paying the money back, with some $5 billion left to pay. Meanwhile, each side is trading accusations over compensation and fair taxation. Here are some of the comments from each side:

"Credit unions' board members make lots of money," said Ballentine. "There's an untold story there."

"The only way I get paid is a dinner. I'm not earning a nice little sum like bank executives," said Cherin.

"Many banks, like the smaller S-Chapter banks"—banks with a small number of shareholders that can avoid corporate income tax—"are not paying federal taxes at all," said Berger

"They are such a small part of the industry (S-Chapter banks), and being able to move money around to cut down on taxes doesn't mean you have a blanket exemption," said Ballentine.

What's likely to happen?

While there's no specific proposal to eliminate the tax exemption—the ABA says it should be part of an overall tax reform bill—there is a separate move to increase the current lending ability of credit unions.

Reps. Ed Royce, R-Calif., and Carolyn McCarthy, D-N.Y., co-sponsored a bill in February to loosen the current cap on business lending by credit unions from 12.25 percent of total assets to 27.5 percent. Raising the asset cap would make it easier for small businesses to get loans and create more jobs, according to Royce's website.

(Read more: Time for tax planning already?)

The measure has yet to make it to a full vote in the House.

As for the tax exemption itself, that's likely to stay in place, said David Primo, a professor of political science and business administration at the University of Rochester.

"While it's not clear the exemption is justified, I think the credit unions have the upper hand politically," he said.

"There are credit unions in so many congressional districts, it would be hard for Congress to repeal it. They can mobilize and are well connected to their lawmakers," Primo added.

"Besides, banks have an image problem after the recession and the bailout they got. I don't think helping Chase or any other big bank by ending the exemption is going to fly," he added.

—By CNBC's Mark Koba. Follow him on Twitter @MarkKobaCNBC

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