Amid the worst recession in a generation, the banking industry is again challenging the tax-exempt status of credit unions.

As nonprofit, member-owned institutions, credit unions have long been exempt from corporate income taxes at both the state and federal level. The idea is that credit unions provide a public service by offering loans to those who might not otherwise have access to credit.

But as credit unions have grown in size — six Wisconsin credit unions now count more than $1 billion in assets — some are questioning their protected status. Most credit unions have also managed to remain profitable despite the weak economy, a sore point for many today in the beleaguered banking industry.

"With local, state and federal governments all facing serious budgetary emergencies, the largest and most profit-driven credit unions can and should pay their fair share of the tax burden," says Kurt Bauer, president and CEO of the Wisconsin Bankers Association.

Bauer is pegging his comments to a new report from the President's Economic Recovery Advisory Board which included ending the credit union exemption in a long list of recommendations on addressing the nation's budget deficit.

The panel chaired by former Federal Reserve Board Chairman Paul Volcker was charged with recommending revisions to simplify the tax code, improve taxpayer compliance and reform corporate tax laws. Eliminating some of the specific exemptions would improve efficiency, the panel says.

"Unlike other financial institutions like banks and thrifts, credit unions do not pay corporate taxes on their income," the report notes. "Eliminating this exemption would raise revenue and level the playing field but would clearly raise taxes on credit unions."

Nationally, ending the credit union income tax exemption could bring $19 billion in additional revenues to the U.S. Treasury over the next 10 years, according to one government estimate. In Wisconsin, taxing credit union profits at the same rate as corporations would provide anywhere from $15 million to $40 million in new revenues for the state, according to various reports.

But any tax talk is already meeting stiff resistance in Madison, home of the Credit Union National Association, which lobbies in Washington on behalf of the nation's 7,700 credit unions and their 92 million members.

"The WBA is once again blatantly mischaracterizing information to suit its own anti-consumer agenda," says Brett Thompson, President & CEO of the Wisconsin Credit Union League.

Thompson says the advisory board report merely states a list of options the government could pursue to reform tax law and does not represent the views of the Obama administration.

"I don't believe for a second that the president or Congress wants to raise taxes on 92 million Americans considering the current economic climate," he says.

Thompson says credit union profits are directed back to members in the form of better rates on savings and loans along with lower and fewer fees on other services. In Wisconsin last year, he says that meant $200 million returned to nearly 2.2 million credit union members.

While credit unions were formed in the U.S. early in the 20th century, they didn't enjoy tax-exempt status until 1937. That year, the New Deal Congress granted credit unions a federal tax-exempt status based on their cooperative structure and the fact they are operated solely for their members.

Even as credit unions have evolved to compete with banks on many products and services, Congress has continued to ensure their tax-exempt status, most recently in 1998 with enactment of the Credit Union Membership Access Act.

"The core issue is whether credit unions fulfill a public purpose, such as providing access to credit markets for families, individuals and businesses that commercial banks do not lend to," says Andrew Reschovsky, a professor at the LaFollette Institute at the University of Wisconsin-Madison. "If so, credit unions actions might justify a public subsidy."

But bankers association president Bauer says taxpayers receive virtually nothing in exchange for the credit union subsidy. He says the social mission of serving low- to moderate-income populations that once justified the credit union tax subsidy has been ignored, especially by the largest institutions.

Bauer also notes that six credit unions in Wisconsin have more than $1 billion in assets, making them larger than 95 percent of the banks in the state. He says banks of all sizes are now feeling the impact of "aggressive competition from profit-driven credit unions."

There's little debate that credit unions have continued to get bigger, largely through mergers. The state's largest credit union, Summit, was created through a series of mergers over the past years between the State Capitol Employees Credit Union, Great Wisconsin Credit Union (the former CUNA Credit Union) and State Central Credit Union of West Allis. It now counts some $1.5 billion in assets, 24 locations, 390 full-time and part-time employees and nearly 110,000 members primarily in the Madison and Milwaukee areas.

Credit unions have also managed to remain profitable despite the recession, although six of Wisconsin's 10 largest credit unions showed lower net income in the first half of 2010 than in the same period last year. Still, all were running in the black, led by Eau Claire's Royal Credit Union which saw its net income climb 196 percent during the first half of the year from $1.3 million to $4 million.

Banks, on the other hand, have struggled, with one of every six Wisconsin banks showing a net loss during the second quarter of 2010. M&I Bank of Milwaukee, the largest Wisconsin-based financial institution, lost $126 million alone in the second quarter, although that was an improvement over its loss of $211 million for the same period a year ago.

There have been discussions in Washington before over the fiscal impact of the credit union income tax exemption.

In 2007, former Internal Revenue Service commissioner Kevin Brown wrote a letter to the Senate Finance Committee detailing numerous abuses by tax-exempt entities. He said "many tax-exempt credit unions may be hard to distinguish from for-profit banks."

Also that year, former Treasury Deputy Assistant Secretary Robert Carroll released a departmental background paper citing several items in the federal tax code that could be eliminated to pay for a cut in the top corporate tax rate. Among the options: ending the credit union exemption.

But those suggestions never gained much traction.

While the new Volcker report does include ending the credit union income tax exemption as one way to reduce the federal deficit, it also mentions the growth of Subchapter S corporation arrangements — a way to organize bank ownership to reduce tax obligations.

Subchapter S banks pass their earnings along to shareholders in the form of dividends, who are then taxed as individuals. Theoretically, this can reduce tax liabilities for the bank's owners, who can use other deductions to lower their exposure.

In addition to taxes, banks and credit unions have sparred recently over allowing credit unions to make more small business loans.

The credit unions are now backing federal legislation to raise the limit on business loans from 12.25 percent to 27.5 percent of a credit union's total assets. The banking industry has opposed the changes, saying it will put smaller community banks at an even greater disadvantage in trying to compete with tax-advantaged credit unions.

Wisconsin Credit Union League president Thompson says he finds it ironic that banks are pushing to tax credit unions while they continue to lobby for tax breaks of their own. He doesn't deny that credit unions have gotten bigger, but he says nothing about their basic ownership structure has changed.

"We've grown because we do a good job of serving consumers," says Thompson. "Maybe banks need to do a better job of doing that."