Do Non-Profit Hospitals Deserve Their Tax Breaks?


Mahar_1Monday, The New York Times reported that the IRS, Congress and state officials have begun taking a close look at nonprofit hospitals, all asking one charged question: Do they really deserve their tax-exempt status?

Some 16% of U.S. hospitals are for-profit—and they pay taxes. Nonprofits, by contrast, have traditionally been tax-exempt.  But now investigators are asking: “Are they really that different from the
for-profits?  Do they provide enough charity care and community service to justify the break?

The short answer is this: To understand the economics of the hospital industry,  you first need to understand that it is in many ways very much like the real estate industry: what matters most is “Location, Location, Location.”

A hospital located in an affluent area will draw well-insured patients. By definition, then, it will provide less charity care because it well see fewer uninsured patients.

This is why for-profit hospitals tend to provide less charitable care: If you’re a corporation you don’t a build a for-profit hospital in a market where you expect that half of your customers won’t be able to pay.  For-profits don’t close their doors to the poor, but they purposefully try to locate areas where they won’t see as many of them.  As well they should: a for-profit corporation’s first obligation is to generate profits for its shareholders.

Non-profit hospitals, on the other hand, began as charitable institutions—often with a religious affiliation—and to this day, many are located in inner cities or poor rural areas where they serve a large uninsured or underinsured population. Traditionally, nonprofit hospitals have operated with a sense of “mission”—to serve the health needs of their community. This is argument  giving them a break on their taxes.

Yet, it’s  worth noting that all nonprofit hospitals are exempt from corporate income taxes as well as state and local property taxes—wherever they are located. Perversely, that exemption is most valuable to those located in the most affluent areas because their income is higher and their property is worth more. As David A. Hyman and William M. Sage point out in the current issue of Health Affairs:

“All else being equal, a hospital that provides little charity care and is located in a “desirable” location (in terms of property values) will receive a much greater financial benefit when its income and property go untaxed than a hospital that provides lots of charity care and is located in an “undesirable” location. Thus, in important respects, current subsidies are ‘upside down’ in the sense that they are worth the most to institutions that are likely to” [provide the least charity care. ]

This brings us directly to the question Congress and the IRS are posing: should nonprofit hospitals be exempt from taxes based simply on their status as nonprofits, or should tax-exempt status be dependent on what they actually do to serve their community?

Here, it’s important to remember that caring for the poor is not the only way that a hospital can contribute to its community. Under the law, a nonprofit can  receive a federal tax exemption, if it is organized and operated exclusively to promote one of the specific purposes set forth in section 501(c)(3) of the Internal Revenue Code—which includes charitable, religions, educational and scientific ends.

Thus an academic medical center which  loses money educating  medical students while also investing in the expensive technologies that it needs to do important scientific research might well be able to justify its tax exempt status even if it treated only a small number of indigent patients. Some hospitals also provide educational  services in their communities—running support groups for diabetic patients for instance, teaching them how to monitor their disease.

How a nonprofit uses any money left over after covering the costs of operation is also important.

A for-profit might distribute those earnings to its shareholders, or invest in something that would generate greater profits going forward: valet parking, for example, might attract more well-insured patients. But to qualify as a non-profit, Hyman and Sage note, a hospital must:
“retain its net earnings and use them to promote the purposes for which the nonprofit was created. “ In other words, a non-profit must plough any surplus back into its “mission.”

Yet in today’s fiercely competitive market, non-profit hospitals sometimes spend their capital in ways that seem to have little to do with mission—and much to do with struggling to take market share away from neighboring hospitals.

In Money-Driven Medicine: The Real Reason Healthcare Costs So Much ( Harper/Collins, May 2006).  I quote the director of a Phoenix-based health foundation describing how resources are allocated in his hometown as local hospitals chase affluent newcomers moving into the city’s “Valley of the

“By expanding and modernizing, acute care hospitals are looking to compete with a recent surge in physician-owned hospitals and specialty surgical centers,” he explains. Acute care hospitals fear that these specialty centers will “skim” lucrative business like heart surgery, leaving the general hospitals with the least profitable businesses—burn units, for example, level 3 trauma units or ERS.

Fighting to offset potential losses, the nonprofit acute care hospitals are rushing to add beds in the Sun Valley area where a new young, well-educated and well-insured work force is moving in. The foundation director describes a new facility: “It’s like a luxury hotel.”

Every hospital feels that it  must stake their claim in this newly affluent area, he adds, and “the land-rush mentality doesn’t always take into account planning for the community’s needs . . .  When it comes to breaking down the health needs of the population by age and chronic disease in order to try to decide what mix of ambulatory, inpatient and home health care will be required . . . This,” he observes, “Is not the game that hospital executives are in.”

Meanwhile nationwide, nonprofits like those in Phoenix may be overbuilding—or at least investing their capital in the wrong areas. As they view for well-heeled customers, they may be putting too much emphasis on cosmetics and bleeding-edge unproven technologies, while investing too little in less visible areas like palliative care, or the information technology that could reduce hospital errors.  

In many regions, nonprofit suburban hospitals are trying to take high-margin business away from big city hospitals. “What we have to do to maintain our position in the market is to keep adding services,” a Westchester hospital CEO explained to New York Magazine a couple of years ago. “That’s the whole reason we’re doing liver transplants.”

“Liver transplants”??

Do the residents of Westchester County need a local hospital doing liver transplants? Just how many would the hospital do? Would patients be better off at a high-volume medical center in Manhattan, where the carpeting might not be as nice, but, research shows, “practice makes perfect”?

These questions didn’t seem to come up. Transplants would raise the nonprofit hospital’s image.
And when it comes to enhancing a brand name, sometimes nonprofits seem littler different from for-profits. In Money-Driven Medicine, I quote from a 2005 study in the Archives of Internal Medicine which describes how even academic medical centers trawl for customers with ads like “We Do Botox!” or “FDA Approves Deep Brain Stimulation Therapy for Parkinson’s Disease”
The study pointed out that many of the ads (38%) risked “raising false hopes” by thumping the tub for unproven procedures like “deep brain stimulation for Parkinson’s,” while another 28% were advertising cosmetic procedures. Such ad spending has little to with improving the health of the community, much to do with growing market share.

Yet, with the number of uninsured patients and unpaid bills rising, many nonprofit hospitals find themselves caught between a rock and a hard place. If they can’t bring in the patients willing to pay for private rooms with Jacuzzis in the maternity ward–patients who will be impressed by a waterfall in the lobby and chutney for dinner–they won’t have the money they need to keep the trauma unit open–and serve the larger community. “No [profit] Margin, No Mission” is a favorite saying among hospital CEOs.

Moreover, today’s hospitals are increasingly dependent on the bond market to raise capital. At one time, both government and philanthropists contributed a much larger share of the money hospitals needed to survive, but today, hospitals rely on borrowing by issuing bonds. And, quite understandably, a bondholder’s primary concern is not whether or not the hospital is serving its community, but whether or not he will receive the expected return on his investment. Thus, when bond rating agencies like Standard and Poor’s rate hospital bonds, they can’t give points for charitable care.      

Nevertheless, if we are going to give nonprofits enormous tax exemptions, somebody needs to be keeping an eye on how they are spending their capital.

Two years after the Westchester CEO bragged about his new “product line” (liver transplants) The New York Times reported that a state audit of the very same Westchester hospital showed  “mismanagement, sloppy accounting practices and wasteful spending” which “contributed to staggering financial losses.”  The audit also showed that former executives at the hospital were spending lavishly on things like restaurants, hotels and florists—with scant controls or documentation” even while  “the medical center’s finances were deteriorating.”But while some hospitals should lose their tax breaks, we don’t want to throw out the baby with the bath water by doing away with tax exemptions for all  non-profits.  They are different from for-profits-in ways that are essential to our health care system.   

In the most recent issue of Health Affairs Bradford Gray and Mark Schlesinger very carefully analyze some 162 studies comparing the real-world performance of nonprofit and for-profit hospitals, nursing homes and health plans on a  range of issues and discover that, while they may not be as different as one might expect, the fact is that, on average:

“for-profit organizations more aggressively mark up prices over costs and otherwise maximize revenue. This pattern has been documented among community general hospitals, nursing homes, psychiatric hospitals, drug treatment centers, rehabilitation facilities, and health plans.

“Second, nonprofit organizations appear more trustworthy in delivering services, being less likely to make misleading claims, to have complaints lodged against them by patients, and to treat vulnerable patients differently from other clientele.

“Third, nonprofits are typically the incubators of innovation, using philanthropy and cross-subsidies to finance the development of services for which there is not yet a market.

Moreover, while only about one-quarter of non-profit hospitals provide enough uncompensated care to the poor and uninsured to equal  their  tax benefits, “one  study found that the nonprofit hospitals that were the least involved in free or subsidized treatment were the most engaged in other forms of community” service.

The bottom line is that auditing nonprofits is a good idea, though federal investigators should turn to community experts to find out just how much service a nonprofit offers. Local GPs who work in low-cost clinics, for instance, will know how easy or difficult it is for a Medicaid or uninsured patient to get an appointment with a specialist at a hospital clinic.(And will that patient be seen by residents or a combination of teaching faculty and medical students?) Local educators will know which hospitals are making a contribution to health education in the schools.

Because the hospital industry is all about location, these audits must be done on a local basis, with the community weighing in on decisions. The many ways in which a hospital serves its community are not easy to quantify, and they vary, depending on the needs of the community.

At the same time, it is good for non-profit hospitals to know that they are accountable–and that if they forget their mission, they can (and should) lose that tax exemption.

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13 replies »

  1. I agree with “DRTHOM” over his statement “Charity care is only one facet of the patchwork system we practice in. As the religious orders have aged out of the management of these endowed systems, it has become all about the money.”
    Non-profit hospitals are affiliated with profitable business, they are getting more state funding and even not paying taxes for the services in the profit business.

  2. Hi Maggie,
    Thank you for the well informed and fair perspective you’ve provided on this issue. I would be interested to know your thoughts on how to reduce health care costs in general. Thanks!

  3. A non-profit hospital that has profitable afillatilions and uses its non-profit money’s and manpower to fund profit business should be fined and loose their tax exempt status. Also the people responsable should be proscuted as tax evading crooks as they are frueding the state in two manors. 1-by showing a higher cost of running the nonprofit hospital and getting more state funding and 2 by not paying taxes for items and services in the profit business.

  4. I am a for profit doctor with privileges at a not-for-profit intitution. I do my share of unassigned call, see uninsured patients and I practice with the largest private provider of Medicaid services in my state. When someone comes in for care and can’t pay, I charge him the full amount on the front end and mark down the charges or write it off completely on the back end. Rarely to folks who can’t pay get sent to collections.
    Our hospital, on the other hand, has what our consultants have told us as the most aggressive collection policy they have ever seen, profit or not; a view many of our patients agree with. If you don’t qualify for their charity care guidlines, and they are limited only to the impoverished medically indigent, they will pursue you to bankrupcy court, no matter what the extenuating circumstances. If you pay me $25 a month, I will never send you to collection no matter what the balance. The hospital will not accept anything other than full payment. Then they have the nerve to solicit donations from the very folks they send to collections. Through mergers and dissolutions, managers have left with multi-million dollar golden parachutes
    “Charity” care is only one facet of the patchwork system we practice in. As the religious orders have aged out of the management of these endowed systems, it has become all about the money.

  5. The reason is that charity care has to be predetermined if you make any attempt to collect on a patient’s bill, it’s not classified as charity. It’s ironic because the strapped hospitals that DO treat mostly uninsured patients are often the most aggressive in their collections process, simply out of financial necessity.

  6. The reason is that charity care has to be pre-determined if you make any attempt to collect on a patient’s bill, it’s not classified as charity. It’s ironic because the strapped hospitals that DO treat mostly uninsured patients are often the most aggressive in their collections process, simply out of financial necessity.

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  8. Most people think that non-profit health care is better than for profit health care and there are some examples and research to support this. The thinking goes that if we take the profit motive out of health care, we can focus on delivering high quality, compassionate care to patients. Sounds good in theory but it does seem as if some non-profit hospitals act like for profit companies, doesn’t it?
    One of the problems with non-profit hospitals occurs when they stray too far from their non-profit roots. They conceal information and act less transparent than they should. I know hospitals that won’t release costs of certain procedures (granted, they may not know!) or talk about how much they pay their employees or reveal all the expense of capital projects. Health care deals often take on the same aura as a Chicago political deal. There are good reasons for doing this, they say. But they really don’t want the public to know about multi million dollar deals.

  9. NS–
    You’re entirely right about the importance of the difference of the distinction between “charity care” and “uncollected debt.”
    And the public hospitals that treat the greatest number of indigent patients often fall into this trap–making it appear that they’re doing far less charitable care than they do.

  10. I’m surprised this post doesn’t mention the issue of “charity care” vs. uncollected debt. Here in Illinois, where Lisa Madigan is strongly pushing the idea of an “8% rule” for charity care, we’re routinely treated to tables and graphs that show major inner-city urban health hospitals offering minimal levels of charity care. One such table is available at the Sun-Times here.
    Notice that NONE of Illinois’ inner city or rural hospitals reach that 8% level. Not Advocate Bethany, not Mount Sinai, not Roseland, not Loyola. Stroger/Cook County isn’t included, but I would be surprised if it came up much higher. The reason is that charity care has to be pre-determined — if you make any attempt to collect on a patient’s bill, it’s not classified as charity. It’s ironic because the strapped hospitals that DO treat mostly uninsured patients are often the most aggressive in their collections process, simply out of financial necessity. This leads to the artificial impression that they’re reaping some huge windfall. In fact, if you go by the Sun-Times’ table, hospitals with wealthy patient populations like Northwestern, Rush, and U of C are more “charitable” than inner-city hospitals like Roseland or Sinai. Doesn’t quite match the facts on the ground.
    There’s also an issue of how to get to that 8% quota. How do you determine if a patient is capable of paying when they’re wheeled into the ED? Do you just give the first 8% of your self-pay patients a pass without even trying to assess their ability to pay? Do you subject patients to credit checks and the like before offering service? The current way this works is that you try and collect, and if you’re unable to do so you give it a pass. But that system results in artificially low numbers.

  11. Good commentary.
    Just like to note that liver transplants are about more just than image, they’re about reimbursement.
    The reimbursement system isn’t only skewed by payor mix (privately insured well-off people pay better than Medicaid), but it’s also skewed by procedure mix. Some procedures generate profits, and some generate losses.
    That’s another big part of the reason why doctors are setting up specialty clinics–entire hospitals dedicated to the most well reimbursed procedures, regardless of who’s paying.

  12. In Money-Driven Medicine, I quote from a 2005 study in the Archives of Internal Medicine which describes how even academic medical centers trawl for customers with ads like “We Do Botox!”
    This is correct…it seems like the UPMC ads in Pittsburgh are evenly divided between these three themes:
    A) Pittsburgh is a great place and people love their families and UPMC cares about its patients and the community
    B) Magee Women’s Hospital cares about women
    C) Bariatrics works!

  13. Maggie – that was an excellent commentary on the issue. It is all about location, location location.
    An easy way to measure a hospital’s commitment to mission is “comparing” the population a hospital serves with the make up of its primary serice area (not too difficult to define.) This can work for academic medical centers and community hospitals. Of course, retaining tax-exempt status does little to address the vulnerablity of “poorly” located hospitals. The oft present problems of mismanagement (including foolishly chasing affluent patients, not chasing the insured in the primary service area.) and lousy reimbursment. Regrettably, too many hospital leaders fail to recognize that even in economically disadvantaged communities there are plenty of people with insurance (behind this are often subtle racial and cultural biases.) With regard to reimbursement, the failure/unwillingness of governmental and non-governmental payors to recognize the additional costs associated with a poor location e.g. the added cost of RN recruitment, security (a sweet senior in pink frock or a burly unformed officer at the front entry), % of frequent flyers in the ER.

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