WASHINGTON, April 8, 2014 (UPDATED May 3, 2016)—Almost two thirds of hospitals in the U.S. are nonprofit institutions. Given the significant tax breaks that come with nonprofit status, in the healthcare context, nonprofit translates to massive profits. Critics argue that coupled with the low level of charity some nonprofits provide, in most cases tax breaks are unjustifiable and unsustainable.
Of the country’s thousands of hospitals, 23 percent are owned by governments (state and local), 18 percent are for-profit and the rest are nonprofit, according to the American Hospital Association (AHA).
Most people understand nonprofit hospitals as charity organizations that provide free or discounted services for those who cannot afford to pay, and as such, perform a necessary and valuable community service. However, in reality U.S. nonprofit hospitals are extremely lucrative. At the same time, many fail to provide the valuable services for which they get preferential tax treatment.
The profitable nonprofit
In the U.S. healthcare industry, being nonprofit is more lucrative than being for-profit.
“The 2,900 nonprofit hospitals across the country, which are exempt from income taxes, actually end up averaging higher operating profit margins than the 1,000 for-profit hospitals after the for-profit’s income-tax obligations are deducted,” writes Steven Brill in his pioneering health exposé in Time Magazine. “In health care, being nonprofit produces more profit.”
To qualify as a nonprofit, hospitals must follow a number of rules including having a written policy delineating how patients “in need of financial assistance” will be treated, as well as a written policy explaining how charges to patients are calculated. Under the Affordable Care Act (ACA), hospitals will have to conduct a community needs assessment every three years and develop strategies for meeting identified needs.
Nonprofit does not mean that the facility does not make any profits; instead, it means that profits are reinvested in the hospital in the form of new facilities and equipment, massive salaries and bonuses for nonmedical administrators, expanding staff, offering more services and buying out competing hostpitals and health systems.
There are currently no regulatory limits on hospital profits, including nonprofits.
Considering nonprofit hospitals are exempt from local and state property taxes as well as income and sales taxes, profits can be considerable. Add to that the fact that nonprofits may also issue tax-exempt bonds, and nonprofit hospitals are huge moneymakers.
The requirement that nonprofits reinvest in facilities and expand services gives rise to huge hospital systems that virtually dominate host cities and become the area’s largest employer, with some hospitals bringing in more revenue than what the host city collects in taxes and fees.
Another way for nonprofits to spend their profits is compensation, with top administrator salaries in the millions of dollars. For example, in 2010 the combined compensation of the top executives at the 25 most profitable non-profit hospitals in the country totaled $59 million, according to Becker’s Hospital Review. The reported 2011 compensation for Jeffrey Romoff, head of University of Pittsburgh Medical Center Presbyterian (the highest-grossing nonprofit in the country) was $5.97 million.
The high wages do not stop at top-level administrators. A study by the Bureau of Labor Statistics found that, on average, hourly workers get higher wages in nonprofit hospitals than in for-profit ones.
“Payment of excessive compensation to executives, managers, and administrators undermines the purposes of nonprofit corporations because it results in fewer funds being available for their charitable purposes,” concluded a 2013 study by the office of the attorney general in Sacramento, California. “It is often the case that the hospitals, hospital groups, and affiliated medical entities that pay the most excessive compensation also provide less charitable care than comparable institutions that pay reasonable compensation to their executives, managers, and administrators.”
Can tax breaks to nonprofits be justified?
Tax breaks to nonprofit hospitals amount to billions–$13 billion, according to a recent study published in the New England Journal of Medicine. However, critics question whether the community service they provide is commensurate with the economic benefit nonprofits receive.
Many argue that they are not.
“You should get close to the value of tax exemption in community benefit,” said Paula Song, professor of health services organization at Ohio State University, to The New York Times. “I think you’ll find most hospitals aren’t providing that.”
The issue is further complicated because the level of charity services provided varies widely between nonprofits.
“A lot of hospitals are doing a good job of building their communities by providing health services, but other facilities aren’t doing a good job and we need a level of transparency to differentiate between the two,” said Holly Lang, hospital accountability project director for Georgia Watch, a consumer advocacy group, to the Atlanta Journal-Constitution. “The public has a stake in this because we’re forgoing needed tax revenue and we need to know what we’re getting,” she said.
As the largest landowners in many cities and communities, tax breaks to nonprofits represent a significant loss in revenue for the host community, as well as higher taxes for its residents.
Nonprofit supporters argue that in exchange for tax breaks these institutions provide and estimated $39.3 billion in care for those who cannot pay. That figure is hotly contested.
Steven Brill argues that the figure is calculated based on inflated prices listed on hospital chargematers, not what it actually costs hospitals to provide these services. A hospital chargemaster is a hospital’s official price list for every supply, procedure and drug it provides patients. Medicare and Insurance companies pay prices significantly lower than the ones on the chargemaster, as prices listed on these documents are known to be highly inflated.
“Judging from the difference I saw in the bills examined between a typical chargemaster price and what Medicare says the item cost, this would mean that this $39.3 billion in charity care cost the hospitals less than $3 billion to provide,” writes Brill. “That’s less than half of 1% of U.S. hospitals’ annual revenue and includes bad debt that the hospital did not give away willingly in any event.”
Moreover, nonprofits do not necessarily provide more charity care than for-profit hospitals. A Government Accountability Office (GAO) report concluded that while government hospitals devoted a substantially larger share of their operating expenses to charity care, the difference between nonprofit and for-profit hospitals was small.
“Further […], the burden of uncompensated care costs was not evenly distributed among hospitals but instead was concentrated in a small number of hospitals,” states the GAO report. “This meant that a small number of nonprofit hospitals accounted for substantially more of the uncompensated care burden than did others receiving the same tax preference.”
Additionally, while some nonprofits may be providing adequate charity services, many nonprofit hospitals are located in communities that are less likely to have a large percentage of people requiring charity services.
“On average, nonprofit hospitals were found to operate in areas with higher average incomes, lower poverty rates, and lower rates of un-insurance than for-profit hospitals,” states a report by the Congressional Budget Office (CBO).
The definition of charity
The legal definition of charity for purposes of tax breaks is partly to blame for why hospitals are allowed to profit at the expense of community taxpayers while providing little community service in return.
“For decades, being a hospital seemed sufficient justification for nonprofit status, but as medical services took on aspects of big business — aggressive bill collection tactics and six-figure pay for executives — the distinction between not-for-profit hospitals and their for-profit competitors blurred,” writes M.B. Pell in the Atlanta-Journal-Constitutional.
While the federal government, through the IRS, sets several requirements for nonprofit hospitals to qualify for federal tax breaks, a large number of states do not have specific requirements to qualify for state tax breaks.
On a federal level, until 1969 IRS required hospitals to provide charity care (providing services free of charge or at a discount to low-income patients who cannot pay) to qualify for tax-exempt, nonprofit status.
Currently, however, the IRS allows a far broader definition of charity care. Things like running a research lab, hosting health fairs, making environmental improvements, developing community leadership programs and having administrators serve on community boards are all defined as “charity care” and therefore allow the hospital to qualify for nonprofit status (while providing less actual free healthcare).
“Regardless of their merits, these programs do not replace uncompensated care,” said Mark Rukavina, executive director of the Access Project, a Boston-based patient advocacy organization, to the Atlanta Journal-Constitution.
The debate regarding nonprofit hospitals and tax breaks will continue as long as there IRS and local governments fail to set clear guidelines for the receipt of tax breaks based on nonprofit status.
A step in the right direction was a 2009 rule change by IRS that now requires hospitals to itemize what kind of charity care they provide. This will go a long way in helping the public and lawmakers understand whether nonprofits are “worth” the tax breaks. However, much more needs to be done in terms of transparency in the healthcare industry.
[Featured image Steven Depolo, Flickr Creative Commons]
Part of our series on healthcare costs in the U.S.
Part 2: Why Nonprofits are the Most Profitable Hospitals in the US