Nonprofit Tax Exemption

Policy Problem

To qualify for federal tax exemption, NFP hospitals must provide community benefits, which the IRS currently defines as promoting the health of any broad class of people, perhaps including such activities as charity care, health screening, community education about health risks, emergency room services, and basic research. This exemption has been questioned on grounds of efficiency and equity.

  • Is Exemption Justified? But many studies find little or no difference between NFP and for-profit hospitals in terms of community benefit. While early work showed FP hospitals had higher prices or costs than NFPs, more recent studies suggest such differences have shrunk or possibly been reversed. Some analyses indicate that the presence of FP hospitals in an area results in more efficient production of hospital services, including by NFP competitors. Another study provided strong support for the hypothesis that NFP hospitals adjust capacity much more slowly than do FP firms in response to reductions in demand, effectively serving as a socially inefficient capital traps. Because these analyses do not reveal consistent patterns, “analysts and policymakers have reached different conclusions about whether the level of community benefits provided by nonprofit hospitals justifies the tax preferences they receive.”
  • Is the Exemption Enforced Fairly Across Hospitals? The federal IRS’s community benefit standard to qualify for tax-exempt status allows NFP hospitals broad latitude to determine the services and activities that constitute community benefit. As well, IRS has not rigorously enforced the requirement.
  • Is the Exemption Enforced Fairly Across States? Likewise, state community benefit requirements that hospitals must meet in order to qualify for state tax-exempt or nonprofit status vary substantially in scope and detail. For example, 15 states have community benefit requirements in statutes or regulations, and 10 of these states have detailed requirements.
  • Does the Exemption Favor Certain Types of Hospitals? Evidence from the 1990’s shows that the value of tax exemptions varies widely across NFP hospitals:
    • The value of the property tax exemption depends on state and local tax policies and the hospital asset mix.
    • Tax-exempt bonds are concentrated among larger hospitals. Only 19.7 percent of NFP hospitals had outstanding tax-exempt debt in 1994; almost half of existing bond debt could be replaced by using hospital endowments.
    • Deductible contributions also are concentrated among larger hospitals: roughly four percent of hospitals receive 71 percent of the contributions.

Policy Options

  • Blue Cross Blue Shield Tax Preferences
    • Some states already have eliminated the premium tax differential that favored NFP Blue Cross plans even if these plans did not convert to FP status.
    • Some states have eliminated all tax preferences for NFP Blue Cross plans even if these plans did not convert to FP status.
  • NFP Hospital Federal Tax Exemption
    • Cogan, Hubbard and Kessler (2005) recommend that the U.S. Departments of Treasury and HHS study whether the NFP tax exemption for health care institutions is in the public interest.
    • Catholic Hospital Assocation (CHA) and Voluntary Hospital Association.  A Guide for Planning and Reporting Community Benefit (2006). This provides detailed guidelines for measuring and reporting community benefits.
    • HFMA represents health care financial management executives and leaders in all areas of health care, including hospitals. In 2006, the organization also issued financial reporting guidance on community benefit activities, including details on charity care and bad debt.
    • U.S. Senate, Committee on Finance, minority staff, Tax-Exempt Hospitals: Discussion Draft, July 19, 2007 raised the possibility of requiring hospitals to devote a minimum percentage of patient operating expenses or revenues (whichever is greater) to charity care in order to continue to qualify for federal tax exemption.
  • NFP Hospital Tax Exempt Bond Arbitrage
    • CBO (2006) calculated the impact of a hypothetical change in federal policy to broaden the definition of tax arbitrage, thereby reducing the amount of NFP tax exempt borrowing.

Policy Assessment

  • The Joint Committee on Taxation (JCT) estimated that in 2002, NFP hospitals and their supporting organizations received tax benefits of $12.6 billion at the federal, state, and local levels:
    • $2.5 billion related to federal income taxes and $0.5 billion due to state corporate income taxes
    • $2.8 billion related to state and local sales taxes
    • $3.1 billion related to local property taxes
    • $1.8 billion related to federal bond financing
    • $1.8 billion related to federal charitable contributions
  • The above amounts overstate the revenue gains from eliminating tax exemption since NFP hospitals can be expected to restructure their capital and operating costs in the face of higher taxes.
  • CBO (2006) calculated that a hypothetical change in federal policy to broaden the definition of tax arbitrag would increase annual federal revenues up to $504 million per year ($162 million if allowance is made for NFP hospital precautionary savings).

Resources

Analysis

  • Aitsebaomo, Gabriel. The Nonprofit Hospital: A Call for New National Guidance Requiring Minimum Annual Charity Care to Qualify for Federal Tax Exemption (July 1, 2004). Campbell Law Review, Vol. 26, No. 2, 2004; Thurgood Marshall School of Law Research Paper No. 13-03. Available at SSRN.
  • Cogan, John F., R. Glenn Hubbard, Daniel P. Kessler. Healthy, Wealthy, and Wise: Five Steps to a Better Health Care System. AEI Press/Hoover Institution (November 2005). [Table of Contents]
  • Congressional Budget Office. Nonprofit Hospitals and Tax Arbitrage (Washington, D.C.: December 2006).
  • Duggan, Mark. Hospital Market Structure And The Behavior Of Not-For-Profit Hospitals, Rand Journal of Economics, Autumn 2002; 33(3): 433-446. Also available as NBER paper [Abstract]
  • GAO. Nonprofit Hospitals: Better Standards Needed for Tax
    Exemption
    . Pub. no. GAO/HRD-90-84 (Washington: GAO, 1990)
  • GAO. Nonprofit Hospitals: Variation in Standards and Guidance Limits Comparison of How Hospitals Meet Community Benefit Requirements. GAO-08-880, September 12, 2008. [Summary (HTML)][Highlights Page (PDF)][Full Report (PDF, 76 pages)]
  • Gentry, William M. and Penrod, John R. The Tax Benefits of Not-for-Profit Hospitals (February 1998). NBER Working Paper No. W6435. [Abstract]
  • Lakdawalla, D., and T. Philipson, 2006, Non-Profit Production and Industry PerformanceJournal of 

    Public Economics 90 (9), 1681-98.

  • Nonprofit/For-profit Status (Health Affairs topic page)

Links


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