Should not-for-profit hospitals be exempt from taxes? That debate is largely an academic one for now, but strained state and local budgets could make it increasingly relevant to tax-exempt hospitals.
State regulators are putting more pressure on not-for-profit hospitals to demonstrate the community benefits they provide to justify the exemptions, which typically cover income and property taxes at the state and local levels, in addition to federal income taxes. A report released in the waning days of Attorney General Robert Butterworth's administration suggested that not-for-profit hospitals in Florida aren't providing enough charity care in return for the exemption (Feb. 24, p. 12). Eleven states already require a minimum level of uncompensated care to maintain the exemption.
No matter their opinion on the tax exemption, academics who study the hospital industry agree on its origins. Hospitals in 19th century America were little more than wards to quarantine patients with infectious diseases, particularly the poor, says Jack Karns, a professor of finance at East Carolina University, Greenville, N.C. While governments in Canada and most Western European countries took it upon themselves to provide hospital care, "in the United States, the government left that up to `almshouses,' forerunners of the dominant not-for-profit hospital industry," says Karns, who supports maintaining the tax exemption.
John Colombo, a law professor at the University of Illinois at Urbana-Champaign, agrees on how the exemption came to be. "Historically, not-for-profit hospitals were poorhouses," he says. But Colombo argues when modern medical techniques were developed in the early 1900s, the nature of most not-for-profits changed. "They went from being a poorhouse to being a business," Colombo says. "They're selling services for a fee, just like Microsoft is selling software for a fee, just like their for-profit competitors are selling services for a fee." Colombo would allow academic medical centers and major teaching hospitals to earn a tax exemption, but as educational institutions, not as healthcare providers.
Karns, however, argues the tax exemption is a worthy subsidy that not-for-profits earn by promoting health. "The mission of a for-profit hospital is not to promote health," he says. "The mission of a for-profit hospital is to make a profit. The mission of a not-for-profit hospital is to promote health."
James Bentley, the American Hospital Association's senior vice president of strategic policy planning, says not-for-profit hospitals invest in services well beyond any economic benefit to them.
Colombo contends that offering health education programs and low-margin services aren't altruistic examples of hospitals promoting health. Those activities, he says, are merely loss leaders designed to bring in more customers-like a supermarket offering low prices on milk.
If that were the case, Bentley says, then investor-owned hospitals would be providing those services, too.
Karns also argues that as long as the U.S. mixes government and private payers, a mixed system of hospital organization allows the government more regulatory muscle. "You've got this exemption hanging out there, and if you want to keep this, you have to earn it," he says. "Short of a single-payer system, it's the only way to regulate hospitals."
At the federal level, the Internal Revenue Service wields the big stick of revoking the exemption and lesser penalties known as intermediate sanctions. In 1998, the IRS revoked the tax-exempt status of the health plan subsidiary of Intermountain Health Care, Salt Lake City, winning a case against Intermountain before the U.S. Tax Court in Washington (Oct. 1, 2001, p. 28). Intermountain has appealed that ruling to the 9th Circuit Court of Appeals in San Francisco, and the decision is pending.
Federal tax collectors have had less success in their case against St. David's Healthcare Partnership, Austin, Texas. The partnership is a 50-50 joint venture between HCA and St. David's Health Care. A federal judge in Austin reinstated the system's tax-exempt status last year, although the IRS is appealing.
But it's at the local level that Colombo sees the most promise for his ideas. State and local governments are hungry for revenue in the current economic climate, he says, and not-for-profit hospitals are sitting on some very valuable real estate that's going untaxed.
Although state attorneys general have jurisdiction over not-for-profits, Colombo doesn't think they'll pick this fight. "If the issue is going to be pressed, it's going to be by local property tax assessors pulling their tax exemptions and then litigating it," he says.
Their record remains spotty. For instance, officials in Hutchinson County, S.D., stripped the property tax exemption from a senior apartment complex owned by 25-bed Freeman (S.D.) Community Hospital and Nursing Home, but the South Dakota Supreme Court reinstated the complex's tax exemption in 2001.
For two decades, several assessors in Utah have fought Intermountain, which owns 22 hospitals in Utah and Idaho, and other not-for-profit hospitals in the state over tax exemptions. The Utah Supreme Court ultimately handed the hospitals a major victory in 1994, when they ruled that a six-point test that hospitals must pass to earn their exemption was consistent with the state constitution. Two counties revisited the issue again in 2001 with Intermountain, pressing the system to provide more community benefits.
Colombo even supports the idea-controversial in healthcare circles-that the public receives benefits from the taxes for-profit providers pay. Columbia/HCA Healthcare Corp. stirred up a lot of resentment in the mid-1990s by making the argument that taxes should count when calculating community benefit and that not-for-profit hospitals should see their community-benefit totals reduced by the amount of taxes they avoided paying with their exemption.
The AHA's Bentley says that during a career in healthcare that spans three decades, the tax exemption is "always being looked at someplace. ... Attention waxes and wanes, but it isn't out of the ordinary.
"And that's not necessarily a bad thing," he says. "Society has made a judgment to grant the exemptions, and it's its right to decide whether to continue with this policy."