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Weekly UpdatesControlling spending on healthcare costs is a vast and fiendishly complicated task. But, there is a simple idea that could help: Revoke the public charity status of hospitals. Yes, this idea is heresy, of a sort. It is also a man-bites-dog story, coming as it does from someone who has toiled in the nonprofit field during a span of four decades. More important, it is a Big Idea in an industry where we mostly seem to hope that thousands of little ideas will somehow add up to a big one. So give it a fair hearing, and then decide.
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TOO BIG TO BE CHARITIES
Here is the central argument: Hospitals long ago outstripped the bounds of the normal public charity model and as a result their tax exempt status has become an anti-competitive shield rather than the intended idea of facilitator of a public good.
Good luck fitting that on a bumper sticker. Yet, it truly is a simple proposition.
As any person on the street will tell you, most hospitals today look more like for-profit businesses than public charities. Of course, appearances don't mean anything. So what if a hospital happens to look like the field offices of a multi-national giant?
As it turns out, those enormous buildings are part of the problem. Capital-intensive industries--those that require large investments in property and equipment--do not fit easily in the public charity model. But that is only a tangential part of the problem, so we'll return to it later.
The real anti-competitive effect of hospitals' public charity status lies in the way they provide the bulk of their services. The fundamental public charity model is a three-way relationship between consumer, provider and funder. Nonprofit public charities must derive a substantial portion of revenue from the public at large. Practically, this translates into donors, foundations and the government as the main such sources.
By contrast, the far more widespread commercial model consists of a transaction between a buyer and a provider. (See The NPT, June, 1 2008 issue).
In these terms, hospitals are actually an anachronism. The vast majority of the health care system today is based on a standard commercial transaction. Your physician is almost certainly in private practice. So are your dentist, your pharmacist, your optometrist, etc. In fact, the only place where nonprofit private practice predominates is in low-income areas, exactly the kind of area that needs the tax-exempt shield.
Hospitals have far outgrown the boundaries of the ordinary public charity model. As noted above, nonprofit public charities must derive a substantial portion of revenue from foundations, donors and the government. Most hospitals technically comply with this provision, but only because Medicare and Medicaid pay for so much hospital care. And, neither of these programs is a charitable program. Both are pure two-way insurance programs in which the administrator happens to be the federal government.
THE VALUE OF TAX EXEMPTION
It is in the value of their tax exemption that hospitals have gone far beyond the logical economic bounds of the public charity model. Take one of the country's pre-eminent nonprofit health systems in the middle part of this decade, for example. On revenue of more than $6 billion, their system-wide profit was more than $400 million. That represents a profit margin of almost 7 percent. For perspective, consider that the total amount of direct contributions brought in by the system was also more than $400 million, so they raised an amount equal to their profit margin.
What is the value of foregone taxes for the system's profitability? If a for-profit company in the same state were to have posted a $400 million profit after tax, the pre-tax amount that would have produced this level of profit would have been about $280 million. So the value of the health system's tax-exempt status in this case totaled well more than one quarter of $1 billion.
As a public charity in a building-intensive service model, the health system is also exempt from paying property taxes. In their case the tax base was nearly $2.3 billion (less depreciation but with the value of non-depreciated land added back). At these values their host city did not collect the $60 million they would have been entitled to collect were the health system a for-profit company. With the $280 million in saved taxes from above plus $58 million, you have at least $340 million that the respective governments did not collect.
But wait, there's more. Nonprofit public charity health systems are entitled to borrow money at reduced rates. This particular system carried more than $1.6 billion in tax-exempt debt. Tax-exempt bonds are usually considered to be at least a point (1 percent) below commercial rates, so that means each year they did not have to pay $16 million in interest costs for every year they carried that level of debt.
Remember that a public charity does not have to pay sales taxes on the things it purchases. Most state sales tax rates, where they exist, are in the 3 to 8 percent range, which adds up to serious dollars when a health system purchases millions of dollars of supplies.
You get the point. The public charity tax-exempt status in a multi-billion dollar-plus health system adds up to a considerable amount of public funds that have not been collected. In this example, the value of the tax-exempt shield would easily approach half a billion dollars once all benefits were calculated. This is the inadvertent cost of providing hospital services through a public charity model that was never intended to operate at such stratospheric dollar levels.
Some will argue that it isn't fair to gauge the value of tax-exempt public charity status this way because had it not existed in the year from which we drew the numbers the health system would have made different choices. Exactly. The public charity status unintentionally ratchets up hospital costs because it makes growth capital cheaper and lessens the competitive burden. With no effective countervailing force, such as government regulation or unvarnished market competition, the hospital cost spiral can only go up.
Removing public charity status is not the same thing as turning hospitals into for-profit organizations. There are many different types of nonprofits that are not public charities that operate in competitive environments--credit unions and mutual insurance companies come to mind. It might even be best to create a special designation just for hospitals. The idea is not to punish hospitals but to restructure the incentives.
To some extent, this type of re-working in the hospital industry might be forced by other circumstances. For instance, if we were ever to achieve universal health care in this country, much of the rationale for hospitals' public charity status would disappear.
A SECONDARY BENEFIT
A secondary payoff of this idea would be the opportunity to redirect many of those public charity dollars. Try this thought experiment using the health system example. Without the public charity designation of the health system, those $400 million in donated funds would have to go someplace else. Suppose all or a good part of that money was dedicated not to tertiary care as in a hospital (or to research that leads to more tertiary care) but toward prevention? Imagine, each year $400 million going toward helping people stay healthy and to stay out of expensive tertiary care hospitals if they do get sick--in one city.
Is changing the tax-exempt public charity status of hospitals a well thought-out plan? Not yet. Would there be multiple sources of complexity and thorny problems to work out? Count on it. Would it change the competitive dynamics of medical care and save money in the long run? Absolutely.
Think about it.
Thomas A. McLaughlin is director of consulting services at the Nonprofit Finance Fund, and is a member of the faculty at the Heller School for Social Policy at Brandeis University in Boston. His email address is tom.mclaughlin@nffusa.org.
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