Lawmakers Question if Nonprofit Hospitals Help the Poor Enough

by Theo Francis
July 20, 2007

Federal and state officials are increasingly questioning whether not-for-profit hospitals provide enough care to uninsured patients to warrant the sizable tax breaks they get for charitable work.

Yesterday, the Internal Revenue Service released a report noting that many hospitals spend 3% or less of total revenue on care for the poor and others who don't pay. At the same time, Sen. Chuck Grassley, the ranking Republican on the Senate Finance Committee, released a document suggesting Congress might for the first time in decades impose firm rules on how much care charity hospitals must provide to the poor.

The scrutiny is fueled in part by the hospital industry's strengthening finances, after its difficulties in the 1990s. Hospitals of all kinds have seen profits increase by an estimated 35% from 2003 through 2005, in part because of improved government and insurance reimbursements, as well as strong investment returns, according to consulting firm Cleverley + Associates of Worthington, Ohio.

Nonprofit hospitals' net income -- often dubbed "excess of revenue over expenses" -- has risen to about 3.8% from about 2.5% over the same period. (Nonprofit hospitals don't generate returns for private owners, but they can still generate surpluses that are then saved or spent on expansion and improvements.)

"When nonprofit hospitals sit on big cash reserves, I wonder how much public service they're offering," said Mr. Grassley, who last fall held a Finance Committee hearing examining hospital tax breaks, executive compensation and related issues.

Many nonprofit hospitals are cash-strapped and operate on razor-thin margins; more than 200 report cash and investments valued at less than a day's operating expenses.

The intensifying scrutiny also comes as both state and federal policymakers grapple with how best to treat the uninsured. Hospitals, for decades the health-care provider of last resort for the poor and uninsured, have long received a slew of tax benefits in return for ill-defined requirements to provide "community benefits" -- often presumed to include significant charity care for the destitute.

Now, regulators and lawmakers are seeking to put dollar figures to the benefits provided -- and received -- by hospitals, and in some cases they are contemplating stiff requirements on hospitals that have largely grown accustomed to setting their own standards.

In addition to the IRS study and Mr. Grassley's efforts, regulators in Illinois have revoked property tax breaks for three hospitals, saying they provided too little charity care to qualify. And across the country, more states are collecting detailed information about how much hospitals provide, and in some cases how much they reap in tax exemptions.

Not-for-profit hospitals have a long tradition of charity care, or free medical care for those who can't afford it. In part because of that charity work, not-for-profit hospitals have been given special tax breaks by federal, state and local governments. By the Congressional Budget Office's measure, those tax breaks totaled more than $12 billion in 2002.

But the CBO found in a recent analysis of hospitals in five states that not-for-profits provided only slightly more uncompensated care -- or charity care plus uncollectible bills -- than for-profit hospitals, measured as a percentage of operating expenses. Yet for-profit hospitals don't get the tax benefits. That can give not-for-profits a financial edge over competitors, and may account in part for the ability of some to accumulate large cash hoards.

Some states, including Illinois and Texas, are requiring standardized reporting by nonprofit hospitals, and in many cases assembling lists comparing charity care or tax breaks. A January study by Minnesota's health department, for example, found that nonprofit hospitals absorbed about $146 million of charity care and unpaid bills but received $444 million of tax and other benefits.

Complicating the debate is a lack of clarity about what hospitals need to do to quality for the tax benefits. Federal law requires that hospitals provide "community benefit," but doesn't offer much guidance on what that means. In addition to charity care, some hospitals count spending on health fairs, as well as unpaid bills, including the gap between what they bill Medicare or Medicaid and what the government actually pays.

States are also taking a closer look at charity care. By Minnesota's tally, Lake Region Healthcare Corp., a 108-bed facility in Fergus Falls, spent about $300,000 -- or less than 1% of its operating costs -- on uncompensated care in 2005. The state said the hospital's exemptions from property, sales and income taxes on the federal, state and local level were worth about $2 million. Chief Financial Officer Ed Strand disputes the state's figures and says the hospital provided overall benefits to surrounding communities totaling more than $5.9 million, which includes $3.5 million in what it says it lost on Medicare and Medicaid care. Minnesota this year adopted legislation requiring nonprofit hospitals to file standardized reports with the state on their community-benefit spending.

Some states are going beyond collecting data, and even penalizing hospitals they think could be doing more.

Last year, Illinois Attorney General Lisa Madigan suggested hospitals must spend at least 8% of operating costs on charity care to receive tax breaks. She withdrew the proposal after industry protests; her office says she is in discussions with state hospital groups.

Meanwhile, Illinois tax officials have revoked some property-tax exemptions for three hospitals on the grounds that they provide too little charity care. The facilities are contesting the decision.

The IRS survey of 487 hospitals found a broad range in charity-care practices. While 45% devoted 3% or less of their revenue to uncompensated care, nearly a quarter spent less than 1% of revenue on it; one in five spent 10% of revenue or more.

Sen. Grassley's report yesterday, which he explicitly labeled "not proposed legislation," drew a stir from the hospital industry. Among other things, it proposed a firm charity-care threshold in order to qualify for tax exemptions -- 5% of patient operating expenses or revenue, whichever is greater -- and outlined governance changes that would limit the proportion of insiders and physicians, who could sit on a hospital's board if it wanted to protect its tax-exempt status.

"Some people thought when Grassley lost his chairmanship, he'd go away," said Michael W. Peregrine, who represents nonprofit hospitals for Chicago law firm McDermott Will & Emery LLP. Not-for-profit hospitals "clearly have a legislative fight on their hands."