Nonprofit Hospitals: Better Standards Needed for Tax Exemption

Published by the Government Accountability Office on 1990-05-30.

Below is a raw (and likely hideous) rendition of the original report. (PDF)


      Better Standards
      Needed for Tax

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Human Resources Division


May 30,199O
The Honorable Edward R. Roybal
Chairman, Select Committee on Aging
Houseof Representatives
Dear Mr. Chairman:
This report responds to your request and later discussionswith membersof the Committee
staff regarding the role played by nonprofit hospitals in delivering care to the medically
indigent. We undertook this study in light of increasing cost constraints in the hospital sector
that may be influencing hospitals to devote fewer resourcesto providing care to the indigent
and conducting other charitable activities. This report concludesthat the Congressshould
consider revising the criteria for hospitals’ tax exemption if it believes that providing charity
care should be a fundamental basis for such an exemption.
As  agreed with your office, unless you publicly announceits contents earlier, we plan no
further distribution of this report until 30 days after its issue date. At that time, we will send
copies to the cognizant congressionalcommittees and subcommittees,the Commissionerof
Internal Revenue,the Secretary of Health and Human Services,and the Director of the Office
of Management and Budget. We also will make copies available to others upon request.
This report was prepared under the direction of Janet Shikles, Director, Health Financing
and Policy Issues,who may be reached on 275-5451 if you or your staff have any questions.
Other major contributors are listed in appendix IV.
Sincerely yours,

Lawrence H. Thompson
Assistant Comptroller General

Executive Summary

                   In the wake of increasing pressure on hospitals to contain their costs,
Purpose            there are concernsthat somehospitals are reducing their provision of
                   indigent care and other charitable activities. While changesin the mar-
                   ket affect all types of hospitals, nonprofit hospitals are under more
                   scrutiny becauseof their preferred treatment as charities under the tax
                   code. The HouseSelect Committee on Aging asked that GAO assessthe
                   role of nonprofit hospitals in providing (1) acute medical care to those
                   who are unable to pay and (2) other community services,such as health
                   education and screening.

                   Just over half of the nation’s hospitals are private nonprofit (nonprofit)
Background         institutions; the rest are operated either by governments or on a for-
                   profit basis.

                   If they meet certain tests established by the Internal RevenueService
                   (IRS),nonprofit hospitals are exempt from federal taxation; these hospi-
                   tals are also generally exempt from state and local taxes. Poor people
                   without public or private insurance gain accessto nonemergencyhospi-
                   tal services only if the hospital is willing to admit them with little expec-
                   tation of payment. (Seep. 12.) Between 1966 and 1969, the test for tax-
                   exempt status included specific reference to providing (to the extent the
                   hospital’s finances allowed) servicesto those not able to pay. Since
                   1969, however, IRS has not required such care so long as the hospital
                   provides benefits to the community in other ways. (Seep. 16.)
                   GAO  analyzed the distribution of uncompensatedcare among hospitals in
                   five states to analyze the role of nonprofit hospitals in supplying such
                   care. (Seepp. 17-19.) Uncompensatedcare includes both charity care
                   and bad debt expense.Where data were available, GAO also focused on
                   that portion that represented charity care. In addition, GAO conducted
                   casestudies in five communities and surveyed a nationwide sample of
                   hospitals regarding the types of community servicesprovided.
                   (Seepp. 19-20.)

                   In the five states GAO reviewed, government-owned hospitals provided a
Results in Brief   disproportionate amount of the uncompensatedcare. Both nonprofit and
                   for-profit hospitals provided a smaller share of the state’s uncompen-
                   sated care than they provided of general hospital services.
                   Moreover, the burden of uncompensatedcare was not distributed
                   equally among the nonprofit hospitals in these five states. Large, urban

                   Page 2                                        GAO/HRDf40-84 Nonprofit Hospitals
                          Executive Summary

                          teaching hospitals had a higher share of the uncompensatedcare
                          expensethan did other nonprofit hospitals. Among the rest of the non-
                          profit hospitals, the tendency was for those hospitals with the highest
                          operating margins (and, therefore, the greatest ability to finance charity
                          care) to have the lowest rates of uncompensatedcare. Variations in
                          uncompensatedcosts can be attributed both to the hospitals’ geographic
                          locations and to their particular operating policies, such as admissions
                          About 80 percent of the nonprofit hospitals in these states reported
                          total uncompensatedcare costs in excessof GAO’S estimate of the value
                          of their federal tax exemption. Where GAO was able to get information
                          on the charity portion of uncompensatedcare costs, however, it found
                          that a far lower percentageincurred charity care costs in excessof GAO’S
                          estimate of the value of their tax exemption: 71 percent in New York
                          and only 43 percent in California.

                          A majority of nonprofit hospitals offered community servicesin addi-
                          tion to providing charity care. These serviceswere generally offered to
                          the community as a whole, however, and were not necessarily directed
                          at the poor.

                          If the Congresswishes to encouragenonprofit hospitals to provide char-
                          ity care and other community services,it should consider revising the
                          criteria for tax exemption.

Principal Findings

lJneven Distribution of   Nonprofit hospitals provide a lower percentageof their states’ uncom-
Uncompensated Care        pensated care than the percentageof hospital care they provide in the
                          states. For example, in California, nonprofit nonteaching hospitals pro-
                          vide 55 percent of the total days of hospital care but only 27 percent of
                          the state’s uncompensatedcare expenses.Further, uncompensatedcare
                          expenseswere not distributed proportionately through the nonprofit
                          sector, but were concentrated in large teaching hospitals in cities. (See
                          pp. 21-23.)

                          Page 3                                       GAO/HRD-90-84 Nonprofit Hospitals
                            Executive Summary

                            On average,the nonprofit hospitals with the lowest uncompensatedcare
                            rates had better financial results than other nonprofit hospitals. In con-
                            trast, those with the highest uncompensatedcare rates had the poorest
                            financial results. (Seepp. 24-26.)

Some Hospitals’ Potential   Hospitals whose potential tax liability exceededtheir uncompensated
Tax Liability Exceeds       care expenseshad proportionately higher net incomesthan other hospi-
                            tals in their state. Between 43 and 71 percent of the nonprofit hospitals
Uncompensated Care          in the five states provided less charity care than what GAO estimated as
Provided                    the value of their tax exemption, (Seepp. 27-29.)

Goals and Policies Do Not   A hospital’s goals and policies influence the amount of uncompensated
Encourage Elective          care it provides. In the five communities GAO visited, the strategic goals
                            of somehospitals did not focus on the health needsof the poor or under-
Treatment for the           served in their communities. Instead, the goals most often related to
[Jninsured                  increasing their share of the patients within their market area, resem-
                            bling goals of investor-owned institutions. Further, physician staffing
                            and charity admissionspolicies discouraged admissionsof those unable
                            to pay, except in emergencycases.(Seepp. 32-34.) In two of the commu-
                            nities, one hospital bore a disproportionate share of emergencyor
                            obstetrical care for the indigent, causing its administrators to take steps
                            to reduce its role in caring for the community’s poor becauseof the
                            resulting financial burden. (Seep. 36.)

                            Location and proximity to other hospitals willing to provide uncompen-
                            sated care are also factors in determining a hospital’s level of uncom-
                            pensated expense.For example, in three communities, hospitals that
                            were near a public or major teaching hospital known to serve the unin-
                            sured were not affected seriously by uncompensatedexpensesbecause
                            the burden fell on that other hospital. (Seep. 35.)

Some Community Services     A high percentageof nongovernmental hospitals, regardless of owner-
Provided by Most            ship type, provide community services,such as health screening,clinic
                            services,and immunizations. Nonprofit hospitals were more likely than
Hospitals                   investor-owned hospitals to offer these servicesbut were (1) equally
                            likely to charge patients a fee for them and (2) more likely to recover
                            the costs of providing them. (Seepp. 41-43.)

                            Page 4                                       GAO/HRD-90-84 Nonprofit Hospitals
                Executive Summary

                Currently, there are no requirements relating hospitals’ charitable activ-
Matters for     ities for the poor to tax-exempt status. If the Congresswishes to
Congressional   encouragenonprofit hospitals to provide charity care to the poor and
Consideration   uninsured and other community services,it should consider revising the
                criteria for tax exemption, Criteria for exemption could be directly
                linked to a certain level of (1) care provided to Medicaid patients,
                (2) free care provided to the poor, or (3) efforts to improve the health sta-
                tus of underserved portions of the community.

                Page 5                                       GAO/HRD-90-84 Nonprofit Hospitals

Executive Summary                                                                                        2
Chapter 1                                                                                               10
Introduction                 Indigent Care Financed by Government and Hospitals                         11
                             Changing Marketplace Alters Hospital Incentives to                         13
                                  Provide Indigent Care
                             Objectives,Scope,and Methodology                                           17

Chapter 2                                                                                               21
Uneven   Distribution   of   UncompensatedCare Concentrated in Relatively Few                           21
Indigent Care                Rates of UncompensatedCare Vary Among States                               23
                             Substantial Variance Between High- and Low-                                24
                                 Uncompensated-CareNonprofit Hospitals
                             Levels of UncompensatedCare Relative to Value of Tax                       26

Chapter 3
Factors Affecting            Causesof Indigent Care Distribution Examined Through                       30
Distribution of              SomeHospitals Lack Proactive Goals or Policies for                         32
Indigent Care Within            NonemergencyIndigent Care
                             Uneven Distribution of Indigent Care a Problem in Some                     35
Comrnunities                    Communities

Chapter 4                                                                                               37
Community Services           IssuesAddressed by Survey                                                  37
                             SomeDistinctions Between Community ServicesDelivered                       38
Provided by Hospitals            by Nonprofit and Investor-Owned Hospitals

Chapter 5                                                                                               44
Conclusions and              Conclusions                                                                44
                             Matters for Consideration by the Congress                                  44
Matters for
Appendixek                   Appendix I: Legal Basis for Hospital Tax Exemption                         46

                             Page 6                                      GAO/HRD-90-84 Nonprofit Hospitals

          Appendix II: Differences Between Low- and High-                           48
          Appendix III: Most Frequently Reported Community                          51
             Services,by Ownership Type, for Each Service
          Appendix IV: Major Contributors to This Report                            52

Tables    Table 1.1: U.S. Hospitals by UncompensatedCare and                        12
              Ownership Type (1988)
          Table 2.1: Nonprofit Hospitals With Highest Amounts of                    23
              UncompensatedCare: Share of State’s
          Table 2.2: Comparison of Nonprofit Uncompensated                          26
              Expense Rates in Urban and Rural Areas
          Table 2.3: Value of Nonprofit Tax Exemption vs.                           27
              UncompensatedCare Costs
          Table 2.4: Hospitals for Which Tax Exemption Value                        27
              ExceedsUncompensatedCare Costs
          Table 3.1: Hospitals Visited in SelectedCommunities, by                   31
              Ownership Type

Figures   Figure 1.1: Indigent Hospital Care Funding (1986)                         11
          Figure 2.1: Hospitals’ Share of Patient Days and                          22
              UncompensatedExpenses,by Ownership Type
          Figure 2.2: UncompensatedExpenseRates,by Hospital                         24
              Ownership Type
          Figure 2.3: Profit Margins: Comparison of Nonprofit                       28
              Hospitals Not Meeting Tax Threshold With All
              Nonprofit Hospitals
          Figure 2.4: UncompensatedExpenseRates:Comparison of                       29
              Nonprofit Hospitals Not Meeting Tax Threshold With
              All Nonprofit Hospitals
          Figure 4.1: Types of Community ServicesOffered, by                        39
              Hospital Ownership Type
          Figure 4.2: Percent of Hospitals That Target Each                         41
              Community Service to Low-Income People
          Figure 4.3: Percent of Hospitals That Offer Each                          42
              Community Service at No Charge, by Hospital
              Ownership Type
          Figure 4.4: Percent of Hospitals That Reported                            43
              Community Servicesfor Which RevenuesCovered
              Costs,by Hospital Ownership Type

          Page 7                                     GAO/HRD-90-84 Nonprofit Hospitals

Figure II. 1: UncompensatedCare Rates for Low- and                      48
Figure 11.2:Medicaid Patient Mix of Low- and High-                      49
    Uncompensated-CareNonprofit Hospitals
Figure 11.3:Total Profit Margins of Low- and High-                      50
    Uncompensated-CareNonprofit Hospitals


AIDS       acquired immunodeficiency syndrome
IRS        Internal RevenueService

Page 8                                   GAO/HRD-90-84 Nonprofit Hospitals

    Page 9   GAO/HRD-90-84 Nonprofit Hospitals
Chapter 1                                                                                                       -

               Medical care is provided by government-owned (public), private non-
               profit (nonprofit), and for-profit organizations. The nonprofit form of
               ownership predominates in the hospital sector. Nonprofit hospitals pro-
               vide medical and other health-related servicesto their communities and
               devote earnings to hospital improvements, instead of to private gain.
               Under a provision in the tax code exempting charities from federal
               income tax, most nonprofit hospitals have historically been exempt from
               such tax. They often also have received several other financial
               Growing efforts by employers, insurers, and government to contain the
               rapid growth of health care costs have led to an increasingly cost-
               conscioushospital sector. Increased numbers of uninsured people have
               strained someinner-city hospitals’ capacity in this new cost-conscious
               environment. While hospital occupancy rates have decreasednation-
               wide, government-owned hospitals in large cities have high occupancy
               ratesand are sometimesfull, Somehealth policy wdysts, legislators,
               and government officials believe that accessto someprivate hospitals
               has decreasedfor the medically indigent and that the financial burden
               of treating those unable to pay has fallen disproportionately on a rela-
               tively small number of public hospitals.

               Recentefforts to contain health care costs raise concernsabout non-
               profit hospitals’ continued ability and willingness to undertake certain
               charitable activities, especially those targeted to the poor. Nonprofit
               hospitals’ activities are under special scrutiny becauseof their preferred
               treatment as charities under the tax code.The Chairman, HouseSelect
               Committee on Aging, asked us to assessthe role of nonprofit hospitals in
               (1) providing acute medical care to those who are unable to pay and
               (2) providing other community services,such as health education and

               ‘The lost federal tax revenues attributable to nonprofit hospital tax exemption have been estimated
               at $4.5 billion. The tax advantages that nonprofit hospitals may receive include (1) exemption from
               income tax; (2) exemption from property and other local taxes; (3) accessto charitable donations,
               which are tax deductible for the individual or corporate donor; and (4) tax-exempt bond financing.

               Page 10                                                      GAO/HRD-90-84 Nonprofit Hospitals
                 chapter 1

                 Indigent care2is funded from three major sources:(1) Medicaid,3
Indigent Care    financed principally with federal and state tax funds; (2) other federal,
Financed by      state, and local tax-supported programs; and (3) hospital profits from
Government and   paying patients, philanthropy, or other revenue. Figure 1.1 shows the
                 proportion of indigent hospital care financed from each of these sources
Hospitals        in the United States during 1986.

Funding (1986)
                                                                         Medicaid State Payments

                                                                         Private Hospitals’ Uncompensated Care

                                                                         Public Hospitals’ Uncompensated Care

                                                                         Medicaid Federal Payments

                 Note. Aggregate data are not available for uncompensated care provided by private physicians and
                 state or local funding (other than Medicaid) for primary medical care to the indigent.

                 Source: Congressional   Research Service and American Hospital Association, Hospital Statistics, 1988.

                 More than 85 percent of hospital servicesto the indigent are financed
                 with federal, state, or local tax funds. The principal financing for care to
                 those who cannot pay is the federal-state Medicaid program, in which
                 each state designsand administers its own program within federal
                 guidelines. Federal and state governments share the costs of this pro-
                 gram. In addition, when revenuesfrom fees charged to insured or pay-
                 ing patients by local government-owned hospitals are insufficient to

                 ‘We defined indigent care as care to both Medicaid eligibles and those ineligible for public assistance
                 but unable to pay.

                 3Medicaid was enacted to enhance the poor’s accessto health care. Although each state designs and
                 administers its own Medicaid program, at a minimum the program must cover people receiving cash
                 payments from the Aid to Families With Dependent Children program and (in most states) people
                 receiving them from the Supplemental Security Income program. By July 1, 1990, states must also
                 cover pregnant women and infants with family incomes at or below the federal poverty level.

                 Page 11                                                         GAO/HRD-90-94 Nonprofit Hospitals
                                   Chapter 1

                                   cover their costs,those governments usually finance the differences.
                                   Generally, government-owned hospitals treat all persons,regardless of
                                   their ability to pay. Many government-owned and nonprofit hospitals
                                   were constructed or renovated in whole or in part with money provided
                                   through the federal Hill-Burton program.4In these cases,the hospitals
                                   were required to provide a reasonableamount of uncompensatedser-
                                   vices to the indigent population6
                                   At least one-third of the nation’s estimated 31 million uninsured people
                                   are poor but ineligible for public assistance.Hospital care for these peo-
                                   ple is now largely dependent on the willingness of hospitals and physi-
                                   cians to provide care at no charge. Private and government-owned
                                   hospitals finance uncompensatedcare6through (1) donations, grants, or
                                   philanthropy or (2) net income from paying patients. Government-
                                   owned hospitals may also finance someuncompensatedcare from tax
                                   revenues.The number of hospitals and the distribution of uncompen-
                                   sated care among hospital types are shown in table 1.1.
Table 1.1: U.S. Hospitals by
Uncompensated Care and Ownership   Dollars in billions
Type (1988)                                                                                      Percent
                                                                                   Total distribution of   Average
                                                                  No. of uncompensated uncompensated uncompensated
                                   Tvpe                        hosDitals           care              care care rate’
                                   Nonprofit                        3,440                   $8.4                    58                    4.8
                                   For-profit                       1,149                    1.4                     9                    5.2
                                   State and local
                                     government                     1,849                   4.8                     33                    7.6
                                   Total                            6,430                 $14.6                    100
                                   Note: Excludes federal hospitals.
                                   Wncompensated care as a percentage of total revenue
                                   Source: American Hospital Association, Annual Survey of Hospitals, 1988 estimated file

                                   4Between 1946 and 1974, the Hill-Burton program provided federal grants for constructing public
                                   and nonprofit hospitals. In return, the hospitals were required to give assurance that they would
                                   make available, in the facility constructed with the financial assistance, a reasonable volume of ser-
                                   vices to persons unable to pay for medical services, if this was financially feasible.

                                   “The number of hospitals with outstanding Hill-Burton debt and obligations is decreasing. Hill-Burton
                                   obligated hospitals are presumed to have met their obligation if they make available annually the
                                   lower of (1) a dollar volume of services equal to 3 percent of the sum of operating costs minus Medi-
                                   care and Medicaid payments or (2) 10 percent of the federal assistance received. The length of the
                                   obligation is 20 years (in the case of grant recipients), or for the duration of the hospital’s indebted-
                                   ness (in the case of recipients of loans, loan guarantees, or interest subsidies).

                                   “Uncompensated care, which is defined as care provided to a patient that a hospital is not reimbursed
                                   for, consists of two parts: bad debt and charity care.

                                   Page 12                                                          GAO/HRD-90-84 Nonprofit Hospitals
                        Chapter 1

Changing Marketplace    To the extent that recent private and public sector cost-containment ini-
                        tiatives result in reduced hospital net incomes,it may be more difficult
Alters Hospital         for somehospitals to incur expensesfor community service activities,
Incentives to Provide   such as providing charity care. Somelegislators and policy analysts
                        believe that hospital accessfor the indigent has declined. Nonprofit hos-
Indigent Care           pitals’ community role is the focus of scrutiny becauseinvestor-owned
                        hospitals-subject to local, state, and federal taxes-are not treated as
                        charities and many government-owned hospitals are reportedly unable
                        to provide capacity sufficient to treat all indigent patients.

Changes in Technology   Advances in medical technology transformed the nature of hospital care
and Financing Spur      and broadened the patient base of hospitals from mostly the poor and
                        disadvantaged to include also the middle and upper classes.Before the
Changes to Nonprofit    20th century, the demand for general hospitals was relatively small:
Hospitals               nonprofit hospitals were created by various groups for those who had
                        special health problems or who were unable to receive physicians’ ser-
                        vices at home, such as the poor or those away from home. When these
                        hospitals were established, hospital care was primarily custodial
                        becausedrugs and other treatment for illnesseswere lacking and the
                        risks of infection and death from surgery were great. Traditionally,
                        most nonprofit hospitals refrained from charging a significant amount
                        above the relatively low cost becauseit was assumedthat patients were
                        too poor to pay for their care. Development of medical technology, espe-
                        cially ways of treating diseaseand controlling infection, made hospitals
                        more appealing to middle- and upper-income patients. As technology
                        becamemore expensive and more people demandedaccessto hospitals,
                        a smaller percentageof patients were free or charity cases.
                        During the 20th century, the role of private philanthropy in financing
                        hospitals was also reduced. As a result, nonprofit hospitals had a
                        decreasingrole in channeling philanthropy into communities. Hospitals
                        becameless reliant on philanthropic endowments and more reliant on
                        medical insurance and public financing, such as that available through
                        the Hill-Burton program. By the late 1950s someform of insurance pay-
                        ment was made for about 75 percent of patients in nonprofit hospitals.
                        Nonprofit hospitals’ role as providers of free care was further reduced
                        by the enactment of the Medicare and Medicaid programs in 1965. By
                        paying the costs of care for millions of the elderly and the poor, these
                        programs reduced the need for the hospital and its medical staff to pro-
                        vide care at no charge. Many of the patients who would have been char-
                        ity caseswere now insured patients.

                        Page 13                                     GAO/HRLb90-84 Nonprofit Hospitals
                         Chapter 1

Growing Investor-Owned   Another changein the hospital marketplace-the emergenceand
Hospital Enterprise      growth of national investor-owned hospital companies-was spurred by
                         the availability of money accompanying the rise of third-party pay-
                         ments by insurers, employers, and the Medicare and Medicaid programs.
                         Since the 1960s the rate of growth of investor-owned hospital systems
                         has outpaced that of nonprofit systems.Investor-owners have added
                         500 hospitals and nearly 62,000 beds since 1976, more than doubling
                         their previous holdings. In 1988, investor-owned hospitals represented
                         about 18 percent of nonfederal short-term hospitals nationwide.
                         Although in no state do investor-owned hospitals represent more than
                         50 percent of all nonfederal short-term hospitals, they represent more
                         than 30 percent of hospitals in about sevensouthern and western states.
                         As well as consolidating into larger organizations and diversifying into
                         related ventures, investor-owned enterprises are combining with non-
                         profit hospitals to create hybrid organizations.

Changes in Financing     During the 198Os,changesin the way hospitals are reimbursed raised
Make Care to Medically   concernsabout the extent to which hospitals would be able to provide
                         care to those who cannot pay. Increased competition between hospitals
Indigent a Concern       for patients and government-, employer-, and insurer-initiated attempts
                         to contain costs make hospitals less able to subsidize uncompensated

                         Hospitals have typically financed uncompensatedcare through various
                         combinations of philanthropy, cost shifting,7 and general subsidies from
                         state and local governments. Hospitals’ ability to subsidize uncompen-
                         sated care may be decreasingas private insurers and employers attempt
                         to contain their costs and state and local governments face fiscal pres-
                         sures, These factors, combined with the cost-containment initiatives in
                         the Medicare and Medicaid programs, have resulted in a general decline
                         in profits throughout the hospital sector.
                         There are someindications that accessto hospital care for the medically
                         indigent in this cost-containment environment is declining. Demand for
                         intensive hospital care neededto treat gunshot victims, acquired immu-
                         nodeficiency syndrome (AIDS) patients, and illicit drug users, a substan-
                         tial portion of whom are indigent, has outstripped the available capacity
                         of somehospitals in large cities. Reportedly, the hospitals of last resort

                         713ybilling private insurers at rates exceeding costs, hospitals frequently attempt to shift some of the
                         costs of uninsured patients to insured patients.

                         Page 14                                                         GAO/HRD-90-84 Nonprofit Hospitals
                         Chapter 1

                         in these cities treat patients in hallways as their emergencyrooms

Nonprofit Hospitals      The changing hospital marketplace has led somepolicymakers and
Scrutinized Because of   researchersto question whether there is a significant difference
                         between the amounts of charity care provided by nonprofit hospitals
Tax-Exempt Status        and investor-owned hospitals, who are subject to local, state, and fed-
                         eral taxes. Becauseof inconsistenciesin the ways hospitals identify
                         charity care, researchershave measured levels of uncompensatedcare
                         instead. By this measure,national data show there is little difference in
                         overall rates of uncompensatedcare between nonprofit and investor-
                         owned hospitals. Studies have shown, however, that when uncompen-
                         sated care data are analyzed on a state-by-state basis, nonprofit hospi-
                         tals in somestates have higher average rates of uncompensatedcare
                         than investor-owned hospitals. The rates of uncompensatedcare for
                         both hospital organizational types vary substantially, and somenon-
                         profit hospitals have uncompensatedcare rates below the average rate
                         of investor-owned hospitals. Relatively little research has been per-
                         formed, however, to assesswhether such hospitals distinguish them-
                         selves in other ways as charitable institutions.

                         The Internal RevenueService (IRS) has long granted an income tax
                         exemption to hospitals meeting its qualifications for charitable organiza-
                         tions under section 601(c)(3) of the Internal Revenue&de.* To qualify,
                         a hospital applicant must show that it is organized and operated for a
                         charitable purpose, that no part of its net earnings inure to an individ-
                         ual, and that it does not conduct political or substantial lobbying activi-
                         ties. Although hospitals are not exempt specifically in the Internal
                         RevenueCode,IRS has long extended the tax exemption to qualifying
                         hospitals. Importantly, nonprofit hospitals no longer need to provide
                         care to indigents in order to retain tax-exempt status as they once did.
                         However, qualifying hospitals must, in other ways, evince their exclu-
                         sive commitment to the community, rather than to private benefit, in
                         order to obtain the exemption, For a detailed discussion of the history of
                         the hospitals’ ta.x exemption criteria, seeappendix I.

                         “Section 501(c)(3) of title 26 of the United States Code exempts from federal income taxation “corpo-
                         rations and any community chest, fund, or foundation, organized and operated exclusively for relig-
                         ious, charitable, scientific...purposes....” (emphasis added). In regulations implementing section
                         KOl(cX3),equires          charities to be organized and operated exclusively for a charitable endeavor,
                         and not for the benefit of private interests.

                         Page 15                                                        GAO/HRD90-84 Nonprof’it Hospitals
Chapter 1

Recently, IRS and Treasury officials have voiced concernsabout complex
nonprofit organizations, especially universities and nonprofit hospitals,
with substantial unrelated for-profit businesses.R If somenonprofit hos-
pitals are acting essentially as investor-owned institutions do, different
tax treatment for them is harder to justify.
At the state and local levels, the fiscal stress resulting from the provi-
sion of indigent care has intensified debate about the availability of tax
exemptions to nonprofit hospitals. The requirements of tax exemption
have been defined differently in two recent state supreme court deci-
sions. In the most broad-basedchallenge to tax exemption, the Utah
SupremeCourt in 1986 interpreted the state constitution as requiring
that hospitals undertake some “act of giving”-such as charity care-to
the community in order to qualify for property tax exemption. The fol-
lowing year, Utah voters turned down a referendum to changethe con-
stitution to provide tax exemption to hospitals regardlessof their
charitable activities. In Vermont, on the other hand, the supreme court
held that the main test of whether a nonprofit hospital was a charity
hinged on the availability of charity care, rather than the dollar amount
of such care provided.
Local officials have attempted to remove charitable status and property
tax exemptions from nonprofit hospitals in at least 12 states. In addi-
tion, at least 17 states have consideredor enacted legislation to prevent
unfair competition by nonprofits, and somecities have considered
charging nonprofit organizations a fee for the municipal servicesthey
use. In general, these initiatives have (1) respondedto complaints from
the businesscommunity of unfair competitive advantage by nonprofits
when they offer goodsor servicesnot directly related to health care and
(2) encouragedhospitals to provide indigent care. While few hospitals
have lost their tax-exempt status, proposals to require nonprofit organi-
zations to pay municipal service fees to local governments are becoming
more common. Rather than assessingfees, other localities have revised
criteria for continued tax exemption, such as by requiring that nonprofit
hospitals provide a minimum proportion of Medicaid and charity care in
order to retain tax exemption.
Hospital associationshave respondedto these initiatives by creating
tools, such as social accounting budgets, to help health care facilities

“Chapoton, Deputy Assistant Revenue Secretary, Tax Policy, Department of the Treasury; and Gibbs,
Commissioner of Internal Revenue; Testimony before the House Subcommittee on Oversight, Commit-
tee on Ways and Means, June 22, 1987.

Page 16                                                    GAO/HRD90-84 Nonprofit Hospitals
                            Chapter 1

                            plan for, administer, and report benefits provided to their communities,
                            especially the poor.I0The W.K. Kellogg Foundation has funded the Hos-
                            pital Community Benefit Standards Program to develop an accreditation
                            program for certifying hospitals as community benefit organizations.
                            This project has developed standards to help guide hospitals to improve
                            community health status, addressspecial problems of medically under-
                            served populations, and contain the growth of community health care

Objectives, Scope,and       The Chairman, HouseSelect Committee on Aging, requested that we
                            assessthe role of nonprofit hospitals in providing servicesto the indi-
Methodology                 gent. Specifically, our objectives were to analyze
                        . the relationship between nonprofit hospitals’ uncompensatedexpenses
                          and the value of their tax exemption;
                        l the distinctions between nonprofits that provide a high level of indigent
                          care and those that offer a relatively low level, as well as the reasonsfor
                          these differences; and
                        . the extent to which nonprofit hospitals provide to their communities
                          other services,such as health screening and education, in addition to
                          indigent care.

Financial Analysis          To accomplish our first two objectives, we collected hospital financial
                            information from five states for the most recent years for which data
                            were available.” These data are used by the states to monitor and con-
                            tain costs, or to adjust Medicaid reimbursement rates.
                            The states-California, Florida, Iowa, Michigan, and New York-were
                            selectedto include
                        l different geographic regions;
                        l a significant number of the nation’s hospitals;
                        . states with a high prevalence of investor-owned hospitals, as well as
                          states whose hospitals are principally nonprofit; and

                             “‘For example, the Catholic Health Association has reported that although the Catholic health care
                            ministry has a religious tradition of serving the poor and the needy, recent budget constraints and the
                            tax exemption debate call for renewed activity by their member hospitals to target the poor and
                            improve accounting and reporting of services that hospitals provide to their communities.
                            “Data from fiscal year 1987 were used for Iowa, Michigan, and New York. Data from hospitals’ fiscal
                            years ending between June 30, 1986, and June 29, 1987, were used for California, and data from
                            fiscal year 1985 were used for Florida.

                            Page 17                                                        GAO/HRD-90-84 Nonprofit Hospitals
      Chapter 1

    9 states with relatively expansive and restrictive Medicaid benefits and
      eligibility standards.”
      Uncompensatedcare can be emergency,inpatient, or outpatient hospital
      care given to those who cannot or do not pay their bills. It includes both
      bad debt and charity care,I3We used uncompensatedcare, instead of
      charity care, as a measure of hospitals’ servicesto the indigent because
      of inconsistenciesin the way hospitals distinguish between charity care
      and bad debt. This overstates the magnitude of charity care provided by
      hospitals but avoids possible biasesin the results becauseof different
      ways hospitals categorize patient bills.
      Another measure of care to the medically indigent that we used was the
      percentageof hospital care a hospital provided to those eligible for
      Medicaid. For, although hospitals do not consistently identify charity
      care, they do consistently identify the amount they bill for Medicaid

      We reviewed hospitals in selectedstates rather than a national sample
      of hospitals for two reasons.One,reliable national data on uncompen-
      sated care are lacking. Two, an intrastate comparison of uncompensated
      care is more meaningful becausethe amount provided by hospitals is
      affected by local factors, such as the features of the Medicaid program
      for the state in which a hospital is located.

      Using these data sets, we:
l     Determined which nonprofit hospitals provide uncompensatedcare in
      an amount higher than the value of their federal and state income tax

      12Wewere also limited to states with sufficient hospital-level financial data.
      t3Bad debt is defined as services to patients for which payment is possible but not made, such as
      debts of insured patients who do not pay their copayments or deductibles, or debts of the nonpoor
      uninsured. Charity care is defined as services to patients who do not have the means to pay all or a
      portion of their bills. Each state we reviewed issues accounting guidelines and principles to help
      assure that uncompensated care and other data elements are reported consistently.
      t4To estimate the value of nonprofit hospitals’ income tax exemption, we applied the average effec-
      tive tax rate of a sample of for-profit hospital corporations to the nonprofits’ net incomes. Because of
      the imprecise nature of such an estimate, the potential tax liability is presented as a range of values
      rather than as a point estimate, We did not adjust our estimates to account for potential changes in
      laws regarding the property tax exemption, tax-exempt bond financing, and tax-deductible donations
      if the federal tax exemption were eliminated. Hence our calculation potentially overstates the federal
      income tax liability but understates the total value of tax-exempt status because it does not include
      the value of the other tax advantages.

      Page 18                                                         GAO/HRD-90-84 Nonprofit Hospitals
                           Chapter 1

                         . Analyzed the extent to which the following factors are associatedwith
                           high or low amounts of uncompensatedcare relative to their expenses:
                           (1) profit,‘” (2) affiliation with a teaching institution, (3) rural or urban
                           location, (4) patient mix, and (5) size.
                           We discussthe results of this analysis in chapter 2.

Community Case Studies     To analyze the reasonsfor varying levels of indigent care provided by
                           hospitals within the samegeographic area, we conducted fieldwork in
                           five communities-one in each state included in our review-to provide
                           examples of how hospitals interact at the community level and what
                           factors most affect the distribution of indigent care. The communities
                           we visited were San Diego, California; Albany, New York;‘” Ann Arbor,
                           Michigan;17Orlando, Florida; and Des Moines, Iowa.

                           In each community, for the years 1984-87 and 1988, if available, we
                           collected information on trends in (1) the community’s indigent care, (2)
                           methods of financing indigent care by state and local governments, and
                           (3) each hospital’s relative contribution of indigent care. We also col-
                           lected available data and hospital officials’ opinions on factors affecting
                           the distribution of indigent care within the communities’ hospitals,
                           including hospital admissions and patient transfer policies, physician
                           staffing policies, and types of medical serviceseach hospital provided.

                           We discussthe results of our community casestudies in chapter 3.

Questionnaire              To accomplish our third objective, we surveyed a nationally representa-
                           tive random sample of nonprofit and investor-owned hospitals to deter-
                           mine the type and extent of community servicesthey provided in fiscal
                           year 1988. Although there are various estimates of hospitals’ uncom-
                           pensated care, there is no estimate of the extent to which hospitals pro-
                           vide servicesother than acute care to their communities. Of 776 surveys
                           that we mailed to hospitals, we received 522, or about 67 percent. In our
                           survey, we defined community services as activities undertaken to serve

                           ‘“Like an investor-owned organization, a nonprofit organization’s “profit” refers to net income-the
                           difference between revenues and expenses. Unlike an investor-owned organization, however, none of
                           a nonprofit organization’s profit can inure to individuals, such as stockholders.

                           “‘We also reviewed two hospitals in Schenectady, New York

                           17Wereviewed hospitals in Ann Arbor and surrounding towns within Washtenaw County, including
                           Chelsea, Saline, and Ypsilanti.

                           Page 19                                                      GAO/HRD90-84 Nonproflt Hospitals
Chapter 1

the community in addition to providing acute medical care to patients.
We discussthe results of our survey in chapter 4.

We did not independently examine the internal and automatic data
processingcontrols for the automated state data systems we used. The
states rely, however, on the data obtained from these systems as a basis
for Medicaid reimbursement rates and/or partial reimbursement for
uncompensatedcare. Except for this limitation, our work, which was
done from October 1988 through June 1989, was performed in accor-
dance with generally acceptedgovernment auditing standards.

Page 20                                     GAO/HRD-90-84 Nonprofit Hospitals
Chapter 2

Uneven Distribution of Indigent Care

                     The amount of uncompensatedcare provided by nonprofit hospitals is a
                     large part of their benefit to the poor in their communities. Hospitals
                     that treat patients who are uninsured or underinsured with little pros-
                     pect of payment give community residents accessto hospital care that
                     might otherwise be unavailable. When we compared the amount of hos-
                     pitals’ uncompensatedcare expenseswith the money they saved by not
                     having to pay federal and state taxes, we found that nonprofit hospitals
                     as a group provided more uncompensatedcare than their estimated tax
                     savings. Depending on how charitable care is defined, however, between
                     16 and 67 percent of the nonprofit hospitals provided less charitable
                     care than the value of the tax exemption they received.
                     Nonprofit hospitals’ rates of uncompensatedcare vary widely both
                     within and between states. Hospitals with low rates of uncompensated
                     care served fewer Medicaid patients, had higher profit margins, and,
                     with few exceptions, were not major teaching hospitals. Hospitals with
                     high rates of uncompensatedcare served more Medicaid patients and
                     had lower profit margins. Major teaching hospitals were generally high-

                     Generally, nonprofit hospitals as a group provided more uncompensated
Uncompensated Care   care than did for-profit hospitals. However, nonprofit nonteaching hos-
Concentrated in      pitals provide less uncompensatedcare than would be expected based
Relatively Few       on their share of the states’ hospital market. In Florida, for example,
                     these hospitals provide 43 percent of the total days of hospital care but
Hospitals            only 33 percent of the state’s uncompensatedcare expenses.In general,
                     only nonprofit hospitals with major teaching’ programs provided an
                     amount of uncompensatedcare equivalent to their share of the hospital
                     inpatient market. The distribution of uncompensatedcare by type of
                     hospital ownership is shown in figure 2.1.

                     ‘WC have defined major teaching hospitals as those that are members of the Council of Teaching
                     Hospitals. Council hospitals are affiliated with colleges of medicine and participate in training

                     Page 21                                                       GAO/HRD-90-84 Nonprofit Hospitals
                                                  Chapter 2
                                                  Uneven Dietrlbution    of Indigent Care

Figure 2.1: Hospitals’ Share of Patient Days and Uncompensated Expenses, by Ownership Type
Porcoti of Stat0 Total
100 --

         El     Government-owned Hospitals
                Nonprofit Teaching Hospitals
                Nonprofit NonteachIng Hospitals
                Inwstor-owned Hospitals

                                                  Note: Florida data are from 1985; California data are from 1986; and the remaining data are from 1967.
                                                  Iowa and Michigan have Insignificant numbers of investor-owned hospitals.

                                                  In each of the states, uncompensatedcare expenseswere concentrated
                                                  in relatively few nonprofit hospitals, most of which were major teaching
                                                  institutions in urban areas. Ranking the nonprofit hospitals by the dollar
                                                  amount of uncompensatedcare provided, we found that less than 7 per-
                                                  cent of them provided at least 26 percent of the total nonprofit contribu-
                                                  tion of uncompensatedcare. For example, nine major teaching hospitals
                                                  in New York City accounted for 38 percent of all uncompensatedcare
                                                  provided by nonprofit hospitals statewide, though they had only 16 per-
                                                  cent of the state’s hospital beds. Most of these hospitals belongedto the

                                                  Page 22                                                         GAO/HRD90&4       Nonprofit Hospitals
                                       Chapter 2
                                       Uneven Distribution    of Indigent Care

                                       Council of Teaching Hospitals, or were approved to participate in resi-
                                       dency programs and were affiliated with a medical school. Table 2.1
                                       shows the portion of the total nonprofit uncompensatedcare expenses
                                       borne by relatively few of each state’s hospitals.
Table 2.1: Nonprofit Hospitals With
Highest Amounts of Uncompensated                                            Number of Percent of nonprofit               Percent of nonprofit
Care: Share of State’s Uncompensated   State                                hospitals0 uncompensated care                      hospital beds
Care                                   Iowa                                            4                          40                       28
                                       Michigan                                        6                          33                       13
                                       New York                                        9                          38                       16
                                       California                                     10                          26                       11
                                       Florida                                         5                          31                       17
                                       % each state, these hospitals constitute less than 7 percent of the state’s hospitals

                                       The average rate of uncompensatedcare for all hospitals varied sub-
Rates of                               stantially among the states, ranging from 2.7 percent for Iowa hospitals
Uncompensated Care                     to 7.9 percent for Florida hospitals. This variation in rates of uncompen-
Vary Among States                      sated care among states mirrors the interstate variation in (1) the per-
                                       centagesof state residents without medical insurance and (2) the extent
                                       to which the Medicaid program covers residents with incomes below the
                                       federal poverty standard. Among the states we reviewed, Florida and
                                       California have the highest rates of uninsured residents. Similarly, Flor-
                                       ida’s Medicaid program has the strictest income eligibility criteria.
                                       Accordingly, hospitals in these states have significantly higher rates of
                                       uncompensatedcare on average.
                                       Although overall levels of uncompensatedcare varied among states,
                                       nonprofit hospitals without major teaching programs in California,
                                       Iowa, Michigan, and New York had similar rates of uncompensatedcare.
                                       In California and Florida, states with relatively high average uncompen-
                                       sated care rates, government-owned hospitals tended to absorb the addi-
                                       tional burden. That is, their uncompensatedcare rates were much higher
                                       than in other states. The rates of uncompensatedcare by state and hos-
                                       pital type are shown in figure 2.2.

                                       Page 23                                                          GAO/HRD-90-84 Nonprofit Hospitals
                                    Chapter 2
                                    Uneven Distribution       of Indigent Care

Rates, by Hospital Ownership Type
                                    20   Percent UncompensatedExponsr to Total Exponr

                                         Calitomla                Florida (WS)             Iowa (1987)             Michigan (1987)   New York
                                         (1@@9                                                                                       (1W

                                         I       11 Government-owned Hospitals
                                                     Nonprofit Teaching Hospitals
                                                     Nonprofit Nontaaching Hospltats
                                                     Investor-owned Hospitats

                                    Note: Iowa and Mtchigan have inslgnlficant         numbers of investor-owned     hospitals.

                                    California and Florida have significant numbers of both investor-owned
                                    and nonprofit hospitals. In California, the averageinvestor-owned rate
                                    of uncompensatedcare was slightly higher than the nonprofit rate. In
                                    Florida, the averagenonprofit rate was higher than the investor-owned

                                    We arrayed nonprofit hospitals by uncompensatedcare rates to identify
Substantial Variance                characteristics of hospitals with significantly higher- and lower-than-
Between High- and                   average rates. By state, we compared selectedcharacteristics of all non-
Low-Uncompensated-                  profit hospitals at or below the 25th percentile of uncompensatedcare
                                    rates (low-uncompensated-carehospitals) with nonprofit hospitals fall-
Care Nonprofit                      ing at or above the 75th percentile of uncompensatedcare rates (high-
Hospitals y                         uncompensated-carehospitals). We found that high-uncompensated-care
                                    hospitals bore a substantially greater burden of uncompensated

                                    Page 24                                                                GAO/HRD-90-84 Nonprofit Hospitals
                            Chapter 2
                            Uneven Mstrlbution     of Indigent Care

                            care-from three to nine times greater-than low-uncompensated-care
                            hospitals. (Seep. 48.)
                            As well as having significantly different uncompensatedcare rates, low-
                            and high-uncompensated-carehospitals were significantly distinct in at
                            least two other respects.Compared to high-uncompensated-carehospi-
                            tals, low-uncompensated-carehospitals (1) served fewer Medicaid
                            patients and (2) had higher profit margins.

Low-IJncompensated-Care     In every state, hospitals providing low rates of uncompensatedcare
Hospitals Served Medicaid   served lower percentagesof Medicaid patients than did high-
                            uncompensated-carehospitals. (Seep. 49.) The hospitals with high
Patients at Lower Rates     levels of Medicaid patients are sometimesless able to subsidize uncom-
                            pensated expensesbecauselarger percentagesof Medicaid patients
                            often mean lower percentagesof privately insured patients to whom
                            chargescan be increasedto help offset losseson nonpaying patients.
                            Further, a number of states have hospital payment systems for Medicaid
                            that result in lower payment rates than other public and private insur-
                            ance programs. Both of these factors tend to exacerbatethe financial
                            burdens of hospitals’ provision of uncompensatedcare.

Low-Uncompensated-Care      The amount of uncompensatedcare provided by a hospital must be eval-
Hospitals More Profitable   uated in connection with the resourcesavailable to finance that care.
                            Hospitals can finance uncompensatedcare with nonoperating revenue2
                            and operating income-earned by the hospital from its patient care
                            operations. One way to finance uncompensatedcare is to bill private
                            insurers at rates exceedingactual costs and use the profits for uncom-
                            pensated care. Nonprofit and investor-owned hospitals can make better
                            use of this option than government-owned hospitals can becausea larger
                            proportion of their patients are privately insured. Nevertheless,hospi-
                            tals’ ability to subsidize uncompensatedcare through nonoperating reve-
                            nue or operating income has been constrained in recent years by various
                            health care cost-containment measuresadopted by both public and pri-
                            vate insurers.
                            We found that nonprofit hospitals with resourcesavailable to finance
                            uncompensatedcare-either nonoperating revenue or operating

                            ‘Nonoperating revenue consists of investment income and charitable donations, gains or losses on
                            sales of investments, and other items that are not directly related to providing care to patients.

                            Page 26                                                       GAO/HRD-90-84 Nonprofit Hospitals
                                       Chapter 2
                                       Uneven Distribution   of Indigent Care

                                       income” -were often the lowest volume uncompensatedcare hospitals.
                                       Differences in profitability between nonprofit hospitals having low- and
                                       high-uncompensated-carerates are shown on page 50.

Rates of Uncompensated                 Only in Florida were average rates of uncompensatedcare higher for
Care Vary Slightly by                  nonprofit hospitals in rural areas than for those in urban areas. In Iowa,
                                       Michigan, and New York, rural hospitals were more likely than urban
Location                               hospitals to be low-uncompensated-carehospitals. Table 2.2 shows the
                                       difference between nonprofit hospital rates of uncompensatedcare in
                                       urban and rural areas, by state.
Table 2.2: Comparison of Nonprofit
Uncompensated Expense Rates in Urban   State                                                         Urban rate                  Rural rate
and Rural Areas                        California (1986)                                                      3.4                        3.3
                                       Florida (19851                                                         7.1                       10.4
                                       Iowa (1987)                                                            2.5                        2.1
                                       Michigan (1987)                                                        2.8                        2.4
                                       New iork I1 9871        --                                             3.6                        2.4

                                       The amount of tax revenue lost as a result of excluding or exempting
ILevelsof                              certain income from taxes can provide an indication of the relative cost
Uncompensated Care                     of policies designedto achieve specified public goals. To estimate the tax
Relative to Value of                   revenue lost as a result of exempting nonprofit hospitals from federal
                                       and state income taxes, we applied the averageeffective tax rate of a
Tax Exemption                          sample of for-profit hospital corporations to the nonprofits’ net
                                       incomes.4We did not attempt to estimate the value of nonprofit hospi-
                                       tals’ local property tax exemption or the value of tax-exempt bond
                                       financing or charitable donations, which constitute a substantial portion
                                       of the total value of the tax expenditure.
                                       We compared the hospitals’ estimated tax exemption value to the
                                       uncompensatedcare they provided-one measure of hospitals’ charita-
                                       ble activities. In the five states we reviewed, nonprofit hospitals as a
                                       group provided more uncompensatedcare than the estimated value of
                                       their income tax liability. (Seetable 2.3.)

                                       “To measure hospitals’ ability to finance uncompensated care, we examined their total margin: the
                                       percentage of revenues converted into net income.
                                       4Net income is defined as the excess of revenues over expenses. In this calculation, we assumed that a
                                       nonprofit hospital’s net income would remain the same if it were subject to tax.

                                       Page 26                                                       GAO/HRD-90-84 Nonprof’it Hospitals
                                     Chapter 2
                                     Uneven Distribution    of Indigent Care

Table 2.3: Value of Nonprofit Tax
Exemption v8. Uncompensated Care     Dollars in millions
costs                                                                                    Uncompensated                              Value of
                                                                                              care costs                     tax exemption’
                                     Iowa                                                                $27                          $8 - $28
                                     Michigan                                                            161                           ll- 36
                                     New York                                                            457                           28 - 92
                                     California                                                          301                          84 - 278
                                     Florida                                                             253                          35 - 117
                                     %ecause of the imprecise nature of such an estimate, the potential tax liability is presented as a range
                                     of values, rather than as a point estimate. The range represents one standard deviation around the

                                     About 15 percent of nonprofit hospitals, however, provided uncompen-
                                     sated care that was less than the estimated value of the tax exemption.
Table 2.4: Hospitals for Which Tax
Exemption Value Exceeds              Dollars in millions
Uncompensated Care Costs                                                  No. of         Percent of Uncompensated                Value of tax
                                     __^_-__                           hospitals          hospitals     care costs               exemptiona
                                     ___._._                                      14               24                   $8                    $11
                                     ----                                          7                5                    1                      4
                                     New York                          -          23               12                    5                     11
                                     California                                   50               24                   55                     9i
                                     Florida                                       8                9                   10                     13
                                     % companng the uncompensated          care costs to the value of the tax exemption, we used the median
                                     tax exemption value.

                                     Becausetheir profit margins are significantly higher than those of other
                                     hospitals, these hospitals’ tax liability would also be higher. Where aver-
                                     age profit margins in the five states ranged from a loss of 2.7 percent to
                                     a profit of 5.6 percent, profit margins for these hospitals ranged from
                                     4.5 to 14.2 percent. In addition to higher profits, these hospitals gener-
                                     ally had uncompensatedcare expensesless than the average hospital in
                                     the state in which they are located. Figures 2.3 and 2.4 compare the
                                     profit margin and uncompensatedcare rate of the hospitals with the
                                     statewide nonprofit hospital averages,

                                     Page 27                                                            GAO/HRD90-84 Nonprofit Hospitals

                                            Chapter 2
                                            Uneven Distribution       of Indigent Care

Figure 2.3: Profit Margins: Comparison of
Nonprofit Hospitals Not Meeting Tax         16   P&It Margln
Threshold With All Nonprofit HO8pital8





                                                 Califomla                Florida (1995)         lovm(1997)            Michigan (1957)   New York
                                                 (1W                                                                                     0-7)

                                                 1      1 All Nonprofit Hospitals
                                                             Nonprofit Hospitals with Tax Liability > Uncompensated Costs


                                            Page28                                                                GAO/HRD-90-84 Nonprofit Hospitals
                                      Chapter 2
                                      Uneven Matributfon          of Indigent     Care

Figure 2.4: Uncompensated Expenee
Rates: Comparison of Nonprofit
                                      10    Uncompsnaatsd Expanse Rate
HO8pltals Not Meeting lax Threshold
With All Nonprofit HO8pitdS

                                            Callfomla                 Flcrlda (1965)                              Michigan (1967)   New York
                                            VW                                                                                      (1987)

                                                        All Nonprofit Hospitals
                                                        Nonprofit Hospitals with Tax Liability > Uncompensated Costs

                                      When only charity care is considered,more hospitals-about 57 per-
                                      cent-provide care whose value is less than the value of their potential
                                      tax liability. For example, in New York and California, 43 and 71 per-
                                      cent of nonprofit hospitals, respectively, had an estimated potential tax
                                      liability that exceededthe amount of charity care they provided. In Cali-
                                      fornia, Florida, Iowa, and New York, the states we reviewed in which
                                      hospitals differentiated between charity and bad debt, charity care
                                      made up 23 percent of uncompensatedcare expenses.This is consistent
                                      with the conclusionsof a previous analysis, which found that of the
                                      $6.2 billion in uncompensatedcare provided by hospitals in 1982, only
                                      $1.7 billion (about 27 percent) was charity care.” Becausehospitals may
                                      have inconsistent methods for categorizing bad debt and charity care,
                                      however, any distinction drawn between the two is imprecise. The rela-
                                      tive proportions reported, however, indicate that a substantial percent-
                                      age of uncompensatedcare represents care to those expected to pay,
                                      such as unpaid deductibles of privately insured patients, rather than the
                                      medically indigent.

                                      “Sloan, and others. IJncompensated 1Iospital Care, Rights and Responsibilities.

                                      Page 29                                                                GAO/HRD-90-84 Nonprofit Hospitals
Factors Affixting Distribution of Indigent Care-
Within Communities

                    Factors that can influence the distribution of indigent care among hospi-
                    tals include the hospitals’ admissions and staffing policies and practices,
                    their services,and their locations. To better understand the factors
                    influencing the amount and distribution of uncompensatedcare and
                    Medicaid patient care among hospitals, we conducted casestudies of
                    hospitals in five communities- one in each of the states we reviewed.
                    In each community, somenonprofit hospitals’ policies-such as those
                    governing patient admissions and transfers, physician staffing, and the
                    setting of strategic goals- discouragedthe provision of nonemergency
                    care to those unable to pay for it. Most care for the medically indigent
                    was provided by hospitals that historically have provided such care-
                    that is, government-owned or university-affiliated nonprofit teaching
                    In the communities with adequate funding and capacity to treat the
                    communities’ indigent, nonprofit hospitals’ uncompensated-carerates
                    were relatively low and not perceived as a significant problem. In the
                    communities where the numbers of medically indigent people in need of
                    servicesoutstripped the capacity or willingness of the nonprofit teach-
                    ing hospitals to meet the demand, the amount and distribution of
                    uncompensatedcare was a significant issue among hospital administra-
                    tors. In these communities, somehospitals were undertaking actions to
                    reduce the amount of treatment provided to those who could not pay.

Causesof Indigent   Available research demonstrates a large and increasing indigent care
                    burden on government-owned hospitals, especially in large cities. For
Care Distribution   our casestudies, we selectedfour communities in which there was no
Examined Through    government-owned hospital so that we could examine the factors affect-
                    ing the distribution of indigent care among hospitals in the absenceof a
CaseStudies         government-owned hospital. We also selecteda community in a predomi-
                    nantly rural state. In California and Florida, the two states with signifi-
                    cant numbers of both for-profit and nonprofit hospitals, the hospitals
                    we visited included a mix of both types. In the three other states, the
                    communities contained government-owned and nonprofit hospitals only.
                    Table 3.1 shows the hospitals visited in each community, by ownership

                    Page 30                                      GAO/HRD-90-84 Nonprofit Hospitals
                                                            Chapter 3
                                                            Factors Affecting Distribution    of Indigent
                                                            Care Within Communities

                                                                                   ,. - -. -.-,_-...- _, ,
Table 3.1: Hos~ttals Visited in Selected Communities. bv Ownership Tv~e
                                                          Nonfederal    Member of Council
                                                         government-         of Teaching
Community    hospitals
_..- . .- _.__
                    . ....______-        Numbif~dq:            owned            Hospitals Other nonprofit                                         Investor-owned
Central San Diego, California
Unfversfty of California at San Diego                          406                                                    X                    X
M&y                              _ .__...-
                                        -.._--                 411                                                                         X
Paradise Valley             - .-...-- .__.----                 210                                                                         X
Harbor Vtew          -.    _..- ---- --_. ____                 176                                                                                                   X
PhysiciansfSurgeons~                                            69                 -_                                                                                X
   _. .~ Florida
Orlando Re ronal
  Medical L?enter-~                       -~.._---            733                                                     X
F&da.                                                         964                                                                          X
Winterpark Memorial                                         -_301                                                                          X
Humana                                                        267                                                                                                    X
                                          .-.-.-____---       153                                                                          X
Des Moines, Iowa
Broadlawns     ~                                               294                        X
Des Moines General                                             231                                                                         X
towa Lutheran                                                  347                                                                         X
Iowa Methodfst   -.- .- ~~~._.~
                              ..                     -680                                                                                  X
M&y                                                            500                                                                         X
Washtenaw Cdunty, Michigan
Universrty of Michigan                                           799                                                  X
St, Joseph Mercy     ~-. -.                                     511                                                                        X
Saline Commun”ity                                                 63                                                                       X
Chelsea Communrty                                           .-...137 ____-                                                                 X
l%eyer Memorraf          ‘--                                     148                                                                       X
Capital Dia&,‘New       i&k@ _- .-_-.
Albany Medfcal Center                                         654 ----                                                X
St. Peters                                                    437            ---                                                           X
Memonal                                                       233                                                                          X
                                   i...--.--...---            413                                                                          X
St. Clare’s                                                   227---                                                                       X
                                                            Notes: Number of beds available for use as of September 30, 1987. Data are from American Hos ital
                                                            Association Guide to the Health Care Field, 1988 edition We did not review federal + ospltals, such as
                                                            f%@ii%ent of Veterans Affairs hospitals.
                                                            %cludes selected hospitals In Albany and Schnectady.

                                                            Page 31                                                         GAO/HRD-90-84 Nonprofit Hospitals

                          Chapter 3
                          Factors Affecting Distribution   of Indigent
                          Care Within Communities

                          Across communities, we found that somenonprofit hospitals’ admis-
SomeHospitals Lack        sions, transfer, and physician staffing policies generally discouragedthe
Proactive Goals or        provision of nonemergencycare to those unable to pay for treatment.
Policies for              The lack of proactive policies for the indigent results in a distribution of
                          uncompensatedcare largely basedon historic treatment patterns or geo-
Nonemergency              graphic area.
Indigent Care

Many Hospitals’           The admissions policies of many hospitals we visited-both nonprofit
Admissions and Transfer   and investor-owned-limited a majority of charity care to that initiated
                          in the emergencyroom. Nonprofit hospitals in Des Moines, for example,
Policies Limit Elective   referred patients needing elective care to the publicly financed hospi-
Care for Those Unable     tals, Among hospitals we visited, few had admissionsor physician staff-
to Pay                    ing policies that facilitated elective admissions for those who could not
                          pay. In the communities we visited with a mix of hospital ownership
                          types, we found similar admissions and physician staffing policies at
                          nonprofit nonteaching and investor-owned hospitals. Teaching hospi-
                          tals’ physician staffing policies, however, were different in that medical
                          residents could assist in treating the indigent.
                          Both nonprofit and investor-owned hospitals participating in Medicare
                          are required by law to provide necessarymedical examinations to indi-
                          viduals with emergencymedical conditions and women in active labor.
                          In certain circumstances,the hospital may provide for an appropriate
                          transfer to another facility. Four of the states in our review have similar
                          statutes or administrative regulations to assurethat all patients are sta-
                          bilized in emergencies,regardlessof whether they can pay their bills.

                          In contrast, hospitals are not required to provide nonemergencycare to
                          those unable to pay. Policies of both nonprofit and investor-owned hos-
                          pitals we reviewed generally limit the nonemergencycare they provide
                          to those who have insurance or have a physician to treat them.
                          In Albany, three of the hospitals still had Hill-Burton obligations to pro-
                          vide charity care. These hospitals used Hill-Burton criteria to determine
                          eligibility for charity care. The other two hospitals had satisfied prior
                          Hill-Burton obligations and did not have specific criteria for charity
                          care. Officials at these two hospitals told us that uncompensatedcare is
                          usually the result of bad debt rather than charity care.

                          Page 32                                        GAO/HRD-90-84 Nonprofit Hospitals
                          Chapter 3
                          Factom Affecting Distribution   of Indigent
                          Care Within Communities

                          In Ann Arbor, another community without a nonfederal government-
                          owned hospital, hospitals we visited had similar policies regarding
                          admissions.To receive outpatient servicesor to be admitted other than
                          from the emergency room, the patient generally must make financial
                          arrangements before services are rendered. A hospital official told us,
                          however, that indigent patients generally sought servicesthrough the
                          emergencyroom. If a patient is ineligible for Medicaid or another state-
                          subsidized program for indigent care, the hospitals attempt to negotiate
                          a financial arrangement with the patient. Hospitals generally billed all
                          patients and made efforts to collect the amounts owed. Only two of the
                          hospitals have written charity care policies. The policies of both hospi-
                          tals allowed for the elective admissions of persons regardless of their
                          ability to pay.
                          In the two communities with a mix of nonprofit and investor-owned hos-
                          pitals, admissions policies of the two types of hospitals were similar. In
                          Orlando, both nonprofit and investor-owned hospitals sought to deter-
                          mine whether patients were able to pay before admitting them for non-
                          emergency treatment. Two of the three nonprofit hospitals in this
                          community generally referred patients unable to pay to state and county
                          clinics for elective care. Similarly, in San Diego, hospital officials told us
                          that most uncompensatedcare stemmed from mandatory treatment pro-
                          vided in emergencies,not from nonemergencycare. For elective admis-
                          sions, the hospital administrators of both nonprofit and for-profit
                          hospitals generally made a decision in each casewhether to admit
                          patients after determining that they could not pay. For example, one
                          hospital’s policy was to admit such patients only if they were employed.

Some Hospital Staffing    The willingness of physicians to treat Medicaid patients or other
Policies Allow Emergent   patients unable to pay for treatment can affect the amount of nonemer-
                          gency indigent care a hospital can provide. Although the hospitals we
Care but Not Elective     visited allowed the medically indigent to receive care in the emergency
Treatment for Indigents   room, subsequentadmission to the hospital dependedon physicians’
                          willingness to provide treatment without reimbursement.
                          At the teaching hospitals we reviewed, officials told us that indigent
                          patients can be treated by supervised residents, helping to facilitate
                          residents’ experience in treating different kinds of problems. Nonteach-
                          ing hospitals we visited, however, rely on the medical staff to volunta-
                          rily treat indigent patients who need to be admitted to the hospital. The

                          Page 33                                        GAO/HRD-90-84 Nonprofit Hospitals
                           Chapter 3
                           Factors Affecting Distribution   of Indigent
                           Care Within Communities

                           “on-call” duty was generally made a condition of maintaining staff priv-
                           ileges. Generally, physicians providing treatment were not paid by the
                           hospital, but billed patients directly for the servicesthey provided.
                           In the communities with relatively high numbers of medically indigent,
                           hospital administrators told us that it was often difficult to obtain phy-
                           sicians to treat the indigent. In addition to receiving little or no payment
                           from indigent patients, physicians often have to interrupt their regular
                           practice to treat indigents. Somehospital administrators feared that if
                           they increased the on-call duties of physicians practicing at their hospi-
                           tal, somewould eventually move their practices to hospitals without
                           many indigent patients.
                           Physician practice patterns can also affect a hospital’s proportion of
                           Medicaid patients. In Orlando, for example, officials from one nonprofit
                           hospital told us that becausefew of the physicians admitting patients to
                           the hospital participated in the Medicaid program, they admitted few
                           Medicaid patients to the hospital.

Hospitals Did Not          The hospitals we visited provided us information on their strategic
Generally Have Strategic   goals’ and, in somecases,recent minutes of meetings of hospitals’
                           boards of directors. We used this information to determine the types of
Goals Designed to Expand   goals being set and issuesbeing addressedby the boards. From these
or Improve Indigent        sources,we identified goals related to provision of charity care or com-
Access to Care             munity health services.
                           A majority of goals concernedmaintaining the hospitals’ financial vial
                           bility, improving their competitive positions, expanding services and
                           facilities, or developing employee skills and personnel practices.
                           Although the hospitals set numerous goals related to expanding medical
                           services due to increasedpatient demand or to increasetheir market
                           share, generally no goals were directed at serving low-income commu-
                           nity residents.
                           Of the 24 private nonprofit and investor-owned hospitals we visited, 7
                           had strategic goals related to provision of care to the medically indigent:
                           3 in Washtenaw County, Michigan; 2 in Albany, New York; and 2 in Des
                           Moines, Iowa. Someof these goals were not specific to the needsof the
                           community and were not linked to dollar amounts or other quantifiable

                           ‘The Joint Commission on Accreditation of Healthcare Organizations requires for certification that
                           hospitals develop and maintain a set of strategic goals and a b-year strategic plan.

                           Page 34                                                       GAO/HRD-90-84 Nonprofit Hospitals
                             chaptlx 3
                             Factors Affecting Diatrlbution   of Indigent
                             Care Wlthin Communities

                             targets, such as numbers of people to be served. As a result, they were
                             ambiguous. For example, two hospital goals were to (1) ensure contin-
                             ued financial commitment to health care of the poor while strengthening
                             financial viability and (2) develop an analysis and policy regarding care
                             for the medically indigent.

Uneven Distribution of       The absenceof proactive policies among nonprofit hospitals can cause
                             problems in delivering servicesto the indigent and could eventually
Indigent Care a              causegaps in servicesfor entire communities. Delivering servicesto the
Problem in Some              indigent was a greater problem in somecommunities we visited than in
                             In three communities-Des Moines, Ann Arbor, and Albany-most
                             uncompensatedcare was provided by either a government-owned or a
                             major teaching nonprofit facility. Although teaching hospitals provided
                             the largest share of uncompensatedcare, their uncompensatedcare
                             rates were not substantially higher than the average rate of uncompen-
                             sated care provided by other hospitals in the state.

                             In Des Moines, a nonfederal government-owned hospital financed
                             through local tax revenuesprovided most indigent care, resulting in rel-
                             atively low and stable indigent expensesfor the community’s private
                             nonprofit hospitals. Similarly, in both Ann Arbor and Albany, a large
                             teaching nonprofit hospital provided a majority of indigent care.
                             Uncompensatedcare did not represent a large expenserelative to total
                             expensesfor any of these communities’ other hospitals.
                             In two of the communities we visited, the uncompensatedcare costs
                             were relatively high and the nonprofit hospitals providing the largest
                             share of such care were seeking ways to reduce these costs. Hospital
                             administrators in these communities were most concernedabout control-
                             ling the costs of emergency and obstetrical servicesto the indigent.
                             In 1986, the hospital that traditionally served the indigent in Orlando
                             adopted several policies to stem its indigent care costs, including
                       refusing to treat patients unable to pay except those needing urgent

                       medical treatment and those residing in the hospital’s catchment area,
                       encouraging indigent patients to go to a hospital in the area covered by

                       the zip code of their residence,and
                     . rotating their medical residents to a military hospital, rather than the
                       adjacent county clinic, for obstetrical training.

                             Page 36                                        GAO/HRD-90-84 Nonprofit Hospitals
Chapter 3
Factors Affecting Distribution   of Indigent
Care Within Cmnmunities

Other hospitals in the community opposedthese policies. Becauseof the
absenceof a nonfederal government-owned hospital, several hospitals,
including an investor-owned hospital, were inundated with obstetrical
patients. In response,a local health council devised an allocation method
to redistribute indigent obstetrical patients more evenly among the com-
munity’s hospitals. Although participating hospital administrators
believe that the allocation system lessenedthe problem, disagreements
remain. For example, officials at the hospital traditionally serving indi-
gents are concernedthat other hospitals’ requests to transfer women
having a high risk of complications during labor are basedon the
patients’ financial, not medical, condition. Conversely, someof the
area’s hospital administrators expressedconcern that the hospital tradi-
tionally serving indigents is not accepting transfers of all patients who
are at high risk.
Similarly, hospitals in San Diego were attempting to restrict their
indigent care expensesin responseto reductions in state and county
indigent care funding as well as to increasesin the numbers of undocu-
mented aliens lacking means to pay. Administrators’ concern focused on
emergencyservices.The administrator of an investor-owned hospital
located adjacent to a low-income section of the community estimated
that 76 percent of 3,000 emergency visits monthly involved people with
no insurance or inadequate insurance. To reduce its losses,the hospital
corporation planned to closethe emergency room, potentially causing a
domino effect throughout the community. In response,officials from a
nonprofit hospital were considering donating money to the investor-
owned hospital to keep its emergency room open. To avoid financial
stresses,another investor-owned hospital closed its emergency room to
ambulance traffic by downgrading it to an urgent care center. In addi-
tion, it chosenot to contract with the state to provide inpatient services
for Medicaid patients and did not contract with the county to provide
emergency servicesto county-sponsoredindigent patients.
Nonprofit hospitals were also beginning to take actions to reduce the
effect of expensesassociatedwith treating the indigent. At the time of
our visit, the hospital traditionally treating indigents was investing in a
new facility in a suburb to increase its market share of patients able to
pay. Another nonprofit hospital in the area planned to downgrade its
emergency room, closing it to ambulance traffic.

Page 36                                        GAO/HRD-90-84 Nonprofit Hospitals
Chapter 4

(Ihumni@ ServicesProvided by Hospitals

                       In addition to providing care to those unable to pay, nonprofit hospitals
                       also sponsor research or provide education and various types of health
                       screeningservices for their communities.

                       Our nationwide survey of hospital administrators showed that overall, a
                       high percentageof nongovernmental hospitals, regardlessof ownership
                       type, provide community services.Nonprofit hospitals were more likely
                       than investor-owned hospitals, however, to provide such services.
                       Although relatively few serviceswere targeted to low-income residents,
                       nonprofit hospitals were more likely to target than investor-owned hos-
                       pitals. A majority of nonprofit and investor-owned hospitals offered
                       somecommunity services at no charge. When they did charge a fee, few
                       hospitals of either ownership type reported that the revenuescollected
                       for a particular service covered its costs,

                       We undertook a nationwide survey of hospitals to ascertain the types
Issues Addressed       and extent of activities that they perceive as providing community bene-
by Survey              fits. Providing acute medical servicesto people unable to pay is only one
                       measureof the extent to which communities benefit from the presence
                       of a hospital. For example, somehospitals, though not reporting high
                       amounts of uncompensatedcare, may serve their communities’ low-
                       income residents through clinics that offer servicesor low-cost or free
                       screeningto all community residents. Data are not collected on the
                       extent of such community servicesprovided, and the associatedcosts
                       are frequently not reported in uncompensatedexpensestatistics.
                       Our survey questionnaire asked hospital officials whether they had
                       offered various broad categoriesof community servicesduring their
                       most recent fiscal year. It also asked them more detailed questions
                       regarding the characteristics of the servicesthey offered and their costs.
                       The categoriesof community serviceswe asked about included
                   l   health screening,such as cancer or cholesterol screening;
                   l   health education, such as clinics to help people stop smoking or classes
                       to help prevent the spread of AIDS;
                   .   clinic services,such as ambulatory clinics or clinics targeted to specific
                       groups in the community, such as glaucoma clinics for the elderly;
                   .   immunizations, such as flu shots for the elderly;
                   .   housing, usually provided to family members of patients;
                   l   transportation services for patients;
                   .   food and clothing drives sponsoredfor the poor; and
                   .   basic scienceor clinical research subsidies.

                       Page 87                                       GAO/HRD-90-84 Nonprofit Hospitals
                            Chapter 4
                            Cmmuulty Services Provided by Hospitals

                            One way we assessedthe delivery of community servicesby nonprofit
SomeDistinctions            hospitals was by comparing the types of services and method of deliv-
Between Community           ery they used with those offered by investor-owned hospitals respond-
Services Delivered by       ing to our survey. Though a majority of both types of hospitals offered a
                            wide range of community services,a higher percentageof nonprofit
Nonprofit and               than investor-owned hospitals offered such servicesand provided them
Investor-Owned              to more people. A majority of servicesprovided by nongovernmental
Hospitals                   hospitals were not targeted to low-income persons.Nonprofit hospitals
                            were more likely to target than investor-owned hospitals, however. Non-
                            profit and investor-owned hospitals were equally likely to charge a fee
                            for community services,but nonprofit hospitals were more likely to
                            cover the costs of providing the services.

Types of Services Offered   We estimate that nonprofit hospitals provided community servicesto at
                            least 54 million people, while investor-owned hospitals served at least
                            5 million. On average,a nonprofit hospital served about twice as many
                            people as an investor-owned hospital of the samesize. Figure 4.1 shows
                            the percentageof responding nonprofit and investor-owned hospitals
                            reporting that they provided various types of community services dur-
                            ing 1988.

                            Page 39                                     GAO/HRD-90-84 Nonprofit Hospitals
                                          Chapter 4
                                          Community Servicer Provided              by Hospitals

Figure 4.1: Types of Community Services
Offered, by Hospital Ownership Type
                                          Porcortt of Ho8pltalr











                                                 I           Nonprofit Hospitals
                                                             Investor-owned Hospitals
                                          Note, These estimates have confidence Intervals of no greater than plus or minus 8 percentage     points

                                          ‘Not statiskally    significant at the 95percent    confidence level

                                          The community servicesreported were generally diagnostic or prevent-
                                          ative tests or lectures. In comparing nonprofit and investor-owned hos-
                                          pitals that reported providing one of these types of services,we found
                                          that both types of hospitals were likely to provide similar services.For
                                          example, both nonprofit and investor-owned hospitals identified blood
                                          pressure tests, cholesterol tests, and various types of cancer screening
                                          as their major health screeningservices.The most frequently reported
                                          services under each community service category are shown in appendix

                                          Page 39                                                                GAO/HRD-90-84 Nonprofit Hospitals
                            Chapter 4
                            Community Services Provided by Hospitals

Nonprofit Hospitals More    Community servicesoften reflect the character of the neighborhood in
Likely to Target Services   which the hospital is located. A hospital in a relatively high-income
                            neighborhood may offer types of servicesdesignedto attract paying
to Low-Income People        patients or increaseits market share, such as free childbirth classesto
                            women who plan to use the hospital’s birthing center. In contrast, a hos-
                            pital in a poor urban area may offer prenatal care as a service to women
                            who would otherwise not receive treatment.
                            In our survey, hospital administrators reported that a majority of ser-
                            vices were not targeted to a low-income population. Nonprofit hospitals
                            were more likely than investor-owned hospitals to target servicesto
                            low-income people. Sixty-eight percent of nonprofit hospitals and 39
                            percent of investor-owned hospitals reported that they targeted at least
                            one program, Figure 4.2 comparesthe extent to which nonprofit and
                            investor-owned hospitals targeted each type of community service to
                            low-income people.

                            Page 40                                     GAO/HRD90-84 Nonprofit Hospitals
                                        Chapter 4
                                        Community 8ervices Provided by Hospitals

Figure 4.2: Percent of Horpltalr that
Target Each Community Service to
                                        50   Porcont of hospitals
Low-Income People

                                             El        Nonproflt Hospltals
                                                       Investor-owned Hospitals

                                        Note: These estimates have confidence intervals of no greater than plus or minus 11 percentage   points.

Nonprofit and Investor-                 Another way to differentiate between community servicesis to distin-
Owned Hospitals Were                    guish servicesthat were offered free from those that were generally
                                        offered at a fee. Most private hospitals offered somecommunity ser-
Equally Likely to Offer                 vices at no charge. Although philanthropic grants may subsidize the
Community Services at                   provision of these servicesin nonprofit hospitals, these hospitals were
No Charge                               no more likely to provide somecommunity services at no charge than
                                        were investor-owned hospitals. Figure 4.3 shows the extent to which
                                        someservices were provided to the community at no charge.

                                        Page 41                                                        GAO/HRB90-84 Nonprofit Hospitals
                                         Chapter 4
                                         Community Services Provided by Hospitals

Figure 4.3: Percent of Hospitals That
Offer Each Community Service at No
                                         I 00      Porcenl of Hospitals
Charge, by Hospital Ownership Type










                                        TypCi Of   SSNiC0

                                                            Nonprofit Hospitals
                                                            Investor-owned Hospitals

                                         Note, These estimates have confidence Intervals of no greater than plus or minus 10 percentage   points.

Nonprofit Hospitals More                 Both nonprofit and investor-owned hospitals did not generally recover
Likely to Cover Costs of                 the costs of providing community servicesby charging fees to recipients.
                                         Nonprofit hospitals were more likely than investor-owned hospitals to
Providing Service                        recover the costs of delivering particular community services.Figure 4.4
                                         shows the extent to which the costs of somecommunity services
                                         exceededor equaled the revenuesgenerated.

                                         Page 42                                                        GAO/HRD-90-84 Nonprofit Hospitals
                                        Chaptm     4
                                        Community service% Provided by             Hoepit&

Figure 4.4: Percent of Hospitals That
Reported Community Services for Which   so    P8roml of HaopM8
Revenues Covered Costs, by Hospital
Ownership Type                          65

                                               1             Nonprofit Hospitals
                                                             Investor-owned Hospitafs

                                        Note, These estimates have confidence intervals of no greater than plus or minus 5 percentage       points

                                        “Not statistically    significant at the 95.percent confidence   level.

                                         Page 43                                                                  GAO/HRD-90-84 Nonprofit Hospitals
Chapter 6

Conclusionsand Matters for

                       As reflected in IRS rulings implementing the tax code,federal policy
Conclusions            regards most nonprofit hospitals as charitable institutions. Although IRS
                       formerly specified that tax-exempt hospitals provide charity care com-
                       mensurate with their financial ability, it eliminated this criterion in the
                       late 1960s.
                       There are significant disparities in the level of charity care that non-
                       profit hospitals provide. Typically, in the states we reviewed, large
                       urban teaching and public hospitals provide a disproportionate share of
                       charity care. Further, our review of several communities indicates that
                       it is not uncommon for nonprofit hospitals’ strategic goals to resemble
                       those of investor-owned institutions in that they relate to increasing
                       market share, rather than targeting underserved populations or
                       addressing particular health problems of their communities. Finally,
                       many nonprofit hospitals’ community service activities do not distin-
                       guish them from investor-owned hospitals.
                       Clearly, the link between tax-exempt status and the provision of chari-
                       table activities for the poor or underserved is weak for many nonprofit
                       hospitals. To the extent that one of the goals of the tax exemption is to
                       recognizethe charitable role of the hospital and encouragehospitals to
                       continue or expand current levels of charity care and other servicesto
                       the poor in an increasingly competitive hospital environment, changesin
                       tax policy may be needed.One option would be to reestablish the link
                       between tax exemption and the level of charity care provided by hospi-
                       tals. In this way, the tax exemption would be retained by nonprofit hos-
                       pitals providing a valuable community service. On the other hand, those
                       that do not provide a reasonablelevel of charity care or other services
                       to the poor would have their tax exemption withdrawn.

                       Although IRS could revise the standard for charitable hospitals without a
                       legislative mandate, given the important implications for health and tax
                       policy, it would be preferable to have congressionaldirection for such a
                       policy change.

                       Currently, there are no requirements relating hospitals’ charitable activ-
Matters for            ities for the poor to tax-exempt status. If the Congresswishes to
Consideration by the   encouragenonprofit hospitals to provide charity care to the poor and
Congress ”             underserved and other community services,it should consider revising
                       the criteria for tax exemption. Criteria for exemption could be directly
                       linked to a certain level of (1) care provided to Medicaid patients, (2)

                       Page 44                                       GAO/HRD-9084 Nonprofit Hospitals
Chapter 0
Conclusions and Matters for
Congreseional Consideration

free care provided to the poor, or (3) efforts to improve the health sta-
tus of underserved portions of the community.

Page 45                                      GAO/HRD-90-84 Nonproflt Hospitals
Appendix I

LegalBasis for Hospital Tax Exemption

                       Unlike someother activities, such as education, hospital activities are
                       not specifically exempt in the tax code.However, IRS has long inter-
                       preted qualifying hospitals to be charitable organizations, which are
                       specifically exempt. Charitable activities include those that relieve the
                       poor, distressed,or underprivileged; those that lessenthe burdens of
                       government; and those that promote social welfare.
                       Unlike sometypes of tax-exempt organizations, which rely more on
                       donations and endowments and less on fees, most tax-exempt hospitals
                       principally provide services for fees, produce income, and appear in
                       many respectslike taxable, investor-owned businesses.

                       Before 1969 IRSinterpreted the status of nonprofit hospitals as charita-
Tax-Exempt Law and     ble organizations to require that they provide care to those unable to
Theory Focuseson       pay in order to qualify for a continued tax exemption. Since 1969, how-
Organizations, Not     ever, IRS has not specifically required such care, so long as the hospital
                       provides benefits to the community in other ways. Treating patients
Operations             receiving public assistance,allowing physicians from the community to
                       have privileges to admit patients, and using surplus funds to make hos-
                       pital improvements are indications of public benefit that IRS has most
                       recently deemedsufficient to qualify a hospital for the income tax
                       Nonprofit organizations can be profitable; however, the profits cannot
                       be paid out to owners or anyone else associatedwith the organization.
                       Instead, they must be devoted to the organization’s tax-exempt pur-
                       pose.’ In exchangefor the above restrictions, the organization is
                       exempted from federal income tax and receives a number of subsidies
                       and advantages,such as accessto tax-exempt bond financing and
                       enhancedaccessto individual philanthropy.

                       Earlier in this century, when hospitals customarily provided a great deal
Historical Basis for   of care to nonpaying patients, they could easily be categorized as chari-
Tax Exemption          ties. As the percentageof paying patients in hospitals increased due to
                       the growth of health insurance and the creation of public medical assis-
                       tance, IRS identified other criteria that might indicate that a hospital was
                       organized and operated exclusively for charitable purposes and not for
                       the benefit of private interests.

                       ‘&u-ton Weisbrod. The Nonprofit Economy, Harvard University Press, 1988.

                       Page 46                                                   GAO/HRD-90-84 Nonprofit Hospitals
Appendix I
Legal Ba& for Hospital Tax Exemption

In 1966, IRS issued a revenue ruling establishing criteria to be met by
hospitals in order to qualify for the income tax exemption contained in
section 601(c)(3). Relying upon a 1934 SupremeCourt decision directing
that section 501(c)(3) not be narrowly construed, IRSdetermined that
the term “charitable” in that section “contemplates an implied public
trust constituted for somepublic benefit, the income or beneficial inter-
est of which may not inure to the benefit of any private shareholder or
individual.” The ruling set forth four criteria to be met by a hospital
requesting the tax exemption: (1) that it be organized as a nonprofit
organization for the care of the sick, (2) that it operate to the extent of
its financial ability for those not able to pay for the servicesrendered,
(3) that its facilities not be restricted to a particular group of physicians,
and (4) that earnings not inure directly or indirectly to the benefit of
any private shareholder or individual.

In 1969, IRS expressly modified its earlier ruling to remove requirements
relating to caring for patients without charge or at rates below cost. IRS
also held that in considering whether a nonprofit hospital claiming
exemption is operated to serve a private benefit, it would weigh all of
the relevant facts and circumstancesin each case.IRS indicated that the
absenceof particular factors or the presenceof others will not necessa-
rily be determinative. The hospital described in the ruling provided care
to indigents only in its emergencyroom. 2

In a 1983 revenue ruling, IRS decided to extend the tax exemption to a
hospital that did not operate an emergencyroom, becausea state health
planning agency determined that an emergencyroom would provide
unnecessaryand duplicative services.IRS held that several aspectsof
the facility indicated that the hospital operated exclusively to benefit
the community. For example: (1) the board of directors was drawn from
the community; (2) the hospital established an open medical staff policy
allowing physicians from the community to practice; (3) the hospital
treated persons paying their bills with the aid of public programs like
Medicare and Medicaid; and (4) surplus funds were used to improve
facilities, equipment, patient care, medical training, education, and
research.The hospital did not provide care to indigent patients.

“Groups representing indigent patients challenged the 1969 revenue ruling in federal court, asserting
that the ruling encouraged hospitals to deny services to indigents and constituted an erroneous inter-
pretation of section 501(c)(3). The case was dismissed on other grounds. The Supreme Court ruled
that the groups failed to establish their standing to bring the suit. Simon v. Eastern Kentucky Welfare
Rights Organization, 426 IJS. 26 (1976).

Page 47                                                        GAO/HRD-90-84 Nonprofit Hospitals
Appendix II
Differences Between Low- and High-                                                                                                         ’

Figure 11.1:Uncompensated Care Rates
loi Low- and Hlghkncompensated-Care    14   Uncompo~atod       Care Rat0



                                            Calltomia               Florida (1985)           Iowa (lsw)       Michigan (1987)   Now York
                                            ww                                                                                  (1967)

                                            L      1 Low-UncompfmsatedCar        Hospitals
                                                        High-Uncompensated-Care Hospitals
                                       Note: We ranked the nonprofit hospitals by their rates of uncompensated care from lowest to highest
                                       Low-uncompensated-care    hospitals were below the 25th percentile, while high.uncompensated-care
                                       hospitals were above the 75th percentile.

                                       Page 48                                                            GAO/HRD-90-84 Nonproflt Hospitals
                                      Appendix II
                                      Differences Between       Low- and High-
                                      Uncompensated-Care         Hospitals

Figure 11.2:Medicaid Patient Mix of
Low- and High-Uncompensated-Care
                                      25   Madlcald as a Percant of Total Patlsnt Daya
Nonproflt HOSpital8






                                           Callfomla               Florida (1985)         Iowa (1987)       Michigan (1987)      New York
                                           ww                                                                                    wJ;r)
                                           u           Low-Uncompensated-Care Hospitals
                                                       High-Uncompensated-Care Hospitals

                                      Note: We ranked the nonprofit hospitals by their rates of uncompensated care from lowest to highest
                                      Low-uncompensated-care    hospitals were below the 25th percentile, while high-uncompensated-care
                                      hospitals were above the 75th percentile.

                                      Page 49                                                           GAO/HRD90-84     Nonprofit   Hospitals
                                      Appendix II
                                      Diff’erences Between Low- and High-
                                      Uncompensated-Care Hospitals

Figure 11.3:Total Profit Margins of
Low- and Hlgh-Uncompensated-Care
                                      Total Proffl Margln
Nonprofit Hospitals



                                                    Low-Uncompensated-Care Hospitals
                                                    High-Uncompensated-Care Hospitals

                                      Notes: Total profit margin is the difference between total net revenue and total expense, divided by total
                                      net revenue.

                                      We ranked the nonprofit hospitals by their rates of uncompensated care from lowest to highest. Low-
                                      uncompensated-care hospitals were below the 25th percentile, while high-uncompensated-care     hospi
                                      tals were above the 75th percentrle.

                                      Page 50                                                          GAO/HRD90-84 Nonprofit Hospitals
Appendix III
Most Frequently Reported Community Services,
by Ownership Type, for Each Service Category

               Nonprofit hospitals                                   Investor-owned hospitals
               Health Screening Services:
               Cholesterol (67)                                      Cholesterol (73)
               Cancer (62)                                           Blood pressure (63)
               Blood pressure (62)                                   Glucose (43)
               Health fairs/promotions     (45)                      Cancer (40)
               Glucose (40)                                          Health fairs/promotions   (36)
               Glaucoma (17)                                         Lung (20)
               Lung (14)                                             Glaucoma (9)
               Health Services Education:
               Obsterical/gynecological  (51)                        Heart disease (34)
               Diabetes (39)                                         Diabetes (33)
               Heart disease (28)                                    Obsterical/gynecological  (28)
               Cancer (28)                                           Cancer (25)
               Emergency procedures (27)                             Emergency procedures (23)
               AIDS (21)                                             Smoking cessation (20)
               Lectures (21)                                         Hypertension (15)
               Health fairs/promotions (19)                          Health fairs/promotions (14)
               Smoking cessation (19)                                Stress management (14)
               Cholesterol (14)                                      Nutrition (13)
               Nutrition (12)                                        Cholesterol (12)
               Drug/alcohol (11)                                     AIDS (11)
               Weight control (11)                                   Weight Control (10)
               Clinic Services:
               Women and children (64)                               General walk-in (36)
               General walk-in (42)                                  Eye, ear, nose, and throat (23)
               Eye, ear, nose, and throat (17)                       Senior citizens (16)
               Specific diseases (16)                                Women and children (14)
               Cancer (12)                                           Specific diseases (7)
               Mental health (9)                                     Cancer (5)
               Other Community Services:
               Meeting rooms (29)                                    Meeting rooms (25)
               Senior citizens’ programs (23)                        Holiday drives (24)
               Health information services (13)                      Fitness programs (19)
               Ivleals(l3)                                           Senior citizens’ programs (18)
               Lifelines (IO)                                        Meals (11)
               Note: Percentage of hospitals offering the services is in parentheses.

               Page 61                                                          GAO/HRD-SO-84 Nonproflt Hospit&
Appendix fV
Major Contributors to This Report

                          Mark V. Nadel, Associate Director, (202) 2756195
Human Resources           Edwin P. Stropko, Assistant Director
Division,                 Sarah D. Strum, Evaluator-in-Charge
                          Darrell J. Gaskin, Economist
Washington, D.C.          Mark Vinkenes, Social ScienceAnalyst
                          Michael O’Dell, Social ScienceAnalyst

                          Chester A. Sipsock, Regional Assignment Manager
Detroit Regional Office   Jerry     w,   Aiello,   Site   Senior

                          Javier J. Garza, Evaluator

                          Darryl W. Dutton, Regional ManagementRepresentative
Los Angeles Regional      Monica Kelly, Site Senior
Office                    DeniseDias, Evaluator
                          Leah Gear, Evaluator

                          Anthony Lofaro, Regional ManagementRepresentative
New York Regional         Robert McKay, Site Senior
Office                    Bonnie Derby, Evaluator
                          Terrie Bijeau, Evaluator

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