oversight

Nonprofit Hospitals: Better Standards Needed for Tax Exemption

Published by the Government Accountability Office on 1990-06-28.

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

                   United   States General Accounting   Offke
                   Testimony
GAO

For Release           NONPROFIT HOSPITALS:
on Delivery           Better Standards  Needed
Expected at           For Tax Exemption
9:30 a.m. EDT
Thursday
June 28, 1990




                      Statement    of
                      Mark V. Nadel, Associate           Director
                      for National    and Public        Health Issues
                      Human Resources Division
                      Before the
                      Select Committee on Aging
                      House of Representatives




GAO/T-HFID-XI-45
                                                                        GAO Form 160 (12/W
                                           SUMMARY
In the wake of increasing     pressure   on hospitals     to contain   costs,
there are concerns that some hospitals       are reducing        their
provision of indigent     care and other charitable       activities.
Changes in the market affect      all types of hospitals,          but
nonprofit hospitals    are under more scrutiny       because of their
treatment as charities     under the tax code.
Our report,      Nonnrofit        Hosoitals:        Better     Standards     Needed for Tax
Exemotion,      assesses the role played by these hospitals                          in
providing      charitable        services     to the indigent           population      of their
communities.         We show that the link between tax-exempt                        status    and
the provision        of charitable         activities        for the poor or
underserved       is weak for many nonprofit                 hospitals.        Typically,      in
the states      we reviewed         large urban teaching            and public       hospitals
provided      a disproportionate           share of charity           and other
unreimbursed        care.      The nonprofit          hospitals     providing      the lowest
levels      of such care served the fewest Medicaid                      patients      and often
had the highest         profits.        These were among the hospitals                  most
financially       able to provide          additional        care to the medically
indigent,      and also the hospitals               that profited        most from their
tax exemptions.
Furthermore,        in the communities            we reviewed     it was not uncommon
for nonprofit         hospitals'       strategic      goals to resemble those of
for-profit      institutions.            For example, both focus on increasing
market share, rather             than targeting        underserved    populations or
addressing      particular         health    problems of this segment of their
communities.          For the most part,           the nonprofits'     admission
policies     effectively         limit    charity     care to emergency room and
admissions      resulting        from emergencies.
In addition      to providing      care to those unable to pay, nonprofit
hospitals     provide    such community services          as health     education    and
screening,     clinic    services,      and immunizations.       However, these
activities     do not distinguish         nonprofits    from for-profit
hospitals.       Nonprofit     hospitals     were just as likely        as for-
profits    to charge a fee for these services              and more likely        to
recover    the costs of providing          them.
Currently,        the Internal      Revenue Service    has no requirements
relating      hospitals'     tax-exempt       status to the charitable
activities        they provide      to the poor or underserved       residents of
their      communities.       If the Congress wishes to encourage nonprofit
hospitals       to provide      charity    care to the poor and underserved     and
other community services,               it should consider  revising      the
criteria      for tax exemption.
Mr.     Chairman,           I am pleased               to be here         today      to discuss                 our
report,         Nonprofit           Hosoitals:           Better        standards          Needed for              Tax
Exemotion.'              We prepared             it     at your        request       that     we review                 the
role      played        by nonprofit             hospitals            in providing           charitable
services         to the        indigent          population            of their       communities.                      To do
so, we analyzed                the     distribution              of uncompensated                  care         among
hospitals          in five          states--California,                   Florida,          Iowa,      Michigan,
and New York.                 Uncompensated              care        includes      both      charity             care            and
bad debt         expense.            Where available,                  we focused           on data             concerning
charity         care.         In addition,              we conducted            case studies                in five
communities             and surveyed             a nationwide             sample      of hospital
administrators                as to the          types      of community             services             they
provided.


In the         wake of increasing                     pressure        on hospitals           to contain                     costs,
there      are concerns               that     some hospitals              are reducing              their
charitable            activities.              Changes           in the market            affect          all        types         of
hospitals,            but     nonprofit          hospitals            are under       more scrutiny
because         the     tax    code treats              them as charities.


For many nonprofit                   hospitals,            we found        the     link      between             tax-
exempt         status       and the          provision          of charitable             activities                  for        the
poor      or    underserved            is weak.            Typically,           in the       states             we
reviewed         large        urban      teaching          and public           hospitals           provided                 a


lGAO/HRD-90-84,                May 30,          1990
                                                                 1
disproportionate                share         of uncompensated                   care.               The nonprofit
hospitals         providing           the      lowest          levels         of such care                    served       the
fewest       Medicaid         patients           and often             had the highest                        profits.
These were among the hospitals                                 most financially                        able      to provide
additional          care      to the medically                     indigent.                 They also             were the
hospitals         profiting           most from their                    tax     exemptions.


Further,         in the        communities              we reviewed               it     was not              uncommon for
nonprofit          hospitals'           strategic              goals      to resemble                   those        of for-
profit       institutions.                   For example,               both      focus          on increasing
market       share,        rather       than          targeting          underserved                   populations               or
addressing          particular               health       problems             of this           segment            of their
communities.               Finally,           many nonprofit                   hospitals'               community
senrice         activities            do not          distinguish              them from               for-profit
hospitals.


Currently,           the     Internal           Revenue Service                    (IRS)         has no requirements
relating         hospitals'            charitable              activities               for      the      poor       to their
tax-exempt           status.           If      the     Congress          wishes              to encourage                nonprofit
hospitals          to provide               charity       care        and other               community             services,
it     should      consider           revising           the      criteria             for      tax      exemption.                   The
bill      you have introduced,                        Hospital          Tax-Exempt                   Status       Reform         Act
of 1990,         provides           one way of accomplishing                                 this.




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                                                                          .
By way of background--                     just      over        half     of the       nation's           hospitals
are private,            nonprofit            institutions.                 The rest         are operated
either       by governments                or on a for-profit                   basis.


Nonprofit          hospitals          that        meet certain              tests      established             by the
IRS are exempt                from    federal         taxation:             they      generally           are also
exempt       from      state        and local         taxes.            Though nonprofit                  hospitals
derive       their          tax    exemptions         because           they       are considered
charitable            organizations,               the      IRS presently              has no requirements
relating         hospitals'           tax-exempt             status         to their            charitable
activities            for     the    poor.


Between          1956 and 1969,              IRS's        test      for     tax-exempt             status      included
specific          reference          to providing--               to the       extent           the hospital's
finances         allowed--          services         to     individuals             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.
Presently,            the major           distinction             between          for-profit            and nonprofit
hospitals            is that        the     nonprofit            hospitals'           surplus           earnings      (or
profits)          cannot          be paid      out to owners                or anyone            else     associated
with       the    organization.                Instead,           they      must be devoted                  to the
hospitals'            tax-exempt            purposes.
In light        of significant                  changes           in the hospital                  sector,          IRS is
beginning        to explore              its     tax      policies.                During      the      198Os,           changes
in the way hospitals                     are reimbursed                  raised          concerns          about         the
extent       to which           hospitals          would          be able         to provide            care        to those
who cannot            pay.       Increased          competition                 between        hospitals             for
patients        and attempts               by government,                     employers,            and insurers                to
contain        costs         make hospitals                less        able     or willing            to subsidize
care.


There       are some indications                       that       access          by the medically                  indigent
to hospital            care      in this         cost-containment                     environment              is
declining.             Poor people              without           public          or private           insurance               gain
access        to nonemergency                  hospital           services          only      if     the      hospital               is
willing        to admit          them with             little          expectation            of payment.                  In
some large            cities,       demand has outstripped                            the     capacities             of some
hospitals         to give          the      intensive             care        needed to treat                 gunshot
victims,        AIDS patients,                  and illicit                drug     users.           A substantial
portion        of these          patients          are          indigent.           Reportedly,               the
hospitals         of last          resort         in these             cities       treat          patients         in
hallways         as their          emergency             rooms overflow.


At the        state      and local             levels,           the     fiscal       stress          resulting            from
the       provision          of publicly           subsidized                 indigent        care      has
intensified             debate       over       what nonprofit                    hospitals           should        do in
exchange         for     their       tax       exemptions.                  In at least             12 states,             local
officials         have attempted                  to remove charitable                        status          and property

                                                                   4
tax      exemptions             from    nonprofit             hospitals.              In addition,            at least
17 states           have considered                    or enacted           legislation            to prevent
unfair       competition               by nonprofits.                    Few hospitals             have lost       their
tax-exempt               status,       but    proposals            to require             them to pay municipal
service          fees       to local         governments               are becoming          more common.
Rather          than      assessing          fees,         other        localities         have revised
criteria           for      continued         tax       exemption.               For example,          some require
nonprofit           hospitals           to provide             a minimum             proportion        of Medicaid
and charity               care     in order            to retain           tax     exemption.


UNEVEN DISTRIBUTION                     OF
UNCOMPENSATEDCARE


As to what we found--                    the      amount           of uncompensated                care    provided         by

nonprofit              hospitals        is a large             part        of their        benefit        to the    poor
in their           communities.               By treating                patients         who are uninsured                or
underinsured                and offer         little          prospect            of paying,         hospitals      give
residents              access      to care          that      might        otherwise        be unavailable.                 In
five       states         we reviewed,              government-owned                  hospitals        provided        a
disproportionate                   amount       of the         uncompensated               care.        Both
nonprofit              and for-profit               hospitals            provided         a smaller        share      of
the      state's          uncompensated                care    than        they      provided        of general
hospital           services.            For example,                   in California,             nonprofit
hospitals              provided        66 percent             of the         total      days of hospital              care
but      only      39 percent           of the          state's          uncompensated             care    expenses.



                                                                   5
Moreover,          the     burden        of uncompensated                  care     was not           distributed
equally       among the           nonprofit           hospitals            in these           five     states.
Large,      urban         teaching         hospitals          often        bore      a disproportionate
share      of the uncompensated                     care      expenses            incurred           by the
nonprofit          hospital          sector        than    did      other         nonprofit           hospitals.
For example,              nine    major       teaching         hospitals             in New York            City
accounted          for      38 percent          of all        uncompensated                care       provided        by
nonprofit          hospitals          statewide,           though          they      had only          16 percent            of
the     state's          nonprofit         hospital        beds.


Nonprofit          hospitals          that      had the highest                   rates       of uncompensated
care      served         more Medicaid             patients         and had lower                profit          margins.
Conversely,              those    with       the    lowest         rates      of uncompensated                    care
served      fewer         Medicaid         patients        and had higher                  profit         margins.
Because       of their           higher       profits,            nonprofit          hospitals            with     the
lowest      uncompensated                care      rates      received            the greatest             benefit
from their          tax      exemption.             Consequently,                 these      hospitals            were
generally          more financially                 able      than     other         nonprofit            hospitals          to
increase          services        to their          communities'              indigent           population.


SOME HOSPITALS'                  POTENTIAL TAX
LIABILITY          EXCEEDS CHARITY CARE PROVIDED


One way of gauging                   the     reasonableness                of the         levels       of care
provided          by nonprofit             hospitals          to those            who cannot           pay is to
compare       the        value    of that          care    to the value               of the          hospitals'            tax

                                                              6
exemptions.            To estimate           the      tax    revenue          lost      as a result                of
exempting         nonprofit          hospitals          from      federal           and state          income
taxes,       we applied          the     average        effective            tax      rate       of a sample                of
for-profit          hospital         corporations            to the          nonprofit            hospitals'                net
incomes.


In the       states       where we were able                 to get          information             on the
charity         portion       of uncompensated               care        costs,        we found            that      about
57 percent          of the       hospitals           provided          care     whose value                was less
than      the    value     of their         potential            tax     liability.               For example,                    in
New York         and California,              43 and 71 percent                     of nonprofit
hospitals,          respectively,             had an estimated                     potential         tax        liability
that      exceeded        the      amount     of charity              care     they        provided.


GOALS AND POLICIES                   DO NOT ENCOURAGE
ELECTIVE TREATMENT FOR THE UNINSURED


When we visited                the     hospitals         in five         communities--one                   community
in each state              we reviewed--            we found           a general           absence         of
proactive          policies          regarding         the     indigent.              As     a   result,          the
distribution              of uncompensated               care     among the             communities'
hospitals          was largely            based      on historic              treatment           patterns              or the
hospitals'            locations.


The admissions              policies         of many hospitals                     we visited--both
nonprofit          and for-profit--                limited       a majority             of charity              care        to

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                                                                  .
that        initiated           in the        emergency       room.          Few hospitals                had
admissions              or physician            staffing       policies            that      facilitated
elective          admissions            for     those      who could             not pay.            In the
communities              with       a mix of hospital               ownership             types,        admissions
and physician               staffing           policies       at nonprofit                and for-profit
hospitals           were similar.


For example,              in Orlando,             both     nonprofit             and for-profit                hospitals
sought         to determine             whether         patients          were able          to pay before
admitting           them for           nonemergency           treatment.              Two of the               three
nonprofit           hospitals            in this         community         generally               referred      patients
unable         to pay to state                 and county          clinics          for     elective           care.


The willingness                    of physicians           to treat          Medicaid              patients       or other
patients          unable           to pay for        treatment            also     can affect             the     amount
of nonemergency                    indigent       care     a hospital             can provide.                 Although
the    hospitals            we visited            allowed         the medically               indigent          to
receive          care      in the       emergency          room,       subsequent             admission           to the
hospital          depended           on physicians'            willingness                to provide            treatment
without          reimbursement.


In the         communities             with     relatively          high         numbers           of medically
indigent,           hospital           administrators              told      us that          it     was often
difficult           to get          physicians           to treat         the     indigent.              In addition
to receiving              little        or no payment              from      indigent              patients,
physicians              often       have to interrupt               their         regular           practice         to

                                                              8
treat       them.         Some hospital            administrators               feared      that         if    they
increased           the     on-call      duties       of physicians              practicing              at their
hospital,           some would          eventually           move their          practices          to hospitals
without       so many indigent               patients.             Furthermore,             officials                from
one nonprofit               hospital      told      us that,           because      few of         its
physicians            participated           in the Medicaid               program,         they         admitted
few Medicaid               patients      to the hospital.


The hospitals               we visited        gave us information                   on their             strategic
goals       and,      in some cases,              recent       minutes       of their         board           of
directors'            meetings.          From these            sources       we tried         to     identify
goals       related         to provision           of charity           care      or community                health
services.             The hospitals           set     numerous          goals      that     related             to
expanding           medical       services         to meet increased                patient          demand or to
increase        their         market     share.         But generally              no goals          were
directed           at serving          low-income          community           residents.


This       absence         of proactive           policies        among nonprofit               hospitals              can
cause       problems          in delivering           services          to the       indigent            and could
eventually            cause gaps in services                     for    entire      communities.
Delivering            services         to the       indigent       was a greater              problem              in some
communities               we visited       than      in others.             In two communities                       we
visited,           uncompensated           care      costs       were relatively              high            and the
nonprofit           hospitals          providing        the      largest         share      of such care                  were
seeking        ways to reduce              them.        Hospital           administrators                 in these



                                                             9
communities          were most concerned                   about       controlling             the     costs      of
emergency        and obstetrical                services         to the         indigent.


COMMUNITY SERVICES PROVIDED BY MOST HOSPITALS


Provision        of acute        medical         services          to people            unable       to pay is
only     one way in which               communities             benefit         from the          presence        of a
hospital.            For example,          some hospitals,                 though        not      reporting        high
amounts        of uncompensated             care,        may serve           their       communities'             low-
income       residents         through      clinics         that        offer        services         or perform
low-cost        or free        screening         to all         community            residents.           When we
surveyed        a sample        of hospital           administrators                  nationwide          as to the
types       and extent         of activities             they      perceive           as providing
community        benefits,         we found         that        nonprofits            and for-profits              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     screening          services.             Nonprofit            hospitals          were more
likely       than     investor-owned             hospitals             to offer         these        services      but
were     (1)    equally        likely      to charge            patients          a fee        for     them and (2)
more likely           to recover          the    costs      of providing                them.


CONCLUSION


For many nonprofit                hospitals,          the       link      between        tax-exempt             status
and the        provision        of charitable              activities             for    the poor         or

                                                           10
underserved              is weak.              If     one goal             of the          tax     exemption          is to
recognize            the     charitable               role         of hospitals               and encourage                 them to
continue          or expand            current             levels          of charity              care     and other
services          to the          poor,        changes             in tax        policy          may be needed.                 One
option       would         be to reestablish                        the      link      between          tax       exemption           and
the      level       of charity            care        provided              by hospitals.                    In this        way,
nonprofit            hospitals            providing                a valuable              community           service        would
retain       their          tax     exemption.                   On the other                hand,        those      that     do not
provide          a reasonable              level            of charity              care         or other         services       to
the      poor     would        have it              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
Congressional                direction               for         such a policy               change.           The bill         you
have introduced,                    Hospital               Tax-Exempt            Status           Reform       Act    of 1990,
would       provide          the       IRS such direction                        and better               assure      that      all
segments           of the          population,                   including           the     medically            indigent,
benefit           from      the     tax    exemption                 accorded          hospitals.                 Under       current
tax      policies,           some       hospitals                 can and do take                   measures         to avoid
serving          the       indigent.                Many simply              do not          explicitly            address          the
health          needs of this              segment                of their           communities.                 Such evasion,
whether          active           or passive,               increases               the burden            on the       remaining
hospital           community            that         serve         this      population.                   Increased
charity           care      alone       will         not         solve     the       problems          faced       by our large



                                                                      12
uninsured    and underinsured      population,       but      it   can be part   of the
solution.


This   concludes    my prepared    statement.        I will        be happy   to answer
any questions      you may have.




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