The Non-Profit Healthcare Myth

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Steven Brill’s recent Time article, “Bitter Pill,” should refocus attention on non-profit hospitals, which have long deserved increased scrutiny. The exposure comes at an opportune time, as America is grappling both with a healthcare and budget crisis and Congress is discussing long-term budget measures that may include eliminating tax loopholes. If closing tax loopholes, from individual and business deductions to carried interest is all on the table, then the tax exempt status of certain non-profits, particularly hospitals, should be as well.

As Brill and others before him rightly point out, the “non-profit” designation that projects an air of selflessness, benevolence and charity, in many cases, is undeserved. When people hear “non-profit,” many naturally assume that money is not the primary motivation behind the institution.  In reality, however, non-profits, particularly in medicine, have become a huge business in America. Not that there is anything wrong with that, only that we should consider why taxpayers subsidize these entities and what we are getting for that subsidization in return.

In the case of non-profit hospitals, which comprise over 60 percent of the hospitals in America (for-profits and public tax-exempt hospitals make-up the remainder), the answer is not enough.

Under the Internal Revenue Code (Section 501(c)(3)), non-profit hospitals are eligible for federal tax exemption if they fulfill a charitable purpose. These organizations are also typically exempt from property taxes, are able to accept tax-free donations, and are able to issue tax exempt bonds that lower their cost of capital. Prior to 1969, IRS regulations required that non-profit hospitals actually provide, to the extent of their financial capability, charitable care for those who could not afford medical services. But the IRS relaxed those requirements, and now hospitals need only promote the health of the community at large to meet their tax-free exemption obligations.

As a result, non-profit hospitals often inflict devastating financial pain on individuals that lack insurance or are under-insured. What is particularly troubling too is that these non-profit hospitals are providing virtually no price transparency to patients, one of the fundamental assumptions behind any free market.  Hospital chargemasters create bills seemingly out of thin air, after-the-fact, making the enormous invoices often sent to uninsured or under-insured patients and resulting in financial ruin even more sinister.

Meanwhile, many non-profit hospital executives make millions in salary annually. The non-profits have also embarked on an aggressive M&A spree that has consolidated supply, raising healthcare prices further, and making real consumer choice tougher. Overall, the average, non-profit hospital operates at a profit margin that is comparable to for-profits while receiving billions of dollars in tax subsidies per year.  HCA, one of the largest for-profit hospital operators, alone paid nearly $900 million in income tax in 2012.

This is in addition to the billions of dollars that goes to the top line of these institutions through Medicare and Medicaid payments. While many hospitals plead poverty because the government reimburses at a lower rate than private insurance, these payments still usually exceed the hospitals’ marginal cost. This incentivizes hospitals to churn volume with Medicare and Medicaid patients, another contributing factor to out-of-control healthcare costs.

Some state legislatures have also begun to question whether these non-profits in healthcare are earning their tax exemptions and have looked to tighten standards. That would include requiring a certain percentage of donated care, in some cases three to five percent of revenue (even those requirements would likely be abused, however, as hospitals will argue that the calculation of charitable care should be based on the retail price rather than cost).

Another reason to reconsider the special status of certain hospitals is the odd paradox that greed may infect the non-profit healthcare model—at the expense of patients—more than the for-profit model.  That is because for-profit hospitals are at least accountable to somebody, namely tax collectors, and, more importantly, shareholders. Shareholders have an incentive to police executives who may otherwise loot an enterprise with high salaries and perks and engage in overly aggressive capital expenditures. While for-profit institutions are primarily concerned with the bottom line, as opposed to charity, they at least must be somewhat cognizant of how the public perceives their business practices.  Ostensibly, non-profits should be as well, but with no shareholders to report to, boards, and therefore executives, are less accountable.

There is always something dubious about Congress trying to incentivize behavior by doling out special tax incentives in the first place.  I also worry about Congress trying to dictate the right price to charge for medical care.  That is why, instead, we should insist on transparency in pricing and on very compelling reasons for special tax breaks—particularly given the need to close our budget deficit.  If such compelling reasons currently exist, somebody should start justifying them fast.

Brett Joshpe is an attorney at the law firm of Joshpe Law Group LLP and an author (Why You’re Wrong About the Right) in NYC.