Monday, May 26, 2008

Let's talk about tax exemptions

An excellent article by Stephanie Strom in today's New York Times covers what appears to be a growing controversy about the degree to which non-profit organizations should or should not be permitted to be tax exempt under federal and state rules. This is a legitimate area for public debate, and the article sets out a number of examples and points of view.

I do not know much of the history of tax-exempt status, but I am guessing it was given by Congress and state legislatures to certain categories of non-profits in light of their public service obligations and activities. I am personally involved on the boards of several tax-exempt non-profits, including BIDMC, an academic medical center devoted to clinical care, research, education, and community service; MIT, a university; ISO-New England, the organization that supervises the reliability and pricing of the regional electricity transmission system; and the Celebrity Series of Boston, an organization that acts as an impresario to bring concerts to the Boston community and also education programs to children in that region. Previously, I have been on the boards of other tax-exempt non-profits, ranging from the Newton Girls Soccer League and Boston Area Youth Soccer to the Silent Spring Institute, which conducts research about breast cancer. As this list alone indicates, the range of services provided by tax-exempt non-profits is very wide.

Now, if we think about it, any one of these lines of services could be provided by for-profit corporations. Taking my current affiliations in order, there are for-profit hospitals and for-profit colleges; the transmission system used to be run by for-profit utilities; and there are obviously for-profit entertainment impresarios. What does society get out of granting tax-exempt status to these institutions? The most obvious thing is that none of the gains (i.e., "profits") of non-profits are distributed to private investors. They are all recycled into the mission and services of the organization.

Society also gets these services delivered at lower cost. Why? Because the non-profits do not have to pay property tax, sales tax, or income tax and because they can finance their capital needs using tax-exempt debt instead of a higher cost mixture of equity (i.e., stock) and tax debt. Also, they are more likely to receive philanthropic donations to help pay for the services offered. Thus, the underlying cost structure of non-profits to end-users and/or society, everything else being equal, should be lower. (I say should be lower because some people have argued that non-profits are less businesslike and less efficient that for-profit firms in the same lines of business and therefore actually deliver services at a higher cost. Truthfully, I haven't seen much evidence of that, but that is not my argument for today.)

So, here's the big policy question. What would people hope to achieve by actually taking away the tax-exempt status of current non-profits? Putting aside the self-interest of people in for-profits who are in competition with non-profits, this desired outcome has to be driven by the conclusion that society would be better overall by having certain services provided only by taxable organizations, whether non-profit or for-profit. In essence, the goal would mainly be an attempt to create tax revenues at the federal, state, or local level.

But, I think the actual question is more interesting and subtle: What do people hope to achieve by threatening to take away the tax-exempt status of current non-profits? If their goal is not actually to take away the tax exemption, then they are seeking to have these organizations do more of what they feel is appropriate in the way of public service. (I set aside, for today, other purposes for such activity that are designed to achieve results altogether different.)

Currently, the determination of whether an organization deserves tax-exemption is left to the IRS and states' Attorneys General or tax departments. (The Minnesota court case cited in the Times article represents what I believe to be an unusual judicial foray into this determination, but I might be wrong on that front.) The IRS and the others use broad categories of eligibility, as directed by their respective legislatures. When questions are raised, these governmental bodies have the authority to examine programs and records and take away an organization's tax-exempt status.

So, the question I pose for you is this. Are you content with the existing form of rules and regulations covering the applicability of tax-exempt status to non-profits? Does your answer depend on whether you are talking about hospitals, schools, social service agencies, athletic organizations, research institutes, or other categories? (Let's leave religious institutions out of the discussion for today!) If you want changes, what are you hoping would be accomplished? How would you measure success?

13 comments:

fairhavenhorn said...

A minor correction. The rules that determine what is and is not tax exempt are established by Congress. State exempt but not Federal exempt are a tiny exception. The role of the IRS, Justice Dept, et al is to enforce those rules.

I'm not sure which of many various tax exemption complaints you have in mind.

An older change is the requirement that a certain percentage of foundation endowment be spent on their mission. This restriction placed on foundations in response to the practice of using foundations as a tax shelter but paying out only a portion of net investment revenues. This led to an ever growing investment pool that was in fact being used as a vehicle for maintaining and acquiring control of corporations. That was felt to be an improper use of tax exemption, so foundations are now required to disburse at least a legally established minimum.

All of the current complaints that I've seen fall into: 1) political complaints regarding use of tax exempt funds to influence elections, 2) complaints that the funds are being spent primarily for the wrong purposes, e.g., 95% on administrative costs that benefit the managers, and 3) greed, e.g., a big wealthy organization is only spending at a sustainable rate and I want more.

Anonymous said...

The question is worded appropriately: the threat is in response to poor practice. Transparency, accountability and responsibility have not been demanded for continuing status, and a sea change is required. And it should begin with the 900-lb gorillas. Leaders should be examples. Your work at BIDMC shows that it can be done.

Barry Carol said...

Paul,

To answer your question, I would divide non-profits into three categories as follows:

The first is what I would call pure charities and small social service organizations like local sports leagues, etc. These derive all of their funding from donations and, in some cases, direct taxpayer support. Recipients of services are either not charged at all or are charged a very modest sum.

The second category includes museums and performing arts organizations like operas, symphonies, etc. They charge admission, but those revenues don’t come close to covering the full cost of operations. Even if they were taxable, they wouldn’t owe any taxes because they don’t make a profit from their revenues alone.

In the third category, I include non-profit hospitals and universities. The tax exemption is a much more controversial issue here. First, with respect to the major universities, they have done an absolutely miserable job of controlling their costs. When I went through the University of Pennsylvania in the 1960’s (graduated in 1967), the all in cost for all four years – tuition, room, board, books, etc. was $14,000. When my son attended the same school in the late 1990’s, the all in cost was $140,000. Current attendees and their parents pay $50,000 per year before any financial aid which between 35%-40% of students doesn’t receive. Since the 1960’s, general inflation, as measured by the Consumer Price Index (CPI) increased “only” about six fold.

Hospitals, for their part, have also increased their list prices far faster than general inflation. At many hospitals, chargemaster rates are still increasing at a double digit percentage each year despite subdued inflation in the rest of the economy (except food and energy currently, along with college tuition). While I applaud your leadership on the transparency front as a way to hold your people and your organization accountable and to drive continuous improvement, the huge gap between chargemaster rates and what you routinely accept as full payment from Medicare, Medicaid and private insurers is scandalous, in my opinion, especially when it comes to billing the uninsured who have financial resources to go after.

If we were starting with a clean sheet of paper, I would eliminate the tax exemption for non-profit hospitals, but I would compensate them for their research and education portion of their mission with tax dollars, supplemented with charitable giving. I would also phase out the mortgage interest deduction and the tax preference for employer provided health insurance and lower general tax rates while increasing the standard deduction to insure that the government does not raise anymore net revenue.

The bottom line is that these tax preferences distort resource allocation, and eliminating them would improve economic efficiency. Non-profit hospitals that are making decent profits should be taxed. Take a deduction for your uncompensated care but at Medicare or private insurance rates, not chargemaster rates.

Anonymous said...

Well, I'll take a stab at this complex question, but only by concentrating on what concerns me the most - hospitals and universities. (My mind boggles at trying to address day care centers, soup kitchens, etc., and I doubt they have large endowments/large staff salaries, the two main objects of my wrath.)

The crux of the matter with these two institutions is that we do NOT receive the services more cheaply than with for-profits - college tuition is rising at obscene rates (and I have recently experienced what they must spend on marketing) and for profit hospitals have not been shown to charge more on average than nonprofits. Add to this the facts that a) both hospitals and universities pay their executives at comparable rates to for-profits (of course all universities are nonprofit so there is no real comparison, but university presidents are not poor) and b) they do NOT plow their "profits" back into their services; they sit on truly huge endowments instead, or use them for (a).
So I will turn your question around - why SHOULD they be allowed to not pay taxes, when their behavior does not differ from that of any other business? In fact, they function much like a privately held company where the profits go to those who run the company, in the form of large salaries and large expenditures not subject to outside oversight. So in that sense they are even worse than publicly held companies where at least shareholders can try to object!

So my answers are, yes - either take away their tax exempt status or require that they spend x amount of their endowments per year on providing the services they claim to provide - charity health care on the one hand, and lowering of tuition on the other. And yes, I would hope to provide some relief to strapped state and federal governments with the taxes that these institutions would then pay - why should I subsidize their endowments with my tax/tuition money, respectively?

Of course I recognize that there are many poor hospitals and many colleges with small endowments. But these are the ones who are truly functioning as nonprofits. Some distinction must be made between them and the others; however one chooses to do it.

nasov said...

I think it's the same cause as every call for regulation: the few ruin it for the many. So you have Harvard raking in a zillion dollar non-profit pocket money endowment, not paying taxes, it makes people mad. People feel as if they subsidize Harvard and can't get there kids in there anyway. How many Cambridge kids does Harvard admit each year? Not enough to douse the anger is my bet.

Jaz said...

I think in the case of non-profit hospitals a lot of people, myself included, just can't figure out how an organisation can receive tax-exempt status in return for delivering charity care, but then throw people who can't pay their hospital bill into collections. Pick one.

Obviously this is over-simplified and possibly not true of all non-profit hospitals, but I think the point still stands.

e-Patient Dave said...

I have only the lightest education in this area but there's something I don't see others mentioning, so I'll rely on someone else to fill in the specifics:

Somewhere along the line I picked up the idea that a great civilization supports and nurtures institutions that are there not for investors' benefit but simply to serve.

mdspencer said...

The last eight years have made it ESSENTIAL that our non-profits survive! We all know of examples of bad non-profits, bad for-profits. Let's go after the bad and leave the good to do all of the incredible work they do.

Anonymous said...

Agree with mdspencer... all those huge endowments that we want to use as quickly as we can are what would cushion the organizations so they do not become the poor non-profits that should be closed in case of a bad economy. I cannot even imagine how much their expenses have increased with the ridiculous increase in oil prices. Maybe one of the hosp execs could let us know.

Oh, and while I think Harvard is exorbitant, I doubt any one would be able to pay for the very expensive research that on there. Everybody talks about costs charged to them, I wish there was a researcher on here that would tell us how much it costs to run a full fledged biochemistry lab. Maybe Mr. Levy can get this information. I do not think that all of there expense comes from the tuition we are charged... most of it is actually paid for by those huge endowments. Now I do agree that the non-profits should do a much better job at really helping the poor... but let us also realize, that there is no way you can essentially give to everybody that comes your way. Give some, but wisely... If Bill Gates gave "each and every" person or entity that shows up at his door step, he would not be able to give the millions he gave to research on Malaria.

Anonymous said...

Ah, sorry to the last 2 commenters; you are imbibing the institutions' propaganda regarding those endowments. The number of billions possessed by Harvard et al is not required to fund research nor a 'rainy day'. Check the entire budget of the NIH to see what good the endowments really COULD be doing.

One of the benefits of age is no longer believing everything someone tells you.

ChicagoKid said...

To answer your question directly, I am not content with how existing rules and regulations cover the applicability of tax-exempt status for non-profits. As an individual that works within the healthcare field, I can only comment on hospitals and other healthcare delivery systems, and will not be able to provide an informed opinion the other agencies mentioned.

Coming from a highly competitive hospital market (Chicago) where there are a plethora of hospitals focused in the area, there is a stark difference between the populations that are served by the different institutions. Much like the responders previous to me, my believe is the transparency of how funds are being spent at a non-profit need to be increased and scrutinized more carefully... but more importantly, regulation needs to address strict standards as to what charity care is defined as. Currently, charity care remains fairly amorphous, with loopholes as to what can be evaluated and added into the financial reports each year. Clear standards of what falls into charity care and audits to ensure that this is appropriately reported is a start to leveling the playing field.

More importantly, for a healthcare system in a competitive urban environment to work, there needs to be a larger global strategy to help balance the costs of the uninsured. Within Chicago's market (and likely any urban environment), there are hospitals that are easily not making enough to cover operations/maintenance/upgrades and other hospitals that have over 365 days cash on hand and continue to realize very large revenues. The difference between these hospitals? Payor mix.

There is no question that every city will have its share of uninsured patients who cannot be collected on, will not be able to pay, and do not qualify for any government aid... but how to all these patients find their way to the same few hospitals, while other places only a few blocks away continue to see an increase in commercially insured patients?

IMHO, the global strategy that needs to occur is an assessment of the cost to take care of each city's uninsured/underinsured population (including Medicare/Medicaid shortfalls), and this cost should be spread across all non-profit hospitals within a defined range to share the burden. Hospitals that do not meet this criteria should either lose their tax exempt status, or pay the difference along with a significant penalty to a fund which is routed back to the hospitals that covered the additional burden.

Non-profit status make sense, only if organizations are demonstrating that they are providing appropriate levels of service to the surrounding community relative to the local market.

mdspencer said...

To clarify -- let's focus on the bad ones, which are in the minority, and foster the good ones, not put them out of business.

Anonymous said...

First of all tax exempt health systems do not re-invest their dollars. Many build up huge cash reserves and their main focus seems to be monitoring their bond rating and managing investments vs. providing patient care. Second, tax exempt health systems do not provide a more efficient or less expensive good. Their underlying cost structure is not less. By many measures for profit health systems often out perform not for profit health systems.

Why do people want to take away the tax exempt status of some organizations that have that status? The answer has been stated by others already: they have abused the privilege of their tax exemption and should no longer enjoy that privilege. I am not content with the existing rules nor in the enforcement of the existing rules. In my market their is no difference between Tenet and the large tax exempt health systems.