The Impressive Profits of Nonprofit Hospitals

by Danielle Ofri
New York Times Op-Ed

“So, how much money do you guys make if I do that test you’re ordering for me?” This is a question I hear frequently from patients, and it’s often followed by some variant of, “I thought hospitals were supposed to be nonprofit.”

Patients are understandably confused. They see hospitals consolidating and creating vast medical empires with sophisticated marketing campaigns and sleek digs that resemble luxury hotels. And then there was the headline-grabbing nugget from a Health Affairs study that seven of the 10 most profitable hospitals in America are nonprofit hospitals.

Hospitals fall into three financial categories. Two are easy to understand: There are fully private hospitals that mostly function like any other business, responsible to shareholders and investors. And there are public hospitals, which are owned by state or local governments and have obligations to care for underserved populations. And then there are “private nonprofit” hospitals, which include more than half of our hospitals.

Nearly all of the nation’s most prestigious hospitals are nonprofits. These are the medical meccas that come to mind when we think of the best of American medicine — Mayo Clinic, Cleveland Clinic, Johns Hopkins, Mass General.

The nonprofit label comes from the fact that they are exempt from federal and local taxes in exchange for providing a certain amount of “community benefit.” Their explosive growth has many questioning how we define “nonprofit” and what sort of responsibility these hospitals have to the communities that provide this financial dispensation.

It’s time to rethink the concept of nonprofit hospitals. Tax exemption is a gift provided by the community and should be treated as such. Hospitals’ community benefit should be defined more explicitly in terms of tangible medical benefits for local residents.

It actually isn’t much of a surprise that nonprofit hospitals are often more profitable than for-profit hospitals. If a private business doesn’t have to pay taxes, its expenses will be lower. Additionally, because nonprofit hospitals are defined as charitable institutions, they can benefit from tax-free contributions from donors and tax-free bonds for capital projects, things that for-profit hospitals cannot take advantage of.

The real question surrounding nonprofit hospitals is whether the benefits to the community equal what taxpayers donate to these hospitals in the form of tax-exempt status.

On paper, the average value of community benefits for all nonprofits about equals the value of the tax exemption, but there is tremendous variation among individual hospitals, with many falling short. There is also intense disagreement about how those community benefits are calculated and whether they actually serve the community in question.

Charity medical care is what most people think of when it comes to a community benefit, and before 1969 that was the legal requirement for hospitals to qualify for tax-exempt status. In that year, the tax code was changed to allow for a wide range of expenses to qualify as community benefits. Charitable care became optional and it was left up to the hospitals to decide how to pay back that debt. Hospitals could even declare that accepting Medicaid insurance was a community benefit and write off the difference between the Medicaid payment and their own calculations of cost.

An analysis by Politico found that since the full Affordable Care Act coverage expansion, which brought millions more paying customers into the field, revenue in the top seven nonprofit hospitals (as ranked by U.S. News & World Report) increased by 15 percent, while charity care — the most tangible aspect of community benefit — decreased by 35 percent.

Communities are often conflicted about the nonprofit hospitals in their midst. Many of these institutions are enormous employers — sometimes the largest employer in town — but the economic benefits do not always trickle down to the immediate neighborhoods. It is not unusual to see a stark contrast between these gleaming campuses and the disadvantaged neighborhoods that surround them.

In some communities, nonprofit hospitals are beloved institutions with a history of caring for generations of families. In other communities, the sums of money devoted to lavish expansions, aggressive advertising and eye-popping executive compensation are a source of irritation.

The average chief executive’s package at nonprofit hospitals is worth $3.5 million annually. (According to I.R.S. regulations, “No part of their net earnings is allowed to inure to the benefit of any private shareholder or individual.”) From 2005 to 2015, average chief executive compensation in nonprofit hospitals increased by 93 percent. Over that same period, pediatricians saw a 15 percent salary increase. Nurses got 3 percent.

A number of communities that think nonprofit hospitals take more than they give back have started to sue. The University of Pittsburgh Medical Center fought off a lawsuit from the city’s mayor to revoke its tax-exempt status. Morristown Hospital in New Jersey lost most of its property-tax exemption because it was found to be behaving as a for-profit institution. The judge in the case wrote that if all nonprofit hospitals operate like this, then “modern nonprofit hospitals are essentially legal fictions.”

It’s important to recognize the extreme variance in hospitals’ financial status. Many nonprofit hospitals, especially in rural areas, struggle mightily; scores of rural hospitals have closed — and hundreds more are teetering — leading to spikes in local death rates. At the other end are hospitals that earn several thousand dollars in profit per
patient.

The most profitable nonprofit hospitals tend to be part of huge health care systems. Consolidations are one of the driving forces behind the towering profits, because monopoly hospitals are known to charge more than nonmonopoly hospitals.

Should these highly profitable institutions be exempt from the taxes that pay for roads, police services, fire protection and 911 services? Should local residents have to pay for the garbage collection for institutions that can afford multimillion-dollar salaries for top executives?

Tax exemption needs to be redefined. Low-impact projects such as community health fairs that function more like marketing shouldn’t be allowed as part of the calculation. Nor should things that primarily benefit the institution, like staff training.

Additionally, hospitals should not be allowed to declare Medicaid “losses” as a community benefit. While it’s true that Medicaid typically pays less than private insurance companies, Medicaid plays a crucial role for private insurance markets by acting as a high-risk pool for patients with severe illness and disability. Hospitals benefit mightily from this taxpayer-funded arrangement. These medical centers also enthusiastically accept taxpayer money for research, something that burnishes their image and bolsters their rankings. That enthusiasm needs to be mandated to extend toward Medicaid patients and the face value of their insurance.

The I.R.S. states that charitable hospitals “must be organized and operated exclusively for specific tax-exempt purposes.” So charitable care should be front and center. Spending on social determinants of health can also be a legitimate community benefit, but the community that is footing the tax break needs to have a forceful say in how this money is spent, rather than leave it up to the hospital.

As many policy scholars have noted, tax exemption is a blunt instrument. For struggling hospitals, particularly in communities with a shortage of health care resources, tax exemption can make sense. In medically saturated areas, where profits and executive compensation approach Wall Street levels, tax exemption should raise eyebrows.

If society decides that tax exemption is a worthwhile means to improve health — and it certainly can be — then our regulations need to be far stricter and more explicitly tied to community health. As the United States continues to fall behind its international peers in terms of health outcomes in local communities, there is certainly no lack of opportunity.