The Committee for a Responsible Federal Budget (full disclosure: I am on its board) and the American Hospital Association recently debated whether nonprofit hospitals provided enough community benefits to justify their tax exemption (valued at more than $10 billion in 2018 by my TPC colleague Adam Looney and Nathan Born). The US Government Accountability Office (GAO) and Elisabeth Rosenthal of the Kaiser Family Foundation, among others, have also weighed in on this issue. Meanwhile, the nomination of vice-presidential candidate J.D. Vance brings this issue further to the fore, given his past exhortation to “eliminate all special privileges that exist for our nonprofit and foundation class.”
Ideally, the community health needs assessment (CHNA) that Congress requires of these hospitals would help resolve this debate. But the CHNA tool doesn’t ask nonprofit hospitals to report and reconcile their charitable resources or inputs against their community benefits or charitable outputs.
However, nonprofit hospitals could still choose to do so, much like for-profit organizations do when they reconcile their profits and use of those profits on their income statements. Regardless of any Congressional requirement, improved assessments would help non-profit hospital boards more clearly determine how well they meet their own stated charitable purposes.
How can a charity be non-charitable?
While a nonprofit charity does not earn profits for its shareholders—it has none—executives or other workers can still maximize their own incomes or otherwise waste charitable resources. (Less than one-quarter of top executives of nonprofit hospitals had their pay assessed using activities to improve community or population health.)
Consider two hospitals—one a for-profit and the other a nonprofit charity—operating in the same city and providing the same level of free and low-fee care required partly by the government. Assume each has no debt and a net worth of $1 billion. The for-profit’s net worth is held by its shareholders. The charity’s net worth is held effectively in endowment and other net worth, derived from contributions over time from its founders and other gifts in the form of money or voluntary or paid-below-market labor.
Assume the nonprofit hospital also gets another $10 million this year in new contributions of money, volunteer time, and work at below-market wages, while the profit-making hospital gets none.
The profit-making hospital provides a return to its stockholders, perhaps 8 percent after-tax, showing up in its accounts as $40 million in dividends and $40 million of surplus earnings used to buy new equipment and facilities.
The nonprofit also earns an $80 million return on its net assets, including endowment, and, by definition, owes nothing to stockholders. To increase its future charitable output and remain competitive, it might invest $40 million in new equipment and facilities, leaving $50 million (with the $10 million in this year’s new contributions) to distribute charitably in ways the profit-making hospital will not.
But imagine the nonprofit chose to distribute only $20 million on charitable services and tout those services in its CHNA. Would that report prove the hospital is charitable? Only partly: Its endowment provided $30 million more in resources for charitable services than were used. While GAO and others suggest that hospitals could define community benefits better, that still wouldn’t prevent this “nonprofit hospital” from wasting or misappropriating $30 million.
There’s at least one way to improve assessments.
Matching or reconciling available charitable resources to their uses could help determine not just the existence but also the size and depth of a nonprofit hospital’s charitable footprint. The resources available for a nonprofit hospital’s charitable work include an imputed return on net asset value and new contributions, whether of money, volunteer labor, or labor at lower than market wages.
Calculating the charitable uses of those resources is more complicated since the activities that nonprofit and profit-making hospitals undertake in equal measure cannot be counted. For instance, when government regulation requires each to accept people coming to the emergency room, regardless of resources, a nonprofit hospital would only count the differential amount of free care it provides through its charitable resources as “charity.”
What I offer is not a perfect assessment tool, only a better one. My example simplifies on several fronts. For instance, it suggests thinking about the charitable output payable today as equivalent to a profit-making hospital’s dividend rate, and reinvestment as equivalent to a profit-making hospital’s use of retained earnings. Similarly, it suggests that a hospital serving more Medicaid patients than other hospitals should count its lower-than-average reimbursement fees as one way it provides services to the community. Standard accounting practices offer ways to think about these and many other issues uncovered here, such as subsidies through tax-exempt bonds and above-average levels of reinvestment.
Who deserves to receive these improved assessments? Certainly Congress, the IRS, the GAO, or any public agency trying to assess the efficiency and fairness of tax laws applying to nonprofit and profit-making hospitals. But nonprofit charity boards should want this information to help ensure that their organizations are the best charities, not just the best businesses, they can be. More importantly, individual contributors, consumers, and taxpayers could be better assured that their support of nonprofit tax-exempt hospitals serves the public—not the organizations’—interests.