Is Tax-Exemption Necessary? Enlightened Health Systems Should Consider the Unthinkable
In the mid-1800s, English philosopher and political economist John Stuart Mill developed “utilitarianism,” a framework for making moral decisions. In Mill’s formulation, an action achieves optimal social utility when it advances the well-being of the most people, i.e., “the greatest good for the greatest number.”
No industry is more utilitarian than healthcare. People pursue healthcare careers to alleviate pain and human suffering. It’s not a coincidence that most hospitals operate as not-for-profit (NFP), mission-oriented companies.
To support their contributions to social well-being, American society does not require NFP health systems to pay income, sales, excise, property or other taxes. They also can issue lower-cost tax-exempt bonds to finance capital investments. Tax-exemption is not a trivial subsidy. NFP health systems save tens of billions of dollars annually through tax avoidance and lower interest costs.
NFP does not mean no profit. NFP health systems are often very large, complex organizations with highly-compensated executives. Ironically, seven of the 10 most profitable health systems in America operate as NFP companies.
However, tax-exemption is not free. It comes with societal expectations for community benefits exceeding the tax subsidies. By law, NFP health systems must publicly report the level of annual ‘community benefit’ they provide. This mission-benefit discussion between health systems and their communities is becoming increasingly fraught.
The Punching Bag Problem
In July 2017, Politico’s Dan Diamond authored two investigative reports that contrasted the success of America’s leading NFP health systems,1 including Johns Hopkins and the Cleveland Clinic, with the endemic poverty and chronic illness plaguing adjacent neighborhoods.2
Apparently being a large employer and providing world-class care isn’t enough. As the Politico articles make clear, society’s implicit social contract with NFP health systems imposes a duty on them to invest substantially in local economic development, workforce empowerment and community health in exchange for tax-exemption benefits.
By contrast, for-profit health systems that pay taxes are free to focus on optimizing resource utilization and profitability. Their community benefit contributions are purely philanthropic and not subject to governmental oversight.
A Health Affairs study released in January 2018 confirmed that tax-exempt- hospital investment in community benefits measures increased by only onehalf of a percentage point, from 7.6 percent in 2010 to 8.1 percent in 2014. Most of that spending went toward unreimbursed treatment, rather than to disease prevention efforts that might improve community health.3
Increasingly, tax-exemption is becoming a double-edged sword for NFP health systems. It offers sizable financial benefits, but comes with substantial community benefit obligations. Reflective of the times, challenges to health systems’ tax-exempt status and requests for payments-in-lieu-of-taxes (PILOTs) are increasing.
In post-reform healthcare, all health systems must deliver better outcomes at lower costs to maintain their competitiveness. NFP health systems have the added burden of providing adequate community benefit while transforming their operations. This makes an already tough challenge tougher.
Given the tradeoffs, a utilitarian ‘greater good’ analysis suggests the unthinkable—that select NFP health systems would contribute more to society by paying taxes. This would liberate these organizations to pursue more efficient resource utilization with less public scrutiny. It would enable them to deliver better healthcare at lower costs with enhanced customer service.
Some health systems might consider even going further and converting to for-profit status. This expands capital formation alternatives, but could reduce philanthropic support.
The Downside of Tax-Exempt Status
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