Much is given by hospitals, more is asked

Nonprofits reaping more in tax breaks than they report in charity work. Some say that must change article page player in wide format.
By Scott Allen and Marcella Bombardieri
Globe Staff / May 31, 2009
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One man donated a pig "of an uncommonly fine breed." Another donated an Egyptian mummy. The founders of the state's first hospital needed any gift they could get.

In 1817, hospitals served patients too poor to afford a doctor's house call, so the wealthy had little incentive to support them. To cut costs, the Legislature ordered prison inmates to quarry the gray granite blocks that went into Massachusetts General Hospital's walls.

Today, glass-and-steel medical towers dwarf that first building, a campus befitting the flagship hospital of Massachusetts' largest healthcare company. But one thing at Mass. General remains much as it was in the 19th century: The hospital, like most in Massachusetts, is taxed as a nonprofit charity - which means it's hardly taxed at all.

Nonprofit hospitals are popular institutions, especially in Boston, home to seven major tax-exempt teaching hospitals that attract billions in federal research grants and patients from around the world. Mass. General's parent, Partners HealthCare, is not only the state's number one private employer, but one of its most successful companies, with an investment portfolio valued at more than $4 billion.

However, as hospitals have prospered and grown, so too has the value of the breaks on state, federal, sales, and property taxes they enjoy as charities. And that fact has triggered a growing debate, among policy makers and politicians, about whether the public is still getting its money's worth from an exemption that dates to the 19th century and was created to encourage hospitals to treat the poor.

Today, in fact, the value of tax exemption far exceeds the amount the state's leading hospitals spend on free care for the poor and other community benefits they report annually to the attorney general, a Globe review has found.

What's more, hospital spending on free care is declining because of the state's 2006 healthcare reforms. Today, hospitals typically spend about 1 percent of expenses on free medical care, as measured by the attorney general, half of what they spent before reform made insurance available to many more low-income people.

The gap between tax benefits and charity care varies widely among hospitals. The gap is widest at the most prosperous hospital companies. And some less profitable institutions actually spend more on charity than they save on taxes.

Massachusetts regulators and elected officials have gently pressured tax-exempt hospitals to give more to their communities since the early 1990s when former attorney general Scott Harshbarger asked them to annually report the cash value of their charity work. But determining how much charity is enough has been difficult because no one - not even the Internal Revenue Service - had calculated how much hospitals save from not paying taxes.

With the help of authorities in nonprofit healthcare and management, this report aims to fill that gap.

The tax break numbers are large.

The 10 leading hospital companies benefited from an estimated $638 million in federal, state, and local tax breaks as well as state discounts on borrowing in 2007, the latest year for which complete data are available. More than half of that goes to two large and growing companies, Partners and Children's Hospital. Overall, the 10 hospital companies' tax breaks and other benefits were worth $264 million more than the value of the "community benefits" - care for the poor and other charity work - they reported to the state attorney general that year.

The rewards of tax-exempt status have helped to keep some of these hospitals on solid fiscal footing; five of the top 10 are expanding. But as governments face yawning budget deficits and state leaders question whether they can continue to afford healthcare reform, some officials are asking whether the most affluent hospitals should do more either in the form of payments to government in place of taxes or increased charity work.

US Senator Charles Grassley of Iowa, the senior Republican on the Finance Committee, believes federal regulations may be needed to ensure that nonprofit hospitals are required to do more charity work than their profit-making peers.

"I want the IRS to go back and establish a difference so we can have the expectation that if you're a nonprofit and you get these [tax] benefits, you ought to serve the public adequately," Grassley told the Globe.

State Inspector General Gregory W. Sullivan thinks the issue needs examining at the state level, as well.

"There comes a point where the value of the tax break becomes so large that the question is whether it's justified," said Sullivan, who has made controlling healthcare costs one of his main issues. "The time is right for the Commonwealth of Massachusetts to objectively and comprehensively examine the total tax breaks that are being provided to nonprofits in healthcare versus the community benefits."

Grassley and Sullivan have company in thinking that it's time for a thoughtful look at the public responsibilities of charity hospitals in the 21st century. Ever since the creation of government-funded programs to pay for medical treatment of the poor and the elderly in the 1960s, taxpayers have assumed the primary burden of paying for care of indigent patients, undercutting the historic justification for exempting hospitals from taxation.

Meanwhile, the hospital business has exploded, especially for elite teaching hospitals, which increasingly have been expanding into the suburbs. The value of Partners' property and investments, for example, more than doubled from 2001 to 2007, and the company is now in the midst of the costliest expansion program in state history. Partners reported making $119 million from the operations of its hospitals in 2008, a modest increase over 2007, but the profits were more than offset by heavy losses in the stock market.

Neither Sullivan nor any other influential figure in Massachusetts is calling for an end to the hospitals' tax exemption, but it is revealing to examine what it would mean if the state's 61 charity hospitals were run by for-profit companies. All their growth over the last decade would have yielded government revenue as well. The hospitals would have paid increasing state sales taxes as they purchased ever-greater volumes of supplies, more city taxes as they expanded, more state and federal income taxes as they generated large surpluses through much of the last decade. Instead, they pay none of these taxes aside from modest lump sum payments to local governments in place of property taxes.

Cash-strapped governments are eager to get more help from affluent tax-exempt organizations, especially in Boston where governments and nonprofit hospitals and schools own half the land. Mayor Thomas M. Menino doesn't oppose the principle of charities receiving tax exemption, but he has appointed a task force to develop a system for collecting more revenue from nonprofit landowners in the city.

The city tax assessor found that the 10 leading hospital companies own $5.4 billion worth of tax-exempt property in Boston that, if taxed like conventional business holdings, would bring in $146 million in tax revenue in 2009 - enough to cover the entire $140 million budget shortfall forecast by Menino. Instead, the hospitals pay only a few million in "payments in lieu of taxes."

On Beacon Hill, meanwhile, State Representative Michael J. Moran, a Democrat from Allston-Brighton, has 16 cosponsors for a bill that would allow cities and towns to collect up to 25 percent of the property tax bill from nonprofits of all kinds. However, his is not among the major tax proposals now under debate in the Legislature.

"Not one of us wants to hurt the soup kitchen or the homeless shelter, but when I see stories about billions and billions being amassed by nonprofits and properties being bought all over the place, that's not what people think of when they think of charities," explained Moran.

To estimate the value of tax exemption, the Globe assembled detailed financial data on the leading nonprofit hospitals from company filings, state reports, and municipal property records. Then, with the aid of Harvard School of Public Health management professor Nancy Kane and Tom McLaughlin, a nationally recognized authority on nonprofit management, the Globe calculated what the hospital companies would have paid in taxes in 2007, if they had not enjoyed exempt status.

Without the exemption, the 10 leading hospital companies would have paid about:

$61 million in sales taxes on purchases of supplies and equipment.

$72 million more in interest payments on construction loans and other borrowing. (Non-profit hospitals and colleges can get low-interest financing through the state.)

$83 million in property tax bills.

$417 million in state and federal income taxes on profits.

In addition, the hospitals greatly benefited from their eligibility, as nonprofit charities, to receive tax-deductible gifts. Collectively, they received more than $500 million in gifts in 2007, from donors who were able to reduce their federal income taxes by $100 million to $150 million by deducting their contributions.

The benefits of tax exemption aren't spread evenly. Three companies - Tufts Medical Center, UMass Memorial Health Care (owner of UMass Memorial Medical Center in Worcester) and Boston Medical Center - reported spending more on community benefits than the value of their tax breaks as estimated by the Globe. Two others, Baystate Health (owner of Baystate Medical Center in Springfield) and Caritas Christi Health Care, received just slightly more in tax benefits than they paid in community benefits.

The other five - Partners, Children's, Beth Israel Deaconess Medical Center, Dana-Farber Cancer Institute, and Lahey Clinic - accounted for 75 percent of the tax breaks. Together, the five saved more than twice as much from tax exemption as they reported in charity work to the attorney general.

These are, necessarily, estimates. Tax law is complex and nonprofit hospitals would, like other businesses, adjust their finances to minimize taxes if they were not tax-exempt. But most of the hospitals agreed that the Globe's figures, and the means used to calculate them, are reasonable and close to their own internal estimates. All 10 companies received detailed briefings on the Globe's findings, and eight offered no objection.

The main objections to the estimates came from the two hospital companies that benefit the most from tax-exempt status.

Partners HealthCare received at least $271 million in tax breaks and savings from low-interest state financing in 2007. That's twice as much as any other hospital company, the Globe estimated. Moreover, the value of Partners' benefit from exemption nearly tripled from 2001 to 2007.

The second-biggest beneficiary of such tax breaks, Children's Hospital, has seen its savings from tax exemption more than quadruple during the same period - to $131 million - as profits grew, the Globe review found. Like Partners, Children's is pushing ahead with major expansion during the recession, though scaled back somewhat from pre-recession plans.

Partners executives said the Globe estimate of tax savings was incorrect, though they declined to say whether the figures were too high or too low despite repeated requests for clarification. Company officials would say only that they disagreed with the Globe numbers on four of the five major taxes.

Children's officials put the value of their tax exemption at $41.9 million - less than one-third of the Globe estimate - mainly because Children's doesn't count taxes on the income of its parent company, which handles the hospital's fund-raising, real estate deals, and drug royalties, and manages the hospital's $2 billion endowment fund. The parent company, which is also nonprofit, reported $241 million in net income in 2007. Only about 20 percent of that income was turned over to the hospital with the rest invested in stocks and other financial instruments.

Children's officials say the parent company's earnings should not be considered profit, but as a reserve fund for difficult times such as the present recession.

"As a nonprofit, Children's shareholders are the children and families who directly benefit from our patient care, research, teaching, and service to the community," said David Kirshner, Children's chief financial officer.

However, others say Children's parent company should be included in any analysis of the company's savings from tax exemption, since the parent generates an enormous surplus of revenue that a private company would be taxed on.

"You need to look at both entities," said Richard A. Grafmeyer, a leading Washington tax lobbyist and former deputy chief of staff of the Congressional Joint Taxation Committee, noting that Children's parent exists only to support the hospital financially.

Whatever objections hospitals have raised in the details, the trend lines are clear: The value of tax exemption to hospitals has risen rapidly over the last decade even as hospital spending on free care has dropped fast in recent years - down 20 percent at the top 10 hospital companies in 2008 alone.

That's a sensitive subject for hospitals, many of which have earned a reputation for charitable works, and on a large scale. Massachusetts nonprofit hospitals provide more than $500 million in free care and other charity that they voluntarily report to the attorney general each year. No hospital spends more than Partners, which provides services ranging from jobs and scholarships for East Boston High School students to funding community health centers around the city. The Boston Business Journal ranked Partners the fifth-largest charity in the metropolitan area in 2007 measured by the cash gifts it makes to a host of local agencies.

"They are our de facto human services department here," said Jay Ash, Chelsea's city manager. "I'd be lost without them."

However, the combined value of Partners' charitable work in 2007, $151.4 million, is $120 million less than the value of Partners' tax breaks and interest discounts, as calculated by the Globe. That's a big swing from 2001, when Partners reported spending more on community benefits than it got back in tax breaks.

Children's Hospital also runs a highly regarded charity program, but its cost is $96 million less than the Globe's estimate of savings from not paying taxes.

Nonprofit hospital officials say the attorney general's charity reporting system is too narrow and that they should get credit for other good deeds such as seeking cures for disease and treating low-income patients who are covered by government insurance that does not pay them the full cost of their services. Virtually every hospital contacted by the Globe pointed to some combination of activities that could be called "community benefits" and that added up to more than their tax breaks.

Using a new community benefits reporting form developed by the IRS, Partners listed $817 million in community benefits, more than triple the amount the company saves in tax benefits. Similarly, Children's Hospital estimated its community benefits at $79 million, more than twice the amount tallied by the attorney general.

However, the IRS reporting system is intended more as a broad survey of hospitals' activities rather than a rigorous accounting of how hospitals justify their tax exemption. The IRS allows hospitals to count some big-ticket categories of "charity" without taking into consideration the financial benefit they get in return.

Partners, for example, contends that it lost $135 million on scientific research in 2007 under the IRS reporting system. But that does not take into account a $207 million royalty payment the company received for research that led to the development of an arthritis drug, Enbrel.

It was because of such complicating factors that Massachusetts officials used a more conservative measure of hospitals' charity work when state Attorney General Martha Coakley tightened the rules for the community benefit program last winter. Barbara Anthony, a former assistant attorney general who largely created the program in 1994, said community benefits should be something that a hospital undertakes on its own initiative to improve the community's health.

"The whole idea is that a hospital is supposed to develop with its community a plan to meet unmet healthcare needs," explained Anthony, Governor Deval Patrick's new undersecretary for consumer affairs, who also served on Coakley's task force.

Massachusetts made history in 2006 when Governor Mitt Romney signed healthcare reform into law, but not just because it became the first state to mandate that almost every citizen have insurance. In vastly reducing the ranks of the uninsured, the measure also marked a historic shift of responsibility for medical care of the poor.

Partners, the leading industry player in crafting the law, spent $400,000 over two years lobbying for healthcare reform, an effort led by John Sasso, the former adviser to John F. Kerry and Michael Dukakis known for his extraordinary clout on Beacon Hill. In the end, Partners' chairman, Jack Connors, rescued the faltering plan from collapse, showing up to inspire House Speaker Salvatore F. DiMasi with a videotape of comedian John Belushi making his stand in the frat house classic, "Animal House."

"Nothing is over till I say it is over," Connors jokingly told DiMasi, echoing Belushi's most famous line.

Connors was right: Partners and other reform advocates prevailed, and the landmark bill became law.

Reform benefited hospitals in two ways. First, it mandated raises in what the state pays hospitals to care for low-income patients covered by Medicaid. Second, by insuring 432,000 more people, the law reduced the number of uninsured patients who come to the ER with no way to pay the bill.

In the first two years, the state spent more than $550 million extra on health programs and the federal government put in $330 million, according to an estimate the state calculated at the request of the Globe. Hospitals, meanwhile, reaped over $450 million: about $230 million in higher Medicaid payments and more than $220 million in reduced charity care expenses, according to a Globe analysis of data from the attorney general's office. Partners alone received at least $30 million more in Medicaid payments - though it says it still lost big money on the program - and saved $81 million on free care.

Hospital advocates say the new money was imperative for the financial well-being of these vital institutions, and they point out that hospitals will not do as well in 2009, because of state budget cuts.

As healthcare reform was crafted and then implemented, no one asked the hospitals to provide more charity work to offset the free care savings.

Asked in September whether Partners had thought about doing just that, chief operating officer Thomas P. Glynn called it "a very fair question."

"I don't think we've thought about it," he said.

Partners' spending on free care and community benefits reported to the attorney general has fallen 20 percent since it peaked in 2006.

In a bright exam room atop one of Worcester's seven hills, Dr. George Abraham methodically examines his patient, adopting a soft, casual tone usually reserved for an old friend.

The patient, Dennis Grady, 61, had a steady job and private medical insurance when he underwent a triple coronary bypass operation last year. Since then, his pay has been slashed, and his insurance has lapsed.

He had been worried, too, about losing his doctor. But he didn't. Grady now sees him at the free ambulatory care clinic that Abraham has directed at St. Vincent Hospital for nearly a decade.

Grady's most recent visit was one of the more than 2,100 made yearly to the clinic by patients whose care in 2008 cost $250,000 - costs absorbed by Vanguard Health Systems of Tennessee, the for-profit company that owns St. Vincent. In addition, the hospital provides nearly $1 million a year in free care to uninsured people who come to St. Vincent itself.

Massachusetts activists tried to prevent for-profit companies from acquiring hospitals here in the first place, fearing they would usher in a heartless brand of medicine.

Today, healthcare officials who work with both types of hospital say the fears were overblown. St. Vincent, for example, spends about as much of its budget on charity as nonprofit hospitals such as Lahey - in addition to paying $2.3 million in sales taxes and property taxes to Worcester. No surprise then that when St. Vincent's former owner put the hospital up for sale in 2004, Worcester officials insisted that the next buyer be another tax-paying company.

The rationale for generous tax breaks has eroded in recent years as investor-owned companies have shown that hospitals can be run as profitable businesses. Today, 15 percent of US hospitals are owned by tax-paying, for-profit companies, including four in Massachusetts.

At the same time, as nonprofit hospitals have been increasingly run like businesses, the successful ones have adopted practices similar to those of for-profit companies, aggressively expanding into the markets of other hospitals and using their clout to charge higher prices for their services. The Partners-owned hospitals, and Children's, have, as the Globe reported last fall, used their market power to demand and win dramatically higher payments from insurance companies for treatment of their members.

And some hospital corporations have diversified, moving into other businesses aside from the care of hospitalized patients.

"Without a scorecard, it is sometimes difficult to tell the difference between the for-profit and the not-for-profit," Lois Lerner, chief analyst of nonprofit organizations for the IRS, said in February. Lerner released a survey showing that many nonprofit hospitals pay their chief executives more than $1 million a year. At least 13 Massachusetts hospital executives made that much in 2007, the latest year for which data are widely available. Several compensation specialists said salaries at for-profit hospitals are generally comparable to nonprofits, although stock options can make the jobs more lucrative.

Grassley, the Republican senator from Iowa, has led the effort to hold nonprofit hospitals more accountable, and is considering a requirement that they spend 5 percent of their revenues on free medical care, a standard Massachusetts hospitals don't meet because the state pays for much of this care.

Nonprofit hospitals and their allies bristle at the assertion that they behave too much like for-profit companies, noting that studies have shown that nonprofit hospitals are more likely to offer unprofitable services such as psychiatric care or intensive care units for burn patients.

With healthcare costs expected to reach 18 percent of the national economy this year by some estimates, governments are reasserting their role in supervising nonprofit hospitals. The IRS is increasing scrutiny of nonprofit hospitals after decades in which the agency admits it seldom pressured them to do more.

And with healthcare reform at the top of the agenda in Washington, tax exemption for hospitals is already getting a second look. At a discussion hosted by the Senate Finance Committee earlier this month, Grassley pointed out that universal insurance on a national level would reduce the need for free care, as it has in Massachusetts.

"Given this trend, does it make sense to retain tax exemption for hospitals?" he asked.

Though few are prepared to do away with the tax exemption, Grassley's question resonates deeply among those, like McLaughlin, an expert on nonprofit management, who believe the charity care system has to be updated from its 19th-century roots.

"We need to rethink the whole model," said McLaughlin.