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The Estimated Value of Tax Exemption for Nonprofit Hospitals Was About $28 Billion in 2020 [1]

['Jamie Godwin', 'Zachary Levinson', 'Scott Hulver']

Date: 2023-10

Our analysis defined the value of tax exemption as the benefit of not having to pay federal or state corporate income taxes, typically not having to pay state and local sales taxes and local property taxes, and any increases in charitable contributions and decreases in bond interest rate payments that might arise due to receiving tax-exempt status. To estimate the value of these benefits, we drew on methods from three studies and a report commissioned by the American Hospital Association (AHA). As is the case with prior work, we assumed that nonprofit hospitals and health systems would take various allowed deductions if they were required to pay taxes, but we do not capture all nuances of the tax code, nor do we model any other actions that hospitals take to reduce their tax burden, such as by changing how they operate or changing how they account for revenues and expenses. Two of the studies that we draw from estimated the total value of tax exemption or of federal tax exemption. Our estimates are smaller than these amounts, which likely reflects aspects of our approach that are more conservative than these papers. We detail our specific approach for each component below. As a starting point, we relied on RAND Hospital Data, which applies cleaning and processing steps to annual cost report data submitted by hospitals to the Healthcare Cost Report Information System (HCRIS). Every Medicare-certified hospital must submit a cost report to a Medicare Administrative Contractor (MAC) under contract with the Centers for Medicare & Medicaid Services (CMS), meaning that HCRIS pulls data from all US hospitals except federal hospitals and some children’s hospitals. We used the calendar year version of RAND Hospital Data, which apportions data from different cost reports for hospitals that do not use a calendar year reporting period. For example, 2019 data reflect the weighted average of hospital finances during various periods from 2018 through 2020 (i.e., both before and during the COVID-19 pandemic) for a subset of hospitals. We excluded hospitals in the U.S. Territories and hospitals that did not report positive operating expenses in a given year (about 0.3% of remaining hospitals). We also relied on the AHA Annual Survey Database and IRS Form 990 data, focusing on hospitals and systems that we were able to match to RAND Hospital Data. We imputed values for supply expenses, charitable contributions, and tax-exempt bonds in instances where data were missing or unavailable for a given hospital or health system or year. We did not attempt to impute net income when missing (about 1.0% of remaining hospitals). Federal corporate income tax. We estimated the federal corporate income tax that a given nonprofit hospital or health system would have to pay without the tax exemption by multiplying an estimate of taxable income by the federal corporate income tax rate, which was 35 percent from 2011 through 2017 but decreased to 21 percent in 2018. Our estimate of taxable income reflects the difference between revenues and expenses, accounting for deductions allowed under the federal tax code for interest rate payments, state corporate income taxes, state and local sales taxes, and local property taxes and adjusting for estimated changes in charitable contributions and bond interest rate payments. Hospitals may report unrealized gains or losses on financial instruments, which do not affect their tax base, as part of their net income. We aggregated hospital level data to the system level, as applicable, before estimating tax benefits. Aggregate estimates of tax benefits are lower when calculated at the system versus hospital level, as systems may be able to offset taxable profits from one system member with losses from another. We also modeled options for businesses to offset taxable income with losses in earlier and later years. Other studies have used an alternative approach that multiplies net income by estimates of effective tax rates based on tax filings from for-profit hospitals, nursing homes, and residential care facilities. Using this approach would have increased our estimates by $3.6 billion. We chose our approach because it is more closely tied to financial data from nonprofit hospitals. State corporate income tax. We estimated the state corporate income tax that a given nonprofit hospital or health system would have to pay without tax exemption by multiplying an estimate of their taxable income in a given state by the state corporate income tax rate. We used a similar approach to estimating taxable income as above, except that we did not deduct the state corporate income tax (by definition) and we did not allow entities to offset taxable income with losses from later years, in line with state law. We obtained state corporate income tax rates by year from the Tax Foundation. State and local sales taxes. We estimated the state and local sales taxes that a given nonprofit hospital or health system would have to pay without tax exemption by multiplying their total non-pharmaceutical supply expenses (or, for a system, the total supply expenses among member hospitals in a given state) by the average state and local sales tax rate in that state. We obtained total non-pharmaceutical supply expenses from the AHA Annual Survey Database. We obtained average state and local tax rates by state and year from the Tax Foundation. Property taxes. We estimated the local property taxes that a given nonprofit hospital would have to pay without the tax exemption based on the amount paid by for-profit hospitals that reported this information. In the small number of states with five or more for-profit hospitals, we calculated the median ratio of property taxes to operating expenses among for-profit hospitals for a given state and year and then multiplied this amount by the operating expenses for a given nonprofit hospital. In states with fewer than five for-profit hospitals, we instead relied on the national median ratio among for-profit hospitals. Charitable contributions. If nonprofit hospitals were no longer tax-exempt, donors who take itemized deductions for income taxes would no longer be able to deduct their contributions. We assumed that donors would decrease their contributions by an amount equal to their tax increase. We estimated this amount by multiplying charitable contributions by the estimated average household marginal tax rate of donors to health care organizations (32% from 2011 to 2017 and 23% from 2018 to 2020). Our 2011 to 2017 estimate of the marginal tax rate comes from a previous study. We updated this amount for 2018 to 2020 based on a Tax Policy Center estimate of the decrease in the average effective marginal tax rate for all donors in 2018 as a result of changes to the tax code. We estimated charitable contributions from Internal Service Revenue (IRS) Form 990 data by subtracting government grants and in-kind contributions from total contributions, gifts, grants, and other related amounts. Bond interest rate payments. We assumed that, if interest rate payments from hospitals to bondholders were taxed, issuers would increase interest rates accordingly. We estimated the difference between taxable and non-taxable interest rates by: (1) estimating the average taxable interest rate using a rolling average of the Moody’s Seasoned Aaa and Baa index over the previous 10 years, (2) assuming a marginal tax rate for investors of 24 percent (based on a Capital Group post suggesting that municipal bonds are a better investment than taxable bonds for individuals with a marginal tax rate of 24% or higher), (3) assuming that average bond interest rates for nonprofit hospitals are equal to the after-tax bond interest rates among for-profit hospitals (so that investors are indifferent between the two), and (4) taking the difference. To estimate the value to a given hospital of paying lower interest rates, we multiplied the difference by the total value of tax-exempt bonds issued, which we obtained from IRS Form 990 data. We used RAND Hospital Data to estimate charity care costs in 2020 based on amounts reported by the hospitals in our tax exemption analysis. HCRIS instructions indicate that hospitals should report amounts related to both their charity care and uninsured discounts as part of their charity care costs. After cleaning these data, we imputed values in instances where data were missing.

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[1] Url: https://www.kff.org/health-costs/issue-brief/the-estimated-value-of-tax-exemption-for-nonprofit-hospitals-was-about-28-billion-in-2020/

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