Health Affairs
June 2023
By Derek Jenkins and Vivian Ho

Abstract

Nonprofit hospitals are exempt from paying most federal and state taxes, can issue tax-exempt bonds, and can receive tax-deductible contributions,¹ with the expectation that they will direct proceeds to community benefit. Yet recent news articles assert that some nonprofit health systems are reducing staff, demanding payment from patients who qualify for charity care, and shifting services from low-income to high-income neighborhoods, while increasing profits.^2,3

Similarly, previous research has found that 86 percent of nonprofit hospitals did not provide more charity care than the value of their tax exemption.⁴ Moreover, nonprofit hospitals have been found to have lower ratios of charity care to total expenses than for-profit hospitals.⁵ In this study we compared the changes in charity care spending versus cash reserve balances associated with changes in profits from 2012 to 2019. We found that increases in profit at nonprofit hospitals were not correlated with increases in charity care (exhibit 1).

Hospitals rely on cash reserves to cover capital costs such as maintaining facilities and upgrading information systems. They also use cash reserves to cover unexpected shortfalls in reimbursement from private and public payers. Furthermore, hospitals must maintain significant cash holdings to earn higher bond ratings, which lowers the cost of investing in new projects.⁶ Although cash reserves are an important component of the financial health of hospitals, significant allocation of profits toward cash reserves relative to charity care would call into question the justification for favorable tax treatment of nonprofit hospitals.

If hospitals prioritize community health over financial gain, then we would expect our research to show larger increases in charity care versus cash reserves for hospitals that increased their profits between 2012 and 2019.

Study Data And Methods

We obtained hospital financial data for 2012 and 2019 from Medicare Cost Reports, which are submitted annually to the Centers for Medicare and Medicaid services (CMS) by all hospitals that treat Medicare patients. CMS publishes the information from hospitals’ cost reports in its Healthcare Cost Report Information Systems (HCRIS).⁷ We applied the methodology from the National Academy for State Health Policy’s (NASHP’s) Hospital Cost Tool to the HCRIS data to construct measures of hospital profits, spending on charity care, and cash reserve balances.⁸

We limited the sample to the 4,958 short-term acute care and critical access hospitals in the HCRIS data set in 2019. Of these, 1,258 were dropped from the sample for incomplete data on the financial variables we considered. Next, we omitted the remaining 917 hospitals that were government owned in 2012 or 2019. The final analytic subpopulation included 2,783 hospitals, of which 2,219 were nonprofit hospitals and 564 were for-profit hospitals in 2019.

To estimate the relationship between hospitals’ allocation of funds and changing profitability from 2012 to 2019, we first regressed the change in hospitals’ charity care spending on their change in profits. We then regressed changes in cash reserves on profit changes. We also ran separate specifications for for-profit and nonprofit hospitals to test whether the two types of hospitals acted differently when their profits changed.

The dependent variables of charity care and cash reserve balances were highly skewed, so direct estimation using ordinary least squares could have yielded biased estimates of their relationships with changes in profit over time. To address this concern, we used the inverse hyperbolic sine transformation, which allows for negative values and adjusts for right-skewed dependent variables.⁹

To control for differences in hospital size and populations served, we included as additional explanatory variables county-level data from the American Community Survey¹⁰ on the percentage of people uninsured and mean household income for each county, and the number of hospital beds categorized by quartile from HCRIS.⁸ The county of each hospital was identified using the American Hospital Association Annual Survey.¹¹

There were fifty-seven for-profit hospitals in 2012 that had changed to nonprofit ownership by 2019 and fifty-six nonprofit hospitals in 2012 that had become for-profit by 2019. As a sensitivity analysis, we reestimated the regressions after omitting these hospitals from the sample.

Our analysis had limitations. We could only measure an association between changes in profits and changes in other financial measures, which does not demonstrate causality. Changes in Affordable Care Act subsidies and differences in Medicaid expansion across states that we did not account for may have affected hospitals’ charity care differentially. However, these differences would be unlikely to explain any disparity in hospitals’ relative allocation of profits toward cash reserves in favor of charity care.

We limited our assessment of hospitals’ contributions to community well-being to charity care, even though the Internal Revenue Service (IRS) definition of community benefits includes a range of other services such as community health improvement services and health professions education.¹² Charity care and unreimbursed costs for the treatment of Medicaid patients are the two largest components of hospital spending on community health benefits.⁴ However, researchers have noted that the IRS’s definition of unreimbursed Medicaid costs likely leads to overestimates of their true cost to hospitals. Furthermore, there are four other categories of community benefit that are small in magnitude, and hospitals likely benefited directly from their marketing-related effects.¹²

Study Results

Exhibit 2 presents descriptive statistics for nonprofit and for-profit hospitals for 2012 and 2019. In 2012, nonprofit and for-profit hospitals in our sample had mean hospital operating profits of $43.01 million and $31.85 million, respectively. By 2019, mean operating profits had grown to $58.61 million for nonprofit hospitals and $43.38 million for for-profit hospitals. Cash reserve balances grew substantially from 2012 to 2019, with nonprofit hospitals increasing their mean cash reserve balance from $133.34 million to $224.33 million, whereas for-profit hospitals saw an increase from $101.81 million to $181.15 million. Nonprofit hospitals’ spending on charity care decreased from $6.65 million in 2012 to $6.36 million in 2019, whereas for-profit hospitals increased their charity care spending from $2.29 million to $6.30 million during the same period.

Exhibit 1 presents the regression results from the untransformed data. We found that a one-dollar increase in profit between 2012 and 2019 was not associated with a statistically significant increase in charity care for nonprofit hospitals or the sample with both for-profit and nonprofit hospitals (p>0.10). For-profit hospitals had a four-cent increase in charity care spending associated with each one-dollar rise in profit between 2012 and 2019 (p<0.05).

In contrast, every one-dollar increase in profits between 2012 and 2019 was associated with a $1.74 rise in cash reserves during the same period for all hospitals in our sample (p<0.05). When the analysis was conducted by ownership type, the estimated increase in cash reserves was $1.73 for nonprofit hospitals and $1.92 for for-profit hospitals (p<0.05).

Estimating the change in charity care associated with changes in profits using the inverse hyperbolic sine transformation to control for right-skewed bias yielded similar results, which are in online appendix exhibit A.3.¹³ With the transformation, we estimated that a one-dollar increase in profit between 2012 and 2019 was associated with an increase of cash reserve balances of $1.23 for all hospitals in our sample (p<0.05). When the analysis was conducted by ownership type, the estimated increase was $1.21 for nonprofit hospitals and $1.58 for for-profit hospitals (p<0.05). A one-dollar increase in profit was associated with a two-cent increase in charity care spending for for-profit hospitals, using the inverse hyperbolic sine transformation (p<0.05), and the association between a change in profit and changes in charity care spending for nonprofit hospitals and the sample including both nonprofit hospitals and for-profit hospitals remained statistically insignificant (p>0.10).

After we omitted the 113 hospitals that changed ownership type from 2012 to 2019, the results were similar and can be found in appendix exhibits A.12 and A.13,¹³ along with the full regression estimates for all analyses.

Discussion

Mean hospital profits grew from 2012 to 2019, but this increase was not associated with the provision of more charity care by nonprofit hospitals, even though their cash reserve balances increased. In contrast, although charity care is not required for for-profit hospitals, an increase in profit was associated with an increase in charity care for them; this may be because spending on charity care is tax deductible.¹⁴

Allocation of more hospital profits toward charity care would ease the financial stress faced by families in the US.

The allocation of nonprofit hospital profits toward cash reserves rather than charity care has important policy implications. A recent survey found that 41 percent of adults currently have some debt caused by medical or dental bills, and 24 percent of adults have medical or dental bills that are past due or that they are unable to pay.¹⁵ We are unaware of data that track trends in medical debt. But with this debt being so prevalent, allocation of more hospital profits toward charity care would ease the financial stress faced by families in the US.

Although hospitals must maintain cash reserves to weather financial crises, they may also be borrowing on these reserves to build facilities in new locations to expand their market share.¹⁶ These new locations are often in wealthier areas, and hospitals’ prioritizing market expansion over community benefits invalidates their rationale for favorable tax treatment.³

The IRS has not stated specific quantitative requirements for the community benefits that nonprofit hospitals must provide.¹⁷ Our results suggest that linking minimum contributions to charity care with profit increases may be helpful.

With operating profits for nonprofit hospitals growing, the share of community health benefits they provide should also be growing to justify their favorable tax treatment.

ACKNOWLEDGMENTS

The authors acknowledge grant support for this work from Arnold Ventures. The authors thank Marilyn Bartlett for helping them understand the National Academy for State Health Policy Hospital Cost Tool. To access the authors’ disclosures, click on the Details tab of the article online.

 

 

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