Double Taxation of Hospital Services Pushes Patient Bills Up

July 01, 2008

This commentary was published in the July 1, 2008 issue of the Heartland Institute's Budget & Tax News. It references this earlier Tax Foundation study.

As medical costs continue to rise, an under-appreciated factor is states' double taxation of hospital services. In many states, hospitals must pay sales tax on purchases of medicine and equipment—taxes that get passed on to patients in the form of higher bills.

In a new report, "States Should Avoid Sales Taxes on Nonprofit Hospitals," the Washington, DC-based Tax Foundation found only seven states exempt all hospital purchases from the sales tax and six states impose sales tax on even nonprofit hospital purchases.

"Ideally, a sales tax should be levied on all goods and services sold at retail, and to prevent distortions and hidden taxes, it should be levied only once on each good or service sold at retail," the study points out. "Just as imposing sales tax on manufacturing inputs leads to hidden taxes and pyramiding on retail consumers, so too does imposing a state sales tax on hospital purchases lead to hidden taxes and pyramiding on patients."

The report reviews all 50 states and the District of Columbia to see which impose sales taxes on hospital purchases of medicine, equipment, and other materials.

Double Table

Thirteen states have a generic sales tax exemption for purchases made by any nonprofit or charity, the study notes. Thirteen others have provisions specifically exempting nonprofit hospital purchases from the sales tax but not necessarily purchases by other nonprofits or charities.

Seven states exempt inputs purchased by all hospitals. Arkansas and North Carolina exempt certain purchases by nonprofit hospitals.

Seven Tax Everything

Seven states are the worst on taxing hospital inputs. Louisiana, Oklahoma, and West Virginia tax all inputs purchased by nonprofit hospitals, and Tennessee, Washington, and Wyoming tax all but medical equipment purchases. Oklahoma's tax is upside-down: It taxes hospitals' inputs but exempts retail sales.

Greg Barker, director of planning and business development with Touro Infirmary in New Orleans, estimated his facility spends $4 million annually in sales taxes on hospital inputs.

"This disadvantage in the marketplace is not good tax policy and does not offer fairness among area hospitals because the tax burden is not equally applied to all facilities," Barker said. "A $4 million savings goes a long way to improving the financial status of one of New Orleans' longest-serving hospitals."

Tennessee Hospital Sues

In the 1970s in Tennessee, Parkridge Hospital in Chattanooga brought a lawsuit after the state ordered it to pay sales tax on its business-to-business purchase of human blood for patient transfusions, even though Tennessee law limits the sales tax to retail sales. Tennessee legislators responded by enacting a specific sales tax exemption for blood purchased by charities.

While the "blood exemption" is still on the books, many other purchases of inputs by hospitals in Tennessee remain subject to the sales tax. Patients in Tennessee thus pay hidden taxes embedded in their hospital bills, and Tennessee's tax system is less transparent and neutral.

Even states that exempt nonprofit hospital purchases tax other business-to-business transactions that should be exempt.

Business-to-Business Taxes

Of those states that impose a state-level sales tax (45, plus the District of Columbia), many impose sales taxes on business-to-business transactions that do not involve a final retail sale, the study notes.

"[M]ore than half the states (27 plus D.C.) tax two or more inputs. 14 states and D.C. tax the purchase of manufacturing machinery, an especially distortionary tax, and Hawaii imposes sales tax on all but one examined business-to-business transactions," the report notes.

"For many states, exempting inputs from the sales tax should be a part of any tax reform effort," the study concludes.

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