Is a Nonprofit Hospital Sales Tax Refund Defensible in North Carolina?

June 18, 2013

One point of contention in the North Carolina tax reform debate has been the fate of one particular tax expenditure—the uncapped sales tax refund for nonprofits. The refund applies to "sales of taxable tangible personal property to nonprofit hospitals, nonprofit education institutions, churches, orphanages, other nonprofit charitable or religious institutions and organizations, and homes for the aged, sick or infirm." Eligible institutions can recoup the sales tax they pay since they are not explicitly exempted from paying it. The new Senate plan wouldn’t remove the refund entirely; it would just phase in a cap on the total amount an entity can claim. Since the refund wouldn’t be completely repealed, it would still preserve the refund for small nonprofits. The cap would be structured as follows:

  • $7.5 million at the state level and $2.25 million at the local level in 2014;
  • $5 million at the state level and $1.5 million at the local level in 2015;
  • $1 million at the state level and $300,000 at the local level in 2016; and
  • $100,000 at the state level and $30,000 at the local level in 2017 and after.

Who stands to lose here? Large nonprofits, particularly hospitals, obtain a disproportionate amount of refund benefits. Table 35B of the Statistical Abstract of North Carolina Taxes outlines the recipient types of high-dollar nonprofit sales tax refunds (those that are $100,001 or more). I’ve reproduced a portion of the table below.

Percentage of Total High-Dollar Refunds Granted by Type of Institution

Nonprofit Entity Type

FY 2006-07

FY 2007-08

FY 2008-09

FY 2009-10

FY 2010-11

Hospitals and medical accommodations

76.9

78.4

79.9

75.2

81.2

Collegiate institutions

16.4

14.5

13.2

17.5

11.0

Elementary and secondary institutions

0.5

0.6

0.9

0.5

0.8

Churches and other religious institutions

1.4

1.7

0.9

1.4

1.2

Charitable and other related institutions

2.9

2.7

3.6

4.4

4.1

Retirement and convalescent facilities

1.8

2.1

1.5

1.0

1.8

Nonprofit hospitals have been the largest beneficiary for quite some time and in the 2010-11 fiscal year, they received over $309 million in high-dollar sales tax refunds. We also know that the largest proportion of the total refund benefit goes to beneficiaries that claim a refund of $1 million or more, and you can bet that most of those big checks go out to large hospitals.

Classifying nonprofit hospitals as a “nonprofit” is a complete misnomer because most of them earn a hefty sum. The Wall Street Journal reported on the topic a few years ago:

The combined net income of the 50 largest nonprofit hospitals [in the U.S.] jumped nearly eight-fold to $4.27 billion between 2001 and 2006… Nonprofits…are faring even better than their for-profit counterparts: 77% of the 2,033 U.S. nonprofit hospitals are in the black, while just 61% of for-profit hospitals are profitable [emphasis added].

That trend is apparent in North Carolina, too. Most hospitals claim the nonprofit designation. According to the American Hospital Association, of the 4,973 community hospitals in the country, 1,025 were for-profit hospitals (just over 20 percent). It turns out a hospital doesn’t have to do much to obtain this classification, either (again reported by the WSJ):

In return for not paying taxes, nonprofit hospitals are supposed to provide a "community benefit," a loosely defined requirement whose most important component is charity care. But many hospitals include other expenses in their community-benefit accounting to the Internal Revenue Service, including unpaid patient bills…Excluding those other expenses, many hospitals spend less on charity care than they get in tax breaks, studies by various counties and states show [emphasis added].

All this leads me to vehemently argue that these hospitals shouldn’t receive this tax refund. But there’s a complicating matter I can’t ignore: the taxation of business-to-business transactions. In theory, shouldn’t purchases made by medical service providers be exempt from the sales tax to prevent tax pyramiding? In theory, yes.

But remember the ultimate problem in the sales tax pyramiding case—because the product is taxed at multiple points in the production chain, the effective tax rate at the end becomes higher than was originally intended. But medical services are not currently taxed under the sales tax. In fact, no state applies the sales tax to medical services. So while purchases by hospitals are technically a business input, we won’t see much tax pyramiding here.

This portion of the legislation seems like a backhanded way to apply a bit of tax to medical services (and I’d like to see all end consumer services taxed for neutrality purposes) and make some state revenue off a highly profitable industry. It’s far from perfect, but I can see some merits. The moral of the story is that we should apply the sales tax to medical services and exempt business inputs (the purchases of hospitals and other medical providers), not do a halfway-in-between approach where we exempt the end product and tax the intermediary.

This also brings up the broader issue of nonprofit designation. Cash cows that happen to be able to take advantage of the ambiguous federal tax code and call themselves not-for-profit should not be able to reap such generous tax benefits (don’t forget that these hospitals get out of paying a lot of other taxes, too). To me, this just seems like another carve-out that benefits a politically expedient and well-organized industry, and we should seriously consider addressing it not just in North Carolina, but in the U.S. as a whole.

More on North Carolina here.

Follow Liz on Twitter @elizabeth_malm.

For more information on the increasing similarities between nonprofit and for-profit hospitals and a discussion of the historical evolution that led to this convergence, see “The convergence between for-profit and nonprofit hospitals in the United States” by Guy David, published in the International Journal of Health Care Finance Economics in 2009. An older, but similar version, can be found here (Section 2, “The Dynamics of the US Hospital Market," page 3).


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