Six States TaxA tax is a mandatory payment or charge collected by local, state, and national governments from individuals or businesses to cover the costs of general government services, goods, and activities. Nonprofit Hospital Purchases; Only Seven States Exempt All Hospital Purchases
Fiscal Fact No. 125
Summary
States seeking a neutral, transparent sales taxA sales tax is levied on retail sales of goods and services and, ideally, should apply to all final consumption with few exemptions. Many governments exempt goods like groceries; base broadening, such as including groceries, could keep rates lower. A sales tax should exempt business-to-business transactions which, when taxed, cause tax pyramiding.
system should exempt all business-to-business transactions and impose sales tax only on final retail sales of goods and services. Because many states continue to impose sales tax on business-to-business inputs, examining the tax treatment of a variety of such transactions can provide insight into the neutrality and transparency of a state’s overall tax system.
While income tax exemptions for nonprofit hospitals may not be justified under the principles of sound tax policy, sales tax exemptions for the purchase of inputs are. Only seven states exempt inputs purchased by all hospitals, and six states do not exempt inputs purchased by nonprofit hospitals. For many states, exempting inputs from the sales tax should be a part of any tax reform effort.
Inputs Should Generally Be Exempt from Sales Tax
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. Take the example of bread sold at retail. The bread is the final retail product, coming after the farmer purchased seeds from a store owner, the miller purchased wheat from the farmer, the bakery purchased flour from the miller, and the supermarket purchased the bread from the bakery. If a sales tax is imposed on each of those transactions, the taxes cascade or “pyramid” on top of each other, resulting in taxes on top of taxes.
Tax pyramidingTax pyramiding occurs when the same final good or service is taxed multiple times along the production process. This yields vastly different effective tax rates depending on the length of the supply chain and disproportionately harms low-margin firms. Gross receipts taxes are a prime example of tax pyramiding in action. distorts economic decision-making because goods or services provided by one company become artificially favored over those requiring multiple production steps. If the farmer, the miller, and the baker must pay sales tax on pre-retail steps, those taxes will become embedded in the final retail price. Consumers thus end up paying hidden taxes, and the tax system is less transparent and neutral.
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. In the Tax Foundation’s 2008 State Business Tax Climate Index, the tax treatment of ten business-to-business transaction categories was examined. While no state exempted all ten, more 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.1
The Income Tax ExemptionA tax exemption excludes certain income, revenue, or even taxpayers from tax altogether. For example, nonprofits that fulfill certain requirements are granted tax-exempt status by the Internal Revenue Service (IRS), preventing them from having to pay income tax.
for Nonprofit Hospitals May Be Unjustified
Of the approximately 3,400 hospitals in the United States, 60 percent (2,033) are nonprofit and enjoy tax-exempt status.2 This exempts nonprofit hospitals from paying income tax on investment earnings or surpluses, and donations to them are deductible.
In Tax Foundation Special Report No. 137, “Charities and Public Goods: The Case for Reforming the Federal Income Tax DeductionA tax deduction is a provision that reduces taxable income. A standard deduction is a single deduction at a fixed amount. Itemized deductions are popular among higher-income taxpayers who often have significant deductible expenses, such as state and local taxes paid, mortgage interest, and charitable contributions. for Charitable Gifts,” we argued that the justifications for such favorable tax treatment are thin. “[H]ospital services are not economically different from other goods and services such as rock-climbing lessons or auto care. That makes it difficult to see how either is subject to market failure and would be significantly under-provided in the absence of a tax subsidy.”3 IRS Commissioner Mark W. Everson reached the same conclusion in a 2005 report, writing that there was little difference between nonprofit and for-profit hospitals “in their operations, their attention to the benefit of the community or their levels of charity care.”4 Large salaries and a perception that nonprofit hospitals are not providing a quid pro quo in return for their favored tax status may lead to increased scrutiny and perhaps congressional action.5
Nonprofit Hospital Inputs Should Be Exempt from Sales Tax
A second, more justifiable, tax benefit enjoyed by many nonprofit hospitals is a sales tax exemption on purchased inputs. Just as imposing sales tax on manufacturing inputs leads to hidden taxes and pyramiding on retail consumers, so too would imposing a state sales tax on hospital purchases lead to hidden taxes and pyramiding on patients.
Tennessee provides one illustrative example. Parkridge Hospital in Chattanooga purchased human blood from a commercial blood bank, in turn making it available to patients in need of transfusions.6 The state ordered the hospital to pay sales tax on the purchase of the blood from the blood banks. The hospital complied under protest and then sued for a refund. Even though Tennessee’s sales tax statute specifically limits the sales tax to “selling tangible personal property at retail in this state,7 the Tennessee Supreme Court ruled against the hospital and ordered the tax paid on the business-to-business transactions. Tennessee legislators responded by inserting a specific sales tax exemption for blood purchased by charities into the state code.8 While the “Blood Exemption” is still on the books, other purchases of inputs by hospitals (aside from some equipment) in Tennessee remain subject to sales tax. Patients in Tennessee thus pay hidden taxes embedded in their hospital bills, and Tennessee’s tax system is less transparent and neutral.
Of the 45 states that impose a state-level sales tax, 39 exempt all or most purchases by nonprofit hospitals. In 13 states, all purchases of inputs by charities or nonprofits are exempt from the sales tax, and in another 13 states, nonprofit hospital purchases are specifically exempt. Seven states exempt inputs purchased by all hospitals. Arkansas and North Carolina exempt only certain purchases by nonprofit hospitals.
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. See the tables below for a complete listing.
Table 1
Sales Tax on Nonprofit Hospital Purchases by Category
| Category | Number of States in Category |
|
MOSTLY TAXED |
|
|
Taxed |
2 |
|
Some medical equipment exempt |
3 |
|
Hospital inputs taxed, but retail sales exempt |
1 |
|
SOME EXEMPT |
|
|
Nonprofit hospitals specifically exempt, except for some major items |
1 |
|
MOSTLY EXEMPT |
|
|
Items “ordinary and necessary” for operation of nonprofit hospitals exempt |
1 |
|
Most purchases of medicine and equipment exempt |
2 |
|
Charities exempt, except for some items |
2 |
|
Services and materials to hospital exempt, but not building materials |
1 |
|
EXEMPT |
|
|
Nonprofit hospitals specifically exempt |
13 |
|
Hospitals specifically exempt |
7 |
|
Sales to nonprofits or charities exempt or generally exempt |
13 |
|
No Sales Tax |
5 |
Source: Tax Foundation
Table 2
Sales Tax on Nonprofit Hospital Purchases by State
|
State |
Taxed/Exempt |
Notes |
|
Alabama |
Exempt |
Nonprofit hospitals specifically exempt |
|
Alaska |
No Sales Tax |
|
|
Arizona |
Exempt |
Nonprofit hospitals specifically exempt |
|
Arkansas |
Mostly Exempt |
Services and materials to hospital exempt, but not building materials |
|
California |
Exempt |
Nonprofit hospitals specifically exempt |
|
Colorado |
Exempt |
Charities exempt |
|
Connecticut |
Exempt |
Nonprofit hospitals specifically exempt |
|
Delaware |
No Sales Tax |
|
|
Florida |
Mostly Exempt |
Most purchases of medicine and equipment exempt |
|
Georgia |
Exempt |
Nonprofit hospitals specifically exempt |
|
Hawaii |
Exempt |
Hospitals specifically exempt |
|
Idaho |
Exempt |
Hospitals specifically exempt |
|
Illinois |
Exempt |
Charities exempt |
|
Indiana |
Exempt |
Nonprofits exempt |
|
Iowa |
Exempt |
Nonprofit hospitals specifically exempt |
|
Kansas |
Exempt |
Hospitals specifically exempt |
|
Kentucky |
Exempt |
Sales to charities exempt |
|
Louisiana |
Taxed |
|
|
Maine |
Exempt |
Hospitals specifically exempt |
|
Maryland |
Exempt |
Nonprofits exempt |
|
Massachusetts |
Mostly Exempt |
Most purchases of medicine and equipment exempt |
|
Michigan |
Exempt |
Nonprofit hospitals specifically exempt |
|
Minnesota |
Exempt |
Nonprofit hospitals specifically exempt |
|
Mississippi |
Mostly Exempt |
Items “ordinary and necessary” for operation of nonprofit hospitals exempt |
|
Missouri |
Exempt |
Charities exempt |
|
Montana |
No Sales Tax |
|
|
Nebraska |
Exempt |
Hospitals specifically exempt |
|
Nevada |
Exempt |
Nonprofits exempt |
|
New Hampshire |
No Sales Tax |
|
|
New Jersey |
Mostly Exempt |
Charities exempt, except for some items |
|
New Mexico |
Exempt |
Nonprofits exempt |
|
New York |
Mostly Exempt |
Charities exempt, except for some items |
|
North Carolina |
Some Exempt |
Nonprofit hospitals specifically exempt, except for some major items |
|
North Dakota |
Exempt |
Hospitals specifically exempt |
|
Ohio |
Exempt |
Nonprofit hospitals specifically exempt |
|
Oklahoma |
Taxed |
Hospital inputs taxed, but retail sales exempt |
|
Oregon |
No Sales Tax |
|
|
Pennsylvania |
Exempt |
Nonprofit hospitals specifically exempt |
|
Rhode Island |
Exempt |
Nonprofit hospitals specifically exempt |
|
South Carolina |
Exempt |
Nonprofit hospitals specifically exempt |
|
South Dakota |
Exempt |
Hospitals specifically exempt |
|
Tennessee |
Mostly Taxed |
Some medical equipment exempt |
|
Texas |
Exempt |
Nonprofits exempt |
|
Utah |
Exempt |
Charities exempt |
|
Vermont |
Exempt |
Nonprofits exempt |
|
Virginia |
Exempt |
Nonprofits generally exempt |
|
W. Virginia |
Taxed |
|
|
Washington |
Mostly Taxed |
Some medical equipment exempt |
|
Wisconsin |
Exempt |
Nonprofit charities exempt |
|
Wyoming |
Mostly Taxed |
Some medical equipment exempt |
|
Dist. of Columbia |
Exempt |
Nonprofit hospitals specifically exempt |
Source: Tax Foundation
Notes
1. See also Federation of Tax Administrators, 2004 Survey on State Taxation of Services (May 2005), at http://www.taxadmin.org/fta/pub/services/services04.html.
2. See John Carreyrou and Barbara Martinez, “Nonprofit hospitals, once for the poor, hit gold,” the Wall Street Journal (Apr. 6, 2008).
3. Andrew Chamberlain and Mark Sussman, Tax Foundation Special Report, No. 137 “Charities and Public Goods: The Case for Reforming the Federal Income Tax Deduction for Charitable Gifts” (Nov. 2005), at http://www.taxfoundation.org/legacy/show/1191.html.
4. See Robert Pear, “Nonprofit Hospitals Face Scrutiny Over Practices,” New York Times (Mar. 19, 2006), at http://www.nytimes.com/2006/03/19/politics/19health.html.
5. See, e.g., Carreyrou and Martinez, supra note 1.
6. See Parkridge Hospital, Inc. v. Woods, 561 S.W.2d 754 (Tenn. 1978).
7. Tenn. Code Ann. § 67-6-201 (then Tenn. Code Ann. § 67-3003).
8. See Tenn. Code Ann. § 67-6-304.
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