Evaluating Hospitals’ Provision of Community Benefit: An Argument for an Outcome-Based Approach to Nonprofit Hospital Tax Exemption

Abstract

Nonprofit hospitals are exempt from federal income taxation if they pass organizational and operational tests, including satisfying the community-benefit standard. Policymakers, however, have questioned the adequacy of the community benefits that nonprofit hospitals provide in exchange for these exemptions.

The Internal Revenue Service recently responded to these concerns by redesigning its tax forms for nonprofit hospitals. The new Form 990 Schedule H requires nonprofit hospitals to provide additional information about their community-benefit activities. This new reporting requirement, however, places an undue focus on input-based community-benefit indicators, in particular expenditures.

We argue that expanding the current input-based reporting requirement to include not only monetary inputs but also population health outcomes would achieve greater benefit for society.

NONPROFIT HOSPITALS ARE vital to the health and welfare of millions of Americans¹ and constitute a major portion of our economy.² The tax exemption that these institutions received was worth $12.6 billion in 2002 and has subsequently grown.³ To remain tax-exempt, nonprofit hospitals have to meet the Internal Revenue Service’s (IRS’s) community-benefit standard, which grants health care organizations tax exemptions in exchange for engaging in activities that promote health for the benefit of the community.⁴

Policymakers have recently started to question the adequacy of the community-benefit activities that nonprofit hospitals provide in exchange for their substantial tax exemptions. The IRS responded to these concerns by redesigning its federal tax return for nonprofit hospitals, Form 990, and adding Schedule H.⁵ However, this new reporting requirement only partially achieves its policy objective because it is hampered by an undue focus on input-based indicators of community benefit, in particular how much nonprofit hospitals spend on community-benefit activities. The current standard does not assess the health outcomes that these community-benefit activities do or do not help to achieve. The community-benefit standard would provide a more meaningful evaluation of hospitals’ community-benefit activities if it complemented input-based measures of community benefit with information on population health outcomes, thereby better effectuating the standard’s original policy goals and achieving greater benefit for society.⁶

A standard that includes input as well as outcome measures would offer significant incentives for nonprofit hospitals to increase public benefit. A new community-benefit standard should thus take a more balanced approach, evaluating both input and outcome-related measures, which show how benefit accrues to the public. A more robust conception of community benefit, with tighter criteria for inclusion and exclusion of potential population benefits, would help facilitate this transition.

Provisions in the Patient Protection and Affordable Care Act (ACA) have modified the community-benefit standard to include measures of both input and outcomes. As of this year, nonprofit hospitals are required to conduct regular community-health needs assessments and implement improvement plans, which may provide some of the information necessary for a meaningful evaluation of the outcomes of a hospital’s community-benefit initiatives.⁷

Policymakers at both the federal and state level have many tools at their disposal to help make the community-benefit standard more outcome-focused. The IRS, for instance, could require nonprofit hospitals to complement their community-benefit expenditures disclosed in Form 990 Schedule H with a detailed report on the population health outcomes of their community-benefit activities. Federal and state governments could then use this information when deciding whether to grant nonprofit hospitals tax exemptions.

OVERVIEW OF NONPROFIT HOSPITAL TAX EXEMPTION

Federal policy supports charitable organizations through tax exemptions as a way of furthering policy goals. These tax exemptions are codified in Section 501(c)(3) of the Internal Revenue Code.⁸ Historically, the goal of this policy has been to give nonprofit hospitals incentives to provide additional benefits to their communities beyond providing health care service in exchange for reimbursement.

Originally, for an entity to be tax-exempt, it either had to fit into one of the enumerated categories contained in Section 501(c)(3) (educational, religious, etc.) or else be charitable.⁹ Charitable had 2 meanings: either broad-based public benefit or alleviation of poverty.⁹ When hospitals were in the business of providing free care to the poor, they fit neatly into the alleviation of poverty category. In 1956, the IRS codified this qualification in the financial-ability standard, which required hospitals (to the extent financially possible) to provide health care to those who would otherwise be unable to afford it.¹⁰

Because of changes in both the practice of medicine and the financing of health care, hospitals evolved out of the parameters of the exemption they had once received. In its 1969 Revenue Ruling, the IRS introduced a new standard for tax exemption, the community-benefit standard, which grants health care organizations tax exemptions in exchange for engaging in activities that promote health for the benefit of the community.⁴ To be granted tax exemptions, nonprofit hospitals generally have to meet all of the following criteria:

1. operate an emergency department that cares for anyone, regardless of ability to pay;

2. provide nonemergency department care for anyone who can pay;

3. participate in Medicare and Medicaid;

4. create a governing board that represents the community;

5. allow any qualified professional who applies to receive medical-staff privileges; and

6. reinvest surplus funds, rather than disseminate them as dividends.¹¹

In 1983, the IRS determined that hospitals without emergency departments could be considered tax-exempt if all other factors were satisfied.¹² Moreover, not all of the factors have to be satisfied in every circumstance because the IRS can make determinations on a case-by-case basis.¹² Despite the broad scope of the community-benefit standard, many nonprofit hospital leaders still consider community benefit to be largely synonymous with charity care despite the fact that they are no longer required to provide such care to qualify for tax exemptions.¹³

In addition to federal income tax exemptions, states and localities frequently grant nonprofit hospitals exemptions from state income and local property taxes. Although in principle federal and state tax systems are separate, a number of states and localities automatically grant tax exemptions to hospitals that have been awarded 501(c)(3) tax-exempt status by the IRS.¹⁴

Policymakers at the federal, state, and local levels are concerned that the current standards used to determine whether nonprofit hospitals receive tax-exempt status do not achieve their full policy objective of promoting health for the benefit of the community. As any tax exemption shifts the tax burden from the tax-exempt entity to the rest of the tax-paying community,¹⁵ there must be a compelling justification for any tax exemption.¹⁶ Sen Charles Grassley (R, Iowa) stressed this point during a hearing in 2006 on nonprofit tax exemptions.¹⁶ Moreover, once the ACA takes full effect, a substantial number of currently uninsured people are expected to gain health insurance coverage,¹⁷ which will reduce the need for charity care in many communities. Nonprofit hospitals in these communities will thus be required to seek alternative avenues for providing community benefit if they wish to remain tax-exempt.

UNDUE FOCUS ON MONETARY INPUTS

In 2008, the IRS revised its Form 990 and added Schedule H, which henceforth requires hospitals to disclose their community-benefit activities in detail.¹⁸ This new reporting requirement is intended to enable the IRS to better assess hospitals’ compliance with the community-benefit standard.¹²

In Schedule H, nonprofit hospitals are required to report on the care provided to charity patients and patients covered under means-tested government programs such as Medicaid and the Children’s Health Insurance Program. In addition, hospitals are asked to report on select other community-benefit activities, including subsidized health services, community health improvement services, medical research, and health professions education.¹⁸ At a minimum, nonprofit hospitals are required to disclose their net community-benefit expenditures, which is their total expenditures minus any direct offsetting revenues.¹⁹ Furthermore, hospitals may choose to provide additional information such as the number of activities they engaged in during the reporting period and the number of people served through their community-benefit programs.¹⁹ The fact that the IRS now asks for an account of a broad range of community-benefit activities signifies some recognition of the notion that the term community benefit not only includes charity care but also encompasses other services aimed at improving the health and well-being of the community at large.

Form 990 Schedule H, as it exists currently, focuses on inputs to assess the adequacy of a hospital’s community-benefit activities. Inputs, both monetary and nonmonetary, play a crucial role in improving community health. In addition, from the perspective of the IRS, inputs are easy to measure and, more importantly, do not require risk adjustment and are thus less susceptible to gaming.¹⁹ However, committing additional resources to community-benefit activities does not always result in better population-health outcomes. We therefore argue that the community-benefit standard should be expanded to include not only input-based but also outcome-related measures. A combination of input and outcome metrics would allow policymakers to better evaluate whether a hospital’s community-benefit activities are actually generating benefits for the community. For example, a nonprofit hospital may report that it spent $50 000 on workforce development. This number and the accompanying financial data, however, indicate nothing about whether the program created any real benefit. Based on the expenditure information reported in Schedule H alone, there is no way to accurately identify how many individuals were trained, what they were trained in, and whether they were successfully placed in jobs.

Rather than evaluating community benefit solely in terms of dollars spent, a modified approach based on both input and outcome measures would require hospitals to design community-benefit programs that make a measurable difference in the health of their respective communities. Such an approach would assess hospitals’ achievements by measuring both dollars spent on the set of community-benefit activities defined in Form 990 Schedule H and improvements in a number of health-outcome indicators tied to the specific community-benefit activity. Reforms of this type are already under way at the state level. Maryland, for instance, passed legislation in 2012 that requires hospitals to describe their efforts to track and reduce health disparities within their communities as part of their community-benefit reports.²⁰

CHALLENGES OF AN OUTCOME-BASED APPROACH

Complementing the current input-based approach to nonprofit-hospital tax exemption by also assessing hospitals’ performance on a number of health outcomes brings with it certain challenges, among them the problems of (1) how population-health outcomes can be measured and (2) how these outcomes can be attributed to individual hospitals and their community-benefit initiatives.

With respect to the first challenge, measuring health outcomes is the routine work of epidemiologists. Scholars have already provided compelling examples of ways to mount community-based interventions²¹ and have shown measurable differences in health outcomes between different health systems.²² Moreover, many hospitals across the country have engaged in targeted interventions to fulfill particular health needs in their communities with very positive results.²³ In addition, efforts are under way at the national level to develop population-health measures that will allow hospitals to assess their contributions to the community. The National Quality Forum, for instance, has endorsed a set of standardized, scientifically evaluated indicators that hospitals can use to assess population-health performance.²⁴ Likewise, the Agency for Healthcare Research and Quality has developed a number of indicators, such as the measures of preventable admissions included in its Prevention Quality Indicators, which could be utilized to evaluate the efforts of hospitals at improving population health.²⁵

Attributing population-health outcomes to individual hospitals and their community-benefit initiatives remains a more difficult challenge. Given that many factors influence population health and do so in complex ways, no single entity can be held accountable for health outcomes. In particular, in large urban settings with multiple nonprofit hospitals, members of the communities surrounding any 1 hospital may not necessarily seek services at that particular hospital, so the correlation between the health status of the surrounding communities and a hospital’s community-benefit programs may be weak or even nonexistent. Hospital managers are thus understandably apprehensive about any discussion that suggests using health-outcome measures to complement the current input-based approach for the purpose of maintaining tax-exempt status.

Despite the inherent difficulties, attributing outcomes to specific community-benefit interventions is possible in well-defined circumstances.²⁶ For instance, a study conducted via a series of large-scale trials in Elmira, New York; Memphis, Tennessee; and Denver, Colorado, found that when nurses educated new parents from disadvantaged populations about proper infant care, the health of both mother and child improved on several dimensions, including better perinatal health, lower rates of abuse and neglect, and reduced reliance on public-assistance programs.²⁷ A second example comes from the 1990s, when the New York State Department of Health and Mt. Sinai Hospital worked together to combat tuberculosis. Together, the hospital and the department created “TB directly observed treatment” to help those afflicted with tuberculosis to properly care for themselves. Many of those afflicted were homeless or HIV positive, and presented special treatment difficulties. All those who began the program either completed it or were finishing at the time of the study. The study found that the program greatly improved the health of the indigent population of New York. ²⁸

Besides having programs that focus on improving health outcomes of certain subgroups of patients, nonprofit hospitals have also begun to engage in activities calibrated to improve the health of the population at large. For instance, St. Joseph Mercy Hospital in Ypsilanti, Michigan, has established a weekly farmer’s market in the hospital lobby to provide fresh fruits and vegetables to a population of patients whose access to fresh produce may be limited.^29,30 In addition to local initiatives, nonprofit hospitals are also participating in broader efforts to improve health outcomes. For example, Vermont has been working steadily to reform its health care system by turning it into a “pay-for-population health system.”³¹ Vermont’s efforts rely on the convergence of several different factors, which include implementing and strengthening Patient Centered Medical Homes and Accountable Care Organizations. The successful development of both of these concepts depends in large part on the participation of hospitals. Another example is Community Care of North Carolina (CCNC), which is a program that has been spearheaded by primary care physicians who aim to improve quality, utilization, and cost objectives among North Carolina’s Medicaid population.³² The CCNC works to link all of its patients to medical homes and has forged partnerships with hospitals that help the CCNC connect to communities and provide essential resources.

Alternatively, if the community-benefit activities a hospital engages in are evidence-based and contribute to measurable improvements in health behavior or community environments, then it may be unnecessary to require proof of a causal connection between a specific community-benefit initiative and improved population-health outcomes. In such cases, documentation of the specific community-benefit activities as well as evidence of their effectiveness should be considered sufficient for the purpose of tax exemption. However, given that each hospital’s community-benefit program is unique, the IRS should—as it has always done—use discretion in assessing the adequacy of a hospital’s community-benefit activities given the complexities of existing programs.

FIRST STEP TOWARD AN OUTCOME-BASED APPROACH

In addition to recent amendments to federal nonprofit hospital reporting standards, the ACA established a number of new requirements that nonprofit hospitals must comply with in order to remain tax-exempt.³³ Most importantly, the ACA’s “Additional Requirements for Charitable Hospitals” mandate (§9007 ACA) requires that, starting in 2012, nonprofit hospitals conduct a community-health needs assessment (CHNA) at least once every 3 years. A CHNA is a written document that describes the community served by the hospital and identifies the health needs of the community. As part of their CHNA, hospitals are asked to develop and implement an improvement strategy to address unmet needs identified through the CHNA. In their implementation plans, hospitals are asked both to identify specific activities to be conducted to improve community health and to develop a set of valid and actionable performance measures to ensure accountability.

The requirement that nonprofit hospitals conduct regular CHNAs and implement community-health improvement plans will compel such institutions to evaluate community-health needs and the impact of their community-benefit activities on the health of the communities they serve. Evaluating changes in population health outcomes from one community-health needs assessment to the next could provide some of the information needed for an outcome-based assessment of hospitals’ community-benefit activities and thus be a first step toward a modified approach to nonprofit hospital tax exemption. In this way, the new requirement may represent a first step toward an outcome-based approach to nonprofit hospital tax exemption.

To implement this new approach, the Federal Government, via the IRS, could integrate population-health outcome measures into its current process for determining nonprofit hospital tax exemptions under section 501(c)(3) of the tax code. Specifically, the IRS could assess hospitals’ contribution to the health of their communities by noting the improvements in the population-health performance measures that hospitals specified in their implementation plans. Similarly, depending on their particular legal framework, state governments could integrate outcome-based measurements into their tax exemption determinations either administratively via a state revenue agency or legislatively through either new state or local laws. State tax assessors could thereby promulgate new standards for exemptions from state income and local property taxes.

Developing effective community-benefit programs that are responsive to the health needs of the community and aimed at improving community-health outcomes will become increasingly important for hospitals in the future. Beyond the additional community-benefit requirements mandated by the ACA, the new health reform law mandates significant changes to the way health care will be delivered and paid for. In particular, the move toward bundled or even population-based provider-reimbursement systems, as exemplified in the rules and regulations governing Patient Centered Medical Homes and Accountable Care Organizations,³⁴ will provide additional incentives for hospitals to establish community-benefit programs that promote health in the community and reduce the need for and use of expensive hospital services, for which hospitals may no longer be reimbursed separately. Adopting an outcome-based population-health approach to community-benefit planning will thus serve hospitals well in the long run, and not only for the purpose of maintaining their tax exemptions.