Larger nonprofit hospitals and health systems are using their low-interest debt to indirectly offset billions of nontaxable investments, giving this portion of the hospital market a competitive advantage over their smaller or for-profit peers, researchers wrote in an analysis published Monday.
Such practices, referred to as indirect tax arbitrage, generated nonprofit hospitals and health systems an estimated of $9.4 billion in profit during 2022, accounting and policy researchers found.
About $2.9 billion of that return (investment assets above debt costs) was generated by the largest 1% of nonprofits—23 organizations out of more than 2,200 nationwide.
The findings, based on annual IRS tax filings showing a decade of rising investment portfolios and more concentrated tax arbitrage among the largest nonprofits, add to prior tallies of the net value of nonprofit hospitals’ tax exemptions, researchers wrote. A study published last year describing a $37.4 billion benefit in 2021, for instance, would increase by about 20% to $44 billion when also considering tax arbitrage alongside the inherent benefit of low-interest debt.
“These findings warrant attention from policymakers concerned with nonprofit hospitals’ taxpayer subsidies,” Elizabeth Plummer of the Neeley School of Business at Texas Christian University, Stephen Lush of the Gatton College of Business and Economics at the University of Kentucky and Ge Bai, Ph.D., of the Johns Hopkins Carey Business School, wrote in the journal Tax Notes Federal. (Bai was also a co-author of last year’s study estimating the tax exemption benefit.)
“The opportunity for tax arbitrage, arising from the privilege of issuing tax-exempt debt and earning tax-free investment returns, is disproportionately concentrated among large nonprofit hospitals. This incentivizes these hospitals to issue tax-exempt debt despite having sufficient investment assets, creating an uneven playing field in the hospital market with implications for hospital consolidation and affordability,” they wrote.
The researchers noted that nonprofits are prohibited from directly using their tax-exempt debt proceeds to buy tax-free investment assets. However, they wrote, no laws on the books keep them from doing so indirectly by using their debt to fund healthcare projects while separately buying and retaining investments.
For their analysis, the researchers reviewed nonprofit hospitals' recorded investment assets and their total tax-exempt debt. Assuming that hospitals’ recorded debt was used to fund projects, they defined each organization’s arbitrage as the amount of debt that could have been eliminated if it instead used recorded investment assets.
In 2022, 2,230 nonprofit hospitals held $447 billion of total investment assets, with $189.3 billion held by the top 1% of hospitals alone (23 hospitals) and $182.5 billion held by the next 9% of hospitals (200 hospitals). Per hospital, the top 1% each held an average of $8.2 billion in total investment assets, the next 9% an average of roughly $900 million and the remainder an average of $40 million.
Total outstanding debt across the hospitals was $178.7 billion, with the top 1% holding $41.9 billion ($1.8 billion each on average), $72 billion for the next 9% ($359.4 million each on average) and the remaining 90% holding $65 billion ($32.3 million each).
Based on those numbers, total arbitrage among the top 1% of nonprofit hospitals was $41.9 billion, $66.9 billion for the next 9% and $25.4 billion for the remainder of hospitals, “meaning that $134.2 billion of tax-exempt debt could be eliminated if hospitals used investment assets to fund projects,” the researchers wrote.
Of the nearly $9.4 billion estimated collective profit from arbitrage—which assumes a 7% return based on the difference between the S&P 500’s annual return since 2012 and hospitals’ average 5% to 6% interest rates—the top 1% of hospitals alone would have generated $2.9 billion in 2022.
Among the nonprofit hospitals for which a decade of filings were available, the analysis also highlighted a substantial rise in total investment assets as well as increasing concentration of arbitrage toward the larger hospitals.
Notably, from 2012 to 2022 among the top 1% of hospitals (19 hospitals), total investment assets grew by 84% to $171.5 billion, by 79% to $166 billion for the next 9% (164 hospitals) and actually declined from $77 billion to $74.5 billion among the remainder. Meanwhile, the percentage of hospitals with any arbitrage amount declined from 46% to 34%, while average arbitrage amount rose from $160 million to a peak of $207 million in 2020 before dipping to $186 million in 2022.
“The largest hospitals are best positioned to take advantage of these strategies because of their large investment portfolios, higher debt ratings and lower debt costs, raising questions about distributional equity of the tax benefits of tax-exempt debt,” the researchers wrote.
Monday’s analysis comes amid scrutiny into nonprofit hospitals’ tax-exempt status and how it may impact market dynamics, such as consolidation and negotiating power. During a House Ways and Means Oversight Subcommittee hearing held last month (in which Bai also participated), witnesses told lawmakers larger nonprofits are well equipped to uncompetitively, but lawfully, exploit requirements like community benefit reporting or Medicare status classifications.
Nonprofit hospitals’ tax exemptions are granted with the expectation that organizations return more benefit to their communities than they receive from their status, thus fueling the debates on how exactly to measure their total benefit. The hospital industry has asserted that such community benefit far outstrips the tax exemption’s value, though critics disagree over what types of hospital spending are appropriate to weigh against the exemption benefits.