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Case No. 2009-2310 DIALYSIS CLINIC, INC.,

Appellant,

V. Oii Appeal i'om the WILLIAM W. WILKINS [RICHARD A. Ohio Board of Tax Appeals, LEVIN], TAX COMMISSIONER OF OHIO, Case No. 2006-V-23 89

Appellee.

APPENDIX TO BRIEF VOL[JME II

RICHARD CORDRAY (0038034) SEAN P. CALLAN* (0062266) Attorney General of Ohio *Counsel ofRecord SETH SCHWARTZ (0080961) SARAH SPARKS HERRON (0083803) RYAN P. O'ROURKE* (0082651) DINSMORE & SIIOHL LhP *Couns•el ofRecord LAWRENCE D. PRATT (0021870) 1900 Chemed Center ALAN P. SCHWEPE (0012676) 225 East Fifth Street Assistant Attorneys General Cincinnati, Ohio 45202 Telephone: (513) 977-8200 Taxation Section 30 East Broad Street, 25th Floor Facsimile: (513) 977-8141 [email protected] Columbus, Ohio 43215 Telephone: (614) 466-5967 Facsiniile: (614) 466-8226 [email protected]

Counsel for Appellant Counsel for Appellee William W. Wilkins [Richard A. Levin], Tax Dialysis Clinic, Inc. Commissioner of Ohio Page 1 6 LEXSEE 37 BC L RBV I

Deeember,1995

37B.C.L.Revl

LENGTH: 27836 words

ARTICL.E: EVOLUTIONARY FORCES: CHANGES IN FOR-PROFIT AND NOT-FOR-PROFIT HEALTH CARE DELIVERY STRUCTURES; A REGENF,RATION OF TAX EXEMPTION STANDARDS *

NAME: Nina J. Crimm **

1310:

** Professor of Law, Director, Project for Socially Responsive Taxation, Center for Law & Public Policy, St. John's tJnivcrsity School of Law; A.B., Washington University (1972); J.D. and M.B.A., Trilane University (1979); L.L.M. in Taxation, Georgetown University Law Center (1982); author of'1'AX COUR'C L1'1'1GATION: PRACTICE AND PROCEDURE (1992 & 1993 eds.). The author would like to acknowledge the support received frotn the Faculty Resew•ch Progrant at St. Jolm's University School of Law, the helpful library assistance of Arundhati A. Satkalmi, Reference Librarian, and the able research assista xe of Amy Bucci, Class of 1997, and Lisa Amt Spero, Class of 1995_

SUMMARY: _.. As far as the IRS and courts are concemed, the conuuunity benefit standard and concepts cnunciated in Revenue Rulings 56-185, 69-545, and 83-157 apply as a starting point to cotrsider whether any freestanding or affiliated health care organization pursuing initial tax-exempt status or seeking to retain tax exemption wider I.R.C. ... Focusing on the IRS's argrunent that qualification as a charitable health care organization under L.R.C. ... As part of its standards, the IRS has not articulated a requirenient that each component (e.g., the medical foundation and the hospital) of a foundation modellDS be considered per se a health care provider. A former IRS official and cun-ent tax practitioner/commentator has expressed the opirrion that a medical foundation in a foundation model IDS should be considered a health care provider. ... The IRS does not view an MSO as a health care provider, but rather as a health care arranger or facilitator.... Because the IRS does not consider an MSO to be a healtlt care provider, it wonld refuse I.R.C. .._ Yet, on a more micro-level, the IRS has tightened certain criteria for detennining whether a health care organization in ttie contemporary health care enviromnent deserves tax-exempt treatntent. ... By cornparison, the IRS defines an IDS as a "healtlt care provider (or one component entity of an affiliated ttetwork of providers) created to integrate the provision of hospital services with professional medical (e.g., ptiysician) services. ...

TEXT: [*541

Appx. 218 Page 2 37 B.C. L. Rev 1, *

[EDITOR'S NOTE: PART 2 OF 2. THIS DOCUMENT FIAS BEEN SPLIT INTO MULTIPLE PARTS ON LEXIS TO ACCOMMODATE ITS LARGE SIZE.] h. Cominunity Benefit Standard Applied to L KC. § 501(c) (3) Health Care Organizations As far as the IRS and courts are concerned, the cotnmunity benefit standard and concepts cnunciated in Revenue Rulings 56-185, 69-545, and 83-157 apply as a starting point to consider whether any freestanding or affiliated health care organization pursuing ittitial tax-exempt status or seeking to retain tax exemption under I.R.C. § 501(c)(3) deserves such tax-exempt treatment. n205 However, as illustrated by GCM39,862, and as indicated in the following discussion of stand alone HMOs, as well as in the later discussion of IpSs, horizontal hospital networks, aud physician-hospital arrangements, the IRS has extended its inquiry beyond the four walls of these revenue rulings when determining whether a health care organization deserves 1. R. C. § 501(c)(3) tax exentpt status. The expanded hrquiry necessitated by an evolving health care envirannient reflects a revival or regeneration of certain concepts leading to a more refined definition of the conmiunity benefit standard. (1) Stand Alone HMOs andI.R.C §,¢ 501(c)(3) and (c)(4) For the most part, contemporary HMOs are for-profit enterprises. As of 1993, approxitnately 180 enjoyed tax- exetnpt status under either LR.C. § 501(c)(3) or (c)(4)_ n206 Of those 11MOs that have been granted [*551 tax-exempt stahts, 130 have been granted tax exemptions as "social welfare" organizations under I.R.C. § 501(c)(4), n207 while fifty IIMOs enjoy the more favorable treatment of tax-exempt "cltat'itable" organizations under LR.C § 501(c)(3). n208 HMOs seeking exemptiott either as I.R.C. ,ys' 501(c)(3) or (c)(4) organizations tnust demonstrate that they satisfy the cotmnunity benefit standard. Although satisfaction of the community benefit standard is a requisite for either type of tax-exetnpt IIMO, the standard appears to be stricter for IIMOs seeking to qualify htitially for or retain I.R. C. § 501(c)(3) tax-exempt status. Assuming that a not-for-profit HMO satisfies the community benefit standard for tax exemption under 1. R.C. § 501(a), it must also satisfy the requirement,s of I.R.C. ,ys 501(rn). To do so, no "substantial part" of the HMO's activities can be "commercial-type insuranee." 1. R.C. § 50I (nu) is untested to date with respect to 1. R.C. § 501(c)(3) HMOs. In 1978, in Sound ifealth Assra v. Comrnissioner, n209 a case of first impressiott, tlte Tax Court was confronted with the issue of whether a not-for-profit HMO qualified for tax exemption as an I.R.C. § 501(c)(3) "charitable" organization. Sound Health Association ("SHA"), had as its primary, but not sole, purpose the provision of health care services to members on a prepaid basis. n210 It served only members wlro could afford to pay a set premium plus a $ 200 capital dues levy. n211 In order to become a member of the I-IMO, an individual was required to pass a physical examination, even if the iudividual belonged to SHA through a group metnbership. n212 SIIA etnployed only two physicians [*56] and was considered a staff model HMO. However, SI-IA physicians were able to refer patients to an SHA "cottResy staff," initially consisting of sixteen physicians, who worked on a fee-for-setvice basis for SIIA but did not exclusively treat', SI-IA patients. n213 Membership on the "courtesy staff' was open to all physicians who applied, and no physicians had been refused privileges. n214 Consistent with a long line of cases and general counsel meinoranda, n215 the IRS argued that SHA provided preferential treatment to members and failed the organizational and exclusive operational requirements. To this ettd, the IRS suggested that SHA was not formed to provide medical services to the community-at-large. 'The IRS further alleged that the HMO failed the community benefit test because it failed to deliver medical services to the eomtntutity-at-large. 7'he Tax Court rejected the IRS's arguments. The coutt indicated that one need not conclude that because an IIMO is a membership organization it necessarily is organized and operated for private benefit rather than public benefit. n216 The court stated, "[The] requirentent that the connnunity tnust benefit from a charity's activities has, as its natural corollary, that private interests must not so benefit in any substantial degrec." n217 Relying on the community benefit standard of [*57] Rcroenue. Ruling 69-545, n2 18 the court concluded that the HMO satisfied the community bene6t test and did not violate the prohibition against excessive private benefit. n219 The court reviewed the factors listed in Revenue Ruling 69-545, assigning the most importance and the g-eatest weight to the comntunity benefited. n220 It considered the potential eligible membership class of the IIMO to be sufficiently broad. In its view, for all practical purposes HMO tnetnbership was open to the entire comtnuttity because the HMO had a subsidized dues program. n221 The court considered a number of other factors: (1) the HMO provided emergency and nonetnergency medical care to individttals unable to pay; n222 (2) the HMO had an open medical staff policy; n223 [*58] (3) the HMO's board of directors was coniposed of prominent citizens of the cotmnunity; n224 and (4) the I IMO offered a public educa-

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tional program. n225 Tltus, for putposes of detertnining whether SHA was a"charitable" health care organization under IR.C. § 501(c)(3), the Tax Comt essentially adopted the factors that the IRS had established as its guidelines for the cotnmmnity benefit standard applicable to hospitals under Revenue Rzrling 69-545. n226 Approximately two years later, the IRS issued General Counsel Memorandum 38,735 ("GCM 38,735"), n227 which relied on Sound Aealth Ass'n and modified another general counsel memorandutn. n228 In GCM 38,735, the IRS conceded that an HMO membership organization such as SIIA may be considered a"charitable" organization tmder I.R.C. § 501(c)(3) if: (1) it has a"treily open" nsensbership program; n229 (2) it directly provides medical services to members and nonmembers, including Medicare and Medicaid patients; (3) it is not actively engaged in providing insurance because its salaried physicians and secondary health care providers are contpensated a fixed amount without vari- ance for the nature or frequency of services perfortned during a contract period; (4) it has an emergency room open to mcinbers and nomnetnbers; n230 (5) it has healtlt research and education programs open to the members and nonmembers; and (6) it has a subsidized dues program. n231 [*59] Several years thereafter, the IRS issued General Counsel Memorandum 39,057 ("GCM 39,057"). n232 That memorandum involved a notfor-profit HMO which proposed to arrattge for health care for prepaid members through an affiliated individual practice association ("IPA"). n233 The IPA would assure availability, accessibility, and continuity of medical care tttrough agreements with an established network of healtli care centers. The IRS compared this HMO to SHA and found it lacking numerous qualities present in SI-IA. n234 Emphasizing that the instant IPA model HMO was not a health care provider but merely an arrartger of health care, the IRS fonnd that it did not satisfy the criteria of Revenzee Ruling 69-545. n235 It concluded that as a health care arranger, rather than a provider, this HMO's operations and activities served substantial private benefits that were not incidental compared tc> the commnnity benefits. n236 Therefore, once again, the IRS firmly had stated its position: for an HMO to be considered a"charitable" organization within the nieanutg of LR.C. § 501 (c) (3), among other things, it must directly provide health care services. The IRS had considered SIIA to be such a provider-type HMO even though it had employed merely two physicians who used ttie HMO facilities to treat enrolleepatients (representative of a staff model HMO) n237 and had contracted on a fee-for-service basis with a "courtesy staff' to provide medical services on a referral basis. In 1990, the IRS issued General Counsel Memorandum 39,828 ("GCM 39,828") as an elaboration on GCM39,057. n238 The IRS listed numerous iniportant features mtder the community benefit standard relevant to HMOs seeking LR.C. § 501(c)(3) status: (1) direct provision [*60] of health care services and maintenance of health care facilities and staff; (2) delivery of services on a fee-for-service basis to nonmembers; (3) inaintenance of a ttuly open em-ollment witltout restrictions, as evidenced by such facts as whether individuals and small groups coinprise a "substantial portion of inenrbership" and whether the HMO has an "overt program" to attract utdividuals as potential enembers; n239 (4) usage of a conmtunity rating system and similarity of rates cltarged to individuals attd gronps; n240 (5) operation of a "tneaningful° subsidized membership program; (6) provision of health education and research programs; (7) operation of an open emergency rootn and cotnmunication to the eoinmunity of its availability; (8) treatment of patients covered by Medicare, Medicaid, and similar programs; (9) payment of health care providers, such as physicians, on a fixed fee basis; and (10) utilization of surplus funds to iniprove facilities, equipment, patient care, and educational programs for the public. The IRS seemed to take the position that certain characteristics, including the direct provision of ltealth care services, truly open enrollment, and the delivery of care through reduced rates to the medically indigent, are mandatory for an HMO to achieve LR.C. § 501 (c) (3) tax-exempt status. n241 More recently, in Gei.singer 1, n242 Geisinger Health Plan ("GHP"), a non-staff tnodel HMO, which the IRS recognized as an LR.C. § 501(c)(4) "social welfare" organizatiou, soughtl:R.C § 507(0)(3) tax-exempt status_ n243 GHP contracted with more than 400 physicians for their services. n244 The Tax Court held in favor of GHP. Using the community benefit standard that it had enunciated in Sound Health [*61] As.s'n n245 and comparing GFIP to SHA, the'fax Court ruled that tite class of possible ntenibers in GFIP is "practically unlimited." n246 The Tax Court found that GHP had no substantial limitation on the class of iodividuals eligible for membership nor on persons eligible for membership in GHP's planned, but unimplemented, dues program. n247 The court supported this decision by reciting the following factors: (I) individuals alone and through groups could enroll for the saine prepaid preinium based on a comnnmity rating system; n248 (2) groups with at least 100 eligible enrollees withio GHP's service area could etuoll without completing a medical histoty questiomtaire, but questionnaires were required of enrollees through smaller groups; n249 (3) Medicare recipients were offered medical services at a reduced rate on a wraparound basis; and (4) the HMO would cover Medicaid patiettts when it reached an agreement with the State for coverage. The Tax Court concluded that the con munity benefited and the prohibition against excessive private benefit was not violated. n250 Fo- cusing on the IRS's argument that qualification as a charitable health care organization under I.R.C. § 501(c)(3) requires

Appx.220 Page 4 37 B.C. L. Rev 1, *

the entity to be a"provider" of inedical services -- which GHP was not, but rather was merely an arranger of health care setvices -- the Tax Court responded, "thc furnishing of inedical care or the operation of a hospital or an HMO is not specifically listed as a qualifying exempt activity under section 501 (c)(3). The provision of medical services nntst therefore fall within the words 'charitable purpose' to be exempt." n251 The court concluded that actual provision of medical services by the HMO is not requircd to qualify, but "it is the purpose toward which an organization's activities are directed that is ultimately dispositive." n2521'he 7'ax Coutt then held that "it is the organization's ability to ensure that adequate health care sei-vices are actually delivered to a sufficieutly large class in the cotmnunity that it serves that is critical." n253 The Third Circuit disagreed with the 1'ax Cotut's holding, but, while insisting on a facts and circumstances analysis, agrae^,'^'^^ u.ut5ounua [*62] I.eaaF: Ass'n, Rcn,er.ue Ruling 69-545, and the revenne ruting's progeny provided appropriate precedents as an analytical starting point_ n254 The appellate court asserted a narrower approach thau the Tax Court in analyzing GHP's purpose and activities. It concluded that GHP, on its own, did not satisfy the community benefrt test. The Third Circuit stated:

GHP cannot say that it provides any health care serviees itself. Nor does it ensure that people who are not GHP subscribers have access to health care or information about health care. According to the record, it neither conducts research nor offers educational programs, much less educational progra ns open to the public. It benefits no one but its subscribers.

... The community benefited is, in fact, limited to those who belong to GHP since tl c requirernent of subscribership remains a condition precedent to any setvice. Absont any additional indicia of a charitable purpose, this self=imposed precondition suggests that GHP is primarily benefithig itself (and, perhaps, secondarily benefiting the community) by protnoting subscribership throughout the areas it serves.

In sum, GHP does not qualify for tax-exempt status under section 501(c)(3) since it does no more than atrange for its subscribers, many of whont are medically underserved, to receive health care services fi-om health care providers.... Arranging for the provision of tnedical services only to those who "belong" is not necessarily charitable, particularly where, as here, the HMO has arranged to subsidize only a small mmnber of such persons. GIIP, standing alone, is not entitled to tax-exempt status under section 501(c)(3). n255

As interpreted by the Third Circuit, the community benefit standard requires that an LR.C. § 501(c)(3) stand alone HMO be an actual provider of healtli care rather than mcrely an arranger or deliverer of health care. The Third Circuit did not articulate a means for differentiating a health care provider from a health care arranger. Reading between the lines of the Third Circuit opinion, it appears that the court may have distinguished the two classifications based on wlrether the [*63] organization employs the physicians actually delivering the rnedical care_ Assunting this distinction, network ntodel HMOs, IPA model HMOs, aud dedicated and ordinary group ntodel HMOs would be precluded from qualifying for tax-exentpt status under LR. C. § 501 (c)(3) on a stand alone basis. n2561n that event, only staff model HMOs would remain capable of obtaining and retaining "charitable" organization status. Although tite Third Circuit niled that GHP was ineligible for I.R.C. § 501(c)(3) status, GHP was left with its previously conferred status as a "social welfare" organization. Neither GHP nor the Coinmissioner hnd questioned on brief or during argument GHP's entitlement to LR.C. § 501(c)(4), and conseqnently the Tax Court and the Third Circuit did not address the issue. (2) Stand Alone HMOs attd LR.C. ,¢ 501(^n) lt appears that as a first step for qualification as a tax-exempt "charitable" organization under LR_C. § 501(c)(3), an HMO must be an actual provider of health care services -- that is, a staff model HMO. Additional ly, its ntetnbership must be truly open to the entire community, as evidenced by all facts and circumstances, An HMO that satisfies these conditions then must overcome another Ittirdle. Pursuant to I.R.C. § 501(rn)(1), "no substautial part" of the activities of an otheitivise qualifying I.R.C. § 501(c)(3) or (c)(4) organization may consist of "providing commercial-type insarauce." n257

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[*64] LR.C. ^ 501(m)(3)(B) provides that "conrmercial-type insurmce" shall not include "incidental health insurance provided by a health maintenance organization of a kind customarily provided by such organization." I.R.C. § 501 (m) was enacted primarily to subject Blue Cross and Blue Shield, previonsly tax-exempt as I.R.C. § 501 (c)(4) "social welfare organizations," to taxation as insurance cotnpanies. n258 The conference comntittee report to the Tax Reforin Act of 1986 indicates tlratLR. C. § 501 (m) is not intended to affect the exemption of any HMO. n259 This seutiment is reiterated in the conf'erence committee report to the '1'echnical and Miscellaneons Revenue Act of 1988. n260 How- ever, as commentators have pointed out, the statutory language is ambiguous beeanse LR.C. § 501 (m)(3)(B) appears superfluous to LR.C. § 501 (rn)(1). n261

The IRS's own pronouncements have indicated eonftision as to the effect of LR.C. §§ 501(m)(1) and (m)(3) on the tax-exempt status [*65] of HMOs. In 1968, the IRS issued Revenue Ruling 68-27, which htdicated that a staff model IIMO would not be considered an "insurance contpany" because it provided preventive health care, which did not involve insurance risk but merely businress risk. n2621'hereafter, in a release purpo tedly involving Geisinger Health Plau, the IRS took the position that a non-staff model HMO was not eutitled to LRC. § 501(c)(3) status because it engaged in substantial activities as a comtnercial-type insurance company in violation of LR.C. § 501 (m). n263 More recently, the IRS issued General Cozunsel Mernorandum 39,829 ("GCM 39,829"), n264 to amplity and clarify GCM 39,828. GCIoP 39,828 presented the IRS's legal approach for deterrnining under LR.C. § 501(rn) whether an LR.C. § 501(c)(4) HMO engages in "commercial-type insurance" atrd whether the HMO at issue provided more than inicidental health insurance of the kind customarily provided by I-IMOs_ The HMO in GCM 39,829 was a not-for-profit IPA model HMO that was considered tax-exempt under LR.C. § 501(c)(4)_ It was not a point-of-service plan nor an open-ended HMO, and members were locked into care tlirough the HMO's affiliated providers so that nonemergency treatment could not be obtaiued outside the f IMO's providers. The IRS did not wholly rely on Revenue Ruling 68-27_ n265 Instead, it also reviewed general counsel nientoranda, n266 cases, n267 and legislative histoty n268 in its attentpt to deterrnine whether the principal activity of modern HMOs is the provision of healtlt care or the provision of commercial-type insurance.

[*66] The IRS took a facts and circumstances approach in GCM 39,829. It reviewed the following factors witlt respect to the IIMO at issue: (1) whether the IIMO transferred and distributed an insurance risk; (2) whether the IIMO operated in a manner simIlar to for-profit insurers or Blue Cross and Blue Shield; (3) wltether the IIMO tnarketed a product similar to for-profit insurers or Blue Cross and Blue Shield; (4) wliether the HMO provided health care services directly to patients; and (5) whether the IIMO shifted any risk of loss to service providers through salary or fixed-fee arrangements. The IRS concluded that regardless of the model-type label attached to an I.R.C. § 501(c)(4) HMO, if the HMO compensates some primary care physicians exclusively on a salary, capitation, or other fixed fee basis, it is considered to be principally a health care provider and to pt'ovide insnrance only incidentally. This last attr'ibute brings the HMO within the exception of L R.C. § 501(m)(3)(B). Heuce, even if the HMO pays additional health care providers on a fee-for-service basis, under GCM 39,829, it is deemed not disqualified from tax-exempt treatment by virtue of LR.C. § 501(m)(1). n269 In the instant case, the IPA model HMO qualified under the stated criteria for I.R.C § 501(c)(4) tseatnient and was not disqualified by LR.C. §501(m). (3) HMO Summary In snmmary, there is considerable confasion and variation in the b-eatnrent of stand alone not-for-profit HMOs. The clear message of GCM 39,829 is thatl.R. C. § 501(c)(4) staff and non-staff niodel IIIv1Os that compensate a number of primaty care physicians on a salary, capitation, or other fixed fee basis are considered medical service providers and not cominercial-type insurers for pttrposes of1.R.C. § 501(m). Consequently, such LR.C. § 501(c)(4) HMOs can qualify for tax-exempt treatment turder I]tC_ § 501 (a). n270 By contrast, in Geisinger 1, the Third Circuit held tfrat GHP, as a stand alone IPA model IIMO, did not qualify for LRC § 501(c)(3) treatment because it did not directly provide health care services. n271 Therefore, as a first step, to qualify as a "charitable" health care organization witlrin the meaning ofl.R. C. § 501(c)(3), the coinmunity benefit standard requires an HMO to satisfy health care [*67] provider status. n272 It appears that only staff model nonprofit HMOs will so qualify. n273

As a second step for tax exernption under LR. C. § 501(a), pursuant to I. R. C. § 501(m), an L R. C. § 501(c)(3) HMO must prove that "no substantial part" of its activities consists of "comtnercial-type insurance." The question arises as to whether this determination is superfluons because under the connnunity benefit standard, an LR.C. § 501(c)(3) HMO must have already proved that it was a health care provider. n274 Although utitested to date, it seems unlikely that such an H MO would again need to demonstrate that it is a Itealtlt care provider in the context of LR.C. § 501(m). How-

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ever, if the HMO were required to do so, it is unclear whether the standard would be the same as that for demonstrating compliance under the community benefit test for "charitable" organization status. What does appear clear is that under 1.R. C. § 501 (m) such an LR.C. § 501(c)(3) IIMO would need to prove that no more than atr hicidental portion of its activities are insurance related and that any insurance activities are of the kind common to all I-IMOs. In conclusion, not-for-profit stand alone staff model and non-staff tnodel HMOs migltt still enjoy the potential of qualifying for tax-exetnpt status under LR.C. § 501 (c)(4). By contrast, assuming incidental hcalth insurance activities of a type common to HMOs, not-for-pro6t staff model 11v1Os are the only type of stand alone HMO with the opportunity to qualify under I.R.C. § 507(c)(3)_ Of course, even these staff tnodel stand alonc HMOs must satisfy the LR.C. § 501(c)(3) public policy doctrine and the prohibitions against private inurement and excessive private benefit. C. Prohiliition Against Private fnurement

J.R.C. §§ 507(c)(3) and (c)(4) contain a prohibition againtst private inurement. n275 This proscription is intended to ensure that an organization's funds are dedicated to its exempt activities by forbidding individuals "in a position to do so fi-om siphoning off any ... income or assets for personal use" or benefit. n276 The aim is to prevent [*681 distributions of charitable assets in any forin by tetvzs that would not be considered arms length and would not be identical to ordinary business practices -- such as payment in excess of fair market value of assets purchased or payment of tnore than reasonable compensation -- with respect to persons having an opportunity to control or influence the organization's activities. n277 Therefore, the prohibition applies to "insiders" having a personal or private interest in the organization. n278 It is clear from the intent of the private inurement prohibition that directors and officers of a not-for-profit organization will be considered insiders. n279 The Office of General Counsel of the IRS has taken a broad view, and in the context of not-for-profit hospitals, it consistently has regarded a] l physicians on a hospital's medical staff as "insiders," n280 eveu if they are not employed by the hospital but have a close professional working relationship with the hospital. n281 Because the proscription is an absolute prohibition with tto existing dc minimis exception and the exclusive sanction for its violation is revocation of tax-exempt status, this statutory prohibition is formidable. n282 [*69] It may be eluded only by the cotnplete absence of private beuefit. n283 As explained by the Tax Court, the prohibition against private inurement shares conimon and overlapping elements with the prohibition against excessive private benefit, n284 Private irturement and private benefit must be evaluated utdependently. The presence of private inurement violates both the proscription aganist excessive private benefit and private inurement, n285 The absence of private inurentent however, does not tnean that private benefit can go uuevalu- ated. n286 In fact, private beuefit cau exist without private inurement, n287 D. Prohibition Against F,xcessive Private $enefit The statutoty prohibition agaiust excessive private benefit applies to prevent the tax-exempt organiaation from being organized or operated primarily for the benefit of a small, identifiable group of individuals. The group of individuals is not limited to °insiders," but can include unafftliated "outsiders" as well. Tlnis, the intent of the prohibition is to assure that the tax-exempt organization is operated for public, and not private, purposes_ Unlike the absolute prohibition against private inurement, de minimis private benefit is tolerated. If private benefit exists, it tnust be uicidental to public benefit in both a qualitative and a quantitative [*70] sense, n288 To be considered qualitatively incidental, a private benefit must oceur as a necessary concomitant -- that is, natural, ind'n•ect, or unin- tentional -- to the activity that benefits the public at large. n289 To be classified as quantitatively utcidental, the benefit inust be insubstantial when compared to the public bene6t that arises from the activity. n290 Ttnis, the two-prong test balances the private betiefit resulting &otn a particular activity agantst the public bettefit accniing from that same activity. n291

Similar to the prohibition against private inurement, the sole sanction for violation of the private benefit standard is revocation of an organization's tax-exempt status. In recent years, the issues of private inuretnent and private benefit in the health care setting have arisen pritnarily in the context of hospital-physician joint ventures, physician retention and recruitment, and heatth care provider networks, including the formation of IDSs as well as reorganizations of Itospitul networks. n292 The IRS has taken the position that some aniount of private benefit is present in "all typical hospital- physician relationships." n293

1. IIospital-Physician Joutt Ventures

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Jouit venture an'angements between tax-excmpt hospitals and physicians are highly suspect. n294 In detennining wliether a hospital's [*71] participatiott in a joint venture shottld jeopardize its exemption, the IRS considers four questions: (I) How are the hospital's tax-exempt purposes futlhered by the arrangement? n295 (2) ls any private benefit received by the persons involved in the joint venture merely incidental to the tax-exempt purposes of the tax-exempt orgattizaflon? (3) Do any assets of the tax-exempt organization httn'e to tlte private beneftt of any insider? and (4) Is any pablic policy violated as a result of the arrangement? n296

Focusing on the prohibitions against private inurement and excessive private benefit, GCM39,862 is perhaps the ntost infamous of the IRS releases applicable to physician-hospital joint ventures. n297 In that general counsel memorandum, the IRS reconsidered and reversed the position it took in tluee previously issned private letter rulings. n298 Each situation involved the transfer of a hospital department or laboratoty, snch as an otupatient surgical unit or gerstro- enterology laboratoty, to a joint venttue organization formed by the hospital and staff physician-investors. The IRS took the position that the tax-exempt status of the hospital would be jeopardized if the hospital transferred or sold the future net incotne streatn of its department or laboratory to tlte joint veuture organization. n299 This stance was based on tlte prohibitions against private inurement and excessive private benefit. n300 [*72] The IRS noted that where a hospital retains ownership of property, it operates the property, and it shares its net profits fronl designated exempt activities with staff pltysicians, the venture displays attributes of a "shell type arrangement." n301 The IRS concluded that ttte arrangements described in GCM39,862 were shell type aiTangetnents and would confer "direct and substantial" private benefit on the physicianinvestor "insiders" by the joint venture's receipt of net revenue streanss of the hospital's department or laboratory_ n302 If "for any reason these benefits should be found not to constitute inurement, they nonetlie- Iess would exceed the tolerable bounds ofprohibited private benefit." n303

After the release of GCM 3Q862, the issue arose as to whether a tax-exeinpt hospital's sale of the future gross revenue stream from an outpatient surgical unit to a joint venture with staff physician-investors would threaten its tax- exentpt status under LR. C. § 501(c)(3). n304 Based on GCM39,862 and its reasoning, the IRS ruled in the affirmative. The IRS was unpersuaded by the joint venturers' assertions that the formation of the arrangement was necessary to stave off competitors and therefore should not jeopardize the exemption. n305 Recently, the fortnation of hospital-physician joint ventures that threaten the tax-exempt status of a hospital have abated to a large degree. On the other ltand, issues of private inurement and private benefit have inereased in the context of pliysician retention and recniitinent.

2. Physician Retention and Recruitment

For years, hospitals have competed for physicians and have attemptedto lure and hire staffphysicians by offering incentives. A 1969 reveuue ruling provided a framework for contesting subsequent compensation arrangements between hospitals aud physiciaus. n306 The ruling [*73] involved a compensation package offered by a hospital to a staff radiologist. n307 Ptvsuant to the arrangement, the radiologist would receive a flxed percentage of gross billings of the radiology division_ 1'he IRS found that the radiologist's overall compensation was reasonable in tenus of responsibilities and activities assumed by the physician under the contract. n308 Moreover, the physician did not control the organization and the contract was negotiated at anns length. n309 'I'he IRS found no private inurement. n3 10

In 1986, the IRS issued General Counsel Memorandum 39,498, which addressed whether the tax-exempt status of a hospital would be jeopardized by a physician recruitment incentive program that guaranteed a niinin um annual income for several years without a co-existing obligation by a recipient physiciau to repay the subsidies after the contract period. n311 As part of the arrangement, a physician could be required to perform signifieant setvices for the hospital, including emergency room duties. n312 The IR,S took the legal positiort that a recruit who became an employee of the hospital or who merely had a close professinnal working relationsltip would be considered an "insider." n313 The IRS accorded great significance to the parties' faiture to cap the guaranteed annual payments that cotdd be ntade to a recntit. n314 It reasoned that the physicians had potential to gain substantial economic benefit in excess of reasonable cornpen- satoryamounts. n315 The total sums possible under the program miglit not qnantitatively be incidental when compared to the hospital's attentpt to further the pronto8on of health care, n316 Therefore, because such uni-estrieted income subsidies could violate ttte I.R.C § 501(c)(3) prohibitions against private [*74] inurement and excessive private benefit, the IRS concludcd that such recruitment programs would jeopardize the tax-exempt status of a hospital. 1017 Over the past several years, physician incentive arrangements have proved a"hot bed" of controversy. In December 1994, Iienuann I-Iospital, threatened by a withdrawal of its tax-exenipt status, entered intu a clos9ng agreement with the IRS. n318 The closing agreemcnt addressed corrective actions to be iuitiated by the hospital with respect to transac-

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tions conducted over a four-year period. n319 In a rather unusual step, the IRS disclosed the elosing agreement and suggested that pending the issuance of foinial gaidelines on physiciaii recniltment and incentive packages, the closing agreement demonstrates one practical application of IRS policy on physician recniitment. n320 Although the guidelines of the Hcrmann Hospital Closing Agreement are fact-specific and the agreement is not all-encompassing, n321 it indicates an IRS stance with respect to the recruitinent of physicians wlto maintain private packages. 'I'he closing agreement delineates pennissible and impermissible recruitment incentives with respect to attracting a physician from outside the hospital's community. It imposes a requirement that incentives not be conditioned on a physician's admitting or referring patients to the hospital, on restrictions regarding staff privileges at the hospital, or on req- uisites associated with the physician's treatment or admission of patients to another hospital. The closing agreement eiliiiIlerat'Ss aiiditii7nai dtities, at ieast one

1. Bob Jones University v. United States In 1983, hi the context of education, the Supreme Court articulated the comtnunity benefit standard in eonjunction with a prohibition against the violation of law and public policy. n330 In a sweeping stateinent, the majority opinion, delivered by Chief Justice Burger, stated in Bob Jones University v. United States_

Charitable exemptions are justified on the basis that the exempt entity confers a public benefit -- a benefit which the society or the comrnunity may not itsclf choose or be able to provide, or which supplements and advances the work of public institutions already suppoited by tax revenues.... An institution must fall within a category specified in [I.R.C. § 501(c)(3)] and must demonstrably serve and be in harmony with the public interest. The institution's purpose must not be so at odds with the common commuuity conscience as to undertnine any public benefit that might otherwise be conferred. We are bound to approach these questions with full awareness that deterntinations of public benefit and public policy are sensitive matters with serious implications for the institutions affected; a declaration that a given institution is not "cliai-itable" should be tnade only where there can be no doubt that the activity involved is contraty to a fundaniental public policy. 031

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Applyhtg the critical elements of the passage and other language throughout the majority opinion, it is clear that to be considered a tax-exempt charitable organization, the entity's purposes and activities must ( 1) comport with fundamental public policy and (2) be deerned to eottfer commnnity benefit, which the Court referred to as "pt blic benefit." n332 However, it is not entirely clear froin the [*77] opinion whether the public policy doctrnte merely is one prong of the operational exclusivity test and thus subsumed within the deteivriuation of satisfaction of one of the eight perinissible classifications of I.R.C. § 507(c)(3) organizations -- that is, charitable, educational, scientific, etc. - or whether it is a wholly separate requirement added by judicial gloss to LR.C. § 501(c)(3). n333 In other words, the majority opinion is not clear as to whetlier the public policy doch'ine is an independent test or is a factor that must be satisfied for an or- ., ga7IIZaiiOn to be i,03-SiuerBU ,CuailtaJie witiffii ifle I,Ieaning ui the SfaiuiC. f}'uo4^,,tonC it5 Dpiiii0il, iue iaYUTI appe$i'S [*78] to indiscrinrinately and intelmittently mix the various standards and requiretnents. n334 Regardless of onc's reading, the majority opinion in Bob Jones University, which tlpheld the denial of tax exetnption to a religious school that practiced racial discrimination, certainly is sufficiently broad to iinpact not only educational institutions, but also all I.R.C. §507(c)(3) organizations. n335 Viewed in this way, the Supreme Cotut decision would broaden the judicially sanctioned standards to include a public policy element wlten detennining a not-for-ptnfit health care organization's qualification for tax-exempt status.

2. Public Policy Doctrine and Medicare/Medicaid Anti-Kickback Rules In 1972, Congress enacted the first version of the Medicare fraud and abuse rules, known popularly as the Medicare anti-kickback statute. n336 After nutnerous amendtnents, n337 the statutes currently prohibit [*79] a healtll care provider froin knowingly and willfully offering, soliciting, paying, or receiving remuneratiott, wliether in cash or in kind, in return for or to induce the referral of a patient for any service for which Medicare or Medicaid tnight pay. n338 Congress amended the Medicare statutes in 1989 and 1993 in an effort to prohibit physician "self referral." n339 Pursuant to the amended provisions, a physician is now also forbidden from making referrals for certain Medicaid- reimbursed services to entities in which the physician has a prohibited financial relationship n340 -- that is, a financial interest in clinical laboratory services, physical and occttpational tlierapy, radiology and diagnostic services, durable medical equipment, prosthetics, honte ltealth services, prescription drugs, and inpatient and outpatient hospital services reimbursed by Medicare or Medicaid. n341 The enforcing administrative agency, the Office ofInspector General ("OIG") of Health and Human Services ("HHS") has iitterpreted the fraud and anti-kickback laws broadly, so that a violation occurs if a health care provider intentionally arranges to offer financial incentives for referrals. However, more than ten safe harbors to the anti- kickback ntles cutTently exist underIIIIS regulations. n342 T'hese anti-kickback [*80] safe harbors involve investment interests and joitit venture arrangements, n343 space and equipment rental, n344 personal service and manage- mont contracts, n345 sale of a practice (emrently pertnitted only if the sale is to another practitioner, rather than to a hospital or other entity), n346 referral services, n347 warranties and discounts, n348 payments to employees, n349 group purchasing organizations, n350 and waivers of co-insurance or deductibles (currently permitted exclusively by hospitals). n351 Similarly, several exceptions exist to the physician self-referral rttles. n352

3. Public Policy Doctrine and Anti-Dumping Standards As previously ntentioned in part II.B.3, n353 dttring t11e late 1970s and early 1980s, there were continuous allega- tions of "patient dunlping" [*81] by liospitals -- that is, the transfer of indigent patients, generally the sickest and most costly of patients, to other hospitals, usually public hospitals, before treatment. To contend with the problem, in 1985, Congress enacted anti-dutnping laws that require all hospitals participating in Medicare (which includes almost all hospitals) to accept nonpaying patients in their ernergency rooms (if they have emergency roonrs) to the extent of their ca- pabilities, and all hospitals with Medicaid agreements to admit Medicaid patients withottt discrimination. n354 'I'hese laws are designed to extend certain limited protections to persons unable to pay for hospitalization and health care without the assistauce of a federal progranr. The anti-dumping rules require that a hospital provide patients with a medical screening examination and stabilize the patient before transfer by appropriate means to anotlrer uistitution. Sanctions for violation of the statute include, but are not liinited to, civil pecuniary penalties and suspension or termination of an of- fending hospital's Medicare provider status. n355

4. Pnblic Policy Doctrine and the IRS

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The IRS has clearly signaled tttat the public policy doctrine dictates that a cliaritable hospital deserves exemption from tax only if it coniplies with the Medicare/Medicaid anti-dumping, fraud, attd antikickback rules. n356 Although in the past IRS and IIHS interpretations occasionally have differed as to acts and arrangements that may be considered to violate public policy, n357 the two agencies' concems are converging, and the agencies are attempting to coordinate enforcement effotts. n358 Evolution of the IRS's attitude is notable with respect to joint ventures and other arrangements between physicians and hospitals. [*82] For example, in the late 1980s, one typical joint venture at-rangement between anot-for-profit bospital or its subsidiary and physiciatts on the hospital staff would be stntctured as a sale of the hospital department's or service's gross or net revenue stream to a pat-tnership consisting of ttte hospital and physicians. The departnrent or service, such as an outpatient snrgical unit, would con+.inue to be owned and operated by the hr,spitaL However, after the sale, through their partnership interests, the physicians could personally profit from increased referrals and patient utilization of the facilities. n359 For a number of years, the IRS ruled that such joint ventures and partnership anaugetnents would not jeopardize the tax-exempt statns of the hospital partner. n360 However, in 1991, the IRS changed its position. In late 1991, in GCM39,862, the IRS reexamined three previously isstied private letter ndings involving a hospital's sale of the net revenue stream from its outpatient sttrgical unit to a joint venture between the ltospital and physicians on its staff n361 The IRS reconsidered its position taken in those tulings and, contrary to its earlier position, determined that such arrangements do jeopardize a hospital's tax-exempt status. n362 This conclusion was based on the violation by the joint venuire aiTangements of the three tests of I.R.C. § 501(c)(3): the prohibition agantst private inurement, the prohibition against excessive private benefit, and the public policy doctrine. Focusing on the public policy test, the IRS concentrated on whetlter the joint venture arrangements breached the Medicare/Medicaid anti-kickback rules. n363 The IRS first noted that not all physician-hospital joint venttues and hospital atrangements would violate tlte Medicare/Medicaid statute_ n364 [*83] After finding that the atrangements questioned in GCM39,862 did not fall within any of the statutory safe harbors, the IRS determined that these johst venture arrangements contauted abusive and illegal features that the 01G had highlighted in its Special Fraud Alert -- Joint Venlure Arrangements. n365 It enunclated a guiding principle: "Where participating in a joint venture does not demonstrably further the hospital's exempt purposes in sonte legitimate manner, the Service ought not rule favorably on the anaugement" n366 In the tnetnorandum, the IRS examhted the joint ventures to determine whether they fiu-thered the hospital hi a legitimate manner and fotutd that they were "no more than a sham" because of the "total absence of any valid business purpose or activity." n367 It concluded: "We believe that engaging in conduct or atrangements that violate the auti-kickback statute is inconsistent with continued exemption as a charitable hospital.... No matter how economically rewarding, such activities cannot be viewed as fur- tliering exempt purposes." n368 The IRS has been uilndful of the Medicare/Medicaid fraud and anti-kickback niles in the context of hospitals' purchases of physicians' practices. n369 A potential probleni may arise where a not-for-profit hospital purchases a physician's practice or a group practice and the physician(s) continue practicing medicine. If the form and amount of the payment made to the physicians suggest an intention to induce or reward the referral of business, the disguised payment may violate the anti-kickback ntles. n370 More recently, the IRS voiced in Announcement 95-25 n371 its coneern over the Medicare/Medicaid auti- kickback rules in the context of physician recruitment by hospitals_ n372 It clearly stated its position: when [*84] a hospital is adjudicated guilty of knowingly aud willfully violating the Medicare/Medicaid anti-kickback statute by providing recruitment inceutives that eonstitute paytnents for referrals, the hospital will fail to be recognized as fiirthering charitable purposes if such activities are substantial. n373

5. Currettt Relationship Between the IRS and HHS The IRS has ackttowledged that, althouglt the tax and health laws are different, the concerns of the IRS and IIHS overlap to some extent, and infoniiation on potential violations of the Medicare/Medicaid laws and IIFIS regulations should be shared. n374 "I'he significance of GCM 39,862 and Announcement 95-25 extends well beyond the strict scrutiny of hospital-physician joint ventures and physician recruittnent practices. They provide a benchmark for the IRS's position on the prohibitions agahtst private inurement and excessive private benefit. n375 Both pronouncements are a formal rccognition that all health care organizations, including those forming an IDS or hospital network, must contply with Medicare and Medicaid laws to satisfy the public policy doctrine. Absent cotnpliance, initial qualification or reten-

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tion of tax-exempt status under I.R.C. § 501(c)(3) would be denied to any component organ3zation of an IDS or hospital network. n376

F. LR.C. §501(c)(3) Ta.x-Ezenpt Tests and Standards Applied to Health Care Networks

1. In General

In comparison to the declining nutnber of freestanding hospitals, n377 the health care sector continues to experience the formation [*85] and growth of horizontal liospital networks and IDSs. n378 This expansion has been the result of many factors, including efforts to reduce hospital overcapacity, to increase efficiency, and to fiunish comprehensive health care benefits to patients under managed care plans. The degree aud type of uttegration of these assorted networks varies geeatly,Regional xnetworks othoitzontaiiy attiuarea . .. tiospriatslomea . . . under. contrachtat an-ahgements or joint ventures to offer medical services are increasingly popular. Vertically integrated IDS tnodels range fiom partially inte.grated systems, such as the managentent services organization ("MSO") model to a total integration model -- that is, a snigle entity IDS composed of merged groups of hospitals, physicians, and possibly HMOs, offering health care services. n379 In some states, such as Texas, Califomia, Wisconsin, and Petmsylvania, laws prohibit the corporate practice of tnedicine, and therefore do not allow hospitals or other corporations to employ physicians or directly provide physician services. n380 Yet, even in those states, IDSs have appeared in the form of the foundation model. Under the foundation tnodel IDS, a hospital establishes a not-for-profit corporation (the medical foundation). The inedical foundation purchases the medical practice of a group or groups of physicians, including the medical practice's tangible and intangible assets. The medical formdation contracts with the physician group(s) for the delivery of mcdical services to the foundation's patients_ n381

Regardless of the structure of the network and of whether the structure is achieved by merger or sorne otlter fortn of reorganization, n382 it is critical to focus on (1) whether an affiliated entity initially [*86] seeking tax-exempt status under LR.C. § 501(c)(3) qualifies on its own accord or as an "integral part" of the network, and (2) wlietlter a consolidation or otherwise reorganized structure of affiliated entities jeopardizes the existing tax-exempt status of any of the entities. In large part, that determination hinges on satisfaction of the cotntntmity benefit standard as well as the prohibitions against private inurement and excessive private benefit. n383

2. Tax Exemption of Foundation in Foundation Model IDS a. In General In the formation and operation of a foundation model IDS, n384 a major focus is whether the corporate medical foundation deserves [*87] LR.C. § 501(c)(3) stahts. In tnaking this detetmination, the IRS scrutinizes the foundation and the system as a whole, includ'nig the foundation, affiliated hospital.s, clinics, or other health care providers. n385 Cornpliance with the cotnmunity benefit test of Revenue Ruling 69-545, as expanded by IRS rulittgs and other pronouncements, is essential. n386 The IRS recoguizes that integration of hospital and physician services will result naturally from fonuation of the IDS and will be of general benefit to the cotntnunity. n387 For example, integration of patient records and information systeins helps to eliminate duplication of tests, procedures, and treatments, which will result in increased efficiencies, enhancentent of a health care organization's ftnancial health, and a reduction in health care costs to the conmtunity. However, the IRS considers such increased efficiencies and enhanceenent of an instint- tion's finances alone as insuff-icient for satisfaction of the connnunity benefit standard. n388 Fulflilment of the rules regarding protiibitions against private inurement and excessive private benefit is crucial, with the IRS largely focusing on the physician composition of the foundation's goveming boards. n389 The IRS has set fmth separate exemption criteria for the formation and for the operation of a foundation tnodel IDS. n390 As part of its standards, the IRS has not articulated a requirentent that each component (e.g., the tnedical foundation and the hospital) of a foimdation [*88] model IDS be considered per sea heatth care provider. n391 A former 1RS official and eurrent tax practitionerlcommentator has expressed the opinion that a medical foundation in a foundation model IDS should be considered a bealth care provider. n392 He acknowledges that the medical fnundatiou does not directly employ, but rather contracts witlt the physicians that treat its patients, n393 Nonetlieless, he argues for provider status based on the underlying reasons for the formation of a medical fomidation -- that is, under laws of certain states, n394 a non-profit corporation such as a hospital cannot directly empioy pltysicians and the medical foundation "is hitended to serve as a provider of medical care and not sitnply as a facilitator or arranger of care." n395 By contrast, in specific reference to the Facey Foundation, n396 two other commentators have characterized the role of the medical foundation in fimctional terms that essentially describe it as a facilitator: "[It] . . . facilitate[s] through assets

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purchased and contractttal arrangements with third parties, the delivery of inpatient, outpatient and other necessary services to patients/enrollees of [its related] hospitals and managed care programs." n397 As these contrasting views demonstrate, the debate remains unresolved.

b. Formation

The primary IRS criteria for formation of a foundation model IDS include: n398 (1) a demonstration of fair inar- ket valuation purchases of physiciaus' assets -- that is, proof that the hospital pays no more tltan fair market value for the inedical group's tangible and intangible assets; (2) a govetiting board representative of the community and [*89] composed of no more than twenty percent physicians; n399 (3) evidence that the Medicare and Medicaid fraud and anti- abuse rules are not violated; (4) proof that the cotnpensation agreement with the tnedical group is negotiated at arms- length (preferably by an independent board without physiciait representation) and does not provide more than incidental private benefit; and (5) evidence that any covenant not to compete is natrow in geographic scope and time duration. Furthermore, the IRS has noted that it is ntore inclined to recognize a medical foundation as tax-exenipt under LR.C. § 501(c)(3) if it acquires the inedieal group's assets ontright rather than pursuant to a lease or license asangernent. n400

c. Operation

With respect to the operations of a foundation model IDS, the IRS places primaty emphasis ou: (1) the maintenance of open medical staffs by affiliated hospitals (open medical staffs are not required of affiliated clittics); n401 (2) the formation of the foundation's governing board, with board mentbership broadly representing the community and consisting of no more than twenty percent physicians or other interested parties; n402 (3) the establishment of fee committees to set [*90] payment amounts for medical services, with independent rnembetsltip subordinate to the authority of the foundation's goventing board; n403 (4) the organizatiott of a separate comntittee to negotiate physician compensation, with menibership void of physician representation; n404 (5) the provision of medical education and research; n405 (6) a demonstration that the system increases accessibility to treattnent by Medicare and Medicaid patients and treats such patients on a nondiscriminatory basis; n406 and (7) evidence that hospitals or clinics maintain att open einergency room policy and treat patients regardless of their ability to pay, n407

In several private letter ntlings, the IRS has taken a clear position that charity care is an essential component of tlte community benefit standard to be applied to foundation tnodel IDSs. n408 In comparing [*91] fi-eestand'n g hospitals, the IRS has enunciated the rule that in "Snost cases, an IDS will have to go well beyond meethig the ltospital [open emergency rooin and Medicare nondiscrimination factors] standard to detnonstrate sufficient cormntutity benefit, especially in its outpatient or clinic settings." n409

3. Tax Exemption of an Affiliated Health Care Provider in a Foundation Model IDS: The Role of the integral Part Doc- trine

An affiliated not-for-profit health care provider organization, such as a hospital, clinic, or HMO may seek I.R.C. § 501(c)(3) status on a stand alone basis. n410 Absent the ability of such an organization to so qualify, it may pursue tax- exempt status as an integral partof the IDS or network. n411 This double attempt for LR.C. § 507(c)(3) status is the route recently ventured by GHP, a not-for-profit corporation owning and operating an HMO. n412

After the Third Circuit reversecl the Tax Comt and denied I.R.C. § 501(c)(3) tax-exempt status to GHP on a stand alone basis in Geisinger I, n413 GHP sought I.R.C. ,¢ 501(c)(3) status as an "uttegral part" of the Geisinger System of Pennsylvania healtlt care organizations. n414 Ruling against GHP in Gefsrnger IleaZth Plan v. Comtnissioner, ("Geis- inger If'), 11415 ttte 'rax Court reviewed its perception of the integral part doctrine. Stating that the integral palt doc- trute is not codified, the court relied on Preaszny Regulation section 1.502-1(b), cases, and revenue rulings to define and apply the integral part doctrine to GHP. Essentially, [92] the Tax Court applied a two-prong test to determine whether an organization qualifies for exemption under the integral part doctrine.'I'he'rax Court test asked: (1) whetlter the organization's activities ai-e carried on under thc supervision or control of an exempt affiliated organization; n416 and (2) whether the activities could be regularly carried on by ttte affiliate without constituting an unrelated trade or business. n417

Atthough the Third Circuit affirmed the Tax Coutt's hold'utg against GHP in Geisinger II, it took a somewhat different approach to the integral part doctrine. n418 The cotut acknowledged that structural efficiencies of the health care system might be hampered by its interpretation of the doctrine. n419 Nonetheless, it indicated that a subsidiary n ay qualify for tax-exempt status as an integral part of its L R.C. § 501(c)(3) parettt only if:

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[*93] (i) it is not carrying on a trade or business which would be an unrelated trade or business (tliat is, unrelated to exempt activities) if regularly carried on by the parent, and (ii) its relationship to its parent somehow enhances the subsidiary's own exempt character to the point that, when the boost provided by the parent is added to the contributions made by the subsidiaty itself, the subsidiaty would be entitled to Section 501(c)(3) status. n420

Focusing on whether GHP's affiliation wittt the Geisinger System enhanced GHP's exempt nathire, the Third Circuit found that by virtue of the association, GHP did not serve a broader patient base in the community thah if unafnliated, n421 The court concluded that GIIP failed to receive the requisite boost needed to satisfy the integral part doctrine. n422 Under the available altematives, a non-staff model HMO cither may seek I. R.C. § 501(c)(3) status on a stand alone basis or pursuant to the integral part doctrine. If tax-exempt stams is sougltt on the former basis, the HMO tnust satisfy the connnunity benefit standard on its own accord. However, under current case precedent and IRS interpretations that have not treated non-staff model HMOs as health care providers, n423 attainment of that goal appears unlikely. Absent satisfaction of the eonununity benefit test on a stand alone basis, an HMO affiliated with healtlt care providers would have an opportunity to [*94] qualify vicariously if it could satisfy the two rigorous requirements of the integral part doctrine.

4. Tax Exemption of Management Services Organization ("MSO") in MSO Model IDS

a. In General MSO tnodellDSs are less integrated than fotmdation model IDSs. The MSO is organized typically as a separate for-profit or not-for-profit entity. n424 The IRS does not view an MSO as a healtli care provider, but rather as a health care arranger or facilitator. n425 Through fitnding often provided by an affiliated hospital, the MSO purchases the tangible assets of a medical group. The MSO then turns around and under contract witli the hospital and physicians fiir- nishes for their use real and personal property -- facilities, eqttipment, etc_ -- as well as administrative and management services. n426 The medical group continues to own the medical practice itself (i.e., the intatigible assets), and its physicians directly deliver medical services to patients, n427 Thus, an MSO is essentially a joint venture between a hospital and a physician group; as part of its tnanagement responsibilities, it may assume an insurance type function by monitoring finances and physician performances in the provision of tnanaged care. n428 Although to date, the IRS has not ruled officially on the tax-exempt stants of an MSO under 1 R.C. § 501(c)(3), it has stated tltat an MSO is unlikely to qualify for tax exeniption. n429 The IRS would find [*95] sttppott in the Third Circuit decision in Geisinger I: n430 The court denied I.R.C. § 50I (c)(3) treatment to a non-staff model I-IMO on the grotutd that the HMO was not a health care provider and hence did not satisfy the community benefit test on a stand alone basis. n431 Because the IRS does not consider an MSO to be a lrealtb care provider, it would refuse LR.C § 50I (c)(3) status to an MSO on a stand alone basis. n432

[*96] b. Integral Part Doctrine It is unclear whether an MSO might qualify for I.R.C. § 501(c)(3) status under the hiteg-al part doctrine. As set forth in the Third Circuit's decision in Geisinger 11, the organization must satisfy a two-prong test under the doctrine. First, the organization seeking tax-exempt status must not cany on an unrelated trade or business if it were conducted regularly by the parent organization. The Third Circuit cited as illustrative of this prong an example in 1'reasury regulation section 7.502-1(b), which describes "a subsidiary organization wlnch is operated for the sole purpose of furnishing electric power used by its parent organization, a tax-exetnpt organizadon, in canying out its educational activities." It appears that a hospital-controlled MSO is analogous to the electric power snbsidiary described in the regulations. n433 An MSO functions as a managetnent organization which, under contract, provides management services essential to the contracting hospital and physicians. If a bospital-controlled MSO did not exist as a separate entity, the hospital would provide these essential management [*97] services for itself eitlter as part of its overall administrative finrctions or as a separate division_ Consequently, such an MSO appears to satisfy the "unrelated trade or business prong" of the integral part doctrine if its activities are conducted on a scale not in excess of that reasonably required by its affiliates. n434

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The more problematic second prong of the Third Circuit's integtal part doctritte requires that the subsidiary's relationship to the parent enhance the subsidiary's exempt charitable character to the point that, when the boost provided by the parent is added, it transforms the subsidiary from an organization tutdeserving of tax-favored treatment into onc deserving tax-exempt status. n435 Satisfaction of this prong is uncertaut but appears iniprobable. Although there are major differences, n436 an MSO is not totally dissimilar to GIIP, the nott-staff model I-IIv1O in Geisinger Il. While an IIMO is more directly related to the actual delivery of healtlt care services, both organizations provide management support for health care providers. Like an IIMO, an MSO can assume some degree and form of insurance-type function if it monitors finances and physician performances in their delivery of managed health care. n437 The boost needed, but ttot received by GHP in Gersinger II, aecording to the Third Circuit, would have been an expansion of GHP's existing patient base -- titat is, to expand its charitable activities, GHP would have been required to service more patients or a broader ami ]arger cummunity of paiieriis due io its participaiion in ihe IDS. An MSO would need a sunilar increase in its charitable functions or activities tttrough its aff liation. It is rather difficult to conceive of such a boost because an MSO offers largely managementand administrative services to suppotthospitals and pbysicians; the MSO generally has little relationship to the actual delivery of health care services to the coinniunity. Therefore, it supports a charitable purpose but has no independent charitable purpose of its own that can be boosted. Thus, it is unlikely that an MSO would qualify for LR.C. § 507(c)(3) stattis under the integral part doctrine. n438

["98] c. MSO's Ffject on Affrliated Hospital An entirely different issue is whether the formation of an MSO would jeopardize the LRC. § 501(c)(3) "charitable" organization status of an affiliated hospital. There is little published guidance frorn the IRS on this topic. n439 How- ever, the IRS recetrtly issued a private letter ruling addressing this issue with respect to a PHO_ n440 Because botlt a PHO and au MSO are generally physician-hospital joint ventures that share similarities, n44I the recent PHO ruling may be indicative of the IRS position widt regard to MSOs. In that ruling, the hospital and physicians were each fifty percent members in the PHO, with physician membership established on a per capita basis, n442 The PHO was formed as a limited liability company. Its major purpose was to act as a vehicle for solicithig aud reacting to offers and responses to managed care bids for medical services, to provide a centralized franrework for credentialing and educating physicians, and to monitor and improve the delivety of Itealfli care. n443 The IRS focused primarily on the prohibitions against private inurement and excessive private benefit rather than the community benefit standard atid utilized the approach it typically ltas applied to the foundation model IDSs. n444 It nded that [*99] the PHO would not adversely affect the hospital's LRC §501(c)(3) status. n445

5. Tax Exeniption of Superparent in Hospital Network Consolidations of hospitals into regional networks of affiliated liospitals have beeotne increasingly cormnon as a means of p•oviding a full range of ]tealtlt care services detnanded by the public and of creating hospital efficiencies not available on a local level. n446 As patY of these arrangeinents, a "superparent" or "grandparent," a not-for-profit parent corporation to all of the affiliated hospitals, tnight be formed. The IRS has clearly expressed its position that, with respect to these "provider networks," each tiot-for-profit entity, whether hospital or superparent, must qualify for tax- exempt status by its own right, n447 To so qualify, a community benefit analysis will be undertaken, and the superparent supporting organization nntst demonstrate that it satisfies the "structural relatedness test" -- that is, the panicular not-for-profit entity is an integral part of an organizational structure providiug comntunity benefit. n448 One such affiliated network of hospitals with a snperparent, which songht tax-exempt status under LR.C. § 501(c)(3), was Northwestern Healtlicare Network. n449 The network involved multiple hospitals and, in some cases, the hospitals' parent corporations. These entities agreed to affiliate to form a regional academic and research oriented health care network, n450 A superparent was formed generalty to support or benefit and carry out ttie purposes of the hospitals in ttie network, to enhance and improve the delivery of high-quality, cost effective health care services on a regional basis, to promote the education of health [* 100] care professionals, and to advance scientific research through the collaboration of the affiliated hospitals with Northwestem University and its ntedical school. n451 Specifically, the affiliation was designed to: (1) coordinate patient care, the result of which would reduce duplication of services and allow ntore cost effective delivery; (2) offer tnore specialized services to a larger patient base; (3) enhance clinical, research, marketing, plamting, financial and managerial services, and pecuu'rary and organizational expertise; (4) enhance and improve strategic planning on a regional basis; (5) enhance access to capital markets; (6) access technological and medical advances; (7) promote education of physicians and other health care professionals; and (8) advance science through research. n452 Focusing on these factors, the IRS essentially weighed whetlter the sttperparent, in its own right and as a supporting organization through its affiliation with the entities in the network, would supply au essential ser-

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vice to the network, would be an integral part of the missions of the system, and thereby would enhauce the network and benefit the regional community suffiiciently to warrantl.RC. § 501(c)(3) status. n453 The IRS reviewed the composition of the governing boards, the Council of Governors atnd the Board of Directors, and found critical that no more than twenty percent of their representation would be physicians affiliated witlt the hospitals, their parent corporations or the network. n454 Based on these features, tttc IRS granted tax-exempt stahts to the superparent. n455

6. Summary On one level, the criteria for entitlement to tax-exempt status of component institutions of the new and changed health care structures have evolved little duriug the past twenty-frve years. The comnlunity benefit standard, the prohibitions against private muremenr and excessive private benefit, and the pubLc_ policy doctrine continue to demand that, on balance, without violating federal laws and policies, a tax-exempt liealth care organization enhance health care provided to a broad group rather than benefit a private group of individuals. Yet, on a more micro-level, the IRS has tiglit- ened certain criteria for deteinrining whether a health care organizatiou in the contemporary health care environment deserves tax-exetnpt treatment. The IRS has [* 101 ] revived or regenerated its 1956 einphasis on the provision of health care to the medically indigent; n456 it now views the provision of charity care as an essential component of the community benefit standard as applied to IDSs_ n457 To reflect the perceived composition of the cotnmunity, the governing board of a newly structured not-for-profit "charitable" health care organization -- a PHO, a medical fonndation of an IDS, etc. -- should not htclude more tban twenty percent physicians. n458 To demonstrate compliance with the pro- liibitions against private inuretnent and excessive private benefit, separate independent comtuittees should be fornted to negotiate fee structures and compensation arrangements with medical groups affiliated with an IDS. n459 Since the mid-1960s, health care relationships and stntctnres have undergone revolutionary transformations. In the same time frame, the tax exemption standards have evolved little and have been marked by a conservative, nan-ow, and slow approach to rethinking those standards. While this strategy has assured a degree of consistency, the lack of more radical alterations in the criteria for tax-exenipt status may have hindered the outreach, effectiveness, and efficiency of our health care system. It is in this light that the following proposal is suggested. V.PROPOSAL

A. Background Looking at the draniatic changes in our nation's health care delivety system and at the current federal income tax scheme impacting the liealth care sector, scholars and eommentators have suggested several core probletns: (1) the need to provide quality health care to the nation's population; n460 (2) the failure of our health care system to provide those medical services to the medically indigent; n461 (3) the [* 102] perceptiott that not-for-profit hospitals have the responsibility to provide uncompensated medical care to persons regardless of ability to pay; n462 and (4) the failure of the IRS to base deservedness for tax-exempt treatnrent of hospitals on the provision of health care services to the indigent. n463 This list reflects many ratlier obvious, but questionable, assumptions. A central supposition is that hospitals' provision of free and below-cost health care to the poor is truly eleemosy- nary. However, such free and below-cost health care is supported in large part by private payers, generally private insurers. Under hospitals' differentiated systems of charging patients for health care, these private payers, perceived as having the ability to pay higlter fees, pay sums in excess of actual healtlr care costs htcun-ed with respect to covered patients. It is the contention of the author that neither the hospitals nor the private payers involved in this cross- subsidization system are acting out of charity in the donative generosity sense of the word. Rather, the behavior of the hospitals and private payers in undettaking these fmancial arrangements may be driven to some extent by market forces, and, as a result is reminiscent of charity only in its broadest legal sense -- that is, the provision of otherwise unavailable medical services to a medically underserved population. Second, it is assumed that not-for-profit hospitals have primary responsibility to furnish medical services to the needy. n464 Perhaps so, but perhaps riot. Instead, under an even more traditional view of social responsibility and of instihttions that are in positions of meeting thc needs of tnedically indigent, n465 maybe it is the responsibility of every health care provider to provide health care to the poor attd medically underserved population. n466 Another underlying assumption is that even in this competitive health care environment, not-for-profit institutions should not be operated in a businesslike [*103] manner for the purpose of earning a profit. n467 It is the author's belief that such organizations sliould be encouraged to use businesslike approaches to attain surplus income as long as the surplusage is dedicated to the acliievement of the organizations' "charitable" missions. n468 Additionally, it is assumed that only not-for-profit health care organizations deserve the tax preferred treattnent associ-

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ated with the performauce of perceived "charitable" activities. 1'his should not be the case. For-profits should also be entitled to tax benefits if they ttuly contribute to "charitable-type" activities. B. Proposed Tax Regime The author suggests that we set aside these assnmptions and conceive an entirely different federal tax regpne. This new tax schetne would grant some form of tax-favored treattnent to for-profit and not-for-profit health care organizations that engage in the types of charitable activities and programs that society views as valuable and worthy of governmental subsidy through tax relief n469 In other words, for purposes of federal taxes (as opposed to state purposes) health care organizations would be "neutered"; they would not be viewcd through the for-profit/not-for-profit dichotomy. n470 The system would be designed [* 104] to foster the underlying missions of current not-for-profit health care organizations, Wh3ch arc often stated in terms of chai y, quality of care, and community service. This approach should result not only in encouraging all health care organizations to condact charitable activities and programs, but also in reducing criticisms that the tax systein places not-for-profit health care organizations in a preferred competitive position as conipared with for-profit organizations. n471

1. Tax-Favored "Charitable Activity Expenses" There are a couple of tax-favored approaches that could be applied to accomplish these purposes. The new tax system might entitle healtli care organizations to either a federal tax deduction or, preferably, n472 a refundable and recapturable tax credit n473 for "charitable activity expenses." The value of the dednction or tax credit would be deter- mhred on a weighted basis. n474 Siniilar to the business expense deduction, or perhaps as a subset ofl.R. C. § 162(a), the tetnt "charitable [*105] activity expenses" would be defined broadly. The defrttition might include "expenses incurred by a liealth care provider, arranger, or facilitator organization at cost in the direct or cooperative development, production, and carrying on of'charitable ac5vities."' This definition would permit tax-favored treatment to a health care organization, whether or not deemed to be a direct provider of health care. n475 By opetting entitlement to non- providers of liealth care, greater participation is encouraged by PHOs, MSOs, non-staff HMOs, and other health care organizations cnrrently deemed by the IRS to be healtli care facilitators or arrangers. Through cooperative efforts, health care provider organizations, facilitators, and arrangers could contribute vitally to the eriltancement of health care. n476

2_ "Charitable Activity" As recognized by the Supreme Court in Eastern Kentucky 4Velfare Rights Organization v. Simon, societal needs and coucepts of charity change over time, and thus the definition of ttie tertn "charitable activity" must be fluid and sufficiently flexible to account for these forces. n477 Like proposals previously set fotth by organizations and academiciatts [*1061 for redefining the comtnunity benefit standard under the current tax regime, n478 the statutory definition should include -- perhaps tln'ottgli a catch-all provision n479 -- community-or regional-specific medical activities and progranis that are considered worNty of federal tax subsidization. The community/regiottal specificity would account for location-dependent medical needs atid problems. A large urban area in which reside rnany medically indigent who do not have their own primary care physiciatts but use emergency rooms for most, if not all, rnedical care, tnigltt require different types of health care progratns to provide its population better access to quality health care than a wealthy, well- insured snburban area in wltieh, for the most part, residents have their own physicians. For example, Columbia- Presbyterian Medical Center in New York City recently started a free shuttle service to its newly established nearby clinic. n480 A person presenting with a medical problent determined not to be an emergency through a mtrseconducted preliminary examination is given an option: either continue to wait for hours until seen by an enlergency room physician, or be shuttled by direct van service to the clinic for faster (and cheaper) medical care. n481 This program in the New York City setting is valued. By comparison, the same progratn in a wealthy suburban area in which ninety-eight percent of the population ltave health insurance and personal physicians might not be valued.

3. Certifrcation Panel Similar to provisions recently proposed under the Health Security Act of 1993, n482 the new tax scheme should incorporate a community-or [*1071 region-based certification panel. n483 This panel would be responsible for developing and disseminating to health care organizations connnunity/regional enedical plans -- perhaps a five-year and a ten- year plan reviewed and updated biannually -- to outline the medical needs, availability of medical care and resources, medical goals of the particular locale, and determinations of the best means of allocating existing and poteutial niedical resources to achieve a level of health caro considered sufficient. n484 The panel would judge the worthiness of a health care organization's particular activities and programs in ligltt of the medical plans. Activities deemed wotthy of

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"charitable activity" status, and therefore entitled to some tax-favored treatment, would then be subject to further scrutiny. a. Weight Ranges andAlloc•ations Based on the particular comnsunity's or region's medical ueeds and plans, the panel would be responsible for deter- miniug the weiglit to allocate to a patticular "charitable activity." The specific weight would be based oil a federally approved and regulated scale assigned to broad classes of "charitable activities." Each classification would be assigned a perinissible broad range of weigltts based on general societal priorities (e.g., eighty to one hundred), with overlapping weights allowed among the categories. Some of the categories might include: (1) the enhancement of access for minorities and medically underserved populations to preventive health care services; n485 (2) the strengthening of the quality of health care treatment; (3) the improvement of access [* 108] for minorities and medically undei'served populations to emergency care services; (4) the encouragement of cooperative clinical research; (5) the stimulation of cooperative basic science research and medical technologioal advancements; n486 (6) the development or hnprovement of training programs for physicians, nurses, and other medical personnel; (7) the developntent and productiou of imtovafive comtnunity educational programs; and (8) the enhancement of access to conunanity educational progranis for ininorities and medically underserved populations. For argument's sake, the federally approved weight rattge for the first five categories miglit be seventy-five to one hundred; the last three classifications might be assigned a scale of sixty to eighty-five. After assigning locally adjusted weight ranges to each broad federal category and disseininating this information, a certification panel would use these ranges as initial e idelines to evaluate an institution's particular charitable activities and programs. Annually, each panel would disseminate tlte weights that it has assigned to specific charitable activities and programs to the health care organizations within its jttrisdiction. This distribution proccss would permit all health care organizations to make more informed choices when considering programs and activities to undertake. To illustrate, let's return to the previously described Columbia-Presbyterian clinic and shuttle van program. Let's assume tliat Coluntbia-Presbyteriau is in the process of considering such a program. The hospital administrators believe that the plan rnight fall into the first broad category of"charitable activity" -- the enhancement of access for minorities and medically underserved populations to preventive healtb care services. Based on current national soeietal values and sentinient, the federally approved weight range for the classification is known to be seventy-five to one hundred. The achninistrators determine from information disseminated by the New York City certification panel that the category into which the shuttle program fits is valued nsost highly, and because there are no comparable prograins in the area, the likelihood of a high rating is increased. Colutnbia-Presbyterian also discovers through data shared by the New York City panel that otlter "outreach" programs have beeu allocated weights of ninety to ninety-seven. [* 109] "I'he Irospital administrators submit a detailed proposal for the shuttle program, and on review the certification panel indicates that it ultimately will assign a rate of ninety-eight if certain inodifications are made. Columbia-Presbyterian agrees to make the changes and earns the nhtety-eiglit weight. Comparatively, a panel in another location might assign a weigl t range of between eighty and ninety to the same broad federal category and ultimately allocate a weiglit of eighty-four to the same type of shuttle program. In botlt cases, the determinations are based on the federally approved weiglit range, the utedical plans of the community or region, and ttie progratn's tmiqueness in the commimity. Additionally, certification panels would be able to share information on their weiglit ranges, wltich inevitably would be factored into decisions and weight allocations. The next step in the process would convert the assigned weight into a percentage (e.g., ninety or one hundred percent). The health care organization would utilize the percentage to calculate the deduction or tax credit available for expenses incurzed and directly related to the "charitable activity." In other words, the percentage would be multiplied by the "charitable activity expenses." That figure would be the deductible expense or amount of tax credit.

b. Report Cards As another incentive for a health care organization to participate in the development, production, and carrying on of "charitable activities," the certification panel would issue "report cards" at the end of every year or two. Each report card would be organization-specific but would supply data to enable the health eare organization to compare itself with others.l'his would be accomplished by tallyiug and specifying the allocated weights for charitable activities and programs undertaken by each health care organization within the panel's jurisdiction. Thereafter, repott card results would be compiled and distributed to the consumers of the community's/region's health care organizations. Health care organi-

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zations eaming high marks could utilize the results as a marketing tool; consumers would be able to use the data to assist with such medical care clroices as selecting an HMO, a hospital for inpatient care, and the like, n487

[*1101 4. Sununary The tax regime proposed by the anthor to stimulate discussion is contplex, and likely to pose numerous administrative challenges -- bnt, so is the current system. The proposed systetn is designed to foster the underlying missions of current not-for-profit health care organizations, which a-c often stated in tenns of charity, qnality of care, and community service. It attempts to provide a broad base of support for improv'rng healih care delivery, quality, access, aud research; for training medical persotnrel; for providing healtli ca -e education to conununities' popdations; for educating consumers about health care providers, facilitators and arrangers; and for advancing medical technology. It protnotes cooperative, as well as indepeudent, efforts of health care organizations for the achievenient ofthese goals. h aclcitowl- edges that health care needs and values for comparable health care activities and progran s may be location-dopendent. It is devised to be sttfficiently flexible in its implementation to account for changhtg societal values and sentiments, as well as evolving health care stnicthires. Finally, it is intended to strengqhen the ability of independent and affiliated health care organizations to achieve fmaucial and structural efficiencies.

CONCLUSION Federal tax laws, and therefore IRS interpretations, have failed to keep up with the quickly evolving health care environment, perceived medical needs, and societal values. Scholars, commentators, legislators, tax administrators, and representatives of interest groups have repeatedly discussed tbis problem, but solutions are still in the making. At this time, a number of bills await the attention of Congress that, if enacted, would change the current progressive income tax system to either a flatter income tax, a flat tax, or a consumption tax system. While we are in the state of rethinking our federal income tax system, it is appropriate to once again direct attention to the natiou's health care system, which is affected by our federal incoine tax system. The author has reviewed the stntctural changes in our health care system, has indicated the response of the IRS to the altered health care landscape, and has concluded with a new tax proposal designed to foster the underlying missions of current not-for-profrt health care organizations. Part I began with a brief statement about the federal tax statutes that confer tax-exempt treattnent on health care organizations. Focushig largely on the past forty years, part IL of the article higltlighted the [* 111 j evolution of the for- profit and not-for-profit dichotomy of our health care system and its delivery structures. Parts ILI and IV detailed the developtnent and application of criteria utilized by the IRS over the past forty years to determine whether a not-for- profit health care provider, facilitator, or arranger deserved an initial grant or retention of tax-exempt status, with special attention directed to qualification under LR.C. ,¢ 507(c)(3). In partict lar, it concentrated on the operational exclusivity requirement, the prohibitions against private inui-ement and excessive private benefit, and the public policy doctrine. It addressed freestanding voluntary hospitals artd reviewed the evolution of the applicable criteria under the community benefit standard_ It indicated that among the many factors irnpacting tax-exempt qualification pursuant to that standard, a voluntary Itospital has the option of either providinig inpatient charity care to the medically indigent to the extent of the hospital's financial ability or of making medical care available on an outpatient basis in its emergency room to medically indigent without discrimination under Medicare and Medicaid laws. By contrast, the article pointed out later that IDSs must satisfy a somewhat different community benefit standard. In that context, it noted that the IRS views charity care as an essential component of the community benefit standard. HMOs and otlrer health care organizations were reviewed in light of the various tests and criteria. Concentrating on HMOs and MSOs in particular, trends were identified concerning LRC. § 501(c)(3) tax-exetnpt status for evolving health care structrnes. Speculations were set forth that tax- exempt qualification in the future for such organizations may tuni on classification as a health care provider. After detailing these trends and noting that the IRS secrns to be taking a rather slow, deliberate, and conservative tack (including the regeneration of a charity care requirement), it was suggested that thc federal tax system has not kept pace with the swift and dramatic changes in our ccalth care system's delivery stt-uctues. To renew the intpetus to totally rethink the impact that the federal tax system has on the health care sector, part V presented a proposal for a new tax plan to foster financial suppott for the underlying missions of current not-for-profit healtlt care organizations. The proposed tax plan attempts to achieve a number of goals that the current tax system niay not be accomplishing. It strives to protnote cooperative and independent efforts of health care providers, facilitators, and arrangers for the achieventent of numerous goals: the improvement of health care delivery, quality, access, and research; the stimulation of medical personnel trainin2g and medical teclmological [* 1121 advances; and the enhancement of health care educa-

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tion to cotnmunities' populations and of consutner education about health care organizations. It attempts not to hinder healtlt care organizations' quests foi- finaucial sectnity and efficiency. As conceived, it incorporates flexibility to account for changing societal values and sentimeuts, as well as evolving health care stntctures. Never losing sight of these goals and attempting to dispel certain assumptions tnade about our current health care and federal tax systems, the tax proposal provides an alternative means of reacting to limitations inherent in the intersection of those two systems as they now exist. [*113] GLOSSARY

Dedicated atzd Ordinary Group Mode17IMO. See HMO, Dedicated and Ordinary Group Model.

Dlagnostic-Itelated Groups (DRGs). Diagnostic-related groups were fnst introduced in 1975 as a measurement of a hospital's output based on patient groups by discharge diagnosis. They sttbseqnently were extended to nonhospital medical care to establish a meatts of setting unifortn reimbursement. Patients are grouped by homogeneous disorders or medical conditions for reimbursement putposes. 'fhere are 467 specific categories and one catchall classification representing "other" procedures.

F."xclusive Provider Organization (EPO). An exclusive provider organization is a hybrid between a PPO and an HMO. An EPO is a means of directing em-olled patients to health care providers within a specific provider network. An enrol- lee has the choice of paying to see a physician or to be treated 'ui a hospital outside of the established network, or to use the contractual network of physicians with the EPO assuming fitll responsibility to pay the providers. Some PPOs have offered EPO options. The dontinant distinction between an EPO and an HMO is that generally the EPO is uot at financial risk for providhtg health care services to enrollees.

Fottndation ModeIIDS. See IDS, Foundation Model.

Healtlt Maintenrmce Organizatian (HMO). HMOs are organizations that integrate the financing, management, and delivery functions of medical care by contracting to provide medical setvices to an enrol led population on a prepaid basis. Their putpose is to provide healtlt care at low costs, i.e., a form of managed care. HMOs began as an alternative forni of health care delivery in 1929, but after slow acceptance, they finally bccame a focus of ltealth care in the 1970s. 'I'here are basically four models of HMOs: the independent practice association model, the network niodel, the staff model, and the group niodel. There are two types of group model TIMOs, a dedicated group model and an ordinary group model.

HMO, Dedicated and Ordinary Group Models. In the dedicated group model, the HMO contracts witlt the physicians to provide medical services at the HMO's facilities. Physicians in an ordinary group model may treat patients who are not menibers of the I3MO.

[* 114] IIMO, Indepentlent Practice Association Model (IPA). Independent physicians and groups of physicians, provide their services to HMO subscribers at their own medieal facilities. The IPA contracts with the HMO on bchalf of the physicians.

HMO, Network ModeL Two or more independent niedical groups provide setvices to HMO subscribers at the medical groups' own facilities. Usually the medical groups contract with more than one HMO and also maintain a fee-for-service practice.

IIMO, StaffModeL Physicians are the direct employees of the HIvIO and provide medical services exclusively to HMO-enrolled patients at the HMO's facility.

Horizontal Networks ofHospitals. Affiliated hospitals that can include acute-care ltospitals as well as specialized hospitals, such as pediatric, psychiatric, and oncology hospitals.

Intlependent Practice Association Mot1e1(IPA) HMO. See HMO, Independent Practice Association Model.

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Integrated Delivery System (IDS). IDSs are organized primarily for the purpose of pcnetrating the managed care business. The health care industry defrnes an IDS as a group of affiliated organizations joined to provide coinprehensive managed health care services to patients. Therefore, it is a network of health care providers, arrangers, and facilitators which may, but do not necessarily, include a paytnent component (e.g., au IIMO). By conrparison, the IRS defines an IDS as a"health care provider (or one component entity of an affiliated network of providers) created to integrate ttie provision of hospital services with professional medical (e.g., physician) services." Various levels of integration exist, but at a nrinimum, an IDS delivers hospital, physician and related ancillary services. in its simplest fornr, an IDS may be created by a hospital that hires physicians who thereafter provide medical services as salaried employees. More complex IDSs provide fuller groups of services, such as preventive tnedicine, re- nabiiitatiori, tong-te,-m carc, hosptce care, and mental health careCurrently, there arer>Lree IDS mndels: the foundation model, the management services organization (MSO) model, and the total integration model.

IDS, Foundation Model. In the medical foundation model, a hospital forms a notrprofit affiliated corporation (a medical foundation) that generally reports to a tax-exempt parent. (The parent is usually a corporate member of the foundation and of the hospital.) The [* 1151 medical foundation is govetned typically by a board of tntstees with hospital, medical group, and community representatives.l'he tnedical foundation is responsible for providing health care services, and to do so, contracts witli one or more physician groups for the delivery of outpatient medieal services to the foutidation's patients. The foundation acquires the tangible atid intangible assets of the physician group, so the medical foundation owns all medical practice assets and the medical practice itself. The foundation can employ all nonphysician personnel and supply all administrative and managerial services necessary to operate a n.edical practice. This model is typical of those states, such as California, Wisconsin, Texas, and Pennsylvania, that restrict the ability of a nonprofit corporation, such as a hospital, to employ physicians.'I'he foundation model stntetttre satisfies the teclmical requirements oEthose laws by lraving the group practice, usually a professional for-profit corporation, employ the physicians.

IDS, Management.Services Organization (MSO) Model. In the MSO model, a hospital and physician group remain separate but are bound together by contract. "fhe MSO, generally a nonprofit or for-profit corporation, is govenred by representatives of the hospital and pliysician group. Like a medical foundation, an MSO owns most or all of the tangible assets (e.g., equipment, office facilities, etc.); however, the MSO leases these assets and managernent services and nonphysician personnel back to the hospital and physician group pursuant to a inanagement services agreement_ Througlr the professional services agreenzent, the group ofphysicians, who, tinlike in the medical foundation model IDS, continue to own and operate their medical practice, provide all professional medical services. Thus, the MSO funetions as a management component, part of which is an insurance function in that the MSO monitors finances and physicians' per- fotmances.

IDS, Total Integration ModeL The total integration model is a single delivery entity that resnlts frotn the legal nierger of the hospital and physician group or groups. Total integration model IDSs will not be found in California and other states whose laws prohibit hospitals from employing pliysicians.

Managed Conrpetition. Managed Competition is price competition, with total annual premiums paid for comprehensive health care services as the focal point.

[* 1161 Managentent Services Orgarrization (MSO) Model IDS. See IDS, Management Services Orgnnization Model (MSO).

Netrvork Morlel HMO. See I-IMO, Network Model.

Physician-Hospital Organization (PHO). A physician-hospital organization is usually fortned as a limited liability company or as a corporation. It is analogous to an IPA that includes a hospital and seeks payer contracts with tIMOs and employers. 7'herefore, a PHO is a vehicle through which a hospital's medical staff of physicians and the hospital can offer and respond to solicitations from large employers, insurers, aud other managed care groups, and can bid to provide health care. Basically, then, a PHO is a collective negotiating entity that enables physicians and hospitals to contract with HMOs, large employers, and health insurance companies. A PT-IO may also provide mauagement and support services, as does au MSO. A PHO is a centralized framework for credentialing and educating pliysicians artd for monitoring health care improvements. It does not require the integration of flnancial incentives common to an IDS. Typically,

Appx.237 Page 21 37 B.C. L. Rev 1, *

the physicians and hospital govern the PHO. The physicians retain autonomy over clinical decisions. The hospital provides administrative and financial expertise to manage capitated payments.

Preferred Provitler Organization (PPO). A prefeired provider organization is a hybrid health care payer system that developed through the 1970s and 1980s in response to the economic pressures of rising health care costs, cornpetition for patients resulting from excess provider capacity, and significant increases in indemnity health insurance premiums. A PPO is essentially a network of hospitals, physicians, and otlier health professionals who, under contract, provide healtli care services at an agreed price to a group of beneficiaries. PPO vrangentetts then are a fortn of managed care that combine features of managed care and indemnity instrrauce. The arrangements typically encompass sets of contractual relationsbips between the PPO and healtlt care providers, and between the PPO and the beneficiaries. Reimburse- ment_ of the physicians and other healt.h care providers is predetermined on a prospective pricing basis, which reflects a ncgotiated fee-for-service payment rather than a capitated payment. PPOs take on a variety of forms, depending on the sponsor. A"provider-based" PPO is a group of physicians or hospitals, or both, that contracts with commercial insurers or self-insured employers for [* 1171 the provision of health care to their patient base. A "payer-based" PPO is owned by the payer or htsurer, or both, which negotiates and main- tahis a contract with physicians and hospitals to fumish health care to beneficiaries/patlents. An "employee-owned" PPO is fornled and owned by a group of employees who are neither providers nor payers, but whose responsibilities are exclusively to manage the ongoing operations of the PPO. In this form of PPO, the payer could be either a cotmnercial insurer or a self-insured etnployer. An "entrepreneurbased" PPO typically provides administrative services, such as organizing the payment of insurance claims, to a related third party who secures agreeinents witlt both the insnrance payer and ttte physicians and hospitals. One of the principal distinctions between PPOs and HMOs is that the former rarely submits the health care provider to fmancial risk with respect to the economic outcome associated with the actual delivery of the health care services. Moreover, PPOs have petmitted the health care provider to maintain a fee-for-service practice and payment stntcture. Finally, PPOs typically give patients the final choice in selecting their physicians or hospitals.

Prospective Payment System (PPS). A reimbursement system fsst utilized on a large scale by Medicare. It strives to standardize payments to health care organizations for the provision of inedical services_ Payment is Cxed and predetermined as based on the diagnostic-related groups.

Staff Model HtYIO. See HMO, Staff Model.

2otallntegration tYlodel IDS. See IDS, Total Integration Model.

VerttcalIntegration. In the context of managed care and health care organizations, physicians, HMOs, hospitals, clinics, and other healtlt care organizations combine or consolidate, often under a parent corporation, to offer health care services. Efficiency, price competition, and full range }tealth care services are comnion goals of vertical integration.

Legal Topics:

For related research and practice tnaterials, see the following legal topics: Healthcare LawBusiness Administration & OrganizationTax ExemptionsHospitalsHealthcare LawBtisiness Administra- tion & OrganizationTax ExemptionsNonhospital OrganizationsHealthcare LawManaged HealtltcareHealth Maintenance Organizations

FOOTNOTES:

n205 See, e.g., Gefsinger Healtl7 Plan v. Commissioner, 100 T.C. 394 (1993), aJJ'd 30 F3d 494 (3d Cir. 1994) [hereinafter Geisinger II] (HMO seeking LR. C. § 501 (c)(3) status); Sound Health Asah v. Commis•sioner, 71 T.C. 158 (1978) (HMO seeking I.R.C. § 501(c)(3) status); University of Mass. Medical Sch. Group Practtce v. Comrnissioner; 74 T.C. 1299 (1980) (incorporated faculty practice of medical school secking LR.C. § 501(c)(3) status); B.FIGV AnestluslaFound., Inc. v_ Commissioner, 72 %:C. 681 (1979) (incorporated anesthesi- ology department within teaching hospital of Harvard Medical School seeking LR.C. § 501(c)(3) status); Gen. Coun.s. Mem. 39,828 (Aug_ 30, 1990), available in LFXIS, Fedtax Library GCM file, 19901RSGCMLEXIS24;

Appx.238 Page 22 37 B.C. L. Rev 1,

Priv. Ltr. Rul. 95-11-035 (Dec. 19, 1994) (rnerging hospitals seek to retain I.R.C. § 501(c)(3) status); Priv. Ltr. Rul. (Mar. 31, 1993) [hereiuafter Facey Ruling], repririted in 7 EXEMPT ORG. `I'AX REV. 828 (1993) (Facey Medical Foundation, a foundation model IDS seekingl.R.C. § 501(c)(3) status); Priv. Ltr. Rul. (Jan. 29, 1993), reprinted in 7 EXEMPT ORG. TAXREV 490 (1993) [hereinafter Friendly Hills Rul'ntg] (Fricndly Hills Health- care Network, a foundation model IDS seeking l.R.C. § 501(c)(3) status).

n206 Philip S. Neal & Suzanne M. Papiewski, Taxation offIMOs Now and Under Health Care Reform -- Separating Fact From Fiction, 81NS. TfLYREV 637, 640 (1994) (cithig 1993 DIRECTORY OF IIMOs, supr'a note 83; INTERNAL REVENUE SERVICE CUMULATIVE LIST OF ORGANIZATIONS DESCRIBED IN SF:CTIt3..' 170(C) OF'771ELltTER>'Lel; lt_r•;I E,uLtE CODE OF 1986 (PUh No 78) [lsereinafter CUMULATIVE LIST]),

n207 Neal & Papiewski, supra note 206, at 640. For approximately 60 years, the IRS has recognized the tax-exempt status of prepaid health care plans. Boisture, supra uote 95, at 282. The IRS had recognized Bhte Cross and Blue Shield, which introduced the concept of prepaid medical insurance, as tax-exempt social welfare organizations unti11986. At that time, Congress withdrew the tax-exempt status of Blue Cross and Blue Shield beeause they were considered "comntercial-type" insurers. Tax Reform Act of 1986, Pub. L. No. 99-514, § 1012(a), 100 Stat. 2085, 2390 (1986) (codified at LR.C. § 501(m) (1994)). However, as part of the Tax Reform Act of 1986, Congress accorded special tax accounting treatment of rescrves to Blue Cross and Blue Shield. Pub. L. No. 99-514, § 1012(b)(1), 100 Stat. 2085, 2391 (1986) (codified at /.R.C § 833 (1994)). For a discussion of Blue Cross, see supra notes 45, 50-51; infra note 258. For a definition and an explanation of the purpose and functions of HMOs, see infra Glossary. For discussion of the explosive growth of HMOs in recent years, see supra note 83 attd accompanying text.

n208 Neal & Papiewski, supra note 206, at 640.

n209 71 TC. 158 (1978),

n210Id. at 168-69,

n211 Id. at 169-70_ This fee structure might have proliibited low income individuals fi-om joining the IIMO; however, the Tax Court considered the potential class of inembers of the HMO as the entire community. Id at 185.

n212Id. at 169-70. The physical test requirement for group members was a means of screening for any "pre-existing condition." Id. at 170. The physical exaniination requirement for mentbers desiring to join the HMO on an individual basis had the potential of excluding "high risk" individuals and 'utdividuals with pre- existing conditions. Id at 169. For group rnentbers, the pre-existing coudition clause could be waived ttpon satisfaction of four requirements, one of whieh was passing the entrance pliysical examination. Id. at 170.

n213 Id. at 172.

n0 14 Sound Ilealth Ass'n, 71 T.C. at 172.

ti215 See, e.g., Arnerican Women Buyer.s Club, Inc, v. US., 338 F.2d 526 (2d Cir. 1964): Commissioner v. Lake Forest, Ine_, 305 F.2d 814 (4th Cir. 1962); United States v. La Societe Francaise De Bienfaisance Mu- tuelle, 152 F.2d 243 (9th Cir. 1945), cert. denied, 327 U.S. 793 (1946); Ha.ssett v. Associated Ilosp. Serv. Corp., 125 F2d 611 (Ist Cir.), cert. denied, 316 US. 672 (1942); New York State Ass'n of Real F,state Bds. Group Ins.

Appx.239 Page 23 37 B.C. L. Rev 1, *

Fund v. Commissioner, 54 7:C. 1325 (1970), nonacq., 1974-2 CB. 5; Gen. Coidn.s. Mem. 36;734 (May 19, 1976); Gen. Couns. Mem. 22,554, 1941-1 C.B. 243.

n216 Sound Health Ass'n, 77 T.C. at 184-91. In Sound Ilealth Ass'n, the Tax Court indicated that the HMO was not precluded from tax-exempt treatrnent as a membersltip organization. Contraty to the IRS's position, the cotnt fotmd that the private benefits to members were insubstantial when compared to the public benefits. The court considered the "extension of the [private benefit] 'insider tesC" of Treasury Reg. § 1.50I (e) (3)- 1 (d)(1)(ii) inappropriate for application to a membership based HMO representative of the cotnmunity. 71 T.C. at 186.

In 1976, in Gen. Couns. Mem. 36,734, supra note 215, the IRS concluded that a prepaid medical service plan did not yuahfy foi tax c;xeniptiolr beciiu'se ii faiied ilic Witiniiinrt'y' benefit tesi. Although the u i incorporated into the consmunity benefit standard consideration of whether the plan's prepaid pretniunis were based on a corunninity rathig, the failure of tho plan to satisfy ttie cointnunity benefit standard was based on the plan's service to ment.bers only; it did not provide services to nonmembers,

n217 Sound Health Ass'n, 71 T.C. at 181.

n218 See sz:pr•a part IV.B.2.e.

n219 Sound Health Ass'n, 71 T.C. at 184-91; see infra part N.D (discussing the private benefit test).

n220 Sourtd Health Ass'n, 71 T C_ at 187_

n221 The court stated:

The class of persons eligible for membership, and hence eligible to benefit from the [IIMO's] activities, is practically unlimited. The class of possible members of the [HMO] is, for all practical purposes, the class of members of the community itself The major barrier to membership is lack of nioney, but a subsidized dues program demonstrates that even this barrier is not intended to be absolute. The subsidized dues progratn seems designed for such persons as Medicare and Medi- caid recipients, and all those of lesser means.

Id. at 185. For an explanation of the subsidized dues program and treatment of nomnembers on a reduced fee- for-service basis, see id at 172-75. Moreover, the coutt noted that in "an action more charitable than any undertaken by Hospital A [in Revenue Ruling 69-545], the [HMO] adopted a plan to establish a fund to receive contributions which would be used to help subsidize persons who wanted membership but who could not make the fidl monthly payinents required for membership_" Id at 184. The court cottsidered a "substantial benetit" to arise from the HMO's community rated fee structure because it appeared to assure the spreading of the risk of illness throughout the IIMO's fitll membership. ld at 189. In a summary statement, the'i'ax Coutt stated, "When possible membership is so broad, benefit to the membership is beneiit to thc community." Id at 190.

n222 The court found that --

the [IIMO] offers an open emergency room, has a subsidized dues program for the "near poor," and lias provided some free care to the poor. It is clear that those latter services go far beyond the mere emergency room services oftered by respondent's hospital A [in Revenue Ruling 69-545]_ If the charitable hospital can, except for emergency cases, restrict its treatment to paying patients, the [HMO] should be able to restrict itself to paying members. If the charitable hospital can obligate itself to treat only the financially responsible ill, the Association sttould be able to obligate itself to treat only the financially responsible, when and if they become ill.... In neither the case of the [HIv1O] nor the hospital [in Revenue Ruling 69-5451 can the emergency patietit be

Appx.240 Page 24 37 B.C. L. Rev 1, *

refitsed aid. ... If anything, the [IIv1O] has a stronger claim to public benefit than hospital A [in Revenue Ruling 69-5451.

Id at 187-88. The facts in the case indicated that the HMO provided medical care at its clinic and in its emergency room to patients unable to pay the fitll charges. Id. at 172-73.

n223 Id. at 184. The court noted that the courtesy staff was open to all qualified physicians and no one had been denied admission to that staff. The court did not address the policy with respect to the employed physicians.

n224 7d. at 171-72, 184-85.

n225 Sound Health Ass'n, 71 T.C. at 174.

n226 See supra part IV.B.2.e.

n227 Cen. Couns. Me.rn. 38,735 (May 29, 1981), available in LEXIS, Fedtax library, GCM file, 1981 IRS GC'MLEXIS 190.

n228 Gen. Couns. Mein_ 37,043 (Mar. 14, 1977), available in LEXIS, Fedtax libraty, GCM file, 1977IR.S GC:M LEXIS 386.

n2291'he Tax Conrt had ignored 'ut S'ound Health Ass'n that the IIMO's membership practices seemed rather restrictive and had the potential for "cherry picking," -- that is, refusing emollment to high risk individuals. For a discttssion of the Tax Court view of the open membership, see supra note 221. In Gen. Couns. Mem. 38,735, citing facts relied upon by the Tax Court, the IRS appears to accept the Tax Corut's view of Sotutd Health Associa- tiou as an "open membership" organization. However, in this general counsel metnorandum, the IRS emphasizes that "truly open" menibership is a requisite for considering an HMO to be a"charitable" organization. Gen. Couns_ Mem. 38,735, supra note 227, at *18.

n230 The IRS weighed the benefits to the community and found them to be substantially greater than any private benefits served by the HMO. The IRS stated that the detemiination as to whether tlte private benefits are sufficiently incidental both quantitatively and qualitativcly is "measured in the context of the overall benefrt conferred by the activity." Id. at *16-*17 (citing Gen. Couns. Mern. 37,889 (March 20, 1979), available in LEXIS, Fedtax library, GCM file, 1979 IRS GCMLEXIS 309).

n231 Gen. Couns. Mem. 38,735, supra note 227, at * 16-*24.

n232 Gen. Couns. Mem. 39,057 (Nov. 9, 1983), available in LEXIS, Fedtax library, GCM file, 1983 IRS GCM LEXIS 105.

n233 For a defmition of an IPA, see infra Glossary.

n234 For example, the IRS found that the HMO would not serve nonmetnbers and would not maintain any program to assist the nonmernber-poor in obtaining emergency medical care. Gen. Couns. Mem. 39,057, supra note 232, at *10.

Appx. 241 Page 25 37 B.C. L. Rev 1, *

n235 The IRS compared the HMO to Ilospital B described in Revenue Ruling 69-545. It indicated that control of the HMO rested exclusively in the members of the IPA rather than in an independent body representnig the community at large. ld at * 10-* 11. The IRS concluded that the HMO was essentially a shell etitity that promoted the business interest of the IPA, which, in turn, was controlled by health care providers. Id. at * 13.

n236 Id.

n237 See infra Glossary (defining a staff tnodel I-IMO),

n238 Gen. Couns. Mem. 39,828, supra note 205. One commentator has suggested that Plan B, discussed in Gen. Couns. Mem. 39,828 likely was Geisinger Hcalth Plan ("GHP"). See Kenneth L. Levine, Geisinger Health Plan Likely to Adversely Affeet IIMOs and Other Health Organizations, 79 J. TAX'N 90, 91 n.2 (1993). For a discussion of GHP, see infra notes 242-56 and accompanying text.

n239 Gen. Couns. Mem. 39,828, supra note 238, at *16.

n240 This factor, along with open membership and the provision of services on a fee-for-service basis to nonmernbers is an apparent means of distinguishing an HMO from a provider of "commercial-type" insurance within the nteauing of I. R_C. § 501(m) (1994), discussed infra notes 257-74 and acconipanying text.

n241 Gen. Couns. Mem. 39,828, supra note 238, at * 14-* 15.

n242 985 F.2d 1210 (3d Cir. 1993).

n243 See Brieffor the Appellee (CommissionerJ, Geisinger Health Plan v. Cornmissioner, 30 F.3d 494 (3d Cir. 1994) (No. 93-7699), available in LEXIS, Fedtax library, TN"1' File, 94 TNT 97-43 [hereinalter Geisinger I7 BriefJ; Geisinger HMO Denied 501(c)(3), Not Integral Part ofSystem, 4 MANAGED CARE WEEK ATLAN- TIC INFO. SERV., INC., available in Westlaw, MCAREWK database, 1994 WL 2622523. GHP sought I.R.C. § 501(c)(3) status in order to obtain preferential tax treattnent accorded those organizatious. See supra note 19 and accompanying text (describing preferential tax treatment of LR.C. § 501(c)(3) organizations).

n244 Tlte courts described GHP as an entity that arranged for health care to be provided to its subscribers by contracts with hospitals, radiologists, laboratories, clinics, and pharmacies. See Geisinger 1, 985 F 2d at 1213; see also, 62 T.C_M (CCH) 1656, 1661, 1663 (1991), rev'd, 985 F.2d at 1210. It seems likely from the facts that GHP was an IPA model HMO, which was part of a foundafion model IDS. For discussion of the HMO rnodels, and IDS models, see inr(ra Glossary_

n245 See supra notes 216-26 and accotnpanying text.

n246 Geisinger I, 62 T.C.M. (CC'H) at 1663.

n247 Id

n248 Id. at 1657.

n249 Id. at 1659.

Appx.242 Page 26 37 B.C. L. Rev 1, *

n250 The Tax Court focused on the prohibition of excessive private benefit to "insiders," but found none. Id at 1663. For a discussion of the prohibition of private inurement, see infra part IV.C.

n251 Geisingerl, 62 TCM (CClI) at 1661.

n252 Id.

n253Id at1663.

n254 Geisinger f, 985I'.2d at 1216 (discussing the weight to be given to revenue rulings generally and the appropriateness of using a nding involving a]tospital).

n255 Id at 1219-20.

n256 For a discussion of the HMO models, see infra Glossary. Two commentators forcefully argue that the only type of HMO that is a"provider" of health services is the staff model. Neal & Papiewski, supra note 206, at 640. They suggest that to be a provider of health care, an HMO must employ physicians and not nterely contract witli physicians to provide medical services. Merely contracturg for others to directly provide health care services is the equivalent of arranging services, not directly providing them. The commentators suggest that even a dedicated group model HMO is not a "provider" because, like an ordinary group tnodel HMO, the physician- providers are employed by a taxable entity other than the HMO that contracts for their services. Id.

n257 This provision was added by § 1012(a) of the Tax Reform Act of 1986, Pub. L_ No. 99-514, 100 Stat 2085, 2390-91 (1986) (codi6ed as amended at LR.C. § 501 (1994)). The I.R.C. does not det3ne the terni "substantial." The Explanation of Provisions section of the House Report and the Joint Committee on Taxation Gen- eral Explanation refers to Haswel( v. United States, 500 F2d 7133 (Ct. Cl. 1974), and Seasongood v. Commis- sioner, 227F.2d 907 (6th Cir. 1955). See H.R. REP. NO_ 426, 99th Cong., lst Sess. 1, 664 (1985); STAFF OF THE JOINT COMM. ON TAXATION, 99TH CONG., 2D SESS., GENERAL EXPLANATION OF THE TAX REFORM ACT OF 1986, at 585 (Conmr. Print 1987) [hereinafter 1986 ACT BLUE BOOK]. The I.R.C. defnres "commercial-type insurance" only by reference to cost. The House Report defines the terrn as "auy insurance of a type provided by commercial insurance compauies." II.R. REP. NO. 426, supra, at 465.

n258 1986 ACT BLUE BOOK, supra note 257, at 584-88; H.R. RP.P. NO. 426, supra note 257, at 664-65. Congress repealed the tax exetnption of Blue Cross and Bluc Shield because they were viewed as direct competitors to comntercial health insurance companies which did not have the same preferred tax-exempt treatment. 1986 ACT BLUE BOOK, supra note 257, at 584-88; H.R. REP. NO. 426, supra note 257, at 664-65. However, Congress recognized that although health insurance was available through commercial insurers, the competitive enviromnent might result in coverage becotning too expensive or unavailable to stnall and high risk groups. 1986 ACT BLUE BOOK, supra note 257, at 584-88; H.R. REP. NO. 426, supra note 257, at 664-65. Tlterefore, wishing to distinguish between typical conunercial insurance companies and Blue Cross and Blue Shield organizations, as well as to provide some tax equity, as part of the Tax Refonn Act of 1986, Congress enacted LR.C. § 833. Tax Reform Act of 1986, Pub. L. No. 99-514, § 1012(b)-(c), 100 S'tat. 2085, 2391 (7986) (codified at 26 U.S.C. § 833 (1988)). That statute provides certain tax-favored treatment to existing Blue Cross and Blue Shield organizations, as well as other organizations that meet strict requirenients. SeeLR.C. § 833(c) for a definition of the quaBfying organizations to wlrich the statute applies.

In general, I.R.C. § 833(a) provides that a qnalifying organization will be treated as a stock property- casualty insurance company, but it exempts the qualifying organizations froni the requirement of including in income 20% of additions to their unearned premium reserves. I. R.C. § 833(b) perinits qualifying organizations to take a special deduction for regular tax purposes, but not for alternative minimum tax purposes. This special deduction is equal to the excess, if any, of 25% of the smn of claims incurred during the taxable year, and expenses incrm'ed during the taxable year ht cotmection with the administration, adjustment or settlement of claints, over

Appx.243 Page 27 37 B.C. L. Rov 1, *

adjusted surplus as of the begiruving of the year. I.R.C. § 833(b). However, this deduction is lunited to the organization's regular health-related taxable income, determined according to specified rules. Id

n259II.R. CONF. REP. NO_ 841, 99th Cong., 2d Sess., 11-345-46 ( 1986), reprinted in 1986 U.S.C.C.A.N. 4075,4433-34.

n260 H.R. CONF. REP. NO. 1104, 100th Cong., 2d Sess., 11-9 (1988), reprinted in 1988 U.S.C.C.A.N. 5048, 5269; S. REP_ NO. 445, 100th Cong., 2d Sess., 120-21, reprinted in 1988 U.S.C.C.A.N. 4515, 4637-38.

n261 See Neal & Papiewski, supra note 206, at 644 (suggesting that Congress must have intended the HMO exception to have a broader meaning as a result of the repeated langtiage ofI.R.C. §§ 501(rn)(1) and (m)(3)).

n262 Rev. Rul. 68-27, 1968-1 C.B. 315. In the revenue ruling, the IRS emphasized that a staff model HMO was not an insurance company because it directly provided medical services to membcrs through salaried pltysician-employees in the HMO's clinic.l'he HMO provided preventive medical care which the IRS considered to be not equivalent to an insurance risk but to be nterely a business risk. The IRS reasoned that when illness occurs in metnber patients, generally no extra expenses must be incun-ed by the HMO. The HMO is required to pay tlte salaries of its employed physicians, nurses, and tecYmicians regardless of the illness status of the I-IMO members.

n263 Gen. Couns_ Mem. 39,828, supra note 238. On brief before the Tax Court in Geisinger II, IRS abandoned its earlier position thatthe IIMO was a cotmnercial-type insurance provider in violation ofIR.C. § 501(m). Getsinger II erief, 30 F.3d 494 (3d Cir. 1994) (No. 93-7699), available in LEX1S, Fedtax libraty, TNT File, 94 TNT 97-43.

n264 Gen. Coun.s. Mern. 39,829 (Aug. 30, 1990), available in LEXIS, Fedtax library, GCM file, 1990IRS GC Vf LEXIS 25.

n265 Supra note 262.

n266 Gen. Couns. Mem. 39,703 (Feb. 26, 1988), crvailable in LEXIS, Fedtax library, GCM file, 19881RS GCM LEXIS 15; Gen. Couns. Men. 39,828, supr•a note 205.

n267 E.g., Hetvering v. LeGierse, 312 U.S. 531 (1941); Jordan v. Group Health Assn, 107I' 2d 239 (D.C. Cir. 1939); Allied Fidelity Corp_ v. Commissioner, 66 Z C. 1068, 1073 (1976), affd, 572 F.2d 1190 (7th Cir. 1978).

n268 S. REP. NO. 313, 99th Cong., lst Sess. (1986); H.R. CONF. REP. NO_ 841, snpra note 259, at 11-346, reprinted in 1986 U.S.C.C.A.N. at 4434; H.R. REP. NO. 426, supra note 257.

n269 Cf. Tech. Adv. Mein. 94-12-002 (Dec. 17, 1993) (for-profit IPA tnodel HMOs treated as insurance companies)_.__-

n270 See Neal & Papiewski, .supra note 206, at 644.

n271 See supra notes 242-56 and accompanying text.

n272 See supra notes 255-56 and accontpanying text.

Appx.244 Page 28 37 B.C. L. Rev 1, *

n273 See sazpra note 256 and accoznpanying text.

n274 See supra notes 255-56 and accontpanying text.

n2751.R.C. § 501(c)(3) provides that "no part of the net earnings . .. inures to the benefit of any private shareholder or iudividual." 1. R.C. § 501(c)(4) has a similar prohibition: "tlte net earnings of which are devoted exclusively to charitable, educational, or recreational purposes."

n276 Gen_ Couns. Mem. 39,862 supra note 201, at *17. At an earlier time, the Office of Chief Counsel of ttie IILS explained ttzat "inurement is likely to arise where the financial benefit represents a transfer of the organization's financial resources to an individual solely by virtue of the individual's relationship with the organization, nnd witliout regard to accomplishing exempt purposes." Gen. Couns. Mem. 38,459 (July 31, 1980), available in LEXIS, Fedtax library, GCMFile, 19801RS GCMLEXIS 71, at *18; see Treas. Reg. ¢§ 1.501(c)(3)-1(c)(2), 1(d)(t) (as amended in 1990); American Campaign Acad. v. Commissioner, 92 T C. 1053, 1065-66 (1989). For a detailed discussion of the private inureznent concept, see HOPKINS, supra note 19, at 264-99.

n277 See Priv. Ltr. Rnl. 91-12-006 (Dec. 20, 1990); Gen Couns. Mem. 39,598 (Dec. 8, 1986), available in Westlaw, FTX-GCM file, GCM 39598; HOPKINS, supra note 19 at 264-66; Bernadette M. Broccolo & Mi- chael W. Peregrine, Bad Doctor Deals Place Hospitals at Nerv Risk, Part 11-- The Lac Facilities, Inc. Revoca- tion, 11 EXEMPT ORG. TAX REV 267, 268-69 (1995). But see Kennetli L. Levine, Guidelines on Donations of Medical Practices to Tax-Exempt Hospitals, 57 TAX NOTES 1059 (1992) (discussing possible means of outright aud deferred gifts of medical practices to tax-exempt hospitals by retiriug pltysician not considered an "insider" and without violation of Medicare/Medicaid fraud and anti-abuse laws).

n278 See Gen. Couns. Mem. 39,598, siupra note 277, at *18-*19; HOPKINS, supra note 19, at 266-74; see also American Caznpaign Acad., 92 T.C. at 1066.

n279SeeTreas_ Reg. §§ 1.503(c)(3)-l(c)(1),-1(d)(1).

n280 Gen. Couns. Mem. 39,498 (Jan. 28, 1986), available in LEXIS, Fedtax libraty, GCM file, 1986 IRS GCMLEXIS 35, at *7; Gen. Couns. Metn_ 39,862, supra note 201, at *78.

n281 Gen. Couzzs. Mem. 39,862, seipra note 201, at * 19. This position has roots in a prior general counsel memoranduni in which the IRS broadened the concept of an "insider" to the point of including "all persons performing services for an organization [because, in the opinion of tlie IRS, those hidividuals] have a personal and private interest and tlzerefore possess the requisite relationship necessary to fmd private benefit or hzurement." Gen. Couns. Mern. 39,670 (Oct. 14, 1987) available in LEXIS, Fedtax libz.vy, GCM file, 19871RS GCMLEXIS 76, at *8. Two conunentators have aptly labeled the IRS position that all hospital-affiliated physicians are considered "insiders" as a rebuttable presumption. Broccolo & Peregrine, supra note 277, at 269,

n282 Few hospitals have lost their tax-exempt status once granted. Those that have lost their tax-favored status have done so on the basis of violating the prohibitions against private inurement or private benefit. For ex- antples of the revocation of the tax-exempt status of hospitals and clinics based on violation of private inure- nient, see Harding Ilosp. v. United States, 505 F2d 1068 (6th Cir. 7974); Anclote Psychiatric Ctr., Inc. v. Commissioner, 98 T C. 374 (1992); Lowry Hosp. Ass'n v. Commissioner, 66 T C. 850 (1976); Lorain Ave. Clinic v. Commissioner, 31 T.C. 741 (1958); Wendy L. Parker Rehabilitation Found., Inc. v. Contmissioner, T.C.M. (CCH) 51 (1986); Internal Revenue Service, Hospital Chailenges Exemption Revocation in US Court ofFe.d- eral Claims: Technical Advice Memo Underlying Revocation of Ilospital's Exempt Status, 10 EXEMPT ORG.

Appx.245 Page 29 37 B.C. L. Rev 1, *

TAX REV. 1314 (1994) (revoking tax-exempt status of LAC facilities); see also Gen. Couns. Mem. 39, 862, supra note 201; Gen. Couns. Mem. 39,598, supra note 277; Gen. Couns. Mem. 39,646 (Jutie 30, 1987), available in LEXIS, Fedtax library, GCM file, 1987 IRS GCMLEXIS 52.

n283 See infra notes 284-87 and accompanying text (discussing Tax Court's view of overlapping eiements of the two prohibitions).

n284 Aznerican Carnpaign Acad. v. Conemisioner, 92 T.C. 1053, 1068 (1989); Church ofEthereal Joy v. Co»zmis•sioner, 83 TC. 20, 21 (1984); GoldsboroArt Leahnre, Inc. v. Commissioner, 75 T.C. 337, 345 n.10 (1980).

n285 American Campaign Acad. 92 T.C. at 1068-69,

n2861d.

n2871d at 1069. Thtts, the prohibition against private inureinent could be considered a subset of the prohibition against excessive private benefit. Gen. Couns. Mem. 39,862, supra note 201, at *32.

n288 Gen. Couns. Mern. 39,862, supra note 201 at *35-*37; Gen. Couns. tNlem. 37,789 (Dec. 18, 1978), available in LEXIS, Fedtax library, GCM file, 1978 IRS GCM LF.XIS 42, at *7-* 11.

n289 Gen. Coun.s. Mem. 39,862, supra note 201, at *35 *37.

n2901d.

n291 Ttte overall public benefit accruing from the tax-exempt organization as a whole does not enter into the balancing process. See Gen. Couns. Ment. 37,789, supra note 288, at *7-*I 1; Gen. Couns. Mem. 39,862, szu- pra note 201, at *36.

n292 For a discussion of the standards applied to IDSs and hospital networks, includ'utg their reorganizations, see infi-a patt IV.F. In a general counsel memorartdum, the IRS stated that it ntay consider whether not- for-profit hospitals and their parent corporations deserve 1. R.C. § 501(c)(3) treatment based on the relationship between the parent corporation and other public charitable organiz.ations controlled by the satne persons who control the suppotting parent. Gen. Couns. Mem. 39,508 (May 27, 1986), available in LEXIS, Fedtax library, GCM file, 1986 IRS GCMLEXIS 45,

n2931d. at *35. The IRS offered the following statetnent as an explanation of its position:

Pltysicians generally use hospital facilities at no cost to themselves to provide services to private patients for which they cam a fee. 'I'he private benefit accruing to the physiciatts generally can be considered incidental to the overwhelming public benefit resulting &om having the combined resources of the hospital and its professional staff available to serve the public. Though the private benefit is compounded in the case of certain specialists, such as heart transplant surgeons, who depend heavily on highly specialized hospital facilities, that fact alone will not make the private benefit more than incidental.

Id. at *36 (citation omitted).

Appx.246 Page 30 37B_C.L_Rev1,*

n294'I'he IRS sctvtiny focuses on potential violations of the prohibitions against private hiurement ancl excessive private beneftt and on the lack of Medicaid patients serviced by rnost joint venture providers. See U.S. GEN. ACCOUNTING OFFICE, NONPROFIT HOSPITALS: FOR PROFIT VENfURERS POSE ACCESS AND CAPACITY PROBLEMS (1993).

n295 This question adclresses not only the prohibition against private benefit, but also the "operational exclusivity" requirement. See Gen. Couns. Mern. 39,862, supra note 201, at *39 (discussing the qucstion). For a brief discussion of the "operatioual exclusivity" requirement and ttte community benefit standard as applied by the IRS to physician-hospital joint ventures, see supra part IV.B.2.g.

n296 For a discussion of the public policy issue, see infra part I V.E.

n297 See supra note 201. One comnientator stated that the geueral counsel mcmorandum "threw into tur- moil a type of relationship that had developed between many pltysicians and tax-exempt hospitals." Riehard M. Lipton, IRSAttacks Hospital.loint Ventures, 70 TAXES 59, 59 (1992). Not only did jotu'nals directed at tax praetitiouers perceive GCM 39,862 as tax worthy, but popular news media such as The Wall StreetJournal had protninent articles with sensationalized headlines or lead lines. See, Paul Streckfus, Recently Released GCM Serves as Yellow Flagf'or Ecempt Hospitals, 53 TAX NOTES 1456 (1991); Ron W inslow, IRS Stance May Force Some Ilospitals To End Ventures, WAI.L ST. J., Dec. 9, 1991, at Bl. For law review articles discussing GCM 39,862, see Patrick H. Lucas, The S'ervice's Latest Attempt to Regidate Hospital-Physician Relationships: A Critical Analysis, 9 AKRON TAXJ. 13 (1992); Tlteodore T. Myre, Jr., Sign fcant Tax Lcsues in Hospital Re- lated Joint Ventures, 75 KY. L.J. 559 (1986-87).

n298 Gen. Couns. Mern. 39,862, supra note 201, at *1 (citing Priv. Ltr. Rul. 88-20-093 (May 31, 1988); Priv. Ltr. Rul. 89-42-099 (Oct. 30, 1989); tmpublished Priv. Ltr. Rul. (issued Sept. 13, 1984)).

n299 Id. at *43-*44,

n300 The IRS also discussed the distinct possibility that the arrangements violated public policy. See inJi part IV.E.2-3 (discussing the Medicare and Medicaid fraud and anti-abuse laws).

n301 Gen. Couns. Mcm. 39,862, supra note 201, at *44.

n302 Id. at *43 *44.

n303 Id at *36-37. The IRS balanced the pnblic beneGt resulting front the transactions -- enl .anced hospital financial health or efficiencies -- and found tlteni merely "tenuous" to the hospital's charitable purpose. There- fore, private benefit far exceeded the permissible "incidental" standard. Id.

n304 Priv. Ltr. Rul. 92-33-037 (May 20, 1992), reprinted in 6 EXEMPT ORG. TAX REV. 838 (1992).

n3051d

n306 Rev. Rul. 69-383, 1969-2 C I3. 113. The IRS identified a nuntber of factors to be considet'ed in determining reasonableness of conrpensation, including: (1) whether the compensation resulted frotn arms length ne- gotiations; (2) the cxtent of coutrol by the compensation recipient over the payer organization; (3) the reasonableness of the compensation amount compared to ttte responsibilities and activities assumed under the contract; (4) whether the cotnpensation would qttalify for an ordinary and necessary business deduction under I.RC_ § 162(a); (5) whether the compensation payntents serve a real and discernable business purpose of a hospital inde-

Appx.247 Page 31 37 B.C. L. Rev 1, *

pendent of a purpose to operate the hospital for the recipient's benefit; (6) wltether the contpensation principally depends on incoming revenue of the hospital or upon accotttplishment of the objective of the compensation contract; and (7) the presence of a cap or reasonable maximurn compensation to avoid a potential windfall to the recipient. Id.; see Thomas K. Hyatt, Physician Recruitment and Retention for Charitable Hospitals: In tlie Midst of a Sea Change?, 6 EXEMPT ORG. 1AX REV 1314, 1318-19 (1992) (citing specifically Gen. Couns. Mern. 38,905 (June 11, 1982), and other IRS releases generatly).

n307 Rev. Rul. 69-383, supra note 306, at * 1.

n308 Id. at * 1.

n309Id at *1 *2.

n310Id at *3.

n311 Gen. Couns. Mein. 39,498, supra note 280, at *2-*3.

n312 Id

n313 Id. at *6-*7.

n314 Id. at*9-*10, *13-*14.

n315Id.

n316 Gen. Coons. Menz 39,498, supra note 280, at *9-* 10, * 13-* 14.

0 17 Id.

t818 Bernadette M. Broccolo & Michael W. Peregrine, Had Doctor Deals Place Ilospitals at New Risk: PmY I-- Hermann Hospital Clo.sing Agreement, 10 EXEMP`f ORG. 'fAX REVIE W 1341 (1994).

n319 Id

n320 See IRS Closing Agreernent, supra note 15, at.f-1_ Tax attorneys have criticized the closing agreement as "overly restrictive if IRS intends to apply thcm beyond the facts of this case." Id

n321 Broccolo & Peregrine, supra note 318, at 1341. The agreement does not address defetred compensation packages, retention packages, or htcentive programs directed at physician-employees. Id

n322 Id

n323 Ann. 95-25 (Apri13, 1995), 1995-14 LR.B. 11, available in LEXiS, Fedtax library, Rels file, 1995 IRS LEXIS 110, at * 1.

n324 Id.

Appx.248 Page 32 37 B.C. L. Rev 1, *

n325 Fred Stokeld, Expect More Closing Agreements, IRS Official Tells Tax-Exempts, 67 TAXNOTES 1294 (1995) (citing statement by Celia Roady, partner in Washington, D.C. law firm and chaitperson of Anierican Bar Association, Tax Section, Exempt Organizations Comntittee).

n326 Ann_ 95-25, s•upra note 323, at * 15= 20.

n327 Id.

n328 Id.

n329 Id.

n330 Bob Jone.s Univ. v. United States, 461 U.S. 574, 590-600 (1983).

n331 Id at 591-92 (footnotes omitted).

n332 These elements are taken from statements throughout the majority opinion. One such statement provides: In view of our conclusion that racially discriminatoty private schools violate fundamental public policy and cannot be deemed to confer a benefit on the public, we need not decide whether an organization providing a public benefit and otherwise meetutg the requirements of § 501(c)(3) could nevertheless be denied tax-exempt status if certain of its activities violated a law or public policy.

Id. at 596 n.21.

n333 In his dissent, Justice Relmqnist points out this confusion by stating: Another way to read the Court's opinion leads to the conclusion that even thouglt Congress has set forth some of the requirements of a § 501(c)(3) organization, it intended that the IRS additionally require that organizations meet a higher standard of pttblic interest, not stated by Con- gress, but to be determined and defined by the IRS and ttte courts.

Id at 617 (Rehnquist, J., dissenting). Likewise, Justice Powell in his concutring opinion suggests sonic coneern about the clarity of the niajority's approach_ Id at 606-07 (Powell, J., concurring). In portions of the majority opinion, the Court intpHed that the public policy requirement is a separate requirement and not subsmned within another requiretnent. In that event, the public policy requirenient would not impact directly a detennination of whether an organization falls witltin one of the eight express categories enumerated in I.R.C. § 501(c)(3), such as charitable, educational, scientific, etc. Illustrations of the separate requirement ittterpretation can be found in the following exatnples of the language of the majority opinion: (1) "To qualify for a tax exemption pursuant to LR C. § 501(c)(3), an institution must show, first that it falls within one of the eight categories expressly set fuitli in that section, and second, that its activity is not coturaty to settled public policy." Id at 585. (2) "An institution must fall within a category specificd in [I R.C. § 501(c)(3)] and tnust demonstrably serve and be in harmony with the public interest." Id at 592 (citation omitted). (3) "To be entitled to tax-exempt status under § 501(c)(3), an organization tnust first fall within one of the categories specificd by Congress, and in addition nlust serve a valid charitable ptu'pose." Id. at 592 n. 19.

Appx.249 Page 33 37B.C.L.Rev1,*

However, in other portions of the opinion, the majority appears to connect the two concepts of public policy and community benefit as necessaty to satisfy one of the eight categories of LR. C § 501(c)(3). For example, the majority states: (1) "A corollary to the public benefit principle is the requirement, long recognized in the law of trusts, that ttre purpose of a eharitable trust tnay not be illegal or violate established public policy." Id at 591. (2) "[A] declaration that a given histitution is not'charitable' should be made otily where tltere can be no doubt that ttte activity ittvolved is contrary to a fimdamental public policy." Id at 592. See Galston, supra note 154, at 313-15 (describing legislative history behind public policy constraint); Note, Bob Jones University v. United States: For Whom W,.'j1 the Bell Toll?, 29 S7' L pULS U L..I 561, 574-75 (1985) (indicating the majority opinion is not a paradigm of clarity).

n334 See supra note 333 (presenting select quotations from the majority opinion).

n335 See, e.g., Church ofScientafagy v. Commissioner, 83 T.C. 381, 385, 443-44, 504-05 (1984) (holding that petitioner did not qualify for tax-exempt status because it operated for a substatrtial commercial putpose, it violated the prohibition against private inurement, it violated well-defined standards of public policy, and it did not provide a public benefit; leaving undecided the issue of "whettter an organization providing a public benefit and otherwise meeting the requiremcnts of section 501(c)(3) could nevertheless be denied tax-exempt status if certain of its activities violated a law or public policy"); Canada v. Commissioner, 82 7:C. 973, 981 (1984) (citing Bob.Iones University in detennination of whether petitioners were entitled to receive charitable contributions to church); see also Note, Applying a Public Benefzt Requirenient to Tax-Fxenzpt Organizations: Bob Jones University v. United States, 49 MO. L. REV. 353, 353 (1984).

n336 Social Security Amendments of 1972, Pub. L. No. 92-603, § 242, 86Stac 1329, 1419 (1972) (codified as amended at 42 U S.C. § 1320a-7b(b) ( 1994)). This original statute was a narrow prohibition against ceztain fraudulent behavior, and provided for a criminal misdenieanor sanction if violated. For a general discussion of these fraud and anti-abuse rules, see Colombo, supra note 82, at 258-63; Glenn A. Reed & Robert E. DeWitt, Referral Fee Prohibitions, in HEALTH CARE CORPORATE LAW: FINANCING AND LIABILITY 7-1, 7-14 to 7-40 (Mark A. Hall cd., 1994).

n3371n 1977, amendments broadened the prohibited abuses and increased the criminal penalty for violation of the fraud and anti-kickback provision to a felony. Medicare-Medicaid Antifraud and Abuse Amendznettts, Pub. L. No. 95-142, § 4(b), 91 Stat. 1175, 1181 (1977) (codified as amended at 42 (LS.C.'. § 1320a-7b(b) (1994)). See supra note 330 for brief description of penalty uader original statute. In 1980, Congress added a scienter requirement; the offender ltad to "knowingly and willfully" enter into an arrangement considered fraudulent under the antikickback rules. Otnnibus Reeouciliation Act of 1980, Pub. L. No. 96-499, 94 Stat. 2599 (1980) (codified as amended at 42 U.S.C. § 1320a-7b(b) (1994)). The crintinal provision provides a felony charge witli cotnniensurate sanctions. 42 USC. § 1320a-7b(b) (1994). Uuder the procedures for a civil action, the Office of Inspector General ("GIG") or Health and Human Services ("HHS") initiates the case. If the OIG finds the health care provider guilty under the statute, the offender can be excluded from further participation in the Medicare aud Medicaid programs. However, the health care provider may request a hearing before an IIIIS administrative law judge. In such a hearing, the OIG has the burden of proving tttat ttte health care provider violated the statute by a preponderatice of the evidence. An adverse decision by the administrative law judge can be appealed to the HHS Departntental Appeals Board, and court review of this appellate level administrative procedure is permitted. However, contt review is limited to a deteimination of whether HHS's decision was "arbitrary and capricious." See Colornbo, supra note 82, at 224 n.68; Reed & DeWitt, supra note 336, at 7-16 to 7-17 & n.9. In 1987, Congress added a civil penalty provision to supplement the existing criminal sanction. Medicare and Medicaid Patient and Program Protection Act of 1987, Pub. L. No. 100-93, § 3,101 Stat. 680, 686 (1987) (codified as amended at 42 U.S.C. ,¢' 1320a-7h(b) (1994)). This amendment enabled the OlG or HHS to expel the gnilty health care provider from future participation in Medicare and Medicaid programs. Reed & DeWitt, supra note 336, at 7-16 to 7-17 & n.9. These atnendnrents also authorized HHS to issue regulations creating "safe har-

Appx.250 Page 34 37 B.C_ L. Rev 1, *

bors," Pub. L. No. 100-93, § 13, 101 Stat 680, 697-98 (1987) (codified as amended at 42 U.S.C. ,i 1320a-7b(b)). See generally Reed & DeWitt, supra note 336.

n338 42 U.S.C. § 1320a-7b(b)(1)-(2) (1988). Foi- further discussion, see supra note 8.

n339 Omnibus Budget Reconciliation Act of 1989, Pub. L. No. 101-239, 103 Stat. 2106, 2236-41(coditied as atnended at 42 US.C. § 1395nn (1994); Omnibus Budget Reeonciliation Act of 1993, Pub. L. No. 103-66, 107 Stat. 312, 596-604 (codified at 42 U.S.C. § 1395nn). Because these self-refcrral provisions were introduced by Representative Fortney "Pete" Stark, the provisions were referred to as the "Stark Bill."

n340 A prohibited "financial relationship" generally iuchtdes any ownership, debt or other investment inter est in an entity, including any eonrpensation arrangemeut. 42 U.S.C. § 1395nn(g)(3)-(4) (1994). With respect to the prohibition against physician self-referral, a guilty pi-ovider cannot elaim paytnent for the prohibited self-refen-ed service -- and if claimed in violation of the law, it must be reimbrused to the govcrnment. 42 U.S.C. § 1395nn(a)(2) ( 1988 & Supp. V 1993). Additionally, the statute provides for a $ 15,000 penalty per violation for presenting a claim for service that the person knows or shoaid know violates the law, and a $ 100,000 penalty for entering into a prohibited arrangement that the person knows or should know Itas a principal purpose of producing illegal referrals. 42 US.C. § 1395nn(g)(3)-(4).

n341 42 US.C § 1395nn.

n342 Other safe harbors have been proposed by IIHS involving investment interests in rural area facilities, investnient interests in ambulatory surgical centers, investment interests in group practices composed exclusively of active investors, practitioner recruitment in rural areas, obstetrical nialpractice insurance subsidies, referral arrangements to specialty services, and cooperative hospital services. 58 Fed. Reg. 49,008 (1993) (to be codified at 42 C.F.R. § 1001.952) (proposed Sept. 21, 1993)_

n343 42 C.F.R. § 1001.952(a)(1), (2)(i) (1994). This safe harbor protects pltysicians' investment interests in large, publicly hcld corporations having in excess of $ 50 ntillion in net tangible assets, and in certahijoint ven- twes where no more than 40% of the interests are owned by persons capable of referring and no more than 40% of the gross revenues are from referrals.

n344 42 C.F.R. § 1001.952(b)-(c) (1994). A written lease at fair market value must be entered for at Icast one year, with the fair market value not determined by refetrals or value of business reimbursed by Medicare or Medicaid.

n345 42 CF.R. § 1001.952(d) (1994). The health or managenient services must be delineated hi writing and have a term of at least one year. Conzpensation must be established in advance, with none of it determined by Medicare or Medicaid refetrals or business generated.

n346 42 C.F.R. § 1001.952(e)(1)-(2) (1994).'1'he sale inust be completed within one year of execution of the sale agreentent; the selling physician must have relocated, retired or not be in a positioo to make referrals one year after the sale agreement's date.

n347 42 C.F.R. § 1001.95269 (1994).'I'he referral service tnust not exclude qualified physicians 5om participation and must charge fees equally to all participating physicians based only on ttie cost of the service.

n348 42 C F.R. § 1001.952(g)-(h) (1994). Warranties and discounts offered in exchange for volunze referrals are perntitted if both buyer and seller report them on their cost rcports or invoices.

Appx. 251 Page 35 37 B.C. L. Rev 1, *

n349 42 C.RR. § 1007.952(i) (1994). Payments to bona Gde employees are protected; the term employee is defined by reference to I.R.C. standards ttiat distutguish independent contractors from employees.

n350 42 C.F.R. § 7001.9526) (1994). Purchasing agents must enter into written agreements with the provider and make certain disclosures in certaini circumstances.

n351 42 C.F. R. § 1001.952(k) (1994). The waiver or reduction must be universal for all services, but not be offered under a nrice reduction agreement between a hospital and a third-party payer, and tnust not later be claimed as a bad debt.

n352 42 CLS.C. ,¢ 1395nn(b)-(d) (1988 & Supp. V 1993)_ 7'he exceptions fall into thrce categories generally: exceptions to both the ownership and compensation prohibitions; exceptions to the ownership prohibitions only; and exceptions to the compensation prohibitions only. See Colombo, supra note 82, at 226-27; I2eed & DeWitt, supra note 336, at 620-22.

n353 See supra note 78 and accompanying text (discussing patient dumping problem).

n354 See s•upra note 78 (discussing COBRA, Congi-es5s response).

n355 42 U.S.C. § I395dd(d)(l)-(2) ( 1988 & Supp. V 1993).

n356 See, e.g., Gen. Couns. Merrr. 39, 862, supra note 201, at *62;1RS Hospital Audit Guidelines, Manual Transmittal 7(10)69-78, P 333.1(5) (Mar. 27, 1992), reprinted in 5 EXF.MP'I'ORG. TAX REV. 697 (1992) [hereinafter Audit Guidelines]; IRS-CPE TEXTBOOK, supra note 92. Field agents are instructed not only to investigate the denial of treatment to and transfer of patients in an emergency medical condition or wotnen in active labor, but also to examine incidences of "radio triage" -- that is, assessing a patient's financial ability by radio contact, usually with an ambulance, and directntg the pationt be driveo to another institution. Audit Guidelines, supra; see also IRS-CPE TEXTBOOK, supra, note 92.

n357 See Charles F. MacKelvie & Mary Lynn McGuire, Provide^Pirysician Arrangements: An Unea.sy Al- liance Under Fraud, Abuse, and Inuretnent, in LEGAL MBDICINE 1990, at 189, 190-207 (Cyril H. Wecht ed., 1991); Woodhall, supra note 92, at 231-33.

n358 See IRS-CPE TEXTBOOK, supra note 92; Audit Guidelines, supra note 356, at P 333.4; see also IRS and HHS to Coordintrte Oversight Operation ofTax-Exempt Health Care Organizations, 2 EXEMPT ORG. TAX REV., Special Supp. 1989.

n359 See, e.g., Priv. L,tr. Rul. 92-33-037, supra note 304; Priv. Ltr. Rul. 90-29-034 (Apr. 23, 1990); Priv. Ltr. Ru189-42-099, supra note 298; Priv. Ltr. Rul 88-20-093, supra note 298; see also supra notes 294-305 (describing such partnership arrangements).

n360 See, e.g., Priv. Ltr. Rul. 90-29-034, supra note 359; Priv. Ltr. Rul 89-42-099, supra note 298; Priv. Ltr. Rul 88-20-093, supra note 298_

n361 See Gett. Couns. Mem. 39,862, supra note 201 (addressing Priv. Ltr. Rul. 89-42-099, sirpra note 298; Priv. Ltr. Rul. 88-20-093, supra note 298; unpublished Priv. Ltr. Rul., supra note 298).

Appx.252 Page 36 37 B.C. L. Rev I, *

n362 Gen. Coznus. Mein. 39,862, .sup•a note 201.

n363Id at *62.

n364'fhe IRS stated that it should care about whether these physician hospital arrangements do serve an il- legitnnate purpose for several reasons:

First, physicians may be tempted to refer patients for unnecessary services or for necessaty services provided in an unnecessatily costly setting. This overutilization would drive up the costs of the Medicare and Medicaid Programs without achieving auypublic benefit. Paymetits intehdedto influence the exercise of judgtnent with respect to referrals may easily become an added cost of doing business in the health care field. Suctt arrangements may also cause ltarm to individual patients from ttieir being subjected to unnecessary procedures or having their treatnient facilities selected based on pecuniary, rather than quality of care, concerns.... Another important reason to be concenied about these airangements is that the hospital's entire community may be harmed rather than benefitted. Where physicians receive hidden or disguised payments for referrals, honest competition among health care providers based on quality or price is undercut.

Ld. at *65-*66 (citation omitted).

n365 Id. at *58 *59 (discussing abusive features of OIG Special Fraud Alert-Joint Venture Arrangements, issued in April 1989).

n366Id. at *76.

n367 Gen. Couns. Mem_ 39,862, supra note 201, at *77. IRS also cited eoncern for the "laclc of synimetry in upside opportunities and downside risks for the pltysician-investors." Id. at *78-*79. IRS questioned whether the incentives provided to the physician-investors were actually intended to include unstated incentives for referral of Medicare and Medicaid business. Id. at *79.

n368 Id. at *62 (footnote oinitted).

n369 See IRS-CPE TEXTBOOK, supra note 92; see also Levine, supra note 277 at 1060.

n370 Such disguised payments could take a variety of fornis. For example, disguised referral fees could be in the fonn of above-market rates of compensation paid to the physicians or an option to buy the practice where an actual sale is not contemplated. See IRS-CPS TEXTBOOK, supra note 92.

n37I Supra note 323.

n372 For further discussion of the pliysician rectuitment issues, see supra part IV.D.2.

n373 Ann_ 95-25, supra note 323, at 14.1'ax-exempt status will be denied or revoked. Id.

n374 See supra notes 357-58 and accotnpanying text.

n375 See supra part IV.C-D.

Appx.253 Page 37 37 B.C. L. Rev 1. *

n376 To date, no cases or administrative rulings exist involving health care organizations' confonnance with the public policy test other than with respect to the Medicare/Medicaid anti-kickbaclc statutes. However, it is cottceivable that other public policy concerns might enter the picture at sorne point. For example, the media has reported that low-incozne groups in 7'ennessee allege discriminatory practices against them as Medicaid recipi- ents_ Steven A. Holmes, Drug Makers and Black Groups Fight Prescription Controls, N.Y. TIMES, Nov. 20, 1994, § 1, at 32. These individuals under TennCare, Tetmessee's Medicaid program, suggest that TemtCare's ttse of a reshictive formulary of approved drugs results in denied access to certain drttgs that physicians tnight deetn appropriate to prescribe. Id They allege that these practices are discrimutatory in that more affluent individuals are not limited in the kind and quality of available prescriptiou dntgs_ Id Moreover, it is suggested tttat this practice violates Title VI of the Civil Rights Act of 1964, which bars discrimination in any program receiving federal funds, including Medicaid. Id.

n377 See supra notes 57-58, 80-81, 100-03 and acconspanying text.

n378 For a definition of "IDS," see infra Glossary. One survey reports that of ttte 1191 freestanding hospitals represented, 81% expect the hospitals not to operate independetitly by 1999. DELOI'fPE & TOUCHE, supra note 84, at 1, 26. Most anticipate then-hospitals to join provider networks, but without ownership changes. Id at 1. Seventy-one percent of the hospitals either cturently belong or anticipate developing IDSs, and 66% report that it is "absolutely necessary" for an acute-care hospital to have some fot-in of PHO. Id, at 17-18, 21-22; see also Boistttre, supra note 95, at 272; Richardsort, supra note 58, at 907.

n379 For a description of the various IDS niodels, see infra Glossary. See also Gerald M. Griffith & Brad M. Tomtishen, Exempt Hospital Affzliations: Bond and UBIT Issues, 11 IiXEMPT ORG. TAX REV. 709 (1995) (discussntg regional affiliations of hospitals).

n380 See Bromberg, szip-a note 92, at 336; Richardson, supra note 58, at 907.

n381 One practitioner, a fornter IRS official, has described the foundation tnodel IDS as the "progeuy of su- perannuated restrictions on the corporate practice of inedicine." Broniberg, supra note 92, at 336.

n382 Mergers, acquisitions, and otlter forrns of legal reorganizations entered into for the purpose of consoli- dating or streamlining the provision of health care services have become common (luring the 1990s. Many mergers have occutred in the health indushy despite the fact that the expenses of consolidation can be extraordi- narily high. For a disctrssiou of the costs associated with mergers of health care providers, see Jay Greene, The Costs ofHospital Mergers, MOD. HEALTHCARE, Feb. 3, 1992, at 36. It has been reported that between 1983 and 1992, the number of hospital systems increased from 249 to 300, with the number of non-federal acute-care hospitals declining from 5788 to 5292. See Richardson, supra note 58, at 913 (cithtg AMERICAN HOSPITAL ASSOCIA7'ION DIRECTORY OF MUL'1'IHOSP1Tt1L SYSTEMS (1980-1987) and editions of the AZ-IA GUIDE for 1988-1993 (implying these changes resulted from horizontal rnergers of hospitals)). 'fhe issue that arises as a result of reorganization processes is whether the existing LR. C. § 501(c)(3) status of a hospital or other affiliated entity is threatened by the reorganization. Numerous private letter rulings and other IRS pronouncements indicate generally that the changed structure will not jeopardize the existing tax- exempt status of a hospital or other entity taking part in the reorganization if the new sttucture enhances the delivery of health care services and each entity continues to satisfy the requirements of Revenue Ruling 69-545. Sec, e.g., Priv. Ltr. Rul. 95-19-057 (Feb. 16, 1995); Priv. Ltr. Rul. 95-17-051 (Feb. 2, 1995); Priv. Ltr. Rul. 95- 11-038 (Dec. 20, 1994); Priv. Ltr. Rul. 95-11-036 (Dec. 19, 1994); Priv. Ltr. Rul. 95-11-035, supra notc 205; Priv. Ltr. Rul. 92-28-044 (Apr. 16, 1992); Priv. Ltr_ Rul. 92-25-042 (Mar. 25, 1992); Priv. Ltr. Rul. 91-30-002 (Mar. 19, 1991); Gen. Couns Mera 39,326 (Jan. 17, 1985), available in LEXIS, Fedtax library, GCM file, 1985 IRS GCM LEXIS 6 If the systern can show that due to the reorganization it has a more effective ability or more flexibility to respond to the cotnpetitive healttt care environment and to cotnmuttity health care needs, the IRS

Appx.254 Page 38 37 B.C. L. Rev 1,

has indicated that the new structure will be deemed to enliance health care delivery. See, e.g., Priv_ Ltr. Rul. 95- 19-057, supra; Priv. Ltr. Rul. 92-28-044, supra; Priv. Ltr. Rul. 91-30-002, supra. If as part of the reorganization a new corporate entity is created, the IRS will undertake an analysis of wltether the newly created corporation satisfies all requirements atid standards for tax exemption. For example, if a new superparent corporation is created, the orgauization would be required to satisfy the standards applied by the IRS to such entities. See infra notes 446-55 and accompanying text (describing the standards applicable to superparents).

n383 The determination depends on satisfaction of all LR.C. ¢.501(c)(3) tests enumerated in the text. See supra notes 119-25 and accompanying text. The IRS has placed considerable emphasis on scrutinizing these ar- raitgements for purposes of the proh bition

n384 The IRS has set forth separate exetnption criteria for the formation and operation of a foundation model TDS. See infra notes 390, 398-409 and accompanying text. For a description of a foundation inodel IDS, see infr-a Glossary.

n385 See Bromberg, supra note 92, at 338; Robert S. Bromberg, The Tax-Exempt Clinic, 8 EXEMPT ORG. TAX REV. 557, 557 (1993) [he•einafter Bromberg, Clinic]. The criteria for recognizing a clinic as tax-exempt under LR.C. § 501(c)(3) have not been clearly or fully set fortlt by the IRS. However, in Gen. Couns. Mern. 38,394 (June 2, 1980), where a clinic was devoted to the provision of health care services to a commnnity but was not involved in medical education, research and related activities, the IRS took the position that the governing boards of the clinic could not be physiciau controlled. Where a clinic is involved in medical education, research, and related activities, board control by pliysicians creates a "clear potential for abuse" but not a per se violation oftrtles. See Broniberg, Clinic, sagrra, at 557; Michael W_ Peregrine & Bemadette M. Broccolo, New Limitations on Physician Participation in Corporale Governartce, 65 7AXNOTES 121, 124 (1994).

n386 See supra note 383 (listing sonie of the pettinent rulings for foundation model IDSs).

n387 See IRS-CPE TEXTBOOK, supra note 92.

n388 Id. at 225; see Geisinger 11, 30 P.3d 494, 499 (3d Cir. 1994) (where the Third Circuit denicd the HMO, GI-IP, status as a "charitable" organization under LR.C. § 501(c)(3) pursuant to the integral part doctrine of I.R.C. § 502, and clearly stated that efficiency concems are outweighed by "counterveiling policy concerns"); Harriman Jones Ruling, s•upra note 383. This IRS position is consistent with its stance in Gen. Conuas. Menv. 39,862, whiclt involves hospital- physician joint venttues. See supr•a part IV.D. 1.

n389 See, e.g., IRS-CPE 1'EXTBOOK, supra note 92. For further discussion of the composition of governing boards, see infra notes 399, 402 and accompanying text.

n390 See IRS-CPE'fEXTBOOK, supra note 92,

n391 Although the IRS has not articulated a health care provider requirement, an official IRS publication defines an IDS as a"health care provider (or one component entity of an affiliated network of providers) created to integrate the provision of hospital services with professional medical (e.g., physician) services." IRS-CPE

Appx.255 Page 39 37 B.C. L. Rev 1, *

TEX1'BOOK, supra note 92. However, the IRS considers non-staff ntodel HMOs and MSOs to be arrangers or facilitators of healtlt care rather than healtli care providers. See supra notes 255-56 and accompanying text (discussing provider versus arranger status with respect to GHP); see infra note 432 and accompanying text (discussing arranger status of MSO)_ Becanse these organizations can be part of an IDS, this IRS definition may not comport with legal positions that it has taken.

n392 Broniberg, supra note 92, at 336.

n393 /d

n394 See supra note 380 and accompanying text (listing several states in which the laws limit nonprofit corporations' employment ofphysicians).

n395 Brornberg, supra note 92, at 336.

n396 See Facey Ruling, supra note 205.

n397 Michael W. Peregrine & Bernadette M. Broccolo, New "4DS" Determination Letter Offc.rs Promise, Sparks Controversy, 7 EXEMPT ORG_ 7,9X REY. 757, 759 (1993).

n398 Id.

n399 Attention to cotmnunity representation on the goveming board is consistent with the IRS position in Revenvee RzdinA 69-545 that the board of trustees of a tax-exempt hospital must reflect the commanity in which the ttospital is located. See supra part IV.B.2.c (discussing Revenue Ruling 69-545). The 20% figure has been explained as having its genesis in the IRS's perception of the nonnal composition of a cominunity's population.

'Fhe [IRS] has taken the initial position that physicians generally do uot make up more tttan 20 percent of the population of any eomtnunity, and therefore, while tttey are willing to concede that the physicians can have a 20 percent representation on the board, they are insistent that other parts of the comrntmity be represented through the 80 percent non-physician pot3ion of'the board.

Bromberg, supra note 92, at 337-38.

n400 IRS-CPE TEXTBOOK, supra note 92.

n401 See IRS-CPE'fEXTBOOK, supra note 92; Friendly Hills Ruling, supra note 205.

n402 See IRS-CPE TEXTBOOK, supra note 92; see also Facey Ruling, supra note 205; Friendly Hills Rul- ing, supra note 205. IRS representatives sontetimes have referred to the 20% figure as merely a"safe harbor" and "not an absolute requirensent or limitation" on the percentage of physicians and interested parties that may comprise the governing board. Exempt Organizations: IRS Focuses on Community Benefit in Integrated Deliv- ery.Systent Rulings, Daily Tax Rep. (BNA), at D-12 (Aug. 16, 1993), available in Westlaw, BNA-DTR file (statement of T.J. Sullivan, Special Assistant for Health Care, Office of the Assistant Comrnissioner for Em- ployee Plans and Exempt Organizations, IRS). At other times, IRS representatives have indicated a niore aggressive approach touching on a 20% restriction. For example, it has been expressed that "we want to make sure no ntore than 20% of control goes to physicians or employees of the network." hactors Determining If Kealth Sys- terns Are Tax-Exempt Outlined By IRS Ofjicial, Daily Tax Rep- (BNA), at G-2 (Oct. 24, 1994), available in Westlaw, BNA-DTR file (statement of T.J. Sullivan, Special Assistant for Health Care, Office of the Assistant

Appx.256 Page 40 37 B.C. L. Rev l, *

Commissioner for Employee Plans and Exempt Organizations, IRS). Tfiis 20% liniit is perntissive if viewed in light of the absolute prohibition against private inurement rather than the limitation on private benefit. See supra part IV.C-D. In other words, the issue arises as to whether any physician representation violates the private inurement proltibition. See Gen. Couns. Mem. 39,862, supra note 201; Gen. Couns. Mem. 39,498, supra note 280. For an explanation of the basis for the 20% figure, see supra note 399 (discussing IRS's perception of physician coniposition of a community).

n403 See IRS-CPE TEXTBOOK, supra note 92. Like the goveniing board, the IRS takes the position that physicians should be limited to a "minority position" on price setting committees. Makeup ofFee Board Factor C 13 in Sxem^ai:rf^ I l Xe a l l hJJ•^"` Care Provider , b ° nm°Y'o ^I S ° DailJ' Tux Y^ Re^ 1 NA0Ah at G-4 pr. (p ^ 25, 1995)ln cyail- able in Westlaw, BNA-DTR file [hereinafter Makeup ofFee Board] (statement of Phyllis Haney, senior attorney, Office of Associate Chief Counsel, Employee Plans and Exenipt Organizations, IRS). However, if half of the conunittee wcre physicians, there would be little likelihood of a grant oftax-exeinpt status. Id

n404 See Makeup of Fee Board, supra note 403.

n405 See IRS-CPE TEXTBOOK, supra note 92 (describing the provision of inedical education and research as a "favorable factor").

n406 See IRS-CPE TEXTBOOK, supra note 92; see also Facey Ruling, supra note 205; Friendly Hills Rul- ing, supra note 205.

n407 See IRS-CPE TEX'I'BOOK, supra note 92; see also Facey Ruling, supra note 205; Friendly Hills Rul- ing, supra note 205.

n408 In the Friendly Hills Ruling, the foundation was described as operating a general acutecare hospital and ten clinic facilities. Friendly Hills Ruling, supra note 205, at 490. The foundation agreed that the hospital would conthiue to operate an emergency room opeu to the public and to provide etnergency care to anyone regardless of ability to pay. Id. at 491. Additionally, the foundation agreed to treat any person without regard to ability to pay if present at any clinic location and in need of immediate care_ Id. Moreover, indigents receiving emergency room care and requiring hospitalization would be admitted to the hospital for inpatient care and wouid receive at the hospital or clinics all necessary follow-up cai-e free or at disconnted rates, depending on the patient's financial tneans. Id. Fhially, the foundation agreed that the hospital and clinics would pntticipate in Medicare and Medicaid on a nondiscritnuiatory basis. Id. In the Facey Ruling, the foundation agreed to provide $ 400,000 of charity care armually during its first two years of operation and at least $ 400,000 of charity care tttereafter. Facey Ruling, supra note 205, at 830. The foundation also agreed that the medical group with wtiich it had contracted for medical services would provide a "substantial nunrber" of physicians to serve in the hospital cmergency room as "backup." Id at 829. Moreover, the foundation agreed to provide emergency room care without regard to a patient's ability to pay, and the clinic or aftiliated hospital would treat patients without regard to ability to pay. Id 'fhe foundation also agreed to participate in Medicare and Medicaid on a nondiscriminatory basis. Id. at 830. Sirnilar agreements were entered in the Billings Clinic Ruling, supra note 383, and in the Harriman Jones Ruling, supra note 383. In each of those rulings, the IRS permitted J.R.C. § 501(c)(3) treatment.

n409 IRS-CPE TEX'FBOOK, supra note 92.

n410 See, e.g., part IV.B1.2.(I).

Appx.257 Page 41 37 B.C. L. Rev 1, *

n4l t The `1'ltird Circuit has described the integral part doctrine as "an exception to the general rule that entitlement to exemption is derived solely from an entity's own characteristics_" Geisinger II, 30 F.3d 494, 498 (3d Cir. 1994).

n412 See Geisingerl, 62 T.C.M. (CCII) 1656 (1991), rev'd, 985 F.2d 1210 (3d Ch•.), on reniand, Geisinger /I, 100 T.C. 394 (1993), affd, 30 F.3d 494 (3d Cir. 1994). For a discussion of Geisinger I, see supra notes 242- 56 and accompanying text.

n413 Geisinger 1, 985 F.2d at 1210.

n414 Geisinger II, 30 F.3d at 494. The Geisinger System consists of GIIP and eight other not-for-profit entities that prontote health care in 27 counties in tiottheast and north-central Petmsylvania. Id. at 496. The system, which is controlled by a parent foundation corporation, hrcludes two medical centers, a clinic, a detoxifica- tion center, two professional liability ti-usts, and management personnel who provide administrative services to the systcm. /d.

n415 See Geisinger II, 100 7:C at 394.

n416 Tlie Tax Court specifically stated: "'fhe parties agree that an organization is entitled to exemption as an integral part of a tax-exempt affiliate if its activities are carried out under the supervision or control of an exempt organization and could be catTied out by the exeinpt organization without constituting an unrelated trade or business." Id. at 402,

n417 Id. at 404. Elaborating, the Tax Court expressed the following: Given the existence of sales to aud services performed for persons who are not patients of the exempt entities within the Geisinger systeni, we must determine whether petitioner's overall operations are "substantially related to the exempt function" of its exempt affiliates. If petitioner's activities are "conducted on a scale larger tltut is 'reasonably necessary"' to accomplish the purposes of the exempt entities, there is no substantial relationship within the meaning of the regulations.

Id. at 405-06

n418 Con(rary to GHP's prodding, the'Third Circuit flatly refused to accept GHP's position that pursuant to the integral part doctrine, tax-exempt status should automatically be granted if GHP were inerged with its tax- exempt affiliates, which would continue to retain theb- exemption. The Third Circuit stated:

'Phe integral part doctrine does not mean tfiat GIIP [the entity seeking tax-exempt status] would be exempt solely because eitlier GMC or the Clinic [affihated excmpt organizations] could absorb it while retaining its tax-exempt status. While this is a necessary condition to applying ttie doctrine, it is not the only condition.

Geisinger ZI, 30 F.3d at 499.

n419 To this end the Third Circuit exp-essed: We acknowledge that interpreting tlte integral part doctrine in the manncr GHP urges might enable etrtities to choose their organizational stntctures based on efficiency concerns rather than perverting those concerns by making tax considerations relevant_ In our view, however, there are countervailiug policy concerns whichjustify determining each entity's tax status based upon its own organizational structure. It is less complex and more certain for courts and administrators to

Appx.258 Page 42 37 B.C. L. Rev 1, *

assess an entity's tax status in light of its unique organizational composition antl its association with another entity, and ouly to ltave to take into account sorne flypottretical eombination of organizations as a second step in those relatively rare instances when an organization rneets the other precondition of integral patt statns we set forth below.

Id.at499.

n420 Geisinger 11, 30 F.3d at 507. The first prong of the Tltird Circuit test is essentially the second segment under the Tax Cotut's test.

n421 Prior to the Third Circuit decision in Geisinger ZI, the tax bar, the Tax Court, and the IRS had focused on whether the subsidiary furthers the parent's tax-exempt purpose. The Third Circuit's approach appears to approach the question from the opposite direction -- that is, does the subsidiary's affiliation with the parent enhance the subsidiary's tax-exempt putpose? However, one connnentator has pointed out that the Third Circuit's ruling may "simply be another way of saying that the subsidiary must further the parent's exempt purposes." LaVerne Woods, The Third Circuits Integral Part Test in Geisinger Health Plan: 1nsplicationsforlntegrated Delivey Systems, 10 EXEMPT ORG. TAX REY. 1351, 1354 (1994). The commentator elaborated:

Viewed in this light, the second prong of the Third Circuit's test is not novel at all, but ratlier a restatement of the fnst prong, i.e., that the subsidiary's activity tnust tiot be an unrelated trade or business if conducted by the parent. Any activity of the subsidiary that wonld not colutitute an unrelated business if conducted by the parent must by defrnition fiutlter the parent's exempt purposes. Under this interpretation, wltile the Third Circuit forrnally declined to address the issue of whettter GHP's activities would be an tuu-elated business if carried on by its exempt affiliates, it effectively decided that the activities were unrelated by fnding that GHP received no "boost" from the relationship.

Id at 1354 (citation omitted).

n422 Geisinger 11, 30 F.3d at 502.

n423 See supra notes 238-56 and accompanying text.

n424 See Boisture, supra note 95, at 280; Peters, supra note 92, at 28-14. Instead of organizing the MSO as a separate entity, it may be formed a..s a division of the hospital. Id.

n425 See infi•a Glossary (describing IDS ntodels); Boisntre, supra note 95, at 280; Ricl>

n426 See Boisture, supra note 95, at 280; Richardson, supra note 58, at 907; Peters, supra note 92, at 28-14.

n427 If the medical practice is a professional for-profit corporation, it employs the physicians.

n428 Peters, supra note 92, at 28-14.

n429 See IRS EXEMPT ORGANIZATIONS CONTINUING PROFESSIONAL EDUCATION TECHNI- CAL INSTRUCTION PROGRAM TEXTBOOK FOR FISCAL YEAR 1995 [hereinafter IRS-1995 TEXT- BOOK] (basing the positiou on the prohibition against excessive private beneflt by participating physieians and on the lack of charitable purpose); Paul Streckfus, Report on the 8th Annucrt ALI-ABA Course of Study on T ax

Appx.259 Page 43 37 B.C. L. Rev l, x

Exempt Charitable Organizations, Held on December 2-3, 1993 in Washington, D.C.: Sullivan Gives Health Care Tax Update, 9 EXEMPT ORG. TAX RPV. 27, 27 (1994) (apparently basing the statement on the IRS position with respect to 1PAs); see also inft•a Glossary (defining IPA). In Revenue Ruling 86-98,1986-2 C.B. 74, the IRS denied tax-exempt status to an IPA on the basis that it is a physician owned vehicle used for marketing thcir professional services and therefore its purpose primarily benefits its physician owners in violation of the prohibitions against private inuretnent and private benefit. See also Peregrine & Broecolo, supra note 381, at 124. However, there may be an argument, albeit weak, for tax-exetnpt treatment of a university hospital affiliated not-for-profit MSO. In a recent private letter ruling, the IRS ruled that a not-for-profit provider based PPO, qualified for1.R.C. § 501(c)(3) treatment. Priv. Ltr. Rul. (Feb. 17, 1995), available in Intemal Revenue Service, Universi.ry,4ffliate_1 FTealth Care tnc Qnaljiesfor (c)(3) Exemption, 11 EXEMPT. QRG. TAXREV. 825, 826 (1995). Participants in the PPO included a university hospital, clinical practices affiliated with the university hospital, and the physicians of the hospital and clinical practices. ld. The IRS noted that PPO membership was represented by two groups: the university hospital and the clinical practices, the fotmer of which had effective veto power over PPO actions. Id. A similar veto power existed with respect to actions voted on by the board of directors, which is composed of five physicians, two hospital directors, and fotu• clinical practice presidents. Id. The PPO would negotiate contracts with thh•d-party payers and providers of medical services, with each such contract negotiated at artns length, and with compensation based on a fixed amount for each service rendered. [d The PPO would provide its own administrative and operations personnel. Id. The IRS found that the PPO qualified tmder the comniunity benefit standard because it would "enhance the ability of the Clinical Practices to attract a continuum of patients with diverse medical problems to the medical school. The operation of these clinics contributes to the ability of the hospital and its faculty to teacli their medical students." Id. This liberal approach is unlike the strict stance that the IRS takes with respect to most PIIOs -- that is, the organization will fail to qualify for tax-exempt treatment because the organization serves the private interests of the participating physicians and lacks a charitable putpose. See IRS-] 995 TEXTBOOK, suprcr; Participation in PHO Will Not Jeopardize Tax-Exernpt Status,1 0 Ls'XEMPT ORG. TAX REV. 1323 (1994) [hereinafter PHO Rul- ing] (reprinthtg a private letter ruling that addresses the tax-exempt status of a hospital on formation of a PIIO in wltich the hospital and ptrysicians each have 50% interests). However, this position is consistent with the rather liberal IRS ndings and cnurt decisions involving medical faculty practice plans affiliated with university teaching hospitals. See, e.g., University ofMd Physicians, P.A. v. Commissiotter, 41 T.C.M. (CCII) 732 (1987); Uni- versity ofMass. Medical Sch. Group Practice v. Commissioner, 74 T C. 1299 (1980); B.KW. Anesthesia Found. Inc. v. Commis.rioner, 72 TC. 681 (1979); see also Peregine & Broccolo, supra note 385, at 124. An MSO tnigltt be able to qualify for1. R.C. § 501(c)(4) status ttnder the less rigorous connnunity benefit standard, which does not appear to require health care provider status. See supra notes 242-56 and accompanying text (discussing Geisinger I and the comnrunity benefit nile witli respect to an HMO qualifying for 1.R.C. § 501(c)(4) but not (c)(3) tax-exempt status).

n430 See supra notes 254-56 and accompanying text.

n431 See supra notes 255-56 and accompanying text.

n432 Although not addressed officially by the IRS with respect to IDSs, one might raise the question of wltether any IDS component must qualify as a health care provider for tax exemption under I.R.C. § 501(c)(3). If it is considered essential by the IRS, as seemingly argued in Geisinger 1, with respect to an HMO which was part of an IDS, it appears that an MSO would not be entitled to qualify for tax-exempt status under I.R.C. § 50I (c)(3). See supra notes 255-56 and accompanying text (discussing health care provider status of stand alone HMOs); infra notes 433-38 and accompanying text (discussing possible hnpact of integral part doctrine and Third Circuit holding in Geisinger 11 on MSOs). The argument that the IRS considers provider status essential, or at least helpful, for ID5 components to qualify for tax-exempt status is bolstered by assertions of a forrner IRS official and current practitioner and commentator, Robert S. Bromberg. Mr. Broniberg has argued that, at least in California, the foundation in a foundation model IDS is a provider of health care. Broniberg, supra note 92, at 336. Mr. Bromberg suggested that provider status is permitted and was always intended for the foundation under the Californticr Ilealth and

Appx.260 Page 44 37 B.C. L. Rev 1, ip

Safety Code, § 1206(1)_ Id. Mr. Brotnberg distinguished the foundation from the MSO on this basis and labeled the MSO as a "facilitator or arranger." Id. According to Mr. Broniberg, the IRS may view the foundation as a health care provider. Furthermore, the IRS may have failed to articulate that it actually requires health care provider status for tax-exempt qualification by 1DS components. If so, an MSO would be unable to qualify. The IRS might ftuther support its argument by reliance on the ntles prohibiting private inurement and excessive private benefit. An MSO formed by a hospital-physician relationship is akin to a Itospital-physician joint venture. If the MSO were governed by the rules applied to hospital-pltysician joint ventw•es, the MSO could nm afoul of the proscription against excessive private benefit and the prohibition against private inurement. For example, if the MSO were capitalized by the tax-exempt hospital and were to purchase the assets of affiliated phy- ,Il.Iali inedtcal placti:.'s at other than arms length, Pz2n' market value, private benefit and Imlrement _.pncarnS would be triggered. See also Boisture, sz{pra note 95, at 280-81.

n433 From a recent private letter rulhtg it appears that, in order not to jeopardize the hospital's own tax- exempt status, physician ownership of the MSO could not exceed 50%. See PHO Ruling, supra note 429 (a private letter ruling that addresses the tax-exenipt status of a hospital on formation of a PHO in which the hospital and physicians each have 50% interests). If an MSO seeks tax-exeinpt status vicariously through a tax-exetnpt hospital under the integral part doctrine, the hospital's own tax-favored status must not be jeopardiz.ed. 7-ims, the MSO would need to be hospital controlled. The amount of physician control -- whether litnited to 20% pursuant to IDS standards -- is uncertain. See supra notes 399, 402-03 and accotnpanying text.

n434 See Woods, supra note 421, at 1353.

n435 Geisinger 11, 30 F.3d 494, 501 (3d Cir. 1994).

n436 A major difference between an HMO and an MSO is that the fonner integrates tnanagenient and financing ftmctions along with delivering medical care by contracting with physicians, whereas the latter generally is confined to ntanagement and financing functions. See infra Glossary (describing HMOs aud MSOs).

n437 See infra Glossary (describhtg MSOs and HMOs).

n438 But see Woods, .sacpra note 421 (coming to the opposite conclusion but appearing to fail to closely analyze the MSO under the second prong of the Third C'ucuit's nttegral part doctrine test).

n439 On February 17, 1988, the IRS issued au unpublished private letter rniling taking the position that an MSO did not jeopardize the affiliated hospital's tax-exempt status. Sce Gerald M. Griffith, Physician "Cornrot" and Section 501(c)(3) Tax-Exempt Status: LI'hen a Minority Interest Equals a Major'ity Interest, 10 EXEMP7- ORG. ri1XREV. 121, 123-24 (1994). That rul'ntg etnphasized the benefits derived by the hospital from the MSO, including an iniprovenrcnt in the hospital's finances and ftntds available for tax-exempt purpose activities. Id. However, in General Counsel Memorandum 39,862, supra note 201, the IRS clearly took the position that financial improvements without a fiirther demonstration of providing beneGt to the cotnniunity is not sufficient for a hospital to qualify foi-tax exentption. Therefore, it is possible that the Februaty 17, 1988 ruling no longer represents the IRS's position. See Griffith, supra, at 124.

n440 PHO Ruling, supra note 429. For a definition of a PHO, see infra Glossary.

n441 Like an MSO, a PIIO typically is a separate entity that serves the affiliated hospital and physicians that created it. Also like an MSO, a PHO may provide management and support services, but is a facilitator rather than a direct health care provider. The PHO is a centralized vchicle tlnottgh which a hospital and pliysicians can offer and respond to solicitations from employers, insurers, and other groups for managed health care and can bid to provide managed health care. For further discussion of PHOs and MSOs, see infr•a Glossary.

Appx. 261 Page 45 37 B.C. L. Rev 1, *

n442 PHO Ruling, supra note 429, at 1323.

n443 Id.

n444 See supra part 1V.F.2. The IRS cited the following factors as influencing its decision: (1) the daily responsibility tor management, operations, and decision-making functions were vested in a board of directors and not more than 20% of the board would be composed of inedical staff members, former employees, retired medi- aai staffn;en.bers or their relatives, eligible paa-tics or theu affiliate.s; (2) a separate price negot.iatiou cominittee had exclusive authority to manage fee schedules and all financial and persomiel aspects of managed care contracts; (3) the hospital's interest in the PHO was proportionate to its share of capital contributed to the PHO; and (4) physicians received benefits (profits and cash distributions) in proportimt to their capital contribution so that private benefit served by the PHO was incidental. PHO RulinR supra note 429. Interestingly, although not inen- tioned in the ruling, T.J. Sullivan, Special Assistant for Healtlt Care, Office of the Assistant Cotmnissioner for Employee Plans and Exenipt Organizations, IRS, has stated that this ruling is based on the integral part theory. Fred Stokeld & Paul Streckfus, Tax-Exempt PHO Not Your Typical PHO, Says IRS, 67 TAX NOTES 607, 608 (1995).

n445 PHO Ruling, supra note 429, at 1325.

n446 See Griffith &'I'omtishen, supra note 374, at 709.

n447 See Exempt Organizations: 501(c)(3) Hospitals Must Guard Exempdon in Acquisitions and Mergers, Ojjlcial Says, Daily "I'ax Rep. (BNA), at D-13 (Mar. 6, 1995), available in Westlaw, BNA-DTR file (cotmueuts of T.J. Sullivan, Special Assistant for Health Care, Office of the Assistant Commissioner for Employee Plans and Exempt Organizations, IRS).

n448 Id. The organization must be a "supporting" organization within the meaning ofLRC. S 509(a)(3) (1994), which the IRS has viewed as an nttegral part of the system within the meaning of Revenue Rzding 78-41, 1978-1 C.B. 148. See, e.g., Priv. Ltr. Rul. 94-260-40 (Apr. 4, 1994); Priv_ Ltr. Rul. 92-25-042 (Mar. 25, 1992); Priv. Ltr. Rul. 91-30-002 (Mar. 19, 1991)_

n449 Northwestern Ruling, supra note 383.

n450 Id

n451 Id.

n4521d

n4531d.

n454 Northwestern Ruling, sup-a note 383.

n455 Id.

n456 See supra part IV.B.2.b.

Appx.262 Page 46 37 B.C. L. Rev 1, *

n457 See supra notes 408-11 and acconipanying text

n458 See supra notes 399, 402, 444 and aecompanying text.

n459 See supra note 404 and accompanying text.

n460 See Noble, supra note 8.

n461 Public hospitals have the primaty burden for caring for the medieally indigent. Voluntary uot-for- profit hospitals provide a relatively small sltare of the health care required for persons unable to pay, altltough there is evidence that urban not-for-profit hospitals, and especially teaching hospitals, provide a significant amount of care to indigents, especially tliroogh eniergency room care. IRS Issues Health Care ISP Digest, supra note 87; Richardson, supra note 58, at 912; David S. Salkever & Richard G. Frank, Health Services, in WHO BENEFITS FROM THE NONPROFII' SECTOR? 38, 38-54 (Charles T. Clotfelter ed., 1992); Sloan et al., supra note 195, at 20-36. For discussion of the provision of uncompensated care by not-for-profit and for-profit hospitals, including controversy over the defmition of uncompensated care, see generally GRAY, supra note 58; Lewin et al., supra note 195; Sanders, Does Mission Really Matter?, supra note 195; Sanders, Measur•ing Chari- table Contributions, supra note 195; Steinwald & Neultauser, supra note 34; Arrington & IIaddock, supra noto 195; Herzlinger & Krasker, supra note 195; Thorpe & Phelps, supra note 195.

n462 See supra note 196 (discussing the perception of persons regarding the provision of charity care by hospitals).

n463 See supra note 193-94 (citintg sources proposing alternative means of defming community benefit).

n464 It appears that the perception extends not only to public ltospitals but also to private not-for-prol3t hospitals.

n465 See supra notes 21-22, 31-34 and accoinpanying text (discussing the early role of proprietary and voluntary hospitals).

n466'This view may apply especially at a time when market forces have placed health costs beyond the means of a substantial proportion of the nation's residents. See supra notes 11-13 and accompanying text (describing the percentage of the nation's population without health insurance coverage).

n467 See supra note 196 and accompanying text.

n468 See generally, Bittker & Rahdert, supra note 120, at 307-15.

n469 A ntajor undcrpinning of traditional tax theory is the existence of numerous general and specific objectives that the tax system can serve. See Joseph T. Sneed, The Criteria ofFederal Income Tax Policy, 17 STAN. L. RBV 567, 568-69 (1965). In simple ternts, the basic general social, equity, administrative, and eco- nontic objectives and criteria of our tax systent can be categorized as follows: (1) raising revenues; (2) assuring fair and simple administrability of taxes; (3) promoting stability and economic growth while minimizing interference in an efficient economy; (4) assuring neutrality -- equal taxation of persons with equal incomes; and (5) developing a tax system consistent with and for the promotion of the political system and the United States Con- stitution, including the creation of special incentives. See Daniel Shaviro, Beyond Public Choice and Parblieln-

Appx.263 Page 47 37 B.C. L. Rev 1, *

terest: A Study of the Legislative Process as Illustrated by Tax Legislation in the 1980s, 139 U. PA. L. REV. 1, 31-108 (1990) (discussing various theories concerning congressional tax legislation); Nancy E. Shurtz, A Criti- cal Vietv ofTraditional Tax Policy Theory: A Pragmatic Alternative, 37 VILL. L. RF,V. 1665, 1666 (1986) (suggesting the general purposes that should be served by the tax system); Edward A. Zelinsky, Efficiency and In- come Taxe.s: The Rehabilitation ofTax Incentives, 64 TEX L. RE'V 973, 973-74 (1986) (discussing that the inef- ficieticy of tax incentives is widely treated as obvious and well established); see also Borris 1. Bittker, "l'he Prop- erty and Vitality of a Federal Income Tax Deduction for Private Philanthropy, in TAX IMPACTS ON PHI- LANTHROPY 145, 153-62 (1972) (justifying tax deduction for philanthr'opy on grounds that it does not violate tax policy precept of eqtuty and efficiency); Susan Fergenbaum & Thomas Jenkinson, Government Incentives for Historic Preservation, 37NAT'L Ti1XJ 113 (1984). Within certain parameters this approach would attempt horizontal equity -- tliat is, neutrality -- between not-for-protit and for-profit ltealtli care itistitutions eaining equal incomes.

n470 Although the author is aware that this stance wonld result in the abolishnient of the charitable dectuc- tion for htcome, gift, and estate tax purposes, conternporary health care organizations receive relatively little support fi'otn donations. See Hall & Colombo, Charitable Status, supra note 146, at 406 n.350 (citing National Association of Hospital Development, fiscal year 1987-88 figures ntdicating 1.6% of inember hospitals' "total budgets" from cash donations); see also NONPROFIT ALMANAC 1992-93, at 260, 272-73 (Virginia A. Hodg- kinson et al. eds., 4th ed. 1993); Foster, supra note 57, at 351-52 (citing data from American Association of Fundraising Counsel). It has been said that the primary tax benefits obtahted by not-for-profit organizations are those at the state level. See Hyman, supra note 18, at 330. This "neutered" approach would have the side effect of nraking irrelevant issues of private inurement and private benefit, which the IRS seetns to spend considerable tinie monitoring.

n471 See, e.g., OFFICE OF ADVOC., U.S. SMALL BUSINESS ADMIN., ISSUE ALERT: UNFAIR COMPETITION WITH SMALL BUSINESS (1986); OFFICE OF THE CHIEF COUNSEL FOR ADVOC,, U.S. SMALL BUSINESS ADMIN., UNFAIR COMPETITION BY NONPROFIT ORGANIZATIONS WITII SMALL BUSINESS: AN ISSUE FOR TIIE 1980's (3d ed. 1984); Hansmann, Ur?fair Competition, supra note 130, at 605; Mancino, supra note 34, at 1018.

n472 The refundable and recapturable tax credit approach is preferable because, by its very nature as an offset against tax liability, it would provide a larger fmancial incentive for a health care organization than a dednction that serves only to reduce taxable htconte.

n473 A refuudable tax credit is one where the credit in excess of the taxpayer's tax liability is refunded by the Treasury and a recapturable tax credit can be carried back and carried forward if unused. See, e.g., 26 US. C. §§ 38(c), 39, 55 (1994); see also Nhia J. Crinun, A Tax Proposal to Promote Pharmacologic Research, to En- courage Conventional Prescription Drug Innovation and Irnprovenient, and to Reduce Product Liability Claims, 29 YVAKE FORESI'L. REV 1007, 1058 n,268 (1994).

n474 Because the health care organization would not be considered tax-exempt under I.R.C. § 501(c)(3), previous criticisms of the idea of granting business expense deductions to tax-exempt organizations on the grnund that they are not profit seeking institutions would be unfounded with respect to the proposal. See, e.g., Bittker & Rahdert, supra note 120, at 310-13 (proposing income measurement ttteory to explain income tax exentption based on the absence of a practical and traditional accounting method to mcasttre the net incotne of not- for-profit organizations and therefore difficult to categorize charitable activity expenses as business expense type deductiott). But see Atkinson, supra note 146, at 611-16 (criticizittg the incotne measurement theory); Hall & Colornbo, Charitable Status, supra note 146, at 385-86 (same); Hansmatnt, Rationale, supra note 146, at 59-91 (same).

n475 See supra notes 255-56, 391, 424-32 and accompanying text (regarding health care provider versus arranger or facilitator status).

Appx.264 Page 48 37 B.C. L. Rev 1, *

n476 Application of the tax-favored treatment to a non-staff HMO would provide impetus for the HMO to pay for medical personnel training or medical rescarch that does not directly benefit their emollees. HMOs, as cost cutters, have been accused of failing to contribute to the public good. See Troubde for Teaching Hospitals, N.Y. TIMES, May 15, 1995, at A 16.

n477 506 H' 2d 1278, 1286-89 (D.C. Cir. 1974), vacated, 426 U.S. 26 (I976). The term might be defined to encompass the considerations and approaches proposed by organizations, academicians and state governments in efforts to upgrade and broaden the IRS's community benefit staudard. For a reudition of these proposals, see .supra notes 193-94 and relerences cited therein. For example, the tenn might be defined as follows: "Charitable activities" by a health care otganization shall include the provision of: (1) inpatient or outpatient emergency or non-emergency health care services (htcluding medical laboratory services); prescription inedicatious, and medical devices (as defined by the federal Food and Dtug Administration) at or below cost whicit are directly related to the diagnosis, testing, or treatment of a medical illness or rnedical conditiou to persons determined to be at or below the federal poverty linc (as redetermined amtually by the federal govemntent pursuant to guidelines developed in conjunction with Health and Human Services) and to persons unable to obtain health or hospitalization insurance having a $ 500 deductible, having a co-payment requirenrent ht excess of 20% by the insured and having no waiting period nor pre-existing condition itn- pediment, tlsough group insurance provided by his/her employment or the employment of a relative, or tbrough individual insurance after demonstrating that the individual was rejected for coverage in writing by three state chartered health insurance companies; (2) planned educational programs involving aspects of health care advertised and made available to the urban or rural community or region serviced by the health care organization, as defined in its state articles of incorporation or other state licensing doctunent; (3) educational trahiing to tnedical staff physicians, nurses and paramedical persamel; (4) basic science and medical clhtical research perfonned by qualified employees of the organization (alone or by contract with another health care organizatiou), health or medical sciences division in thc federal, state or local government, a college, a university, a certifred medical school, pharmaceutical company or biotechnology company; and (5) such other niedically related services or programs deterniined as furthering a community's or region's tnedical needs, access to medical care, and medical goals (with a focus on medical problems of minorities, the poor, and otliermedically underserved populations) as established ttirough inclusion on the calendar yeai's annually updated community ntedical plan by a certification panel, coniposed of a broad representation of the conununity fornied in accordance with guidelines conlpiled by the Internal Revenue Service aud IIealth and Hutnan Services.

n478 See supra note 193.

n479 See supra note 477 (providing a catch-all provision in the santple definition).

n480 See David Gonzalez, Emergency Room Option: Free Ride to Hospital Clinic, N.Y. TIMES, July 16, 1995, § 1, at I.

n481 Id.

n482 See S. 1757, 103d Cong., lst Sess. (1993) (proposed Health Security Act attempting to establish at least annualty, a requirement that the health care organization, along with community leaders, assess the liealth needs of its community and develop a plan to meet those needs).

Appx.265 Page 49 37 B.C. L. Rev 1, *

n483 The guidelines for establishing the certification panel would set forth niles for assuring that the panel is composed of a broad group of persons representing the commtuuty. If the guidelines liniit the physician composition of the panel, they might provide for an advisory group of physicians and nurses that could provide technical assistance and inform the panel of community medical issues obsetved and requiriug attention. The program tnight be arranged 'nt a manner similar to the federally mandated certificate-of-need programs that review and approve substantial capital expenditures and new services undertaken by health care providers. See generaIly 42 U.S.C. § 300m-6 (1982 & Supp. IV 1986), repea{ed by Act of Nov. 14, 1986, Pub. L. No. 99- 660, Title VII, § 701 (a), 100 SYat 3799, 3799 (1986); Robin Dimieri & Stephen Weiner, The Public Interest and GoverningBoardsofNonprofitHealthCareInstitution.r,3AIYANE).L.REV 7029(1981).

n484 To a large extent, the deterinination of what constitutes a sufficient level of health care must bo made on a political level, after input by the ntedical establislunent and ropresentatives of society, such as educators, social workers, etc.

11485 This categoiy tnight include not only meeting the needs of certain socio-economie groups (e.g., prena- tal care for poor pregnaatt women, care for horneless, etc.) but also those of special age groups (e.g., the elderly, children, etc.).

n486 Scientific and medical research have long been regarded in this coantry as fundainental to the health care system. Research has been perceived as integral to new innovations that inight conceivably lead to better antUor less expeusive treatnients, teclmology, and medications, as well as advances in preventive medicine. See Criinm, supra note 473, at 1017, 1039,1078-81; see also DANIEL CALLAHAN, WLIAT KIND OF LIFE: THE LIMITS OF MEDICAL PROGRESS, 162-75 (1990).

( n487 See Health Care Report Cards, N.Y. TIMES, July 10, 1995, at A12 editorial suggesting healtli care report cards of healtlt plans in order to permit public scrutiny of the plans); Milt Freudenheim, People Want More Information.for Ilealth Choices, Survey Finds, N.Y. TIMES, Sept. 17, 1995, § 1, at 38 (reporting on the findings of a new siuvey by Louis Harris and Associates).

Appx.266 Rob Reich Lacey Dorn Stefanie Sutton

Contact Information: 562 Salvatierra Walk Stanford CA 94305-8620

Rob Reich Associate Professor of Political Science Faculty Co-Director, Center on Philanthropy and Civil Society [email protected]

Appx.267 Anything Goes: Approval of Nonprofit Status by the IRS

Rob Reich Lacey Dorn Stefanie Sutton

DRAFT REPORT of OCTOBER 25, 2009

CENTER ON PHILANTHROPY AND CIVIL SOCIETY Stanford University

Contact info

Center on Philanthropy and Civil Society 562 Salvatierra Walk Stanford University Stanford, CA 94305-8620

Rob Reich Associate Professor of Political Science Faculty Director, Center on Philanthropy and Civil Society reich at stanford.edu

Appx. 268 Americans of all ages, all conditions, and all dispositions constantly form associations. They have not only commercial and manufacturing companies, in which all take part, but associations of a thousand other kinds, religious, moral, serious, futile, general or restricted, enormous or diminutive. The Americans make associations to give entertainments, to found seminaries, to build inns, to construct churches, to diffuse books, to send missionaries to the antipodes; in this manner they found hospitals, prisons, and schools. If it is proposed to inculcate some truth or to foster some feeling by the encouragement of a great example, they for n a soci2ty. Wherever at the /7ead of sonie iiew ilndeiiaking you See the government in France, or a man of rank in England, in the United States you will be sure to find an association. Alexis de Tocqueville, Democracy in America (Vol. 2, Ch. 5) (1840)

Overview Americans, as Alexis de Tocqueville observed nearly 160 years ago, are famous for their proclivity to form diverse associations, even wildly eclectic and eccentric associations. It is a distinctive and valuable American trait, and it has been present, if Tocqueville is to be believed, since the early days of our republic.

Contemporary Americans appear no different than their ancestors about whom Tocqueville reported. We still associate eclectically and eccentrically. But contemporary Americans associate differently from their predecessors in at least one important respect: when people form associations today, they tend to expect not merely the liberty to associate but also a raft of special tax benefits for their associations. Specifically, they seek to obtain formal recognition from the federal government as nonprofit organizations, a status which entitles organizations, and often their donors, to tax exemptions.

This report is not about the distinctive American proclivity to associate. Rather, this report is about the distinctive modern American proclivity to confer special tax benefits to wildly diverse and indeed eccentric associations. The rules governing the creation and operation of a nonprofit organization are found in

The authors wish to thank Roy Elis, Alexander Berger, Debra Meyerson, Karen Long Jusko, Joshua Cohen, Megan Tompkins-Stange, Thomas Pollak, and Jon Durnford for their assistance and feedback. We also thank the Summer Research College at Stanford University, which provided funding and support for this research.

Appx.269 Section 501(c) and 170(b)(1) of the Internal Revenue Code. These rules are a 20th century development in American associational life. We examine the route to approval as a nonprofit organization in the United States, and we find that nearly all applicants are approved. Oversight of the creation of nonprofit organizations, and the conferral of tax privileges that accompany nonprofit status, is weak, bordering on non-existent.

The route to status as a nonprofit organization in the United States runs through the Internal Revenue Service. Nonprofits are tax exempt - they pay no tax on income or profit, and are frequently exempt from property taxation as well - and the IRS must certify an organization as a nonprofit before it can officially declare itself tax exempt. Nearly 1.5 million nonprofit organizations were registered with the Internal Revenue Service in 2005. Nearly 1 million of these nonprofits were so-called public charities or 501(c)(3) organizations. Public charities are the face of the nonprofit sector in the United States, and they include most nonprofits in social services, health care, education, and the arts. (Religious congregations are also treated as public charities, though they are not required by law to seek approval and register with the IRS.)

The total number of nonprofits, or tax-exempt organizations, has grown rapidly in recent years, increasing by 27% from 1995 to 2005 alone. The number of public charities has grown even more rapidly, increasing by 53% during the same period. In each year over the past decade, the IRS has approved, at a minimum, 50,000 new 501 (c)(3) nonprofit organizations.

Obtaining 501 (c)(3) status is a valuable thing. It entitles organizations not only to tax exempt status, but also permits donors to claim tax deductions for their gifts. In 2008 Americans donated more than $300 billion to 501(c)(3) organizations, costing the United States Treasury an estimated $50 billion in foregone tax revenue.1

' This figure is calculated from the section on tax expenditures in the Annual Budget of the United

Appx.270 Though regulation and oversight of the nonprofit sector falls largely to the state or states in which a nonprofit operates, the official designation of an organization as a public charity or 501(c)(3) rests at the federal level with the IRS. Without IRS approval of public charity status, organizations are not tax exempt and cannot receive tax deductible donations from donors.

In this report, we examine the regulatory and oversight structure for nonprofit organizations. But rather than focus, as is often the case, on oversight of existing nonprofits, we focus on the oversight of the creation of new nonprofit organizations, specifically the creation and official designation of 501 (c)(3) organizations. While the IRS has made efforts in recent years to improve oversight of the nonprofit sector by redesigning the tax forms which nonprofit organizations are required to file (if they earn more than $25,000 in revenue in any given year), little attention has been paid to the record of oversight in the determination of nonprofit status. The oversight at the entry point to nonprofit status, as we will show, is weak. Nearly every application on which a decision is rendered is approved.

We focus our attention on the fact that the IRS approves more than 50,000 applications for 501 (c)(3) status every year and rejects only a very, very small number of applicants. Obtaining recognition by the IRS as a public charity is an embarrassingly easy thing to do. It is hardly an exaggeration to say that when it comes to oversight of the application process to become a public charity, nearly anything goes.

The report has four sections. First, we describe the determination process for receiving tax-exempt status as a public charity. Second, we report data on approval rates from 1998 to 2008 and describe the process of obtaining and

States. See http://www gpoaccess gov/usbudaet/fv10/pdf/s [e c.odr and in particular Table 19-3 (p. 308). Accessed Sept. 2009.

Appx. 271 reviewing more than 40,000 newly-approved public charities in 2008. We report trends in the newly-approved public charities, using the National Taxonomy of Exempt Entities. Third, we offer evidence for the "anything goes" claim: short descriptions of what are, in our subjective opinion, the top 20 most bizarre public charities created in 2008. Finally, we propose some reform measures to strengthen oversight of the determination process. We also include an appendix with information about a puzzling data discrepancy in official IRS data sources, and an appendix with an expanded list of 60 eccentric public charities created in 2008?

1. The Determination Process Nonprofit organizations are required to file articles of incorporation in their state of operation before applying for federal 501 (c)(3) status. This is typically a trivial matter, taking no more than a month. Once incorporated, the organization can apply for nonprofit status with the IRS.

Applying for 501 (c)(3) status involves a commitment to pursue a charitable purpose, as set out in section 501 (c)(3) of the Internal Revenue Code. To obtain public charity status, an organization must be organized and operated exclusively for an exempt purpose. The code currently specifies the following:

The exempt purposes set forth in section 501(c)(3) are charitable, religious, educational, scientific, literary, testing for public safety, fostering national or international amateur sports competition, and preventing cruelty to children or animals. The term charitable is used in its generally accepted legal sense and includes relief of the poor, the distressed, or the underprivileged; advancement of religion; advancement of education or science; erecting or maintaining public buildings, monuments, or works; lessening the burdens of government; lessening neighborhood tensions; eliminating prejudice and discrimination; defending human and civil rights secured by law; and combating community deterioration and juvenile delinquency.3

2 Our full dataset for all 501(c)(3) organizations approved in 2008 is available from the authors on request. ' Language taken directly from the IRS website: http://www.irs.(Jov/charities/charitable/article/0,,id=l 75418 00.html Accessed Sept. 2009.

Appx.272 The application currently comprises three forms: the IRS Form 1023, Form 2848, and Form 8821. Most information is contained in Form 1023, which details the organization's basic mission along with its organizational structure. At the beginning of the application process, the organization receives an employer identification number (EIN). The EIN establishes the organization's business tax account. Review of the remainder of the application can take up to 12 months, but expedited approval can be requested if the organization is formed to provide emergency disaster relief services. This expedited process was seen post- September 11, 2001, as well as after Hurricane Katrina.

According to a report released by the Government Accountability Office in 2002, there were, as of January 2002, 207 full-time positions at the IRS involved in evaluating applications for exemption from taxation.° As a general rule, applications result in one of five possible outcomes: approval, rejection, withdrawal by applicant, incomplete application, or fee not remitted.

Once granted federal nonprofit status, an organization can file charitable solicitation forms with its state of operation, allowing it to solicit funds from potential donors. State approval depends on prior federal-level approval. In an attempt to streamline the process, the National Organization of State Charities Officials and the National Association of Attorneys General created the Unified Registration Statement (URS). The URS is an alterriative to completing the specific state forms and requirements to obtain nonprofit status. Some states still require supplemental forms, but the URS allows for some cohesion in the state registration process. Approximately 37 states (including the District of Columbia) accept the URS, with the remaining 13 requiring state-specific forms.5

" Tax-Exempt Organizations: Improvements Possible in Public, IRS, and State Oversight of Charities, GAO-02-526 (2002), p. 57. 5 The application process varies widely across states. Organizations operating and fundraising in a single state are only required to comply with their specific state's requirements. However, many nonprofit organizations solicit donations at a national level, and thus must meet the varying requirements of many states. Delaware, Idaho, Montana, Nebraska, Nevada, and Wyoming have

Appx.273 11. Data A. Data on Approval Rates of Applications for 501(c)(3) Status, 1998-2008 Almost 63% of the roughly 1.5 million nonprofit organizations in the United States are registered by the IRS as 501(c)(3) public charities. 501(c)(3) organizations (with the exception of private foundations) are called public charities and exist solely to provide programs and services that are of public benefit. Additionally, it is estimated that there are over 350,000 religious congregations classified as 501(c)(3) nonprofits, although they are not required to register with the IRS. 6 Other common nonprofit classifications are 501 (c)(4), a designation for social welfare organizations, and 501(c)(7), which are social and recreational clubs.

Applications for 501(c)(3) status in 2008 In 2008, 56,190 organizations applied for 501(c)(3) status and received determinations from the IRS.' A mere 1,211 organizations were not approved, representing 2.17% of the total number of applications.8

very lax nonprofit registration, only requiring organizations to file articles of incorporation. The vast majority of states, however, require additional paperwork orfees. Organizations must submit their letter of determination from the IRS to their respective state(s) to prove their nonprofit status. One widely variable area in state nonprofit regulation is the charitable solicitation form. Charitable solicitation forms allow a nonprofit to fundraise in a given state, but many states impose regulation on organizations utilizing professional solicitation services. These regulations include fees for such services, ranging from $120 in Connecticut to $1,000 in Indiana, as well as surety bonds. Surety bonds guarantee that the professional solicitation service will adhere to all applicable laws; these bonds total thousands of dollars, averaging around $20,000 for states that employ this regulation method, although very few states require them. The most common state requirement for nonprofit applications is an annual fee. Many states do not require a registration fee, but on average the cost ranges from $10 (Colorado) to $400 (Florida). Many states justify the registration fee as a means to pay for application processing, but in reality application fees ^qenerate a considerable amount of revenue for states. The Nonprofit Almanac 2008, available at http /tnccsdataweb urban org(kbfiles/797/Almanac2008publicCharities.odf In 2008 a total of 79,236 organizations applied for 501(c)(3) status, but 23,046 applications were either incomplete, did not include the fee, or were withdrawn. We focus our analysis only on applications for which a determination was made. ° Internal Revenue Service, Data Book 2008, Publication 556, Table 24.

Appx.274 20085 Application Data

aapmv^a aann^no

0 Dsepp+oved Appli:atia s

The rate of rejection in 2008 is actually high, relative to the rejection rate in previous years. In an analysis of 501(c)(3) applications over the past ten years, the number of applications varied from 51,711 in 1998 to a high of 69,885 in 2007. Overall, the rate of disapproval for 501 (c)(3) status has increased over the past decade from .74% in 1998 to 2.17% in 2008, with the disapproval rate peaking at 2.29% in 2007. The rather surprising result: even in the year with the most rejections, nearly 98% of applications were approved.

Using data from the annual IRS data books, we find the following rates of approval and denial.

Appx.275 501c3 Disapproved Appiications

^N 7o:at t:um6er of 501c1 pppflcatioss on 4Yh€ch a tretlsiort Was Rendervd

SEQ1sap^ro1ed Ap?i7ca.:ons

1959 1994 2000 2001 2002 2003 2004 2005 2006 2007 Figcal Year

In 1998, 51,711 organizations applied for 501(c)(3) status, and 382 were disapproved; this represents a.74%o disapproval rate, the lowest in the ten-year data span. In 1999, the application number rose slightly to 53,220 with 447 organizations denied. 2000 saw a jump in the number of applications, totaling 61,461, but a decrease in the percentage of organizations denied with 456. In 2001, 60,538 organizations applied and 629 were denied representing a .29% increase in disapproval rate. 64,719 organizations submitted applications in 2002, with 531 denied. 2003 represented a large increase in the disapproval rate, reaching 1.62%, with 67,674 applying and 1,094 not receiving 501 (c)(3) status. 2004 remained relatively similar, with 65,572 applications and 1,027 denied. In 2005, 64,167 organizations submitted applications and 1.14% -- 765 organizations - did not receive approval. Beginning in 2006, the rejection rate

Appx.276 begins to increase. In 2006, 67,545 organizations applied for 501(c)(3) status and 1,283 were denied, representing a 1.89% disapproval rate. In 2007, the rate spiked at 2.29%, with 69,885 organizations applying and 1,607 not receiving approval. Finally, in 2008 the application number dipped to 56,190 with 1,221 organizations denied, equaling a 2.17% disapproval rate.

We note one important qualification about the data. According to the IRS, these data include determinations for applications of public charities as well as for private foundations. (Private foundations are also classified as 501 (c)(3) organizations but must comply with stricter regulations on their activities, including narrower limits on deductible contributions.) We find evidence that a significant portion of the rejected applications are from persons seeking to establish a private foundation, not from groups seeking to establish a 501(c)(3) public charity. According to a 2002 Government Accountability Office report on possible improvements to oversight of the nonprofit sector, the number of denied applications for 501(c)(3) public charity status never rose above 75 in the years between 1998 and 2001.9 Where the official IRS Data Book records 382 denials in 1998, 447 denials in 1999, 456 denials in 2000, and 629 denials in 2001, the GAO Report, which excludes private foundation applications, records 73 denials in 1998, 39 denials in 1999, 59 denials in 2000, and 58 denials in 2001. Using the GAO data, rather than the IRS Data Book data, would change the approval rates to greater than 99.8% in every year. Thus, controlling for private foundation applications, the IRS gives its stamp of approval to roughly 998 of every 1000 501(c)(3) applications on which it renders a decision!'0

For our analysis, we use the IRS Data Book, which is inclusive of private foundation applicants. The upshot is that our analysis almost certainly overstates

9 Tax-Exempt Organizations: hnprovements Possible in Public, IRS, and State Oversight of Charities, GAO-02-526 (2002), Table 2, p. 21. '0 The IRS renders no decision on applications that do not include all relevant docuinents, are withdrawn by the applicant, or fail to submit the relevant fee.

Appx.277 the denial rate for organizations seeking status as a 501(c)(3) public charity, even when the approval rate is consistently above 97%.

The graph below shows the denial rate trendline. Note that the rate of disapproval has increased marginally over the past 10 years. Reasons for this increase are unknown, although we speculate it may have to do with increased scrutiny of applications post September 11.

entage of 501c3 ApptFcai9ons Disapproved

Gtsapp;oved u APp:iCahQnS m

1996 ?999 2000 2001 2002 2003 2004 2005 2006 2007 2008 Flscat Year

Appx.278 B. Review of Newly Approved 501(c)(3) Public Charities in 2008 Observing the consistently high pattern of approval rates from 1998-2008, we next focused on examining applications for 501 (c)(3) status approved in 2008.11 The IRS makes this data available not in the IRS Data Book but in its so-called Exempt Organization Business Master File. The IRS does not make available data on organizations whose applications were denied.

We sought to review, laboriously, one by one, the publicly available data on every organization approved by the IRS as a 501(c)(3) organization in 2008. By sorting the IRS Business Master File for public charities approved in 2008, we assembled a dataset of slightly fewer than 41,000 organizations. The IRS data in the Business Master File is minimal: organization name, address, and, if applicable, data from recent 990 tax forms.

We reviewed the minimal data points to determine patterns and search for organizations that seemed either peculiar (indeed sometimes bizarre) or perhaps at odds with the law on what constitutes a public charity. The results we report below

" The IRS also revokes the 501(c)(3) status of some organizations every year. 501(c)(3) organizations may jeopardize their nonprofit status primarily through three kinds of activity: Private Benefit and Inurement, Political Campaign Intervention, and Legislative Activities. The first category essentially prohibits 501(c)(3)s from providing excessive private benefit to affiliated persons or organizations, or having shareholders who accrue monetary benefits from the success of the organization. The second category strictly prohibits 501(c)(3)s from participating directly or indirectly in any political campaign, as well as from intervening in political campaigns. The latter category prohibits 501(c)(3)s frorn lobbying. If a 501(c)(3) organization engages in any of these activities, it risks failing the IRS operational test and having its tax-deductible, nonprofit status revoked. In 2008, 198 organizations had their 501(c)(3) statuses revoked, although the IRS did not publicly disclose the specific reasons for the revocations. The revoked organizations included an array of different organizations, ranging from financial and credit counseling organizations to ministries and family foundations.

Appx.279 represent an objective look at trends in approved organizations and a subjective take on the most eccentric organizations approved as public charities in 2008.92

Trends Throughout our data collection process, we found that the trends in number of 501(c)(3)s approved in each state in 2008 tended to be correlated with the state's population, as seen in the table below.

-- -- Top 6 States With Most Approved 6 States/Territories With Least 501(c)(3)'s in 2008 Approved 501(c)(3)'s in 2008 California: 5,103 Alaska: 117 Texas: 2,864 South Dakota: 104 New York: 2,863 Wyoming: 90 Florida: 2,684 North Dakota: 78 Illinois: 1,682 Other Territories 50 Georgia: 1,543 Puerto Rico: 46

The most frequently approved applications were from applicants describing themselves as ministries or religious groups, animal rescue organizations, fundraising organizations, and sports organizations. The following table breaks out the various categories of public charities created in 2008.

" Our method: We downloaded the entirety of Business Master File provided from the IRS website and then sorted through nonprofits with a "ruling year" of fiscal year 2008 and further sorted this group organizations approved as 501(c)(3)s. The IRS makes available a data bank of all nonprofit organizations currently in operation by region and by state. We created datasets of newly approved 501 (c)(3) nonprofits for each state and one master file containing all 40,969 organizations. We then reviewed each organization one by one. The information provided by the IRS is minimal at best; the data points include the EIN, organization name, contact person and/or address, state of operation, and NTEE code. We supplemented this information with a web search for the name of the organization and a Guidestar database search to obtain 990 tax form information, if available.

Appx. 280 Classification of 501(c)(3) Organizations Approved by the IRS in 2008

Charitable 1 29,425 71.84 71.84

Educational ^ 6,691 16.34 88.17

Literary 1 4.7 0.04 88.21

Prevent Cruelty to Animals ^ 328 0.80 89.01

Prevent Cruelty to Children ^ 28 0.07 89.08

Public Safety Testing ^ 34 0.08 89.17

Religious ^ 4,410 10.77 99.93

Scientific ( 28 0.07 100.00

Total 1 40,961 100.00 100.00

The category "charitable" provides little information and is essentially a catch-all for any organization that does not obviously fit under other categories. This analysis tells us little except that very few organizations dedicated to the prevention of cruelty to children, to public safety testing, and to literary or scientific purposes were approved as public charities in 2008.

Fortunately, a finer-grained analysis is possible by sorting the dataset by so- called National Taxonomy of Exempt Entities (NTEE) code. The NTEE was developed in the 1990s by the IRS, in partnership with some nonprofit organizations, to provide better information about the universe of tax exempt organizations. It represents an improvement over the previous status quo, when very little was known about the various purposes of different nonprofits. The NTEE is nevertheless an imperfect scheme, so the following table should be read with appropriate caution. Below, we classify the 40,961 501 (c)(3)s approved by the IRS in 2008 by NTEE code.

Appx. 281 Classification of 501(c)(3) Organizations Approved by the IRS in 2008 by NTEE Code

^ ^^^'te No Entryi 784 1.91 1.91

Ai 3,437 8.39 10.30 A Arts, Culture and Humanities

BI 6,340 15.48 25.78 B Educational Institutions and Related Activities

C 1 807 1.97 27.75 C Environmental Quality, Protection and Beautification

D i 1,112 2.71 30.47 D Animal-Related

E 1 1,237 3.02 33.49 E Health - General and Rehabilitative

F ( 631 1.54 35.03 F Mental Health, Crisis Intervention

G i 648 1.58 36.61 G Diseases, Disorders, Medical Disciplines

H 1 270 0.66 37.27 H Medical Research li 560 1.37 38.64 I Crime, Legal-Related

J i 155 0.38 39.02 J Employment, Job-Related

K 1 325 0.79 39.81 K Food, Agriculture and Nutrition

L ( 950 2.32 42.13 L Housing, Shelter

M i 638 1.56 43.69 M Public Safety, Disaster Preparedness and Relief

N i 2,729 6.66 50.35 N Recreation, Sports, Leisure, Athletics

O l 1,642 4.01 54.36 0 Youth Development

P 1 4,942 12.07 66.42 P Human Services - Multipurpose and Other

Q i 1,435 3.50 69.93 Q International, Foreign Affairs and National Security

R 1 151 0.37 70.29 R Civil Rights, Social Action, Advocacy

s l 976 2.38 72.68 S Coinmunity Improvement, Capacity Building

T i 4,847 11.83 84.51 T Philanthropy, Voluntarism and Foundations

U 1 149 0.36 84.87 U Science and Technology Research Institutes

V 1 53 0.13 85.00 V Social Science Research Institutes

W i 302 0.74 85.74 W Public, Society Benefit- Multipurpose and Other

X ( 5,795 14.15 99.89 X Religion-Related, Spiritual Development

Y ^ 23 0.06 99.94 Y Mutual/Membership Benefit Organizations, Other

Z i 23 0.06 100.00 Z Unknown

Totali 40,961 100.00 100.00

Appx.282 The NTEE classifications show that educational, religious, human services, and philanthropic organizations were the most frequently recognized as public charities in 2008. Several classifications were so unpopular that they did not amount to even 1% of the nearly 41,000 new 501 (c)(3)s. Medical research, employment or job-related organizations, food, agriculture and nutrition organizations, civil rights and social action organizations, science and technology research institutes, and public society benefit organizations did not reach this 1% threshold.

Based on a line-by-line examination of the dataset of 40,000+ newly approved 501(c)(3) organizations in 2008, we then sought to review the minimal data available on each organization. We identified organizations that struck us as odd or especially eccentric, representative of the "anything goes" mentality that we believe characterizes the nonprofit sector in the United States. We developed a list of more than 400 organizations and then sought additional information for each, information beyond that which is available in the IRS Business Master File.

We obtained a 990 tax form, when available, for each of these organizations through the Guidestar nonprofit database. The 990 form contains information on the income, assets and liabilities of the organization; however, it is only mandatory for organizations generating $25,000 or more in revenue per year to file this form. Most of our information came from websites for each organization or websites where the organizations in question were mentioned.

Based on the information gathered through this expanded process, we narrowed down our larger list of 400 organizations to a smaller list of about 60 and then ultimately to 20 organizations.

With comic spirit intended, though with a serious point to illustrate, we present here our list of the 24 most eccentric public charities approved by the IRS in 2008.

ir,

Appx. 283 Ill. Anything Goes: The 20 Most Eccentric Public Charities Approved by the IRS in 2008

1. Gateway Sisters of Perpetual Indulgence: Abbey of the Gateway City

St. Louis, W ssotAri Approved May 2008 http://www.gsoi-stl.org/home files/home.htm From the website: "The Gateway Sisters of Indulgence, "Abbey of the Gateway city" St. Louis Missouri, is an all Volunteer Not-for-Profit Organization. They are a Missionary Order of an International Order of Sisterhoods of the 21st Century Drag Nuns. They don't mock nuns, "THEY ARE NUNS'. They have taken on that role for the Gay, Lesbian, Bi-sexual, Transgender and Gay Friendly Individuals within our community. The Sisters not only enjoy the work of Fund Raising for Charity but they all have FUN doing it."13 "The Gateway Sisters of Indulgence members are all local to the St. Louis area and each member brings their own professional occupational skills, knowledge, community involvements, club involvements, talents and energy to help make the Sisters who they are today. The members of the Gateway Sisters of Indulgence and global Houses are from the LGBT and straight communities, males and females individuals who are either from the Leather community, Cowboys/Cowgirls, drag queens/kings, you name it, they have them as members. The Gateway Sisters of Indulgence do not discriminate membership due to Sexual Orientation, Fetishes, Marital Status, National Origin, Race, Physical Limitations, Religious beliefs."14 Specifically, the Sisters of St. Louis promote safe-sex practices and education, as well as awareness for HIV/AIDS.

2. The Grand Canyon Sisters of Perpetual Indulgence Inc. Phoenix, Arizona. Approved October 2008 http://azsisters.org/ These organizations are the newest chapters of The Sisterhood of Perpetual Indulgence, an international order of drag nuns. From the website: "The Sisters of Perpetual Indulgence are a worldwide nonprofit organization that raises money and awareness for causes within their community. Its members dress in flamboyant and colorful outfits and wear heavy makeup and face paint, all while working it in steep heels that would make stiletto queen Mariah Carey faint. "A lot of people question if we're pretending to be nuns," Wunderbar said. "The truth is that we are nuns. The definition of a nun is someone who gives of themselves in service for a cause. That's what we do." Wunderbar explained that the roots of her sisterhood started in San Francisco in 1979 with five men living in

13 http:!/www_gsoi-stl.org/home files/home.htm Accessed September 2009. "I ttp://www.gsoi-stl.org/home fileslhomehtm Accessed September 2009.

Appx.284 a commune. Upset with the way homosexuals and HIV/AIDS were being treated at the time, they decided to wear nun costumes and march from the Castro down to the beach. "People say we do this to draw attention to ourselves," Wunderbar said. "Of course we do. We're trying to raise money and awareness for different causes and organizations."15 The Grand Canyon Sisters of Perpetual Indulgence describe themselves as a non-discriminatory organization that aims to unite and empower their local community through fundraising, entertainment, and education. They describe themselves as being opulent, "naughty," and decadent. Members include Sister Atopa Sleepurr-Sofa, Our Lady of Broyhill: Sexytary (Secretary); Novice Brother Craven Moorehead; Sister Inga von Schlappenheinie, Barer of the Bodacious Ta- Tas: Mistress of Collections (Treasurer); and Sister Ora Lee Wunderbar: Mistress of Novices (Vice President), Mistress of Evangelism (Propoganda, Marketing, Technology).16 Similar to the Sisters of St. Louis, the Arizona chapter focuses on LGBT issues, in addition to seeking the unification of the LGBT community of Arizona.

3. CrossHeir Outfitters Branford, Florida Approved March 2008 http://www. crosshei routfitte rs. ora/ A Christian organization from Branford, Florida, CrossHeir Outfitters organizes hunting and fishing expeditions as ministry. Their target audience is "Bubba" - a hardworking country man who prefers to go hunting or bond with his buddies other ways in the outdoors during his time off on Sunday rather than go to Church. From the website: "CrossHeir Outfitters is an awesome new ministry, ordained by God and Fueled by the passion of a Few [sic] good Bubbas wanting to see simple blue-blooded American country boys come to the knowledge of the saving power and life-changing experience of a relationship with our Lord and Savior Jesus Christ. We have been equipped with the knowledge of how to put on a men's outreach event- God has blessed us with the equipment to bring to your church through our state of the art 50 enclosed ministry trailer and we are very fortunate to have relationships with Nationally known outdoor product companies like Mathews, Mothwing, Knight and Hale and others. We have helped several churches this fall in three different states host events and have seen over 6000 attendees with over 150 salvations and over 325 rededications to Jesus Christ. Don't let a financial obstacle be a stumbling block in the way of your outdoors event. We know how to do this and we are anxiously awaiting your call to help your church with an event that will change the lives of Bubba's everywhere.07

------1 5 http://azsisters.ora/GCHistory.html Accessed September 2009. 1s http://azsisters.org/who.html Accessed September 2009. 17 http://www.crossheiroutfitters.org/ Accessed September 2009.

Appx. 285 4. Deguello Gunslingers Yuma, Arizona Approved December 2008 http://depuellogunslinoers.com A public charity classified under the NTEE as a Humanities Organization, the Deguello Gunslingers perform old western vignettes and reenactments. Acts include bank robberies, gunfights and horseback shoot-outs. Though they seek bookings for a great variety of functions, they offer up their pro bono services for fundraisers. According to their website, the Gunsliigers are availablc for business promotions, photo ops, commercials, conventions, private parties and meetings, and they are members of The Reenactment Guild of America. They perform every Sunday at Yuma Territorial Prison.

6. Ghostface Ryderz Incorporated New Castle, Delaware Approved November 2008 http7//www.ghostfaceryderz. com Ghostface Ryderz is a public charity based in Delaware whose main goal is "to change the game and bring innovative ideas to the world one bike at a time," while achieving family unity among motorcyclists. They began as an underground organization, waiting until the world's time was right to make their presence known. After researching other bike clubs, choosing a name, incorporating, copyrighting and trade-marking, they became a 501 (c)(3). According to their organizational history: "We started out slow to achieve the ultimate goal of family unity and quality of character we stayed underground just to take notes and see what the game held for us. Now the time is right to show the world a new dimension. The research was prepared on bike clubs. A name was chosen and legally incorporated, copyrighted & trademarked. By-laws were drafted. Finally a tax id number was arranged. Ghostface ryderz inc. is ready to step out and make our presence known. We are a non profit organization and the goal for ghostface ryderz inc. Is to change the game and bring innovative ideas to the world one bike at a time." Their mission statement: "Ghostface Ryderz Inc. was founded on the principles of family unity and respect. Our goal is to promote enthusiasm and respect for all riders and non riders in the community. Through community based service projects and fellowship with others, we will create a harmonious environment that fosters safety, unity, and collective growth one bike at a time."18

7. International Society of Talking Clock Collectors Amherst, OH Approved January 2008 http://www.talkin,golocks.net/collections.aspx This organization was approved under the NTEE code A50 for museums. It is, however, a virtual museum, available to the public only online. According to the website, the purpose of the organizaton is: "To accumulate and preserve a

'$ httpWwww ghostfacervderz com/HISTORY/historv.html Accessed September 2009.

Appx.286 broad base collection of talking clocks and related artifacts. Note: The "Museum" is presently in the home of the Interim President. To make the talking clocks and artifacts available to ISTCC members and the general public through a virtual museum. A portion of the "MUSEUM'S" holdings may be viewed at the "VIRTUAL MUSEUM" located at: httg://www.talkingclocks.net". In short, this appears to be the private collection of talking clocks held in the home of the collector made into a nonprofit museum by taking photographs of the clocks and posting them online.

8. Red Nose Institute Kansas City, Missouri Approved January 2008 http://www.therednoseinstitute.com The Red Nose Institute is a public charity in Kansas City, Missouri that sends red clown noses to overseas troops in order to lighten their moods, along with a letter of support. The group encourages servicewomen and men to share these noses with local children. From the website: "The Red Nose Institute is a non profit, 501(c)(3) corporation designed to put a smile on the faces of our troops overseas. Designed by a clown and with the help of clowns and friends around the world, this program was launched in July 2007. The idea is for folks who care about our military to donate red foam noses. Monetary donations are also accepted and used to purchase even more noses and also to help with mailing costs. The noses are then mailed to U.S. troops deployed anywhere overseas. A letter is enclosed with each package telling that the folks sending them are extremely proud of our military and thankful for what they are doing on our behalf."19

9. GeekAid of Michigan Allendale, Michigan Approved February 2008 www.geekaid.org From the website: "inspired by a group of friends who held a private party in 2005, unofficially dubbed "GeekAid", the cause then was simply to spoof the plight of computer geeks and the only beneficiaries of the revelry were the attendees. Afterwards, in a rare and unexplained moment of serious reflection, the founding "Geeks" decided to take the GeekAid event to the next level in order to make a true difference for the West Michigan community in 2006. Today, GeekAid is all about bringing together individuals passionate about art and technology, and understand that we must encourage and foster that passion whenever the opportunity arises. We also feel strongly that you should have fun doing it."2o

19 htto:Nwww.therednoseinstitute.com/ Accessed September 2009. 2o http://www.geekaid.org/aboutAccessed September 2009.

Appx.287 Parties and Festivals Masquerading as Public Charities

10. Sin for Charity Chicago, Illinois Approved October 2008 httt)://www.sinforcharity.com/about.htm Sin for Charity is an event-planner and producer for charities in the Chicago area. It undertakes no charitable activity itself except for staging events to raise rnoriey for other public charities. Selfwlassified under the NTEE as a Human Service Organization, Sin for Charity has already collaborated with the Make-A-Wish Foundation of Illinois, TACA (Talk About Curing Autism), and Little Angels. A recent event - Make a Jamaica - benefited Little Angels, and featured a swimsuit fashion show, beach volleyball tournaments, live music, kids activities, food and beverages.

11. Woohoo Sistahs Virginia Beach, VA Approved September 2008 http://www.woohoosistahs.com Woohoo Sistahs are a group of tight-knit women who liken themselves to the close group you had in grade school. From the website: the Sistahs are a"a crazy group of women supporting [their] charities, philanthropy and each other and having a whole lot of fun in the process."21 The Woohoo Sistahs work together to participate in fundraisers such as the Relay for Life and the Susan G. Komen Race for the Cure. They also volunteer at and donate to organizations such as the Samaritan House Battered Women's Shelter. Like Sin For Charity, the Woohoo Sistahs do not provide services of their own except for staging events that raise money for other public charities. Their website features some pictures of a pool party for members.

12. All Colorado Beer Festival Colorado Springs, CO Approved September 2008 http://www.allcoloradobeerfestival.org The All Colorado Beer Festival is a two-day event in Colorado Springs and Boulder, featuring seventy beers from over thirty Colorado breweries. Three different four and a half hour-long sessions offer two-ounce beer tasting sessions with entertainment, and after each session, a winner will be proclaimed. All profits go to local nonprofits. The Festival is self-classified as a "fund raising andlor fun distribution" organization.

21http:/Iwww woohoosistahs can/woohooweare.html Accessed September 2009.

Appx.288 We Need a Public Charitv for This?

13. Monticello Graduation Party Inc. Monticello, MN Approved January 2008 Monticello Graduation Party, Inc. is organized as an educational services group. Located in Monticello, MN, the sole purpose of the organization is to provide "a chemical free graduation party for the graduating seniors of Monticello High School on their graduation ninht.°22

14. Planet Jelly Donut Oakland, CA Approved August 2008 http://www.planetiellydonut.org Planet Jelly Donut is a multipurpose human services public charity located in Hawaii (but registered in California) that spreads the message of the goodness of the human spirit to all groups of people. From the website: "Planet Jelly Donut spreads the common belief that the core essence of the human spirit is goodness. As we ride the Wheel of Fortune of life, be it on top of the world or struggling from beneath the weight of it, we as a human race naturally desire to be our best, and assist another in doing the same."23

15. Metempyrion Foundation Cottonwood, AZ Approved April 2008 http://metempyrion.org/about.htm The purpose of the organization is, according to its website: "To set up a spiritual educational institution. People with intuitive and telepathic potential will be given an opportunity to enhance their skills for the higher good of the human population at large. This school will offer Extended Sensory Perception Studies open to all ethnic and religious expressions. Faculty to consist of a resident staff and visiting teachers from around the world, specializing in the fields of extended mental abilities."2h

16. Curtains Without Borders Burlington, VT Approved July 2008 http://www.curtainswithoutborders.org / Curtains Without Borders, a public charity classified as an historical society aims to conserve historic painted theater curtains, primarily in Vermont. Painted theatre curtains were prevalent in the late 19th and early 20th centuries, primarily in Vermont, but also in other New England states. At this time, the

22 2008 990 tax form, accessible at http://www.guidestar.org/FinDocuments//2008/421/745/2008- 421745379-0482f4ad-9.pdf z3 http.'//wwwplanetellydonutorgi'index.html Accessed September 2009. ^4 http:l(metemnyrion.org/about.htm Accessed September 2009.

Appx.289 organization has rescued 176 curtains. Curtains Without Borders receives its primary funding for its Painted Theater Curtains Project from the National Endowment for the Arts and the National Endowment for the Arts and National Park Service's joint "Save America's Treasures."

Looks like a For-Profit Operation

17. Jason Morris Elite Judo Training Inc. Gienviife, i'JY Approved January 2008 Jason Morris is a world class American judoka who won a silver medal in the Barcelona 1992 Olympics, in addition to medaling in many other international Judo competitions. He was the coach of the 2008 United States Olympic Judo Team. He is one of the top Judo trainers in the country, coaching many Olympic- level judokas. He trains out of Glenville, New York, and their Jason Morris Elite site is classified as an N60 (Amateur Sports Clubs, Leagues, N.E.C.) public charity.

18. Mississippi Magnolia Cloggers Clinton, MS Approved June 2008 http://www.magnoliacloggers.or_q/ This Clinton, Mississippi dance studio offers four levels of classes and features its own clogging teams. The beginner ciasses are offered for $50 per eight-week session. Clogging is a form of dance with English, German and Scotch-Irish influences that began in Appalachia. It displays elements of the Irish Jig as well as Scottish Highland dancing, with a style that somewhat resembles tap and involves foot-stomping, shouting and hand-clapping, Mississippi Magnolia Cloggers are self-classified as an A24 (Folk Arts) public charity.

19. Renegade Rollergiris of Oregon Bend, OR Approved March 2008 http://www.renegadesor.com/ The Renegade Rollergirls of Oregon was established in June of 2006 and officially approved by the IRS as a public charity in 2008. From the website: "In only a few months we have successfully established ourselves as Bend's only non-profit roller derby league, and are working on being the hottest show in town, with our no holds barred play. We have created ourselves from a few gals with big dream of roller-skating, athletic competition, and making new friends along the way. The Renegade mission is to provide the women of Bend the opportunity to participate in a team sport that contributes to fitness, making friends and building self confidence. As a nationwide grass roots effort to revive the sport of roller derby, Renegade aims to give back to the community that supports our efforts not only with charitable contributions but with all American no-holds- barred roller derby entertainment." Renegade Roller Girls are affiliated with a

I? A

Appx.290 federated organization of other roller girl leagues in other cities. The Renegade Roller Girls made a donation of slightly more than $1000 to other public charities in 2007, with program revenue of nearly $40,000.25 $20,000 was spent on administrative expenses.

20. Promise Land Ranch, Inc. Charlotte, TN Approved October 2008 http: lhf, ww: prom iseland rallch.com /a bnutu s, html From the website: "The Promise Land Ranch is dedicated to helping people find peace and rest in a fact-paced world. In those moments of stillness they can experience healing and renewal."26 "Promise Land Ranch is a non-profit IRS designated 501(c)3 corporation. We exist to provide healing and hope to hurting individuals. We accomplish this by meeting people in their time of need, accepting them as they are and providing a safe environment for them to share their pain. This may be through organized retreats, or trips to other countries, or just a coffee at Starbucks."27

25 http://www.reneaadesor.corn(renegade rollergirls charity.php. Financial data taken from 2008 990 tax filing, available at: http://www.guidestar.org/FinDocurnents//2008/223/939/2008- 223939180-04d83470-Z.odf. Accessed September 2009. http://www_promiselandranch.com/aboutusourmission.html Accessed September 2009. 27 httl)://www,promisolandranch.com/aboutus.htiyil Accessed September 2009,

Appx.291 IV. Recommendations for Oversight Reform The IRS approves nearly every application it receives from organizations seeking status as a 501(c)(3) public charity. It is a lost opportunity for more vigorous and rigorous oversight of the nonprofit sector.

Before offering some tentative recommendations for reform, we first provide some cautions in interpreting the data we report here.

First, it is not our claim that the IRS screening process for approving or disapproving applications for nonprofit status is completely ineffectual. For one thing, the IRS does indeed reject some applications, albeit startlingly few. But leaving the rejection rate aside, we must allow as a possibility that some actually existing organizations do not even bother applying, or they apply and withdraw their application quickly, because of the IRS screening process.

Second, though all organizations approved as 501(c)(3) public charities are tax exempt and can offer their donors tax deductions, the overwhelming majority of these newly approved organizations have tiny revenues. It is unlikely that there is a large loss of tax revenue from the approval of these many diverse and small nonprofits.

Third, in describing our subjectively selected list of the twenty most eccentric organizations approved as a public charity in 2008, we are not claiming anything about these organizations as representative of the nonprofit sector as a whole. The preposterousness of a virtual museum for talking clocks should not imply to the reader that all nonprofits are this absurd.

We conclude with five recommendations for reform. 1. Congress should allocate more funding to the IRS in order to bolster the staff devoted to reviews of applications for nonprofit status.

Appx.292 2. The IRS should raise the fee for applying for nonprofit status. Increasing the fee (currently about $750, and less for small organizations) would allow, first, increased IRS revenue to pay for more careful scrutiny of applications. Second, the increased fee would be a desirable barrier to seeking nonprofit status: it would signal to organizations that they should be more than a fly-by-night organization, minimally staffed or with no revenue stream, before submitting an application. Another option, suggested by nonprofit consultant Jack Siegel: increase the application fee to $5000, and refund $2500 if the application is approved?a 3. The IRS should reconcile the significant discrepancy in data reported in the annual IRS Data Books and the Exempt Organization Business Master File. See Appendix A. 4. Congress and the broader public should initiate a dialogue about the wildly diverse purposes currently permissible for public charity status, as described in 501(c) codes. Do we wish to attach tax exempt status to the distinctive modern American tendency to associate wildly and for diverse and eccentric purposes? The 501(c) code, we believe, stands in need of reconsideration in light of the massive growth of the nonprofit sector. Is this really an effective way to organize charity? Should the mere desire to associate for nearly any purpose be rewarded with tax privileges? This is a discussion that is fundamentally important to our democracy.

?g http://www.charityaovernance.com/charitv povernance/2008/03/do-we-need-8500.html Accessed September 2009.

7r;

Appx.293 Appendix A: Data Discrepancy between IRS Exempt Organization Business File and the IRS Data Book The gap between data reported in the IRS BMF and in the IRS Annual Data Books is large and troubling. It is important to resolve this discrepancy, and not only because the IRS should be able to produce accurate numbers across various reports. More important is to determine what number is the accurate figure. Were there 54,969 organizations approved in 2008, or was it 41,583?

We can expect that a gap will appear in earlier years, for organizations approved in 2000 may have closed up shop and been de-listed from the IRS Business Master File. There is no reason to think, however, that the number of such dead- letter-office public charities is high enough to explain the >30% gap in each year, 1998 to 2007.

Data Discrepancy: Number of 501(c)(3) organizations approved by the IRS by various official IRS sources

16,317 16,349 1991 18,690 16,378 1992 21,160 22,083 1993 25,922 25,211 1994 25,898 25,218 1995 27,393 27,759 1996 28,492 27,261 1997 30,377 29,791 1998 32,315 32,595 51,329 36.50% 1999 34,968 33,389 52,773 36.73% 2000 37,722 38,473 61,005 36.93% 2001 40,741 39,127 59,909 34.69% 2002 44,799 43,841 64,188 31.70% 2003 41,187 42,134 66,580 36.72% 2004 45,668 44,969 64,545 30.33°/u 2005 37,020 38,040 63,402 40.00% 2006 43,196 41,835 66,262 36.86% 2007 45,695 46,999 68,278 31.17% 2008 40,961 41,583 54,969 24.35%

Appx.294 Appx.295 Appx. 2 9 6 Appx.297 Appx. 2 9 8 Appx.299 Appx.300 Appx. 301 Appx.302 Themissionbf the Stanford University Center on Philanthropy and Civil Society (PACS) is to engage students faculty, and practitioners in scholarship and dialogue#hat examines ways in which philanthropic institutions, nonprofit organizations, and other key elements of civil sOci ty LJOrL.tC address pi ibiir infernets both in the United Statesand aproad.

Why a Center on Philanthropy and Civil Society?

Civil society - the part of society and our culture independent of both thegovernment and the market - is playing a rapidly expanding role in address ng and defining social problems in the U.S. and the world. Asone of the key participants" in civil sociotythe philanthropic sector serves both as a critical supplier of resources for nonprofit institutions and as a catalyst for addressing public needs And as philanthropists likeformer President ^^^- Surprisingly, even aPa time when studies of others take on a more visible and salient role in philanthropy and donative behavior indicate contributing to solutions to global problems the that the next fifteen years and beyond will sector finds itself undergoing be characterized by an unprecedented a major transformation. intergenerational transfer of both leadership and wealth, the knowledge base about philanthropy's Philanthropy's Evolving Role behavior and impact, including its effectiveness, is quite thin. The PACS Center's mission, therefore, Philanthropy's evolving role, with its potential for is to engage students, faculty, and practit onersin increased impact, raises fundamental questions. examining ways in which philanthropic institutions, How do philanthropic institutions, nonprofits nonprofit organizations, and other key elements and other elements of civil societycollaborate of civil society work to define and address public to effectively advance the public good? How interests, both in the United States and abroad: successful are they at solving problems, particularly compared with government, which • We thank the Wilhamand Flora Hewlett Foundation historically has been responsible for shouldering that burden? What relationships currently exist among foundations, nonprofits and voluntary activity in realizing collective goals? Contact Us: Center on Philanthropy For more information on supporting the PACS and Civil Society Purpose Center, please contact: Kim Meredith, Executive Director The Stanford Center on Philanthropy andCivil [email protected] Society(PACS Center) was formed to apply Shana Sachs, Philanthropy Program Manager an analytical lens to these hard questions. [email protected]

Appx.303 Page 1

^^^^^^^xK

LEXSEE 66 WASII L REV 307

April, 1991

66 Wash. T. Rev. 307

LEN(GTH: 36577 words

ARTICLE: THE CHARITABLE STATUS OF NONPROFIT HOSPITALS: TOWARD A DONA'I'IVE THEORY OF TAX EXEMPTION.

NAME: Mark A. Hall * and John D. Colornbo **

B1O:

* Professor of Law, Arizona State University. Robert Wood Johnson Faculty Fellow in Health Care Fi- nance, Jol ns Hopkins University. J.D. 1981, University of Chicago. ** Assistant Professor of Law, University of l l linois. B.A. 1978, J_ll. 1981, University of Illinois. We are grateful for the support provided by the following individuals and institutions: Rob Atkinson, Mark Gergen, Spencer Knapp, Charles Tabb, and 1'ont Ulen, who critiqued earlier drafts of this Article; the Vermont Law School for its hospitality dtving the summer of 1989; the Emory Law School for hosting a faculty collo- quiurn at which sorne of these thouglits were presented; and Holly Caldwell, Mark Siegel, and Paige Volmer for their talented research assistance.

SUMMARY: ... Since the beginning of western civilizatiou, religion, education, attd other charitable activities have been exentpt from various forms of taxation. ... Such a theory sltotild: (1) identify activities deservhtg social subsidy, which eutails a determination of'both wotthiness aud neediness; (2) distribute the subsidy in rough propottion to the degree of deservedness; (3) explain both the inconte tax and the property tax exemption, and, ideally, explain the related charitable deduction as well as ttre various operational constraints that attach to charitable status; and (4) align generally with an intnitive concept of what constitutes a charity and the major historical categories of exempt entities. ._. Because a successful theory of charitable exemption tnust encompass more than free services to the poor and the relief of govemmeot burden, nonprofit organizations should be allowed to dernonstrate that they earn their subsidy by bencfrtting the community in other ways. ... Wltile donative support may rtot be sofficient to qualify all of the nonprofit hospital sector's hold'utgs and earnu gs for property and ine,ome tax exemption, it also seems unfair to disregard this support simply because it represents a small portion of the nonprofit operation. _.

HIGHLICHT: Abstract: This Article examines the growing controversy over the rnrdti-billion dollar charitable tax exemption enjoyed by nonprofit hospitals. It begins by articulating fotir criteria for evaluating a rationale of the charitable exernption: deservedness, incorporatittg the elemettts of wortli and need; proportionality; universality; and historical consistency. "Ilte Atticle then employs these criteria to refiite three conventional explanations of why nonprofit hospitals are exempt: because health care is a per se charitable activity; because the treatment of indigent patients relieves a government burden; and because nonprofit hospitals provide cornmunity benefits. The Article also uses these criteria to refute two academic tlteories: Boris Bittker's income measurement rationale and Henty Hansmann's capital subsidy theory.

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This Article proposes a "donative theory" as an alternative rationale for the charitable exemption. The donative theoty posits that "cliarity" describes an entity capable of attractiag a substantial level ofphilantlu'opic support from the public at large. Donations exist where there is a combined failure of private markets and direct public funding to supply a shared public beneCt at the optunally desired level. Donative utstitutions desetve a tax subsidy because the public's support signals their worth, and the fiee-rider teudency that affects all giving assures the need for an additional, sltadow subsidy. "I'he Article further detnonstrates that the donative theoty comports with the statutory scheme and the four cen- tuw-ies of legal history that shape the legal concept of charity. In particular, the donative theory provides the only explanation of the tax law's otherwise unjustifiable reliance on the law of charitable trusts.

TEXT: [*3091 1. 1NTKC)DUCT1CiN Since the begirming ofwestern civilization, religion, educatiott, and other charitable activities have been exempt from various fortns of taxation. nl In the United States, federal tax law has relieved charitable [*310] organizations from income tax since the law's ittception, n2 atid charities have enjoyed exemption from state and local property taxes even longer. n3 'fhe long history of the charitable exemption has niade it a virtually immutable part of the tax laws -- so much so that the thought of taxing charitable otganiz.ations on the sanre basis as profit-making enterprises seetns contrary to nature. n4It is startling to learn, then, that we have no clear understanding of why the charitable exemption exists or wbat it covers. n5 Various commentators have observed: "despite th[e] long history of the tax [laws], or perhaps because of this long bistory, there is very little logic, or reason, or legislative histoty to support ... the tax exemption"; n6 "the statutory phrases 'exclusively [*3111 used for charitable putposes' [and] 'purely public charity' seem to mean less than nothing"; n7 and "thhtk[ing) more seriously about what is meant by the concept of charity [is] a task that is abont four himdred years overdue." n8 A clear answer to this puzzle has tremendous practical impottance to federal atid state governments hard-pressed to balance strained budgets in ihe face of the steadily uicreasing size of the exempt sector, n9 [*3121 and to nonprofit organizations that increasingly must defend their favored tax status against the roving eyes of revenue-hungry tax collectors and legislators. n10 This topic also holds considerable intellectual challenge. 'fhe academie field of nonprofit enterprise has flowered during the past decade and a half as researchers 8-om various discipluies began to recognize that this "third sector" of the economy (distinct from proprietary tnarkets and govemment) has been neglected as a separate topic of serious n quiry_ These pathbre

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threaten to eliminate the ability of hospitals to cross-subsidize the care of the ntedically indigent fi'om revenues generated by payittg patients. n22It is increasiugly mn-ealistic to expect private hospitals to meet the public's dernaud for e(harity care, precisely at a time when the greatest need exists for such care. n23 Thus, at the core of the tax-exempt debate lies the issue whether nonprofit hospitals should continue to carry a significant share of this societal burden as payment for eonthtued exemption. 'I'he tax-exempt debate also implicates social policy related to proprietary incentive in medicine. 'I'he health care delivery system has experienced rampant commercialization during the past two decades, becoming what a leading critic has called a"medical-industrial complex." n24 'I'his change is epitomized by the rapid growth of large proprietary hospital chains such as Hospital Corporation of America (IICA) and Humana n25 1nlluetttial voices decry the corporatiz-utoi-i ofl.ealth.,a.e as m;;:ioal to Lhhumanistic values traditionally held [*316] sacred in madicine, and ttms view a limitation of tax exemption as a direct attack on this ideological position. n26 Others respond that the crisis gripping the health care system is due largely to the past absence of nonual market forces, and thus see the exemption as a mindless subsidy that tilts the playing field'ut favor ofinefficient providers. n27 "No study -- of a hospital elosing or a new technology in action -- and few sumntaries of these issues manage to emerge without being cast in the language of good and evil, delight and doom, prudence aud waste." n28 The convergence of these several currents of conno- versy render this seetningly nttmdane tax tnatter a provocative subject of study. This Article begins with a survey of the current law and some criteria for evaluating theories of exemption. The Article then proceeds with a critique of both the conventional rationales for the chai-itable exemption and the existing academic theories. Find'nig these explanations unsatisfactory, the Article ttten develops an altetnative rationale for the exemption. This "donative theory" of tax exemption maintains that nonprofit organizations sltould be considered c haritable -- andtlms subsidized tluough the tax system -- only if they are able to attract a substantial degree of donative support from the public. n29

[*317] II. T'HE LEGAL AND ANALYTICAL FRAMEWORK

A. The Existing Law ofHospital Tax F.xemption

1. Federal Law and the Per Se Exempt View The most visible source of law for the charitable exemption is section 501(c)(3) ofthe Internal Revenue Code (I.R.C. or Code), which exempts from income taxes "[c]orporations ... organized and operated exclusively for religious, charitable, scientific, testing for public safety, literary, or educational purposes, or to foster national or international amateur sports competition ... or for ttte preventiou of cruelty to children or anitnals. ..." n30 Legislative history, cotut decisions and secondary commentary establish that the tertu "cliaritable" is not intended to be distinct from the remainder of this rather pecnliar grouping of activities. Instead, "underlying all relevant parts of the Code, is the intent that eutitlement to tax e xemption dependson tneeting certain common-law standards of chatity." n31 The specifically enumetated activities are presurnptively eligible for exemption by virhte of this legislative declaration of their charitable status, as long as they meet other, organizational and operational requiretnents. The exemption also extends to other, nonenumerated organizations that pursue purposes the law considers charitable. This statutory formulation conveniently allows us to examine the single term "charitable," which [*3181 combines these various activities into a unified concept of 501(c)(3) exemption. n32 Nonprofit hospitals, frequently termed "voluntary hospitals," have coine to epitomize the type of activity encorn- passed by the generic concept of citarity. n33 Nonprofit hospitals Itave beeu characterized as voluntary since the nine- teettth century, when tltey were organized by religious societies,heavily fimded by donations, and staffed by doctors who worked without compensation and nurses who worked for room and board as part of their lifetime comniitment to a religious order devoted to caring for the poor. n34 The role of hospitals as "ahnsliouses for the poor" changed rapidly during the first half of the twentieth [*319] century with developments in anesthesia, surgical teclutique and otlter aspects of medical science that suddenly transfornted hospitals from the dumping ground of humanity to the pinnacle establishment of the health care delivery system. Still, nonprofit hospitals continued in their voluntary tradition, despite opening tlteir doors to paying patients and a secular staff, by maintainiuig their commiunent to treat all patients regardless of their ability to pay and by their continued, if partial, reliance on volunteer labor. n35 'f}te voluntary nature of nonprofit hospitals, however, has steadily abated over the past generation as a consequence of widespread employer-provided health insurance and massive governmental programs such as Medicare (for the elderly and disabled) attd Medicaid (for the poor). 'fhe advent of third-party payors transformed the character of the non-

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profit hospital sector. Pressured by tlre emerging competition of investor-owned hospitals, nonprofit hospitals have increasingly taken on the appearance of business enterprises by serving mostly paying patients, decreasing their reliance on donations or volunteer labor, and striving to generate as rnuch surplus revenue as possible through commercial transactions. n36 Still, nonprofit hospitals for a time have retained a reinnant of their voluntary tradition by using these generous sources of reimbrnsement for paying patients to cross-subsidize care for those wlto fall tbrough ttie insurance cracks. This remaining voluntary tradition tlireatens to collapse into a token effort as a result of the swceping restrictions in public and private insurance over the past few years that have severely constrained the ability of hospitals to shift the costs of indigent care to paying patients. n37 The nierger of the operational characteristics of nonprofit and proprietary ltospitals that this trend portends (or, ht the view of many, that has [*320] already occurred) n38 has forccd voluntary hospitals to undertake a fltorougli self-exatuination that seeks to redefine their distinct "n7ission." n39 These shifts in the character of the voluntary hospital sector are inirrored in the sliift of the lntemal Revenue Ser- vice's (IRS) position concenting the exempt status of nonprofit liospitals. n40 A 1956 ruling retlected traditional notions of charity by requiring exempt hospitals to treat indigent patients "to the extent of their financial ability." n4l In 1969, three years after the implemeutation of Medicare and Mcdicaid, the IRS altered its position regarding the standards for exemption in response to the hospital industry's complaint that these public progranis liad greatly reduced the demand for charity care and rendered the existing standard for exemption an anacllronisnr. n42

In Revenue Ruling 69-545, n43 the IRS abandoned the charity care requu-ement imposed in 1956 and adopted a "per se" rule of ltospital [*32 1] exemption: au entity engaged in the "promotion of health" for the general beuefit of the coinmunity is pursuing a charitable pnrpose, even tliough a portion offhe community, such as indigents, are excluded from participation. n44 In this particular niling, the IRS stressed that the protnotion of health for the general benefit of the community had long been recognized as a charitable pnrpose under the cotnmon law of charitable trusts. n45 Though the hospital in question (lid not regularly accept charity patients, several factors, including a board of directors drawn froni the general community and an emergency room open to nonpaying patients, convinced the IRS that the exeinption should be continued. n46 The per se standard was further entrenched by a 1983 ruling establishing that even hospitals with limited services and no open emergency room, such as cancer hospitals, [*322] could qualify for exemption merely by treating all patients able to pay. n47 Public interest advocates mounted an aggressive challenge the lifting of the fi-ee care requirement for hospitals. In Eastern Kentucky Welfare Rights Association v. Simon, n48 these advocates succeeded 'ni the district court, but they lost when the court of appeals upheld the govermnent on the merits of its 1969 ntliug. The Supreme Court disrnissed the case on procedural grounds, reasoning that indigent residents who might one day require free hospital services lack standing to challenge a hospital's exemption, n49 tlrus effectively terminating all future attacks on the federal position. The D.C. Circuit's opniion nevertheless remains the most influential articulation of the per se exempt status of hospitals. The court reasoned that "the rationale upon wltich the [free care] defmition of'charitable' was predicated has largely disappeared," and that "[t]o continue to base the'charitable' status of a hospital strictly on the relief it provides for the poor fails to accormt for these major changes in the area of healtlt care [such as Medicare and Medicaid]." n50 In essence, the court held that nonprofit hospitals are charitable even if they do not provide fi-ee care because the concept of what constitutes a charity niust change "to recognize the changing [*3231 economic, social and technological" environment in which hospitals now funetion. n51 This redefinition of charity is circular because it assumes the question tttat it purports to answer -- whether hospitals should continue to enjoy charitable status. This view seems determined to reshape the concept of charity however necessary to tt the predoininant patteru of what most nonprofit hospitals are currently doing. This unattalytic, question-begging approach characterizes mnch of the argument in favor of granting the exemption to hospitals. n52

2. State Law and the Ckarity Care Standard State statutes and constitutional provisions tend to follow a pattern uearly identical to I.R.C. section 501(c)(3). Many states automatically confer exemption from income tax on any organization that canies a federal section 501(c)(3) exemption. n53 Property tax exemptions exist [*324] by virtue of independent state law provisions, n54 but these are worded in a strikingly similar fashion: the predominant pattern confers the exemption on religious, cduca- tional and charitable organizations. n55 In interpreting these statutes, the vast majority of states adhere to the federal view that promotion of health for ttte general connnmtity constitutes a charitable purpose, regardless of whether the entity in question provides fi-ee or subsidized health care to tlte poor. n56 A small niinority of states, however, cling to the view that health care delivery does not in and of itself deserve cliaritable status. These states require some addi-

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tional coutribution to society, such as charity care, before state law confers tax exentpt status. n57 The leading judicial decision [*325] suppotting this view is Utah County v. Intermountain Health Care, Inc. n58

In Utah County, the Utah Supreme Court affirmed a county boarcl of equalization's denial of exempt status to two nonprofit hospitals, based primarily on then' failure to render sufficient charity care. After examining the historical shift in the mission of nonprofit hospitals fronr treating the poor to h-eating the community at large, tbe majority noted that the hospitals in question derived virtually all their operatuig revenues from patient charges, n59 cotmnitted less than one percent of their gross revenues to charity care, n60 and charged patients prevailing market rates. n61 According to the majority, the hospitals "confuse[d] the element of gift to the community, whicli an entity must demonstrate in ordcr to qualify as a charity under our Constihition, with the concept of community benefit, which any of comitless private enterpi isc-s might provide." n62 In the wake of Utah County, taxing authorities revoked the exempt status of nonproftt hospitals in Missouri, Pemi- sylvania, Tetmessee and Vermont, but state courts reversed in almost every htstznce. n63 Reconsideration [*326] of tax exemptiou for heatth care providers also has been oti the legislative agenda in more than a dozen states recently, although these efforts have generally proved unsuccessflil. n64 The issue has also [*327] attracted sigttificant attention fi-om Cougress. One congressman has publicly questioned the continued need for tax exetnption of nonprofit hospitals, n65 and two major legislative efforts to change hospital exemption standards are underway. n66

Because subsequent comts have found the reasoning of Utah County unconvincing, n67 and becaase the reasoning of Eastern Kentucky is facially unsatisfactory, n68 proper resolution of the tax-exempt status of nonpro6t hospitals is not likely to be based on whetlter liealth care is a per se charitable entetprise, or whether free services to the poor is the essence of the charitable exetnption for hospitals. Moreover, resolving this conflict for hospitals requires an understanding of how charity is generally defined for tax putposes. 'I-his in tum requires the fotmulatiou of a comprehensive theory of what activities deserve subsidization [*328] through the tax system, in otlier words, wliy anj, nonprofit organization should be tax exempt.

B. TheCriteriaforEvaluatingTheorzesofExernption Before undertaking a critique of the various bases for the charitable exemption, it is helpful to articulate tlte precise criteria that a successful theory for exeniption should satisfy. Such a theory should: (1) identify activities deserving social subsidy, which entails a determination of both wotthiness and neediness; (2) distribute the subsidy in rough proportion to the degree of deservedness; (3) explain both the income tax and the property tax exemption, and, ideally, explain the related charitable deduction as well as the various operational constraints that attach to charitable status; and (4) align generally with an intuitive concept of what constitutes a charity and the major historical categories of exempt entities. n69

1. Deservedness This Article follows the prevailing view that the cliatitable excinption constitutes an implicit govenunent subsidy of the activities it covers because it deviates from the ordinary tax base -- either income or property. n70 Accordingly, the exemption is justified only where there is a convincing showing that the activity in question deserves a social subsidy. There are two elements to deservedness: worthrne.rs and neediness. At a minimum, exemption requires some reliable indication of which activities out of the vast at-ray of lmman endeavors are socially worthy. But worthiness alone is not sufficient without necdiness. An organization niay be willing to continue its meritorious pursuits abseut [*329] a subsidy. If so, a subsidy is a waste of scarce govenunent resources that could be devoted to other, more productive causes. Bven if the level of service provided by the nonprofit sector would diminish witltout the exemption, the exentption is not necessary unless neither the proprietary sector nor the govermnent is capable of providing the same social benefits as efficiently. Ideally, therefore, the deflnition of charity should identify activities whose social benefits wonld be irreplaceably reduced absent the subsidy.

2. Yropor'tionalro, In addition to guarding against subsidization of activities that are unworthy or that simply do not need suppott, an ideal concept of charity in the tax exemption arena should guard against oversubsidizing (or undersubsidizing) those activities that are deserving. In other words, a proper concept of charity should at least roughly match the level of support to the level of deservedness. In fact, most theories for the exemption bestow tax relief in such a manner that "it

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would be sheer coincidence if the value of the tax exemption were to match the ... actual needs for the service," n71 or, more perversely, in a fasliion that gives the greatest tax break to the least deserving. Another way to capture ttie substance of the proportionality eriterion is to ask whether it makes sense to administer a deservhrg subsidy through an income or property tax exemption. It is not enough to detnonstrate that charitable institutions deseive government support; it is necessary to show that tax subsidies represent the most sensible vehicle for support, that some form of direct grant migltt not more accurately approximate the optimal level of support, or that direct governmeut provision of the same service is not preferable. n72

[*330] 3_ Universality _ .._ ...... C;lasstitcatton as a cuarttabie organization cames wiih ti noi oniy exemption uom the federai corpurate mco;ne tax but also a host of other benefits and responsibilities. Organizations exempt under I.R.C. 501(c)(3) are generally eligible to receive tax deductible donations, n73 and chatitable status usually results in exemption front state and local property, income, uid sometimes sales tax as well. On the burden side of the equation, the charitable exernp6on imposes certain lintitations on an organization's strttctttre and on its scope of operation. It must be truly nonprofit, so that no earnings inure to the benefit of a private hrdividual, and it may not engage in substantial political lobbying or in any political campaigning. n74 Moreover, the exemption does not extend to earnings derived from activities unrelatad to its exempt purpose, even if those eatnhxgs ultimately support the exempt purpose. n75 A valid concept of charity or theory of exemption should offer a cogent explanation for these tax bencfits and operational constrantts. n76

[*331] 4 IlistoricalConsistency It is not our naive atnbition eitlier to repudiate the charitable exemption or to refornntlate it to fit some overly fine sense of intellectual aesthetics. The charitable exemption has evolved througltout centuries of experience to take on an ahnost universal presence and shape. A complete reformulation or abandonntent is irnpossible to contemplate for both political and pragmatic reasons. n77 A sttccessfut theory, therefore, should be roughly consistent with the present scope of the exemption to encompass the major historical categories of exemption -- religion, education, and social welfare. Ideally, it should also comport with at least a general, unstttdied sense of why the exernption exists and what it attempts to do. In short, the theory should be intuitively comrect. This Atticle proceeds througli a systematic critique of the existing theories for the charitable exemption, employing these four criteria. It begins by examining the conventional rationales for hospital exemption: liealth care per se, free services to the poor, relief of government burden, and conununity benefit. It then addresses two unconventional theories advanced by academics: Professor Bittker's income measurement theory (that it is improper to conceive of charitable organizations as earning income) and Professor Flansmanu's capital subsidy theory (that it is defensible to use the exemption to help cettain nonprofit firms to overcome their comparative disadvantage in accessing capital markets). Finding these tlteories deficient, this Article then outlines a proposal for tiTe donative theory of the charitable exemption.

[*332] III. A CRITIQUE OF TRADITIONAL'fHEORIES OF TAX EXEMPTION

A. Health Care Per Se and the Latv of Charitable Trusts The per se view of exemption employed by the IRS and a majority of states is not new; it derives from an impres- sive and ancient lineage in the law of charitable husts. When Congress first enacted the charitable exemption in 1894 as part of the original uicome tax law, it lifted its concept of charity whole cloth fi-om this established body of precedent. Thus, when ttte IRS published regulations in 1959 stating that charitable is to be understood according to its "generally accepted legal sense ... as developed by judicial decisions," n78 and the Supreme Court reiterated in 1983 that "underlying all relevant parts of the Code ...[are] certain common-law standards of charity," n79 they were refelrutg to the law of charitable trusts, specifically, the 1601 Stantte of Charitable Uses which first codified the legal concept of charity. n80 Nevertheless, commentators have generally igrtored, or at least failed to explain, the relationship between this body of law and the rationale for tax exemption. n8l

1. Health Care Under the Statute ofCharitable Uses Many sources of charitable trust law establish that health care is a per se charitable enterprise, equivalent in its charitable stattse to religion and education. This body of law came into prominence in 1601 witli the Elizabethan Stat- ute of Charitable Uses, which strengtltened [*333] the mechanisnis for preventing the misuse of assets given to chari-

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table purposes. 'fhe statute's preamble catalogued the various ptn'poses for which charitable trusts had until then been established. Despite its liaphazard content, this listhtg has become a virtual oracle of charitable trust law, achieving an "9mmortahty of definition" through centuries of decisions that looked to it to detert une which trusts qualified for protection. n82 Altlzough the Statute of Charitable Uses does not explicitly establish that ttusts to promote health care are cliaritable, the preamble does recite that charitable trusts have been established for the "relief of aged, impotent and poor peo- plc." n83 This language is ambiguous as to whether these purposes are recited conjunctively or disjunctively, n84 but it has been generally supposed that the latter was intended. n85 This reading of the statute is contsined in an earlier literary source, Vision ofPiers Plowman, a fourteettth century epic poem that contains a remarkably similar catalogue of the worthy purposes for which rich merchants are counseled by Truth to leave their forthutes in order to gain full remission of their sins. This listing is explicit in its endorsentent of gifts to "repair hospitals, [attd] help sick people_" n86 A conternporaneous legal source, the 1634 Irish Statute of Chari- table Uses, similarly mentions dispositious for "the relief or maintenance of. .. itnpotent persons, or for the building, re-edifying or maintaining in [*334] repair of any ... hospital," n87 and other enacttnents fi'om that era include hospitals witliin the scope of charitable dispositions. n88 Any doubt that the Elizabethau preamble atcluded health care genet-ally and hospitals specifically was conclusively eliminated by subsequent case law in botlt England and America. Massachusetts Justice Gray included "relieving [] bodies from disease" in 1867, seventeen years before the federal exemption was first enacted, wlten he rendered what has become the classic American statement of charitable putposes. n89 The Supreme Court held over a century ago that a charitable trust is validly established to "erect[] a hospital for fouttdlntgs." n90 The leading modern British case holds that it "is now clearly established both in Australia and in England" that a "gift for the purpose of a hospital is prhna facie a good charitable gift ... because of the use of the word'itnpotent' in the preamble to 43 Eliz. c.4." n91 Finally, the Restaternent (Second) of Trusts and similarly authoritative treaties hold that a "trust for the promotion of health is charitable." n92

2. Deficiencies in Transplanting the Charitable Trust Definition Despite unaniniity of autltority that charitable trust law views the promotion of health as per se charitable, there are considerable theoretical difficulties hi blithely extending this per se approach to tax exemption. The primary defrciency is encountered under the deserv [*335] edness criterion. Simply put, beeause charitable trust law serves a wholly different ptupose than the charitable exemption, the trust definition of charity does not properly identify activities that deserve tax support. Charitable trust law exists pt-itnarily to protect assets which fottnders choose to devote to worthy causes_ Trust law provides this assistance by creating rigorous enforcement mechanisms to police abuses of these socially worthy trusts (such as authorizing attonteys general to bring enforcement actions) and by exempting such trusts from some of tite technical requirements that apply to ordinary trusts. n93 Unlike ordinary trusts, clraritable trusts need not have definite, identifiable beneficiaries; n94 they may exist in perpetuity, n95 and, tlnough tlie cy pres doctrine, courts will stibsti- tutc a new, sitnilar purpose to prevent them from failing when their stated ptupose becomes impossible to achieve. n96 As a consequence of the limited resources required to meet these objectives of charitable tntst law, it covers a far broader subject matter than is deserving of a tax exemption.

a. The.ScopeofCharityUnderCharitableTrustLaw To understand the breadth of subject matter encompassed by the trust law concept of charity, it is necessary to place in proper context [*336] the alniost four centuries of case law after the Statute of Charitable Uses. A significant portion of Anglo-Arnerican judicial resources were devoted for a time to sorting out the cottcept of charity in trust law. Many decisions found trusts to be noncharitable. These restrictive decisions impose a host of arcane technicalities that derive from the law's attempt to define a tetm that is more properly viewed as being virtually without substantive content. The notion that charity is a limiting terin arose from an historical accident centered on Partiatnent's passage of the 1736 Mortmain Act, which reoriented the significance of the charitable label. n97 This shift in the statutory context threw the meaning of eltarity into complete confusion, resulting in sporadically restrictive holdings such as the absurd decision that a trust for "benevolent" purposes does not fall within the Statute of Charitable Uses. n98 The streatn of ilTeconcilable holdiugs emauating from this and other equally inscrutable distinctions typifies the kind of law that gives attomeys a bad natne. 'I'ht'ongh it all, judges claimed to be able to divirte, but not define, the

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"spirit and intendmeut" of the Statute of Charitable Uses that constitutes the essence of the legal concept of charity. n99 George Keeton, a leading British authority, has char'acterized their efforts as "probably the worst exhibition of the operation ofthe teclmiqtte of judicial precedeut, which can be found in the law repotts." n100 Anglo-American law took a large step toward sorting out this confused body of law in Commis.cioners v. Pernsel, n101 perhaps the most celebrated case in the history of charitable tntsts. n102 The distittguished jurist Lord McNaughten eut through centnries of mindless distinctions [*337] by observing that the Statttte of Charitable Uses was never intended to define charity but was merely illustrative of the broad range of particular objects of charitable tntsts that happened to be in vogue at the time. Accordingly, he eneapsulated the legal concept of charity in the following, enduring formulation: "'Charity' in its legal sense comprises four principal divisions: trusts for the relief of poverty; trusts for the advancement of educatiqn; trusts for the advancement of religion; and hvsts for other purposes beneficial to the community, not falling under any of the preceding heads." n103 In 1960, England's Nathan Commission adopted the Pemsel precedent in the Charities Act of 1960, which finally repealed the Statute of Charitable Uses. n104 Simi- larly, in the United States, the Restatement of Trusts adopted essentially the Pemsel fonnulation, inctuding the residual category of "other purposes the accomplishment of which is beneficial to the cmnmunity." n I05 This residual category has been interpreted very broadly. For example, courts have sustained as charitable a be- quest for ptu`poses as trivial as "provid[ing] fishing facilities for the inhabitants of a town." n106 The law of cltaritable ttusts is willing to take such a generous view of the subject matter it protects because all that is at stake is the societal cost of the procedural protection attending these trusts, such as the additional case burden on courts hearing trust enforcement actions. No societal resources are committed to funding the trust, in contrast to the effect of a tax exernption. Given these relatively low stakes, trust law is able to rely for subject-matter limitation simply ou the decision of public- spirited founders to endow whatever purpose they desire. As onc court explained: What is the tribunal which is to decide whether the object is a beneficent one? It caruiot be tho individual mind of a Judge_... On the other hand, it cannot be the vox populi, for charities have been upheld for the benefits of insignificant sects, and of peculiar people_ It occurs to me that the answer ntust be -- that the benefit ntust be one whictr the founder believes to be of public advantage, and his belief must be at least rational, and not contrary eitlier to the general law of the land, or to the prhiciples of morality. A giH of such a character, dictated by benevolence, believed to be beneficent, devoted to an appreciably important [*338] object, and neither c•ontra bonos more.s nor contra legem, will, in my opitt- iorn, be charitable in the eye of the law.... 007 The essentially boundless nature of the subject matter coiisidered charitable in trust law is inanifest in the Restate- meut's residual definitional category, which in a tautological fashion covers any purpose "if its accomplishment is of such social interest to the comrnunity as to jnstify permitting the property to be devoted to ttie purpose in perpetuity." n] 08 This is no definition at all, for it explicitly eschews any attempt to sttbsume social policy judgments within a concept of charitable, as occurs with ordinaty rule-based legal analysis. n109Instead, the Restatetnent applies the term as a contentless label wherever its application seetns justified as a matter of raw policy judgment. This contpletely open-textttred approach to defining the term "charitable" may be appropriate in trust law wliere the eoncern is procedural proteetiou of an individual donor's gift to society. But reliance on these trust law precedents in tax law defies logic where the policy stakes are entirely different. Because a tax exentption represents a government subsidy, a proper concept of charity for tax exemption purposes inust identify activities that deserve the financial support of society. This cannot be accomplislied by relying on an expansive concept of charity that reaches all activities worthy of protection under trust law. Most ttust seholars wonld disagree with the assertion that the legal concept of charity has no boundaries, btrt this misses ttte poust. The limits that tmst law imposes are largely organizational and operational. Charitable status tums not so much on what is done but rather on how it is done. The guiduig precept that emerges from centuries of abstruse case law is that charitable trusts must be created to provide public, not private, bettefit. nl 10 This limitation reqnires that charities benefit the public at large rather than the founder or the founder's [*339] family and friends. nl 11 Tlrus, charities must be nonprofit entities, ttteir eainurgs may not inure to the betiefrt of any private individual, they may not engage in self-dealing transactions, they must serve a large group, and they may not pursue purposes that contravene public policy. n112 With these operational constraints satisfied, however, virtually any substantive purpose will suffice. Charity is "broad enough to iuclude whatever will promote, in a legitimate way, the comfort, happiness and improvenrent of an indefinite nutnber of persons." n113 Students of the law of charity acknowledge that "[n]early everything produced by ... private industry -- ranging from buildings attd food to books and musie - contributes to our welfare." n t I4 This is

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why virtually no one has succeeded in giving "charity" in trust law sotne defmitional content. n115 Instead, courts and commentators find themselves repeatedly forced to rest on the unillumiuating platitude tttat "charity is an evolving [*340] concept which must be allowed to cltange and expand in response to the needs of society." nl 16 b. 1'he Need for a Principle to Limit the Exemption If the trust concept is imported into tax law, essentially any legitimate nonprofit institution that serves the pubtic at large might be eligible for charitable tax exemption. 7'ttis principle largely matches what has occurred in practice and thus meets at least t h e historical consistency criterion_ n 117 I Iowever a defmition of charity that contains essentially no substantive limiting principle, and thus itnposes minimal subject matter restrictions on which activities are exempt (i.e_, rastricts only how the activily is organized and earried out), mnat be ielPntx.d hec;tuse such a definition contaiats no test to ascertain when the exemption is either deserved or proportionate to the benefit society receives. By classifying as "charitable" any activity which meets the inherent procedural restrictions of charitable trust law, this test potentially provides exempt status, and the accompanying tax subsidy, to activities that either might be provided just as well witltout a tax subsidy or to activities whose clollar value to the community is less than the amount of the foregone tax revenues. Binding the law of tax exentption to the satne category of activities covered by charitable trust law is thus mani- festly absurd. This is especially so because a trust law precedent established by the decision of a single donor would have the effect of exernpting au entire industry from taxation. Supposc, for instance, that a successfiil veterinarian left her wealth in tnist to promote the practice of veterinaty medicine. [*341] Such a ttust would be sustained as charitable. ni 18 Subsequently, auy proprietor of an animal hospitaL who chose to organize as a legitimate nonprofit operation would qualify for exemption from federal income tax, local property tax, and possibly state urcotne and sales taxes as well, even if the firin relied entirely on bon-owed capital and cltarged full market rates to all of its customers. nI 19 Such a potentially litnitless extension of the exemption may at first seem like a small risk because adopting the nonprofit form requires the organizer to forgo any share of the profits, a sacrifice that most persons would not care to make absent an overridhsg commitment to benefitting the public. However, businesses do exist frotn wluch organizers expect nothing more than fiill compensation for their labor; such otganizers would benefit by adopting a genuuiely nonprofit fornz of bnsiness that automatically ensures a substantial social subsidy, even if they are thereby denied any return on capital. n120 Physician group practices are just such a business. Even in a proprietaty form, the practice group essentially pays physician members the share of the yroup income attributable to their patients, n 121 a remuneration system that is not sacri5a;d by adopting the nonprofit form. Consequently, physician groups have a strong incentive to seek property tax exemption for their real estate holdings, and sales tax exetnption for their purchase of equipment and supplies. n122 [*3421 Hospitals may be under an equally powerful incentive to adopt the nonprofit fotm merely to enjoy the exemption's subsidy. '1'Iris incentive is likely because doctors strongly influence the organizational form of hospitals and doctors have strong reasons to prefer a tax-subsidized hospital. 'Ihe fmancial success of a hospital depends on its ability to attract conipetent doctors who in turn provide paying patients. n123 Doctors in turn prefer hospitals with the most sophisticated equipment and the broadest range of services, regardless of the profitability of these antenities_ Doctors are generally unconcerned about hospital profits because their income generated from patient fees allows them to remain financially independent of hospitals. Because doctors incur no cost from adopting the nonprofit form, they have a much stronger reason to prefer a tax subsidy than do the corporate organizers of hospitals. For hospitals this means that there is a particularly pressing ueed to guard against a self-justifying concept of charity that allows any activity to qualify automatically by virtue of its nonprofit status. n124 [*3431 The inadequacy of a concept of charity that mechanically refers to trust law precedents is acknowledged at least implicitly by the failure to follow it consistently, even by those who seemingly advocate this approach. A careful analysis of IRS decisions in the health care field, for example, reveals that the federal governntent does not respect in practice the per se characterization that it espouses in tlieory. Through a multitude of rulings ttte IRS ]tas developed the position that only inpatient hospital service -- not health care per se -- is exeinpt; the IRS consistently refuses to extend the exemption to physician groups, n125 and consistently imposes more exacting exemption requiretnents on health maintenance organizations (HMOs), nursing homes, and other nordiospitat health care services. n126 For example, the IRS has ruled that a nonprofit pharmacy is disqualified from the charitable exemption even though supplying drugs is as intimately connected with health care as adtninistering drugs, and even though pharmacy sales witliin a hospital are exempt. n127 A similar dichotoniy exists in some state law decisions, which impose more demanding requiretnents for exetnption of nonhospital services. n128 Recetttly, Congress also displayed atttipathy to the logical implieations of the

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health care per se principle when it voted in 1986 to retnove the exemption [*344] frotn Blue Cross/Blue Shield and from TIAA/CREF n129 because it viewed selling insurance as an inherently "commercial" activity, n130 a charge that is equally applicable to all fornts ofhealth care business, including hospitals. nl3l It is evident from these varied sources that coutts, legislatures, and taxing authorities are searching for a limiting principle that will define which activities deserve the exemption and which do not. n132 For reasons that remain unar- ticulated, they find that doctors, pharmacies, and iusurance companies -- which are fully capable of functioning without a subsidy -- do not merit exetnption, even though they are organized and operated in the same fashion as nonprofit hospitals. These decisions are reasoned on bases that in some cases are unprincipled, in otliers inconsistent, and in others undiseetnible. Thus, while the prevalent instinct to constrain the boundaries of the exetnption is correct, these decisions fail to isolate and articulate a workable limitiug principle. n133 The scope and content of a proper litniting pruiciple is the subject of the remainder of this Atticle. At this point, the Article has only established [*345] that virtually everyone who has given thought to the matter recognizes that some substantial subject matter linsits must be imposed on the charitable exeinption. As a consequence, the health care per se position drawn from cliaritable trust law --to wltich many decisions pay lip service -- cannot be sustained, n134 and in fact is not followed.

B. Charity Care and the Reliefof Government Burden

1. The Basic "Quid Pro Quo" Theory The conventional alternative to the position that health care is a per se charitable entetprise is that only those organizations devoted to serving the poor should be eligible for the charitable exemption, in keeping with the popular conception of charity. The essence of this theory is ttiat tax exemption exists as a quid pro quo for the production by the private, nonprofit sector of goods and services that absent exemption would be the burden of govemment -- treatinent of uninsured patients for example. In the words of Senator Hollis, "[f]or every dollar" of taxes for gone "the public gets 100 per cent" rcturu in tlte form of free hospital services. n135 Relief of the govenunent's obligation to care for the poor or to provide ottter social services is the most widely accepted general theory for the exemption in the ntodent state, n136 and it is essentially the theory adopted with respect to health care providers in Utah County. n137 It is also the primary rationale for [*346] pending legistation that would reform the exempt stattts of nonprofit hospitals, n138 This section proceeds by frst examining how the quid pro quo Yheory applies to hospitals. It explains precisely how the theory should operate if it is to satisfy the deservedness criterion and detnonstrates that nonprofit hospitals by and large fail to meet the proper test. It ttten turns to a theoretical assessment of the validity of the theory. This assessment reveals that the failure of hospitals to satisfy the quid pro quo test should not foreclose their exemption becanse, under our criteria for evaluation, the charity care staudard is not an adequate statemeut of the exclusive basis for the exemption.

2. Deficiencies in Applying the Theory to Nonprofit Hospitals

a. Deservedness When applied to nonprofrt hospitals, the relief of government burden tlteory encounters major probletns under the deservedness criterion. To satisfy this criterion, the health care sector must show that the service on which exemption is based (free care for the poor) would be irreplaceably compromised without the subsidy. While empirical evidence establishes that nonprofit hospitals give away a significant pottion of their services, n139 for-profit institutions do so as well in the form of write-offs for bad debts. Because for-profit hospitals exist as a ready substitute for nonprofits, the relief of govenunent burden theory can meet the desetvedness criterion only if nonprofit hospitals provide a greater proportion in uncotnpensated care than the for-profit hospitals. n140 To illustrate, if for-profit hospitals give away four percent of their care in the fontt of bad debts, nonprofit hospitals must show that they [*347] give away a higher percentage to meet the threshold test of deservedness. This comparison with for-profit hospitals is necessary under the government btirden theory because, without nonprofits, the full atnount of the free care for-profrts provide wonld not fall on the government. Moreover, a certain portion of free care provided by nonprofits is not vohtntarily given in the spirit of charity but merely reflects "a business decision that the cost of attempting to collect on a debt is greater than the potential gain." n141 This fact presents a second justification for deducthig from the nonprofits' free care ledger the proportionate

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amount of free care rendered by for-profits. The bad debt component of uncompensated care represents an ordinary cost of doing business borne by ttonprotits and for-profits alike. Deducting fi-om the notiprofits' free care figure the proportion of free care rendered by nonprofit hospitals is justifiable under the approximation that essentially all for- profit free care constitutes bad debt. n142 [*348] Using this measw-e of desetvedttess, the existing empirical evidence fails to confirm that nonprofits provide geater relief than for-profits of the government burden of delivering health care to the impoverislted and uninsured. One national study indicates that "most voluntaty and proprietary hospitals [are] very similar in their willingness to treat patients freely....[P']or the nation as a whole there appear[s] to be only small differences between voluntary and proprietary hospitals ut access to care." n 143 What differences exist appear to be narrowing under the influence of cost containment pressures from private and government insurers, such tbat, in the aggregate, nonprofit hospitals are provid'ntg proportionately less uncompensated care than their for-profit competitors. n144 These aggregate, riational comparisons have been criticized as unrepresentative because for-profit hospitals are un- evenly distributed across the country. In a study conunissioued by the Volunteer Trustees of Not-For-Profit Hospitals Foitttdation, Lewin & Associates observed that for-profits are concentrated mostly in southem and western states that tend to have less generous Medicaid progratns for the poor and, thus, a greater demand for indigent care by private hospitals. In contrast, nonprofit hospitals are more evenly dispersed across the fifty states, which means that their average national uncompensated care statistics are diluted by those states where there is much [*349] less need for private hospital charity. This study demonstrates tltat, in a selection of four states where for-profits compete witlt nonprofits, nonprofit hospitals outperfornr proprietary institutions at a level ample to meet the deservedness criterion at its threshold_ n145 Accordingly, the existing studies lend mixed suppott to the proposition that voluntaazy hospitals generally provide charity care at a level that would be irreplaceably reduced absent a tax subsidy. Proponents of hospital exemption frequently attempt to cireumventthese inconclusive statistics by positing a notion of deservedness that is not grounded on a strict "quid pro quo" formulation. This alternative theory requires only that tax-exempt hospitals maintain an "open-door" policy, accepting every patient seelcing admission regardless of ability to pay. n146 Hospitals contend that maintaining an open admissions policy meets their social responsibility because hospitals treat all indigent patients who actually seek care. Anytlzing more would require hospitals to provide more free care than is demanded. Even asswning that nonprofit hospitals practice an open door policy as fervently as they preach it, n147 there are two difficulties with this formulation of the governnient burden theory. First, this fonnulation does not reqttire a showing that hospitals actually relieve a government burden. n148 If the need for free care ever becomes so slight that hospitals are prevented froin establishing that they render a quid pro quo for the exemption, then no significant government burden exists for hospitals to relieve- Realistically, there will always be ample opporthmity to dispense free care, but this open-door formulation [*350] allows nonprofit hospitals to shirk their social responsibility by providing less than their share of comrnunity needs. This is true because by convention the hospital corporate entity is passive with respect to patient admissions. Hospitals generally accept only those patients admitted by rnembers of the medical staff. Be- cause doctots in private practice have neither legal obligation, moral dictate, nor financial incentive to accept charity cases, n149 hospitals will not have a significant charity census unless they take affirmative steps to treat uninsured patients, such as requiring doctors to accept some charity work as a condition of inedical staff privileges, n150

b. Proportionality Doubts about the ability of hospitals to justify their exempt status under the deservedness component of the government burden theory are settled by the poor performance of nonprofit hospitals with respect to the proportionality criterion. Even if the value of charity services delivered to the poor and uninsured would be itreplaceably reduced absent a tax subsidy, hospitals still must establish tttat the value of the subsidy roughly matches the level of deservedness; if not, hospitals fail to satisfy the proportionality criterion. This test requires at a minimum that the value of free care provided by exempt hospitals, above a representative proportion of free care rendered by similar for-profits, match the loss of tax revenues to the government. n151 [*351] Unfortunately, much of the data measuring uncompensated care that researchers have generated in recent years does not directly [*352] respond to an analysis of the proportionality criterion because it does not measure the value of the tax relief given nonprofit hospitals. From the fragmeutary evidence available, it appears that nonprofit hospitals do not provide iucremental free care services that match ttteir foregone tax revenues. n152 'fhe only extensive

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study that directly measures the tax savings n153 conservatively estimates that California nonprofit hospitals gave $ 82 million in charity care in 1984-1985 and saved $ 300 million in federal and state tax revenne. n154 [*353] The California study may not represent the nation generally because California has an atypically generous Medicaid program that reduces detnand for charity care. n155 Comparisons in otlier states reveal that nonprofit hospitals provide significantly more free care than for-profits. n156 These comparisous, however, do not measure the inag- nitude of this increment against the amount of tax loss. When this conrparison is made on a national level, nonprofit hospitals provided an increment of utrcompensated care above that provided by for-profits, in the following amounts: 1982 -- $ 1.06 billion; 1981 -- $ 0.51 billion; 1980 -- $ 0.41 billion, n157 These amormts are dwarfed by the $ 8.5 bil- liou estimate of the anm.tal value of the charitable exemption. n158 The same comparison canbo approxuuated by adding ilie percentage of rcveaue for profit hosp.tals typically forego by providing frce care to thc porcentage of revenue they pay in taxes. n159 'I'he proportion of free care nonprofits provide would have to equal or exceed this sum. n160 17re [*354] result on a national level does not justify providing a tax exemption to nonprofits. n l61 '1'he scattered data on a local level are also equally unconvincing. n162 When measured at an individual hospital level, however, many patticular institutions, especially urban teaching hospitals, may meet this standard. n163

3. Deficiencies as a General Theory of Pxemption T7te failure of most voluntary hospitals to justify their exempt status under the relief of governntent burden theoty does not, by itself, invalidate the theory as a general explanation for charitable tax exemption. On the contrary, the solution to the difficidties surveyed thus far is simply to refuse to apply the theory to the particrdar uonprofit hospitals that fail the test. Further examination, however, reveals that the government burden conceptlon of charity fails at a theoretical level as [*355] an exclusive statement of the general basis for tax exemption. n164 The-efore, hospitals' failure to comply should not be conclusive of their claim to exempt status. The government bnrden theory encomtters its primary difficulties under the propottionality and historical consistettcy criteria, n165

a. Proportionality Where the governtnent burden theory is based on the provision of charity care, it fails to meet the proportionality criterion because of its perverse tendency to operate in a regressive fashion, awarding the largest subsidy to those organizations that least need it. Students of "tax expenditure" analysis will recognize that a general tax exemption suffers froin the same "upside down" effect as many tax deductions: n166 those entities with the Itighest net revenues or the greatest value of otherwise-taxable property receive the greatest amount of subsidy, yet these are the entities that least need support. n167 From the standpoint of equity antong different tax-exempt entities, the result of the general tax exemption is that entities that are the "poorest" in eitlter an [*356] income or property tax sense, and thus most in need of govenunent assistance to serve impoverishcd and uninsured patients, receive the least govermnent assistance. Be- cause tmcompensated care is an expense item, those hospitals with the most net revenues are more likely to have actually rendered the least free care, all otlrer things being equal. Sitnilarly, for the property tax exemption, those nonprofit hospitals that retairt the most net surplus for capital expansion, ratlier than using surplus to support the poor, will enjoy the largest subsidy. n168 The same is true for any theoiy of exemption which ties the availability of exemption to an expenditure of resources by the exempt entity, n169 These problems might be ameliorated if the exetnption were administered on a hospital-specific, annual basis, requiring each hospital to demonstrate yearly its delivety of free care in an ittcrenient sufficient to car-n the subsidy. n 170 In such a system, a hospital with sufficient net revenues would receive a tax benefit exactly equal to the dollar value of charity care provided by the hospital. n 171 Nevertheless, such a system wadd not belp those entities that had insufficient revenues to fully benefit from a tax exeniption_ n172 Hence, even this theoretical system [*357] would suffer proportionality problems. Such a system would also be more cumbersome to administer than the cunent systent. n173 The second troubling aspect of the governtnent burden theory under the proportionality criterion stems from the in- tergovermnental nature of the tax exemption subsidy and the multi-jurisdictional nature of many traditionally charitable services. Specifically, the burdens relieved are not necessarily those of tlle taxing authority that grants the exemption. Instead, one governmental utut may be enjoying the charitable services supported by another's subsidy. This phenonte- non has been explored tnost comprehensively in the context of the property tax exemption for education, where, for htstance, it is extremely difficult to maintain that the City of New Haven receives a fair quid pro quo for Yale Univer- sity's exemption via the City's relief from the burden of operating a university of international stature. Clearly, the government burden would be borne at a state or perltaps national level absent the tax subsidy. n 174

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These observations do not have qnite the same force in the hospital arena, for the burden of hospital care historically is shared to a much greater degree among federal, state, and local govemments. Nevertlteless, it is likely that in many situations a large, regional hospital, particularly one affiliated with a medical school, will draw disproportionate support from its local municipal tax base. As noted in Section II.B., one measure of proportionality is to consider whether the particular form of subsidy that the titeory contemplates tnight be more rationally administered tlirouglt a systetn of direct subsidies. n175 This is an apt comparison for liealtli care services [*3581 because the state and federal governmetits in fact provide direct subsidies through the Medicaid program, as do ntany municipalities. n176 A direct subsidy is infmitely more sensible than the exemption_ It easily accommodates the widely varying needs for charity care over time and among different localities according to demographic factors, such as the etnployment rate, the generosity of the particular state's Medicaid program and the presence of local muuicipal hospitals. n177 A direct subsidy spreads the burden of taxation for these services more fairly across the community than a systetn that effectively taxes only those who are sick. n 178 It is also just as easy or difficult to adininister propcrly. n179 Yet another altetnative that potentially offers even greater efficiency is for the government to directly treat the indigent, as it does on a large scale through the public hospital system, conununity health centers, Veterans Aduiinistration hospitals and the Indian Health Service. Direct provision of service is a far ntore targeted means of administering charity care than the charitable exemption.

6. Historical Consisteney and the Gift-to-the-Community Formulatron The relief of government burden theory is also deficient as a general theory of exemption because it circumscribes the field of charitable activity too narrowly as compared with the traditional categories of exemption, thus failing the historical consistency criterion. n180 The prime example of a charitable activity that cannot be explained under the relief of govennnent burden rationale is religion, an activity for [*3591 which there is not only no govemmental obligation but an outright prohibition on govenmiental involvement. The government burden theory might accomnzodate this anotnaly as sui generis in our govennnental stntture, n181 except that there are many other instances of traditionally exempt fonctions that catmot properly be said to constitute a governmental responsibility. Referring to the listing in section 501(c)(3), n182 only education clearly appears to fit the characterization of a traditional govenunent responsibility, and even it is not a traditional funetion of the federal government_ n183 A somewhat modified version of the government burden theory, lmown as the "gift-to-tlie-community" formulation, avoids some of the deficiencies of the pure "quid pro quo" version by encompassing any fie-e service, regardless of whether the particular service is one the govermnent traditionally has provided. n184 This accords witlt the assumption that the government ltas a strong interest in the relief of poverty even if the government is not affirnratively obliged to d'n-ectly rendor the particular form of relief. This theoty avoids the problematie requirement of the strict forntulation of the government burden theory that assumes the government would provide the sante service absent the exemption. In contrast, under the gift-to-the-commnnity variattt, a charitable service rnerits subsidization if the government merely has tlie power to supply the free service itself n185 This variation of the charity care theory, however, does not come any closer to qualifying hospitals for the exemption. Also, as a general theory of exemption, it continues to suffer from the "upside down" effect and the other proportionality problents noted above. The oveniding defect, however, is that this variant fails even at its primary point of attempted rehabilitation -- ltistorical consistency. [*3601 One could arguc for a theory of charitable exemption that extends to the relief of poverty in any rnanner, based on the Statute of Charitable Uses, n I 86 the principal source of the law's concept of charity. n187 This statute was enacted in conjunetion with the Elizabethan Poor Laws, n188 which sought to address the critical problems faced by the ittcreasingly destitute populations in urban centers. The Poor Laws placed the responsibility on local towns to care for their indigent residents. At the same time the Statute of Charitable Uses sought to lessen this local governmental burden by strengthening the role of private philanthropy. The liistorical cotmection between these two statutes demonstrates that the original notion of charity was principally concerned with thc relief of poverty. n189 This notion prevailed for only a comparatively shott time, however. In Commissioners v. Pemsel, n190 Lord McNaughten eaptnred centuries [*361 ] of precedent in rejectitig the relief of povetty as the sole grouttd for charitable classification. n191 Nor has the concept of poverty relief governed the law of charity in modern times. The other bed- rock charitable purposes, religion and education, serve the rich as well as the poor. Lven when hospitals were consid-

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ered paradigms of charitable organizations, they were not pure charities in the popular sense of servinb predominantly the poor. As Rosemary Stevens has explained: Voluntary hospitals were never really charities.... Sometimes one thinks back over hospital liistory and there is this vague notion that there was once something called a voluntary hospital, which the leading donor of the towu gave to the community and all it did was to give away care. This is absolutely untnte.... We have always had a very entrepre- nettrial voluntary sector in this courthy with respect to the attraction of private patients. ..."I'hey were marketing their services vety early, loolcing to govennnent agencies for suppoit and lobbying vigorously for such money. n192 The same observation is true for charities generally, which have devoted only a stnall portion of their resottrces to social services for [*362] the poor since the seventeenth cenhuy in 1 3ngland and since the advent of the inassive gov- eiiuiic talVvcl,uic pi` Gs'rains ithclhiitedSiates.n rii9, One might attempt to rebut these historical authorities by observing that they establish only that charities need not exclusively serve ttte poor; none "supports the much bolder proposition that a nonprofit hospital is a charitable organization even if it provides no care for the poor." n194 Likewise, the government burden theory, including its gift-to-the- community variant, does not require total devotion to relief for the poor, n195 only sufficient free services to match the level of deservedness to the level of subsidy. Neveitheless, the law of charities has long held that charitable thusts need not serve the poor at all. n196 Indeed, several of the classic instances of tax-exenipt organizations in modern times serve the rich almost exclusively. n197 Accordingly, a conception of charity limited to fi-ee services to the poor would dramatically alter the current scope of the exetnption. In sum, both the traditional formulation of the relief of govermnent btnden theory and the gift-to-the-coimnunity variaut are not only unsatisfactory as an explanation for the exentption of voluntary hospitals, but they also fail the proportionality and historical consistency criteria from the standpoint of a general iticory of tax exemption. For these reasons, they are unacceptable both as justifications for the [*363] exemptiott of nonprofit hospitals and as general thco- ries on which to base eligibility for tax exeniption. Because a snccessful theory of charitable exemption niust encompass more than free services to the poor and the relief of government burden, nonprofit organizations should be allowed to demonstrate that they earn their subsidy by benefitting the comniunity in otlier ways. n198

[*364] C. Community Benefit and the Nonprofit Ethia 1_ 7he Community Benefit Theory Nonprofit hospitals face a pair of correlative problcros under the two conveutional theories of exemption examined thns far. Nonprofits easily satisfy the health care per se theory, but that theory, applied logically, does not test whether they earn the exemption. In contrast, the relief-of-poverty branch of the government burden ttteory, which does contain such a test, is too demanding for most hospitals in the present healtli care economy. Recognizing these twin difficulties, the nonprofit hospital sector maintains that the proper test for the exemption should consider whether they benefit the community in a variety of ways less obvious or tangible than direct charity care, such as providing services superior to that of investor-owned hospitals, responding to connnunity needs better than for-profits, or fostering desirable medical values in ways that proprietary medicine does not- Unlike the per se theory drawrt from trust law, the conimunity benefit tlieoty does not automatically validate the exemption of any nonprofit activity. Instead, this theory seeks to identify partieular nonprofit activities in whieh the couununity values the special quality or ethic that the nonprofit enterprise offers. n199 In the hospital context, [*365] the commtmity benefit theory maintains that nonprofits are socially privileged by virtue of their superior quality of service or the superior ethic of nonptatit medicine. n200 As summarized in the preeminent study of organizational fot-m in mcdicine: [S]ome observers believe that the rise of for-profit health care threatens the values and ideals that should guide ... health care organirations_... It is feared that something essential will be lost if a service ethos -- expressed in ternis such as caring, coinmunity responsiveness, fiduciary responsibility -- is abandoned or replaced witlt a principle based on economic goals, n201 The tlleory of exemption based on the superiority of the nonprofrt ethic in inedicine cmues closer to meeting the deserveduess criterion than the per se approach because it requires a positive dentonstration of a community benefit that profit-ntakiug finns do not offer, n202 Thus, [*366] tax exemption proponents maintain that nonprofit hospitals provide many unique benefits besides free care: they support physician education and medical research; n203 provide a full range of services regardless of each service's profitability; n204 and support community health education and pre-

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ventative services such as cltildbirth classes, nreals for the elderly, and innnunization clinics. n205 More arnorphously, they claim to foster an ethos more conducive to proper medical practice than tttat prevailing in profit-oriented environ- nrents. n206 Tbe conmiunity benetit theory also avoids the difficulty that the relief-of-poverty justification faces under the proportionality criteriott. Because this theory postulates that a benefit inheres in all of the organization's services, a subsidy matched to the size of the operation -- as income tax and property tax exemptions generally at-e -- is well calibrated to the extent of deservedness under this theory. The more property a nonprofit hospital has and the more income it earns, the more superior services it can render to the community. n207

2. DeJiciencies in the Community i3enefi1 Theo;y

a. Deservedness Closer examination of this theory reveals that it also suffers from serious infitmaties, priniarily under the deservedness and proportionality criteria. With respect to deservedness, the community benefit theory should show that the social benefits claanedby nonprofit firms [*367] would be lost witlrout the exemption. Without this "but for" connection, the economic benefit of tax exemption is a windfall. In the context of hospitals, it is necessary to ask first, why voluntaties are preferred to proprietaries, and second, why the exentption is needed to secure this preference. These two inquiries mirror the "wortltiness" and "neediness" coniponents of the deservedness criterion discussed earlier. The extensive literature devoted to both the theoretical atid the empirical ditnen.sions of these two inquiries reveals no support for the proposition that whatever social benefrts are provided by the nonprofit fortn in medicine would disappear absent a tax exemption. Scholars of the nonprofit entetprise have long been fascinated with the hospital industry because it provides an in- triguing rnix of all three sectors of the econonty operating in tandem: proprietary, govermnent, and nonprofit firms. n208 These scholars have developed several cotnpeting theories to explain why nonprofit hospitals have historically outtmmbered for-profits. n209 Some explanations relate to a plausible community benefit, while ottters do not. 'rlre theories that find uo inhereut benefit in the nonprofit form directly refute the wotYhiness cotnponent of the c-onununity benett tlteory; those that support the notion of social benefit inherent in the nonprofit form must still pass the "but for" (neediuess) component of the deservedness criterion.

1) Negative Theories ofNonp•ofrt Dominance Theories that are neutral or adverse to nonprofits discem rto ratiouale for preferring this organizational form in medicine, observing that health care is no more ethically incompatible with profit tnotivation than are other essential goods and services, such as food, shelter, an transportation. n210 These uonprofit skeptics offer essentially two rationales for the dominance of the nonprofit form. First, some theorists blame the tax exemption and otlier fortns of unjusti- fted govermnental favoritism for the prevalence of nonprofit hospitals. n211 Nonprofit [*368] skeptics therefore cltaracterize the exemption for hospitals as an anachronism that remaitts "in large part as a consequence of institutional inertia," n212 or even as a mindless subsidy that perpetrates a"fraud" on the public. n213 prefer nonprofits for Others maintain the "parasitic hypothesis" that nonprofit hospitals proliferate because doctors reasons of economic [*3691 self-interest inconsistent with socially optimal patient care. The two principal theories 11214 that rely on physician self-interest are the "pliysiciati control theory" and the "managerial prestige tlteory." These differ in that the first posits physicians' financial interest as the primary determinattt of hospital organization and operation, whereas the second views physician interest as derivative of nonprofit managers' utility fitnction. n215 The physician control theory holds that pltysicians prefer nonprofits because this instittttional forin tends to increase physicians' control over the financial affairs of hospitals by virtue of the absence of any shareholders with overriding or competing authority. n216 The resultu g managerial laxity is said to allow doctors to control their competitors' access to the niedical staff or to direct hospital pricing decisions to their own advantage. n217 The "managerial prestige" theory of nonprofit preferettce posits that physicians enjoy derivative benefits from the way in which nonprofit managers naturally tettd to behave. According to one leading explanation, "the ntility of hospi- serve" and "the status of a hospital is tal adrninistrators is a function of the status [*370] of the hospitals in which they assumed to vary directly with the range of services available and the extent to which expensive and highly specialized equipment and persormel ... are available." n218 Nonprofit hospitals are thought to spend more than for-profits on physician and patient atnenities because they are required to retain their eamings witltin the institation. In economic

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jargon, it is said that nonprofit institutions are "volume maximizers" or "output maximizers," rather tltan proiit maximizers. n219 The same notion is captured in the colloquialism accusing hospital managers of sufferiiirg from an "edi- fice complex." Ilowever expressed, the result is that nonprofit hospitals are charged witlz a "bias against producing low- qttality products, even if they are demanded by a certain segment of the population," aud are blamed for "the often ma- ligned duplication of sopbisticated and expensive equipntent," both of which represent a "misallocation of resources." n220

2) Positive Theories ofNonprofrt Dominance Theories that support nonprofit enterprise in medichte hold that this organizational form predominates because it is preferred by patientc and doctors for socially valued reasons. Qne such theory is drawn froin Professor Hansmamt's pioneering work in which he explains that [*371 ] patrons tend to favor the nonprofit organizational form when com plex and difficult-to-evaluate services are involved. Patrons prefer nonprofits because they have less trust in firms whose profit incenfive provides them a stronger bias to behave opportunistically. Hansmann maintains nonprofits enjoy o eater public confidence because a"nondistribution constraiut" attaches to nonprofit status, precluding anyone from havittg a private interest in the organization's economic perfortnance and requiring the institution to retain any net income to further its public service mission. n221

Hansmann's trust theory for the existence of nonprofrt enterprise has superficial appeal in the medical arena because liealth care is a service that is diifrcult for consumers to evaluate. n222 It is thus surprising that Hansmann finds his theory a poor fit in the hospital industry. [*372] The reason the tntst theory does not readily extend to hospitals is that patients rarely undertake to evaluate hospital services independently_ Ittstead, they rely heavily on the judgmeit of'their pliysicians in selecting a hospital. Indeed, it is sontetitnes said that the true eonsumers of hospital services are doctors, not patients. n223 Because patients tend to follow the advice of learned intermediaries, the difficulty of lay evaluation of hospital care is cotxected witlt.out adopting the nonprofit form_ This explanation stops short of a full examniation of the tntst theory's application to ltospitals because it fails to in- quire whether doctors also have socially valued reasons to prefer nonprofit hospitals -- reasons equivalent to consumer trust. According to one body of scholarship, doctors and, by derivation, patients, do have such reasons. Patients trust their doctors' choice of hospitals in part because doctors are pcrceived to be guided by a professional ethos binding them to etlticat norms of fiduciary responsibility to their patients. Hence, doctors have good reason to promote practice envi- roninents that foster this professional ethos. Nonprofits are considered "superior ff'om the point of view of profcssional ideology and practice" n224 bccause "[tn]any features tltat are generally considered to be speci6c characteristics of the professions -- altruism, autonomy, an empliasis on quality of service, and a certain anti-ntaflcet and anti-bureaocratic ethos -- have also been singled out, quite independently, as the raisons d'etre of nonprofit htstitutions." n225 Nonprofit hospitals stress these values because they tend to attract the managers whose values correspond with those of the founder. n226 For these reasons, "the nonprofit nature of a service organization tends to reinforce the fiduciay cotnponent in the relationship with clients, thus inereasing professional autttority and autonomy." n227 This professional ethic theory contrasts with the physician control theories already discussed in that it maintains that [*373] physicians are primarily eoncetned with the clinical as opposed to the financial control of their practice. n228 Although this theory supports the uotion that there is au uilierent social benefit in the nonprofit form, the theory fails to satisfy the neediness ("but for") component of the deservedness criterion. The reason for this failure is that why nonprofits exist is a fundatnentally different question thau whether they should be exempt, n229 a point tliat many writ- ings on the subject fail to recognize. n230 Even assuming that the favorable view of nonprofrt hospitals is accurate and that it is possible to confirm the production of sufficient net benefrts to eam the exemptiou's subsidy, the deservedness criterion would still not be met because, a priori, there is no reason to asstmre that nonprofits would not continue to pre- dominate absent the subsidy. Indeed, tltere is every reason to suppose the contrary. n231 The favorable view holds that nonprofits [*374] prevail in medicine because this is the socially valued preference of doctors and patients. But if tttere is no obstacle to effeetuating these preferences, then there is no reason to subsidize them. n232 In these circumstances, a subsidy provides a complete windfall. n233 This observation, first made clearly by Professor Hansmann, holds true for any number of services that we tnigltt prefer to pttrchase from nonprofit fums, owing to our greater trust that tltey act less opportunistically. n234 Since consumers are free to tnake this purchasing decisiou tltemselves and have every incentive to do so, they need no encour- agetnent front the government. Any such support would not only be wasteful, it would inappropriately Itinder those whose preferences differ by lessening or eliminating their access to a proprietary provider.

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It is surprising tltatthis point is not better recognized. Elsewhere, govenuuent is not in the habit of paying large atnounts of scarce public funds as gratuitous rewards for good deeds. n235 It is socially desirable to niow our lawns, but no one thinks to reward us for this conununity benefit, nor do we tltitdc to ask for any such reward. No more should the governnietit forego billions of dollars in revenue from nonprofit hospitals for the simple reasou that society values their services. In sum, the community benefit theory fails, not only because of the difficulties it encounters in documenting the amorpttous uature of the claiined benefits, but also because tlie theory is insensitive to whether a public subsidy is necessary to produce those benefits. Obstacles to the optimal provision of some nonprofit goods and services may exist, but the theory does not attempt to idetitify them,

?) Tlre Empirica! Evidence The conclusion tltat the positive tlteories of nonprofit doininance fail the deservedness criterion is bolstered by extensive literature exploring [*375] the ecnpirical dimensions of this nonprofit/for-profit hospital debate. By and large, the literature demonstrates that the two sectors are retnarkably similar in their performance characteristics. The overriding consensus of these studies is that "available evidence on differences between for-profit and not-for-proflt health care organizations is not sufficient to justify a recommendation that invostor ownership of health care organizations be either opposed or suppotted by public policy." n236 For the most significant measures of hospital perfotmance --quality and cost n237 --there is little or no difference between the two sectors. n238 Likewise, for the more anrotphous grouping of services referred to as cornmunity programs -- health screening, cotnntunity education, immunizations, temporary housiug, trausportation, and the like -- nonprofit and for-profit hospitals perfortn approximatcly the same. n239 Hospi- tal behavior is remarkably uniform because the two sectors share identical sources of financing: private and public health insurance. n240 The operational incentives created by these sources of [*376] revenue tend to swanip whatever contrasting incentives exist by virtue of organizational form, a likely result in any industry. n241 Nonprofit defenders observe that these studies were conducted before private and public reimbursement systems placed IzospitaLs under great frnancial pressure. With the advent of atcreasinigly stringent reimbursement controls, the defenders claim the perfornxance of the two sectors is likely to diverge as proprietary hospitals sacrifice quality of care and comprehensiveness of services for profitability. n242 It is, ltowever, a matter of pure assertion that nonprofit hospitals will not be equally sensitive to reimbursenient constrainks. This assertion is belied by the very premise that the behavior of both sectors has been molded into similar patterns in the past by financial considerations. n243 Even if nonprofit hospitals respond differently, it is at Least arguable whether a response is socially desirable if it ignores the intent of these reimbursement reforms to foster market-like incentives in health care and to eliminate excessive duplication, unnecessary services, and inefficient cross-subsidization. Thus, what some observers will characterize as "profi- teering," others will view as neccssaty economizing. Defenders of the volmitary sector respond that the assettions of similarity are flawed because the studies control for an excessive number of variables in a manner that masks important differences between the two sectors. This is persua- sive. For instance, it may be the case that, controlling for facility size and location, the two sectors have very similar service mixes, but hospital size and location are not irrelevant or purely exogenous hospital characteristics; they are important variables that hospitals affect by how they choose to spend surplus revenue. n244 [*377] Facility size and location have independent importance because these characteristics do not vary randonily across the two sectors, and they are positively associated witlt hospitals' level oftechnological sophistication and the nuniber ofunprofttable services. Becanse nonprofit hospitals tend disproportionately to be larger in size and to locate in urban, inner-city areas, they tend to have a proportionately greater number of novel, expensive, and sometimes unprofitable services, such as premature nurseries, burn units, and magnetic resonance imaging. n245 For similar reasons, the two sectors differ even more draniatically in their support of tnedical education and research. n246 There is not complete agreement, however, over the significance of even these perfonnance differences. n247 These hotly contested issuesneed not be resolved in a manner that attracts substantial consensus. It is sufficient for present purposes to observe that neitlrer the positive theories of nonprofit dominance nor the empirical evidence supports the proposition that absent tax exenrption, nonpro6t medical care would lose whatever superiority of quality or ethic that it offers. Without showing that the exenrption overeomes a barrier that creates suboptimal production of the desired service, it is equally likely that the subsidy causes too high a level of production -- in short, too much of a good thing_ Accordingly, the community benefit tlieory fails the deservedness criterion. [*378]

b. Proportionality

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In addition to failing the deserveduess criterion, the conimunity benefit theory has difficulty meeting the proportionality criterion, primarily because the less tangible benefits to which it refers are either difficult to quantify in monetary terms or are inherently tmquantifiable. There is no methodologically sound way to measure the soft values that inhere in the claiin of a superior nonprofrt medical ethic. Without such quantification, it is itnpossible to verify whetlter society is receiving its inoney's worth from the exeinption. David Seay, of the United Hospital Fund, clauns to have devised a quantifiable measttre of commitment to community values by articulating the "key elements of a conununity benefit standard for hospitals ... in quite specific terms .. .[that] demonstrate that ... the notion of'community benefit' [is] not necessarily soft or ambiguous." n248 These "key elements," however, simply ask hospitals to identify cotnmunity needs, develop progratns to tneet those needs, and make changes in the hospital's ntission statement, governance suvcture, and organization necessaty to cany out a program of conrmunity responsiveness. These staudards to not quantify the comtnnnity ueeds that are rnet and, more importantly, do not tneasure whether nonprofit hospitals are out perfortning for-profits in meeting cotmnunity ueeds. n249 As Professor Bittker has expressed, "Lacking a method for measuring these appealing but elusive virtues, one must perforce rely on intuition in comparing the achievements of private charities with those of govemment [and pmtit- making enterprises], when they are performing similar functions." n250 Not every decision of government need be niade [*379] by calculator, particularly social policy decisions made by Congess, but a st-andard that relies entirely on intuition is inappropriate in an administrative arena that requires courts and agencies to apply a legislative mandate. n251 The degree of legislative abdication inherent in the coinmmlity benefit staudard is particularly troubling considering that it leaves to tax collectors -- rather than departments of goventnrent legitimately concerned with substantive public policy -- the task of determining what constitutes socially worthy activity across the broad range of nonprofit enterprise. n252 This arrangement has a high potential for produchig capricious results, tr253 a potential that has been realized in the hospital context. The IRS has ntled, for instance, that hospital cafeteria sales are exempt because they keep doctors close to the hospital in the event of an emergency, but that incotne froin a hospital's laboratory services for its doctors' office patients is not exempt even tltougli the hospital provides this service as a convenienec to keep tlre doctors in au adjoining medical office building. n254 Among [*380] exempt organizations generally, the IRS has a lottg histoty of ad hoc and inconsistent determinations concerning which activities must provide free services to qualify for an exemption. n255 A second reason the communiry benefit tlteoty of the charitable exemption abdicates governmental responsibility is that the tlieory leaves decisions concerning priorities for spending the subsidy to the private entities that receive it. Thtts, assuming that taxing authorities are capable ofjudging which industries are better structured on a non-profrtbasis, once this determination is made, any fitrther decisions about how the subsidy is spent are left to the tirm's managers, consh'ained only by the requirements of maintaining nonprofit status. Thus, hospital managers can choose to use the subsidy to support facility refurbishment rather than meet the more pressing need of treating greater numbers of uninsured patients. This abdication of national health care policy to private p:uties is especially bizarre considering the many facets of tlte health care crisis that demand immediate goverimzent redress, n256 In short, given the inherent dif- ticulty in quantifying the socially desirable values of the nonprofit fonn and the degree of govenmtent abdication in administerittg the exemption, there cau be no assurance that the level of support provided by an exetnption even roughly matches the level of deservedness.

3. Variants of the Comraunity Beneftt Theory The primary strand of the community benefit theory seeks to justify selective coverage of nonprofit organizations by maintaining that the special ethic of nonprofit enterprise is impottant only in certain activities, and then devising a rneans to identify those activities -- a highly problcrnatic undertaking. Two variants ofthe community benefit theory attcmpt to avoid this difficulty by maintaining that these special qualities itiltere in all nonprofit organizations, in whatever activities they are engaged. These two variants -- the "public trust" tlteory and [*381] the "plowback" theory -- might be rejected as merely artful ways of restating the discredited per se theory drawn from charitable trust law; n257 however, because their rationales are different, they require separate responses_ a. The Public Trust Theory The "public trust" variant of the connuunity benefit tlteory liolds tlrat all legitimate nonprofits eani the charitable exemption by virtue of state law provisions that inipose inore stringent organizational and operational constraints on nonprofit than for-profit enterprises to ensure increased atteution to community interests. n258 For example, managers

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of nonprofit corporations have a fiduciary responsibility to the public to exercise care in managing the corporation's assets, a public trust duty enforceable by state attorneys general. 7'he exetnption tnight be viewed as an exchange for the imposition of these greater public responsibilities. n259 However, this public tntst theory also fails the deservedness test. Although the law remains somewliat tmsettled, nonprofit organizations sitnply at'e not under any unique corporate duties. n260 Nonpro6ts generally owe no greater fiduciary responsibility to the public than for-profits owe to their sharebolders. n261 A number of older cases, drawing by analogy from the law of charitable tntsts, lrave applied heightened "ttust-like" duties to nonprofit corporations classified as charitable; n262 but "the tnodern trend is to apply cotporate rather tltan trust principles in determining the liability of the directors of charitable corporations, because their fimctions are vitYUally indistinguishable from those of their 'pure' corporate counterparts." n263 't'he leadiug decision, f*382] for instance, judged a nonprofit hospital's managers by the same rules concerning mismanagement and delegation of duties that govetn all corporations. n264 Even where this decision is not followed, the additional restrictions placed on "noncharitable" nonprofits do not accrue to the net benefit of society. Instead, the restrictions exist primarily to compensate for the fact that nonprofit tnanagers are not subject to sltat'eholder oversight and there'fore they may present a greater risk of misbeltavior than managers of investor-owned cotnpanies, n265 Implicit in rnuch of the argument that underlies the public trust variant is that nonprofits somehow better represent the entire community's interests precisely because they do not have to answer to private shareholders. Tltis assutnption peculiarly posits tttat the interests of shareholders and customers of proprietary establishments differ from the interest of the public at large_ Granting this assumption, nonprofits are under the satne distorting influences. 'hhose nonprofits that prhnarily sell products and services must also satisfy the demands of their customers. Moreover, nonprofits must respond to the demands of the investment cotmnunity because cotmnercial nonprofits still niust rely on borrowed capital to snbstitute for lack of equity or donated capital. n266 The similarity in the sources of operating and capital fhnds helps to explain the essentially indistinguishable belravior of the two hospital sectors, n267 in pa ticular, their eager- ness to earn a profit. n268 [*383] b. The "Plow-back" Theory The plow-back theory represents a second attempt to salvage the cortnnunity benefit theory by resurrecting the per se theoty of exemption. It argues that all nonprofits deserve a public subsidy because they plow their income back into a public institution rather than dispersing it to private investors. n269 Professor Atkinsou recently published the most sophisticated development of this theory. n270 He argues that the ongoing devotion of earnings to the institutional goals of any nonprofit otgauizatiou is deserving of subsidy because it represents, in effect, an altruistic decision for nonprofit organizers to forgo profits. "Under the altruism theory, the presumption would be that any activity carried on altruistically [i.e., on a uonprofit basis] is worthy of encouragement through tax exemption." n271 "The altntistn theory would exempt [any organization whose income] ... is being used to subsidize consumption by someone other than those who control the organization. . . . Under this tlzeory, there would be no inquiry into the merits of such [constunp- tion], no search for public benefits flowing from it. The metabenefit of altruistic production would suffice." n272 There are two crtacial flaws in this tttoughtful statement of the plowback theory, n273 both of which implicate the criterion of deservedness. First, because the theory eschews examination of the worth of the primary benefits that nonprofits provide (for example, any attempt to show that nonprofit hospitals are better thatt for-profits), but instead relies on the secondaiy beuefits of the nonprofit form, proponents of this theory must demonstrate why we should value this "metabencfit." Atkinson balks at this critical juncture. Conceding that "[i]t would be [*3841 logical for me here to prove that altruism [in the special sense of forgoing the distribution of profits] really is a good thing and tltus worthy of tax favors," he states that the task "is too ambitious" because it entails ascertaining "what is ultimately good." He therefore leaves the matter to one of "faith, of freely chosen values and visions." n274 The sweeping expansion of the multi-billion dollar public subsidy suggested by Atkinson's argument cannot be stts- tained by a mere leap of faith. To assunie without argument or explanation that society places great value on nonprofit entetprise per se, sirnply becattse no profit is distributed, is to adopt a question-begging posture tttat argues in favor of expanding the exemption based on a bare description of the present state of the nonprofit sector. n275 The second, and more fundamental, flaw in the argument for subsidizing the altruism cotnmon to all nonprofits is that it does not explain the need for a subsidy. It merely describes the fact that nonprofit organizations are required by law to plow their earniugs back into the enterprise. Even assuming the worth of this devotion of profits to atry etideavor that presently or in the future tnight be encompassed withui the bi-oad scope of the nonproftt sector, we still must ask

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why is a tax subsidy necessary to aehieve this result? The plow-back variant is as silent on this question as is the rnain line of the cotmnunity benefit theory. n276

4. Recapitulation The various strands of the eommunity benefit theoty constitute the nonpnfit sector's most sophisticated attempt to justify the present scope of the exeinption. This theory makes its case on the inherently unquantifiable valnes that nonprofit enterprise serves. There is considerable merit to the view that nonprofit organizations offer advantages over both proprietary markets and the government; otherwise we would not have sucti a large nonprofit sector. On the otlter hand, the size of the nonprofit sector may largely result from the exetnption [*385] itself. The existence of both possibilities demands sotne demonsrration ulai society ueeds ihc exeniptioii to effcauatc its preference for the higher value< and greater diversity that nonprofits offer. Because the community benefit theory is unable to provide a convincing re- spon.se, it fails to establish a coherent basis for the exemption. lIaving exhausted the conventional rationales for the charitable exetnpt9on, we turn to less conventional theories propouuded by academics.

D. Academic I'heories

1. Bittkers Income Measurement Theory Academics have devoted less attention to the charitable tax exemption than to related topics, suctt as the deduction for charitable donations u277 and the general theory of nonprofit enterprise. n278 Professor Bittker offered the first notable, n279 compreltensive treatment of the federal income tax exemption in 1976. n280 Along with his student George Rahdert, Professor Bittker developed the theory that charitable organizations are exempt from corporate uicome tax because it is difficult to apply conventional accounting concepts of revenue and expense to much of their receipts and expenditures. n281 For instance, it is awkward to classify donations as income because they would seem to be gifts excluded from income under section 102 of the Code. n282 More serious characterization problems exist on the expense side. Ordinary principles of tax law would inappropriately hold that disburseinents to beneficiaries of the charity are not deductible as "ordinary and necessary business expenses," because an entity that does not seek profit is generally not considered to engage in a "trade or business" tmder section 162. n283 [*386] To the exteut that this "income measurement" thcory argues that true charities are not taxed on their in- conic because they in fact earn no hicome, it is consistent with the theory for exemption of nou-charitable orgauizations -- so-called nnttual benefit organizations such as social clubs and eondorninium associations -- which are viewed as pooling assets prior to consumption rather than earning income. n2841'his commonality in theoty suggests a degree of universality that other ttteories do not share, sinec all other tlieories, including our own developed later in text, are limited to the charitable exemption. n285 This "income tneasurement tlteory," however, is ultimately unconvincing. Professor Fiansmann, also of the Yale Law School faculty, persuasively demonstrated that the theory is simply incorrect as applied to many of the traditional categories of 501(c)(3) exempt organizations, paiticularly those such as hospitals that rely predominantly on the sale of goods and services rather than ou tlonations, so called "conimercial nonprofits." n286'I'lre theory, moreover, does not attempt to define charity -- the operative statutory concept -- other than as any activity for which it is difficult to measure income. Bittker's theory is at odds with the consistent understanding in the legislative history and decisional law that the charitable exemption exists as a form of sabsidy. n287 In essence, then, the income meastirement theory attempts to avoid the deservedness and proportionality criteria altogether. The income measurement theory also falls short of the universality criterion since it does not even putport to explain the property tax exemption; there is no inore difficulty measuring the value of charitable property than property owned by IBM or AT & T. n288 The theory [*387] also offers little explartation for the various limitations on the incoine tax exemption n289 and it offers no explanation for the deduction for charitable contributions that follows automatically from exempt status. n290

2. Hansrnann;s Capital Subsidy Theory Professor Hansmann's alternative theory suffers from many of the same defects. In the second comprehensive article to address the federal charitable exemption, n291 he develops a "capital subsidy" theory that]ustifies the exemption because it assists nonprofits in overcoming the comparative barriers they face in capital markets by virtue of the

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"nondistribution constraint" disabling them from offerhrg profit shares to private investors. n292 Hansmamt's explanation elegantly addresses the proportionality criterion. Assuming ideal matket conditions, Hatisenann demonstrates that the income tax exemption provides the most capital subsidy to nonprofits when the ittdustry faces increasing eonsumer demand, and hence the greatest capital needs exist. This is true because an increase in demand results in an increase in tax-exempt earnings. Correlatively, the subsidy phases out as capital needs lessen in times of reduced consumer de- tnaud. n293 Hansmann's capital subsidy theory, however, has severe shortcomings in other respects, as Hansmatm recognizes. n294 Under the deservedness [*388] criterion, the theory offers no test for detetmining the existence and scope of a capital disadvantage. Nonprofit hospitals, for instance, appear to suffer no capital funding shortage at all. n295 Ex- tending this determination to other nonproGt activities imposes the burdensome task of verifying capital disadvantage in each instance. n296 H

Nor does Hansmami's theory satisfy the universality criterion. Like Bittker's theory, it attempts to justify only the incotne tax exemption. Indeed, it operates perversely witlt respect to the property tax exemption, which gives the greatest subsidy to those organizations with the most eapitat resources. Finally, Hansmaun fails to address the historical consistency criterion. He offers no evidence that Congress, courts or taxing officials have ever considered the exemption as a subsidy for [*389] capital formation. More troubling, the theory ignores the statutoty lattguage by failing to develop a workable definition of charity; the only concept of charity it offers is those socially valuable nonprofits that suffer a coniparative disadvantage in capital markets. Thus, it is inaccurate to characterize Hanstnann's capital subsidy explanation as a theory of the charitable exemption at all, for it is only a sophisticated explanation of one -- but not necessarily ttte only -- eJJect of the exemption. Hansmann's tlteoty does not identify which organizations should receive capital subsidies. We must look elsewhere in order to develop an understanding of charity that helps us at^.cwer the more fundamental question of identification.

IV. 'I'HE DONATIVE THEORY OF THE CHARI'fABLE TAX EXEMPTION

A. Introduc•tion The present contest over hospital tax exeinption ltas reached a stalemate. '1'he theories of charitable exeniption that nonprofit hospitals advocate to rationalize their exemption -- ttealth care per se and comniunity benefit -- fail to estab- lislt a basis for determining deservedness orproportionality. The alternative ttteories, which disqualify hospitals -- charity care and Hansmann's capital subsidy theoty -- are equally flawed. They either fail under the proportionality criterion to establish a logical basis for subsidy througlt the tax systetn, or they are at odds with the notion of an exeniption that applies to "charitable" organizations. Moreover, they explain only a small portion of the interrelated aspects of the taxation of exernpt organizations, violating the principles of historical consistency and universality. This same stalemate exists forjustifying the exeinption of charitable organizations generally. Defining charitable in the popular sense of poverty relief is conntered by examples of syrnpltonies and prep schools; broadening the exemption to cover the relief of any government burden overlooks the separation of church and state; and the search for a con- crete sense of cotnmtutity benefit fails to keep the exemption within administrable bounds. In frustration, most conventional thinkers have resorted to a superstitious faith in the mystical guidance of the 1601 Statute of Charitable Uses, while academicians have proposed ttteories that ignore our basic hituitions about wliat constiuttes a charity. [*390] These failures of the several conventional and academic theories of exemption require that we search for a new theory of exentption n299 that satisfactorily ties together a convincing understandhig of why nonprofit organizations exist, why tttey should be tax exempt, and the origins of the legal concept of charity. This tlteoretical rebuilding

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reveals that the pritnuy rationale for the charitable exemption is to subsidize those organizations capable of attaacting a substantial level of donative support from the public, a theory that has not previously received full articulation and development. n300'11tis section proceeds by first describing the two foundations for the donative theory: (1) economic theory concerning the socially valuable reasons for the existence of nonprofit organizations; attd (2) charitable hust law, frotn which tax exemption jurisprudenee draws its concept of charity. This section then detnonstrates that the exemption of donative organizations presents a concept of charity that best ineets the four criteria developed above -- deservedness, proportionality, universatity, and historical consistency_ 'L'his section concludes by examining how hospitals [*391] fare under this theory and by briefly mentioning issues that remain for further exploration.

IB. The Positive Economic Tlteory ofNonprofrt Organizations A stimulating body of eeonomic and political theory has emerged over the past decade attenipting to explain why the United States itas such a large "third sector" as an alternative to proprietary frrms and the government. This literature has developed a combined theory of market and goventrnent failure: nonprofits arise where the two principal sectors of society fail adequately to supply desired goods and services. Different categories of nonprofits result from differcnt forms of market and government failure. The particular applieation of the twin-faihire theory niost fruitful for present purposes is that which explaius the existence of donative uonprofits. This branch of the positive theoty of non- proGt enterprise, lying at the intersection of classic microcconoinic and public choice theory, identifies the best case for a tax exemption subsidy.

1. MarketTheory The primary economic explanation for the evillingness to contribute voluntarily to certain causes is the desire to overcome the private tnarket's uudersupply of what economists refer to as public goods. n301 Pure public goods in the economic sense are those characterized by two conditions: durability and indivisibility. The good does not wear out as others use it, and its nature is such that, once produced for one consumer, it is impossible to exclude its consumption by anyone else. Impure public goods partake of these characteristics to a lesser degree. Classic exarnples of nearly pure public goods include air pollution control, border defense, and legislative lobbying. The private tnarket is incapable of supplying pure public goods at any level regardless of their value because no one has an incentive to pay their proportionate share of the benefit, and the supply of impure public goods similarly can be expected to be suboptinral. This market failure exists bocause the darability and the indivisibility of public goods present a severe free-rider problein. As a consequence of durability, consmners realize that if anyone else pays, they can take a free ride. As a consequence of indivisibility, consumers [*3921 realize that if they pay, everyone else can take a free ride on them. Even if some consumers are willing to pay for a public good, they will pay inuch less than is necessaty to produce the good at its socially optimal level because of its large "positive extcrnalities." As a result, coercion or voluntarism are the only means for providing public goods at an optitnal level. Coercion is discussed below. As for voluntarism, it is sufficient to observe tttat classic economic tlteoty is imperfect since some people are willing to overcome severe free-rider incentives by taking a collective view that induces them to contribute individually to the production of a broad social benefit. Thus, donors contribute to edacation, which entails the public good of raising society's level of knowledge and bolsterutg the economy witlt skilled workers. An- other classic object of pltilanthropy -- disaster relief and aid to the poor -- provides the public good of assuaging society's collective concern over the plight of the nation's or world's destitute. n302

2. Public Choice Theory Classical economics tells us that provid'nig public goods is the quintessential role of government, since the government is able to correct the free-rider defect through its power to tax -- in essence coerciug the public's purchase of public goods. Why then should donors ever need to contribute to the private production of public goods? The answer lies in the vagaries of majoritariatt voting logic, which result in the government systematically undersupplying certain public goods. Econonust Burton Weisbrod first had tltis insight. n303 Employing public choice theoty, he demonstrated that certaur blocs of voters will predictably lack the votiug strength to force the govetnnient to nlect ttteir public good needs. This is true because govemmental decisions in a democracy are roughly shaped by the desires of the majority of the electorate. n304 The governntcnt will therefore supply any given public [*393] good at a level approxintating that desired by the mediau voter. As illustrated in Figure 7 for a hypothetical public good, if the govemment were to move much beyond the median demand to a level of production Qb, then the nutnber of voters who prefer a lower level of the public good would vote down the increase (Vnb versus Vpb). Conversely, high demanders prevent the government

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from lowering the provision of public goods to, say, Qa (Vpa versus Vna). As a result, the voting equilibrium settles near the middle of the range of vote tastes (Qm). figure 1- Quantity of a public good supplied by govet-nulent as a function of positive and negative voter demand

[SEE ILLUSTRATION IN ORIGINAL] [*394] This systent of majoritarian politics works reasonably well provided the desire for a public good is fairly homogeneous. In that case, the level of inecliau demand is close to the level of demand at either extreme. n305 Tltis logic tloes not hold, though, for public goods for which there are heterogencous, widely divergent tastes. In snch situations, votiug logic predicts an undersupplied minority of high demanders, indicated by the shaded area of Figure 1. This supramedian group has no ready altemative other than to make voluntary contributions to a private organization_ n306

3. The Charitable Exemption and Deduction as Shadow Subsidies Government failure cotnbined with niarket failure pi-ovides the most rigorous case for private donations_ This combiuation of theories explains why some ttonprofits exist and the fimction they serve. Yet this explanation does ttot demonstrate why these nonp rofits should bestibsidized_ The critical insight derives fi-om the preceding economic analysis that demonstrates that the classic instances of giving are characterized by a free-rider effect. Donors partially overcome market disincentives that attach to public goods, but unlike the governntent, which enjoys the coercive power of taxation, nonprofit providers of public goods ntust rely on persuasion, which htevitably falls short of inducing all consumers to contribute cotnmensurate with their level of benefrt. Wbere donative support for public goods exists, one can therefore anticipate persistent undersupply of that good. This is illustrated in Figure 2, where Qg represents the level of a hypothetical public good provided by the govermnent, and Qd the additional quantity produced thi-ough private donations. The shaded are represents a remaining level ofiut- satisfied deniand. Some form of funding is needed that matches private donations with an additional subsidy to amplify the [*3951 donations, in order to take up the slack left by the free-rider disincentive and move the level of production futther toward Qs. Figure 2-'1'he effect of donations and a donative subsidy on the production of a public good [SEE ILLUSTRATION iN ORIGINAL] This matching, or shadow subsidy, function is precisely the explanation that Weisbrod has offered for the charitable deduction. n307 A deduction from personal incomc taxes for donations to charities is, in ecotiomic analysis, a systent that provides a proportionate government subsidy for each dollar of private philanthrophy. 1'hus, in a thirty percent tax bracket, a taxpayer who donates $ 100 is hi effect contributing only $ 70, because, absent the donation, the taxpayer would have paid $ 30 in tax on those earnings. n308 By forgiving part of the tax bill, the government is in effect providing the taxpayer with a rebate in lieu of [*396] writing a check directly to the charity. This govetmnent assistance is funded by increasing the tax burden on the public including those members of the public who take a free ride by choosing not to donate. n309 Weisbrod's insiglits about the deduction can bc extended to the exentption frnm income and property taxes. The exemption is also capable of providing a form of sbadow subsidy it it is administered with this donative theory in mind. Exempting donative nonprofits from income and property taxation helps to remedy the systematic underprovision of public goods by allowhtg the donation to be more productive tttan it wotdd be if it, or its earniugs, were taxed n310 Unlike the de

C 7'he Donative Element in Charitable Trust Law arid Other Precedents An appealing feature of tlte donative thcory of tlie cltaritable exemption is tltat, while its econoinic justification is rigorous and sophisticated, it leads to a fundamentally basic and intuitive concept of charity -- a concept that reaffirms the popular sense of charity as "the [*397] impulse to give." n313 The pablic goods explanation for donative behavior is captured in the popular conception of altmism that rePlects a donor's disregard of the narrow perspective of economic

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self-interest and, in the very etyinology of philanthropy, the love of mankind. It is incontrovertible that society has an interest in encouragirig giving and supporting the objects of philanthrophy. n3 14 It is tltus serendipitous that a more converrtional analysis of precedent and history confirms the cormnon sense notion of giving as the archetype of charity. n315

1. The Role ofDonation.s in Charitable Trusts 'I'he cormection between tax law and trust law, discussed in Section III.A., emerges as one of the geat puzzles of the charitable exemption, n316 Attglo-American law has employed a uniform coucept of charity for centuries. Yet even casual examination of these two bodies of law reveals that they serve disparate purposes. Cltaritable trust law addresses ihe propct purposes ;cr whic,", the law will relieve a trur;t frotn t.lte requirements of having definite beneficiaries, a limited duration, and an achievable purpose. T'hese comparatively tninor concerns allow trust law to consider as cltaritable any purpose that provides a conceivable social benefit; trust law can afford to be Ienicnt because enforcing a benefactor's disposition of his own assets intposes relatively minor public costs. It seents absurd, then, to adopt this same sweeping concept of charity -- one that encompasses essentially any [*398] activity that benefits the public at large in any manner -- to justify a tax exemption that costs the public billions of dollars in lost tax revenue each year. Yet this is precisely what virtually every tax law atnliority ostensibly advocates. n317 The notion of a uniform concept of charity is so entrenched that a successfirl theory of the exemption must offer a satisfactotyy explanation of the relevance of trust law. Only the donative theory connects these two bodies of law in a sensible fashion. It does so by focusing attention on the donative aspect oP tnrst creation to reveal the following, crucial litniting principle contained in charitable trust law: the reason that trust law does not evaluate what purposes are of sufficient public importance to deserve special legal protection is that the selfsacrifice entailed in forming a trust without private benefit provides safe assurance that its fotmder has considered the object's deservedness. As one early decision explained: What is the tribunal which is to decide whether the object is a beneficent one? It cannot be the individual mind of a Judge.... On the other hand, it cannot be tlie vox populi, for charities have been upheld for the benefit of insignificant sects, and of peculiar people. It occurs to me that the answer must be -- that the benefrt must be one which the founder believes to be of public advantage. n318 In other words, the conception of charity embodied in trust law can afford to be essentially boundless because it contains the inherent limitation that a donor must be willing to divert his wealtli from himself or his family to support the public purpose in questiott. Therefore, tax exemption law bluttders terribly if it transplants trust law's concept of charity without maintaining this crucial limiting principle -- the selfsacrifice entailed in a gift. "fo avoid doing so, tax exemption law must define a charitable purpose as one that the public perceives to be sufficiently meritorious to warrant sacriflcing a significant amount of personal resources to support it. n319 This simple observation is niade even more apparent by reexamining the foundational trust law authorities with the donative factor in mind. n320 Many of the leading authorities that articulate a boundless [*399] public benefit concept of charity qualify their description of charity with the proviso that a gift be devoted to the stated ptupose. The listing of charitable purposes in the 1601 Statute of Charitable Uses, the seminal coditication of the legal concept of charity, is explicitly premised on giving. The statttte's preface stated as its rationale for creating rigorous enforcement mechanism for charitable trusts that "lands, goods, ...[and] money ... have been heretofore given ... by sundry. ... well disposed persons" to these purposes. n321 The seminal Ameiican decision defined "a charity, in the legal sense, . .. as a gift, to be applied ... for the benefit of an indefinite number of persons." n322 The leading modern British case that establishes the per se charitable status of ttospitals declares that "a gift for the putpose of a hospital is prima facie a charitable gift." n323 Even those authorities that do not speak explicitly in tcrnis of a gift implicitly recognize this element by reniinding tts that the deftnition of charitable is in the context of a trust established for the stated purpose. n324

2. T'he Role of Donations in Tax Exemption Precedents The donative theory is also confitmed by the central categories of charitable activity establistted in tax exemption law. Religion and education, the two categories that tutiformly enjoy per se charitable status, are traditional recipients of large amotmts of philantliropy. n325 One might object that the per se exemptions conferred on these two activities refute the donative theory because they seem to declare that [*400] churches and schools are eligible for exemption regardless of their donative support. However, the statutory enun2eration of religion and education creates only a pre-

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sumption of exempt status; the erntmeration is still subject to baseline requh'ements intplicit inttie conmion law concept of charity. In Bob Jones Universiry v. United States, n326 for instance, the Supreme Court upheld the authority to deny the charitable exemption on public policy grounds to racially discriminatory private schools, despite the statute's omission to impose a general public policy requirement. The Court reasoned that the public policy screen is one of the "certain common-law standards of charity" drawn from chaiitable ttvst law that "under[liel all relevaut patts of the Code." n327 Likewise, the donative aspect of the trust law concept of charity underlies all enumerated categories of charitable organizations. Hospitals that enjoy per se charitable status under sotne state constitutional and statutory provisions n328 therefore should still be required to nteet this basic requiretnent of charitable status, just as tttey are still bound by general public policy dictates and required to serve the public at large. The existence of this systeniatic limitation of the charitable exemption is not left to mere speculation. State court decisiotis provide significant precedential support for the donative element of the charitable exetnption despite their apparent endorsement of a tnore sweeping per se view of exenzption. n329 In particular, niany of the state cooi't decisions that most liborally extend the exemption to hospitals are, upon closer exaininatioti, premised on a donative tlieoty. For instance, Ciry of Richmond v. Richmond Memorial Hospital, n330 one of the leading cases thought to establish hospitals as per sc exempt regardless of their willingness to great indigent patients, observed that "these liospitals were built through charitable impulses. Over tttirty thousand charitably inclined citizens contributed to the constrttction." n331 [*401] The donative theory also finds explicit precedential support in the federal sphere_ One study of federal tax exeniption rulings concluded that "there is a sfiong tendency on ttie part of the IRS to require that a charitable organization embody to sonie degree a donative factor." n332 More recently, Congress expressed iniplicit support for the donative thcory by denying the federal exemptiou to certain inherently comniercial activities. n333 In 1986, Congress withdrew ttte charitable exeniption from "commercial-type insurance" n334 and in 1987 held extensive hearings inquiring into the eoncern the tax-exempt nonprofits are engaged in a vast array of commercial activities that constitute unfair competition with proprietary businesses. n335 The essence of commercial activity is tlte sale of goods and services on a quid pro quo basis_ Commercial nonpro6ts are thus polar opposites of those that raise their revenues tlLrough donations. Titerefore, rejection of the [*402] exemption for cotmnercial activity catr be seen as a tacit endorsement of the clonative standard. As a consequence of these many avenues of precedential and historical support for the donative theory for the donative theory of the exemption, it is already embodied in the present structure of the charitable exemption. Tlius, applying the notion explicated in Bob.Iones Univer.siry and the IRS regulations that "certaiu cotnmon-law standards of charity" drawn from charitable trust law "under[lie] all relevant parts of tlie Code," n336 the donative thcory could be adopted atid iutplemented without furtlier legislative directive. n337

D. The Donative Theory's Scorecard

1. De.servedness The donative theory of the charitable exemption offers ut elegant rationale for subsidizing the objects of donative activity, one that 1'ully meets the deservedness criteria in both its woithiness and neediness components. Because the impulse to give stems from the public's recognition of a socially valued service, the donative tlteory assures that donations are directed to activities worthy of subsidy. And becaase those woithy activities that rely on voluntary support systematically receive less suppott than society as a wltole desires, donative activities need to be subsidized_ The donative theory avoids the difficulties that other theories face in establishing exemption desetvedness because it does not require a government official to determine need or worth on an activity-specific basis. For instance, the community benefit theory forces us into a morass of conflicting data and theory over the desirability of the nonprofit form in medicine; n338 likewisc, Hansmann's capital subsidy theory requires us to isolate those socially valued nonprofits that need a capital subsidy to help them conrpete on an even footing with proprietary entcrprise. n339 The donative exemption employs a mechanism thattnakes these intensely empirical determinations automatically by targeting, within the universe of activities that conceivably deserve support, those activities that actoally eatn the exemption by providing services that are not otlreiv3ise available. 'I'his theory also actively [*403] induces those nonprofit firms witli sagging support to search out new ways to satisfy public needs. n340

2. Proportionaliry

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On first inspection, the donative theory appears to meet the proportionality criterion only roughly. IJnlike the charitable deduction, the exemption does not automatically match donations dollar for dollar by a proportionate amount of tax support. NeverYheless, the exemption of property a donative nonprofit holds is proportionate to the amount of contributions it receives. n341 For incometax, the connection between the size of the subsidy (determined roughly by earned surplus) and ttie criterion for deservedness (donations) is muclt ntore attenuated. n342 At least it can be said, in contrast with some of the theories of tl7e exemption explored above, n343 that the correlation between eatuings and donations is not preverse. Instead, donations have an unpredictable, or a best a neuhal, relationship to the inconre tax subsidy. As a result, the subsidy is not so much disproportionate as nonexistent. Even this level of comprotnise in proportionality seems unsatisfactory until one realizes that the donative theory, despite these imperfections, provides the most aceurate measure of deservedness available. This insight is revealed by Weisbrod's explanation of governnzent failure. 'I'he principal litmus test for proportionality is whether, assuming [*4041 a given activity deserves subsidy, the exemption is a more sensible means to administer the subsidy than a direct government grant. I'he "twin failnre" rationale underlying the donative theory confronts this inquiry directly. It reveals that where substantial donations exist, direct governrncnt aid tnust be unavailable because it is the failure of the government to serve a high-demanding mhiority that leaves donors witlr no other alternative than to make voluntary contributions. In essence, the donative theoi-y is designed to cover only cases where the tax subsidy is necessarily a second bcst solution because the theoty excludes all cases wtiere the govermnent in fact subsidizes directly in sufficient amount. Proportionality is thus satisfied because, instrinsically, no more accurate nlechanism for direct govermnent support is available in cases where the donative theory applies.

3. Universality and Historical Consistency The earlier discussion observed the eotnplenieutary aspects of the donative tax subsidy: the charitable deduction is direct to the donor to stimulate making the gift while the exernption goes to the recipient to enable the gift to go further. n344 This symmetrical aspect of the donative theory provides one of its greatest strengths. IJnlike all other theories of the charitable exemption, it satisfies the deservedness criterion for both the income tax exemption and the propetTy tax exemption at the same time that is justifies the charitable deduction_ this universality is critical to a successful theory of charity because, under the structure of the federal and most state codes, all three tax benefits fol low automatically once the organization is characterized as charitable. Only be defining charities as organizations that receive substantial donative support is it possible to make sense of the unified federal/state, exemptionldeduction structure. A futtlter dimension of the donative theory' universality is its ability to explain the value-added tax exentption that many states confer on sales to charities. n345 This exemptiotr from paying sales tax provides [*405] a fotm of match- hig subsidy that assists donations in being more productive by relieving thetn of the tax that otherwise is imposed when the donations are uscd to purchase supplies. Notably, the donative theory would not provide strong support for a value- added tax exemption on sales by nonprofits since such an exemption would target primarily commercial nonprofits, n346 Consistently, very few states exempt cltarities from charging sales tax. n347 Finally, the discussion of cliaritable trust law and other precedents demonstrates that the donative tlieory meets the historieal consistency criterion. It offers a coneept of charity that comports with intuition and fits well with the classic applications of the exemption - religion, education, relief of the poor, and the fine arts. But does it justify extending the exemption to modern hospitals?

E. How Hospitals Measure Up

1. The Low Level ofPresent Hospital Donative Support Nonprofit hospitals nicely illustrate the full dimension of the donative theory. Although they appear on first inspection to be good candidares for the receipt of charity because ntany of their services have strong public good characteristics, hospitals receive sufSciettt govemntent funding that tttcy have almost no need to solicit donations. Thus, while they display many of the classic incidents of market failure, they are not affected by severe government failtire. Hospital services printarily consist of patient care sold throttgh ordinary commercial transactions. Nevertheless, several hospital services [*406] are caitdidates for classic public good characterization. Indeed, Burton Weisbrod uses the hospital industry as one of the principal confirmations of his public goods rationale for the existence ofnonprofit enterprise by demonstrating that tnost hospital services with public good characteristics -- researcti, physiciau education, and the treatmetit of indigent patients -- exist disproportionately in voluntary hospitals. n348 These are also precisely

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the services that nonprofit hospitals use to justify the exemption under the conventional goverrunent burden and com- niunitv benefit theories. n349 Bttt it is not enough to demonstrate the existence of substantial pnblic goods production to justify a tax subsidy. The subsidy is deserved only if the govermnent is supplying these goods at a suboptintal level, as demonstrated by actual public contributions to make up the difference. Today, nonprofit hospitals receive in propottionate terms only neg- ligible stipport from public donations. n350 This was not always tlre [*407] case_ At the turn of the century, hospitals depended on philanthropy for roughly one-quarter to one-third of their operating budget and for the bulk of their capital funds. n351 Tracing the history of the deterioration of hospital giving and the changing characteristics of the nonprofit hospital sector over time helps to confitm the rationale for supporting only donative institutions_ The printary inipetus for the growth of the voluntary hospital sector prior to World War li was ihe desite o'i d verse ethnic and religious groups to create institutions that would cater to their distinct treatment needs without discriuuna- tion. The early growth of voluntaty hospitals after the turn of the centuty "reflected the idiosyncratic qualities of the community they served." n352 Thus, Catholics desired a hospital where last rites would be administered ancl Jews desired one where the staff spoke Yiddish and served kosher food. n353 These distinctive cltaracteristics allowed voluntary hospitals to appeal to defined interest groups for strong philanthropic support to cnsure that treatment would be available when the iteed arose. n354 This association between het- erogencity in demand for hospital services and the strength of donative support confirms tlie role public choice theoty plays in explaining the existence of philanthropy as a response to government failure. As a result of the third-party reimbtirsenient structure that developed after World War 11, hospitals no longer suffer significautly front government or market failure. Private insurance spread rapidly during the 1950s and the government began directly fundiug a substantial portion of hospital operations through Medicare and Medicaid in the 1960s. The goveriunent also increased direct subsidies to specific public good activities, such as hospital construction, medical research aud education. As a consequence, nonprofit hospitals no longer depended on donative support to expand. More- over, third-party sources of ['408] fitnding replaced the quasi-insurance function that donations served of securing a future source of services. n355 This displacement of charitable giving has caused hospital philanthropy to decay rapidly since 1968, with a half-life of about five years. n356 Eithei- hospitals have felt little need to solicit philanthropic suppott, or if they have sooght it, the public has seen little need to contribute. n357 Coincident with these changes, the character of nonprofit hospitals has becotne remarkably homogeneous. One noted medical historian cornments that "[b]y the tnid-1960s, ... the notion of an institution closely connected to its comtnunity seemed like a romantic retnnant of a'pre-scientific' era." n358 I-Iospitals coniplain that this governinent generosity is quickly ending, eliminating their ability to cross-subsidize niany underfiinded but desirable services from the ample surplus previously generated by insured patients. n359 But until the pinch becomes severe enouglt to motivate hospitals to enter the philanthropy market more aggressively, and donors to respoud with more enthusiasm, these assertions are in-elevant under the donative theory. At present, the lack of donative support is evidence either that nonprofit hospitals do not provide a service materially different than that otherwise available, or that if tltey do, they are sufficiently suppotted in tnore direct ways. Accordingly, there is a weak case for supplementiug this suppoit with a tax subsidy. n360

[*409] 2. The Possibilitiesfor Hospitallsxemption Despite the presently low level of proportionate donative support for hospitals, it is mislead"uig to couceive of hospitals as receiving no suctt support. In fact, the aggregate level of donations is quite large_ n361 While donative support tnay not be sufficient to qualify all of the nonprofit hospital sector's holdings and eamings for property and income tax exemption, it also seems unfair to disregard this support simply because it represents a small portion of the nonprofit operation. Fortunately, the donative theory is capable of fine-tuning its application to account for degrees of suppat. First, it is hardly necessary for hospitals to receive 100% of their revenues from donations. Few traditionally charitable organizafions do. n362 The precise threshold of donative support required to qualify for charitable status is ultimately a legislative or administrative policy decision; tiowever, one niight speculate that a threshold based on the level of support hospitals received when they were still considered classic charities - on the order of 30% for capital funds -- woutd represent a reasonable application of the donative theory. u363 Hospitals that fail to meet this threshold for their overall operations may qualify for the exemption if they are capable of segregating those [*410] activities that attract tlte most donative support into separate corporate entities. n364 For instance, oncology and pediatric serviees are popular objects of hospital giving, particularly when contbined into

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children's cancer nnits. n365 Moreover, a taxing authority may make the same accounting adjustment even without fnrmal cotporate segregation. n366 The extent to wltich particular nonprofit hospitals might qualify for the exernption depends in large patt on the details of administering a donative theoty of exemption, details to be developed in a subsequent article. n367

[*411 ] V. CONCLUSION -- REFINING AND IMPLEMENTING THE DONATIVE THEORY We have reached the donative theory of the charitable exemption by proceeding in two analytical modes: whittling away and building up. A negative analysis demonstrates the deficiencies of other theories; a positive analysis detnonstrates the strengtlts of the donative theory. Others who have reflected on the rationale for the charitable exemption have taken for granted the case for applying the exetnption to donative hrstimtions; their primary focus has been to consider whether to broaden the exetnption beyond this base that, apparently, has universal acceptance. This frarning of the issue has caused cotnmentators to overlook the merits of using donations as the basic standard for applying the exemption. The donative Ylteory sltoald not be taken for granted. Understanding its strengtlt illutninates whether there should be an exeinption at all and, if so, how it sltould be properly administered. Nowhere is this niore evident than in the case of nonprofit hospitals. Commentators who judge the issue of exemption for hospitals by inquiring whether they uniquely provide a conununity benefit are asking a question for which the evidence is largely subjecuve. By asking instead whether the public chooses to support nonprofit hospitals with donations, it is possible to evaluate tttc need for tax subsidization on a more objective basis. Precisely how tnuch donative support is needed to qualify for the exemption, an exactly what counts as a donation, turn on questions of theoty and admhtistration that await further development and that, ultimately, must be resolved in the political arena. 'I'hese ftutlter undertakings will be worth the effort if we have chosen to pursue a concept of charity that is correct at its core. [+]

[+] As this article was goittg to press, Representative Donnelly introduced H.R. 1374, 102d Cong., 1 st Sess., 137 CONG. REC. E896 (1991), which incorporates some of the suggestions published by his legislative director in Barker, supra note 64, as described suprcr notes 66, 151 and 202. If enacted into law, this bill would require nonprofit hospitals to maintain their exempt status by either: (1) devoting 5% of gross revenues to charity care apart from bad debts and contractual allowances, or (2) devoting 10"/o of grose revenues to primary health care or substance addiction treatment in medically underserved areas of the country. A hospital would not have to meet those requirements, however, if it is a sole cotmnunity hospital, or if it treats a disproportionate share of low income patients, as defined under Medicare statutes. The Secretary of Healtlt and I-Iuman Services would be authorized to issue regulations that distinguislt bad debt front charity care for purposes of the 5% threshold. Moreover, the IRS may designate other commnnity services that qualify for the 10% threshold.

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For related research and practice materials, see the following legal topics: Healthcare LawBusiness Administration & OrganizationTax ExernptionsHospitalsHealthcare L.awBusiness Administra- tion & OrganizationTax ExemptionsNonhospital OrganizationsPublic Healtlt & Welfare LawSocial SecurityMedicare- ProvidersTypesI Iospital s

FOOTNOTES:

ni "Real property taxation, and exemption therefrom, seems to be about as old as history.... One historian reports that the 'economic equilibrium of ihe state was endangerecl' by the fact that the tax exempt temples owned fifteen percent of the cultivable land and vast amounts of slaves and other personal property during the reign of Ramses III about 1200 B.C." Sierk, State Tw^ F,xernptions ofNon-Projit Organizations, 19 CLEV: ST L. REV. 281, 282 (1970). See Ezc-a7:24 ("[I]t shall not be lawful to impose toll, tribute, or custoin upon .._ priests . .. or ministers of the house of God. ..."); Genesis 47:24 ("Joseph ntade it a law over the land of Egypt unto this day, that Pharaoh should have the fifth part; except the land of the priests only, which beeatne not Pltaraoh's... ."); A. BALK, THE FREE L1ST: PROPERTY Wl'fHOUT TAXES 20-21 (1971) (referring to histoty ofancient Egypt, Greeee and Rome and concluding "[ejxemptions probably are as old as taxes"). England has had a charitable exetnption in its incotne tax law since it was enacted in 1799 and reintroduced in 1842. M. CHESTERMAN, CHARITIES,'IRUS1'S AND SOCIAL WELFARE 58-59 (1979). British chari-

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ntay exempt the remainder in ties enjoy only a 50% exernption from local property taxes by right, but localities their discretion. Id at 243.

n2 The earliest codification of an exeniption for charitable entities appears to have been the Revenuc Act of charitable exemption is traced 'ul 1894, ch. 349, § 32, 28 Stat. 556 (1894). The complete history of the federal of Charities, 39 LAW & nlany sottrces, including Liles & Blum, Developrnent of the Federal Tav Treatment Fxemption Under Section CONTEMP. PROBS. 6(Anthunn 1975); Persons, Osborn & Feldman, Criteriafor 501(c)(3), in 4 U.S. DEPT. OF TREASURY, RESEARCH PAPERS SPONSORED BY TIIE COMMISSION FILER COM- ON PRIVATE PHILANTHROPY AND PUBLIC NEEDS 1909, 1924-25 (1977) [hereinafter MISSION PAPERS],

Ilistori- n3 See generally J. JENSEN, PROPERTY TAXATION IN THE UNITED STATES (1931); Adler, in WESTCHESTER COUNTY CHAM- cal Origin of the Exemption From Taxation of Charitable Institutiorzs, BER OP COMMERCE, TAX EXEMPTIONS OF KEAL ESTATE: AN INCREASING MENACE 15-17 (1922).

n4 Belknap, The Federal Income Tax Exemption of Charitable Organrzations: Its History and Underlying note 2, at 2025, 2029-30 (by 1894, the custom of exetnpting Policy, in FILER COMMISSION PAPERS, supra education, religion, and care of the poor was "so grounded in the nature of our Goventment as to represent a practically irrevocable law"). Even those most critical of the exemption suggest its repeal in otily the most tentative tones, prefetxing a reformulation instead. See A. BALK, supra note 1, at 128.

n5 Modem scholars have a fair idea of the basis for the exemption in prior ages, but there is no agreement ou its rationale in niodem times. In ancient Egypt, Greece and Ronre, teniples and other religious institutions were not taxed because it was thought they were owned by the gods thetnselves and were thns beyond the reach of znortal taxing authorities. In medieval England, churches, monasteries and the like were not taxed, at first because in feudal times there was no centralized govemnient capable of imposing snclt a tax; indeed, the chnrches themselves were a sort of taxing authority, collecting tithes from feudal lords. This power distribufion changed dramatically later in England's history when churcltes were not only taxed but confiscated as part of the suppres- sion of clerical power during the Reformation. However, the charitable exeznption survived during this time by expanding its reach to secular charities as a way of further undermiuing the church's influence. In the American colonies, churches were at first not taxed because the colonies were established as theoeracies and no govemment taxes itself The religious exemption continued even after the constitutional adoption of the separation principle, tltough, largely for reasons of historical Anglo-American tradition. Tlms, it was expanded to cover education and other secular charitable purposes because that was the pattem that prevailed in England at the time. The present form of charitable exemption is essentially unchanged from this time, wheu its political ra- uote 3, at 14-80; Belknap, tionales disappeared. See generally A. BALK, supra note 1, at 23-27; Adler, supra note 2, at 1914, 1923; Stimson, 'I'he Exemption of supra note 4, at 2027-28; Persons, Osborn & Feldman, .rzipra Property from Taxation in the United States, 18 MINK L. REV. 411, 416-18 (1934).

n6 Unrelated Business Income Tax: Ilearings Before the Subcornnt. on Oversight of the House Comm. on (statement of O. Donaldson Ways and Means, 100th Cong., Ist Sess. 11 (1987) [hereinafter UBIT Hearing,s] Chapoton, Deputy Assistant Secretary, U.S. Department of the Treasmy),

n7 Comment, Judicial Restoration of the General Property Tae Base, 44 YALE L.J 1075, 1087 (1935).

nS Hansmatm, The'1'wo Independent Sectors, A Paper Presented at the Independent Sector Sprmg Research Forum 5(Mar. 17, 1988) (tntpublished ntanuscript on file with the Washington Law 2eview) [hereiuafter Hans- mann,'Che Two Independent Sectors]; see also J. DOUGLAS, WHY CHARITY?: THE CASE FOR A THIRI) SECTOR 55-56 (1983) ("["f]lte question'what is a charity?' is quite surprisingly difficult to answer.... Al- though the lawyers have been wrestling with the problem for centttries, they have not been able to define precisely what are the both necessaty and sufficient conditions for charitable status."); B_ WEISBROD,1'HE NON-

Appx. 332 Page 30 66 Wash. L. Rev. 307, *

PROFIT ECONOMY 115 (1988) ("'Nonprofits are a whole can of wortns that Congress has yet to look at in a broad way. I have becn blowing the trumpet for years to get lawmakers to spell out clearly what should be tax- exempt and what should not be.`) (quoting fonner IRS Cotmnissioner); Belknap, supra note 4, at 2031 (the original federal adoption of the exemption occurred "witliout debate and virtually without connnent;" and "[t]he Congressional Record will be searched in vanr for any fuller expression of the policy underlying the exemption" than so that these institutions "'may not suffer under the bill"') (quoting Congressman Tucker, who introduced the amendnient containing the exemption); Bittlcer & Rahdert, The Exemption ofNonprofit Organizatiorrs from Federal lncome Taxation, 85 YALE L.J. 299, 302 (1976) (Congress has groped along, "ennnciat[utg] no developed theory"); Cltisolnr & Young, lntroduction to What is Charity?, 39 CASE W RES. 653, 655 (1989) ("[E]xamination of history has not yet given us a satisfying answer to the question, 'what is charity?'...[W]e find fin the tRC] . no systematiC set of rttlrs and policies thonghtfilny drrived frnm a carefitl rationale.°); Hansmann, Unfair Competition and the Urmelated Busine.ss Income Tax, 75 VA. L. REV. 605, 635 (1989) [hereinafter Hansmattn, Unfair Competition] ("'I'he truly difficult and important issue involving the tax treatment of nonprofits concerns not the UBIT but rather the scope of the basic exemption that underlies it, and that is where future debate should focus.")_ Professor Heller suggests that the charitable exemption is conventionally considered an "easy case" and maintains that only through a Critical Legal Studies (CLS) style of analysis is it possible to perceive the exemption's "indeterniinacy." Heller, Is the Char'itable Exemption from Property Taxation an Easy Case? General Concerns About Legal Economics and Jurisprudence, in ESSAYS ON TIIE LAW AND ECONOMICS OF LOCAL GOVERNMENTS 183, 185 (D. Rubinfeld ed. 1979). Heller misperceives botlt the conventional view of the exemption and the hrsights that CLS has to offer to this problem. Hellet's own analysis reveals that it is not the exeniption that he treats as the "easy case" but the taxation of propetty itself, for the core of his argunteut is focused on problents that exist with the a priori defmition of a standard tax base, from whicit the exenrption is a departure. He only briefly explains why the exemption is a "hard" case, see id at 210-11, and the arguments he musters are ones that academicians and lawmakers have been conversant in since the seminal work of Profes- sor Surrey on tax expenditures, sec S. SURREY & P. MCDANIEL, TAX EXPENDITURES (1985).

n9 "[T]he tax benefits granted to charities and other exempt organizations by the United States are almost rmique in their generosity." Stone, Federal Tax Support ofCharitie.s and Other Exempt Organizations: The Need for a National Policy, 20 U.S. CAL. L. CEN'fER TAX INST_ 27, 30-31 n.l 1 (1968). "[B]y careful planning, one now can llve rnuch of his life ott tax-exem pt properly." A.BAhK, supra note 1, at 5; see also B. WEIS- BROD, supra note 8, at 62 (nonprofits "engage in hundreds of distinct activities; they are growing at the rate of thousands per year; they employ rnillions of workers; and they have hundreds of billions of dollars of amrual revenues and assets"). Aecord'utg to one rough estimate, one-third of all property is tax exempt. 'fwo-thirds of this amount, however, constitittes govermnent property, generally not calculated in the tax base. A. BALK, supra note l, at 11- 12. Therefore, an estitnate that is more representative for the present purposes is that approxinrately 10% of private property is exempt. See Gabler & Shannon, The Exernption of Religiou.s, Educational and Charitable Insti- tutions From Property Taxation, in FILER COMMISSION PAPERS, supra note 2, a12535 (roughly one-ninth of private property is exempt); Stone, supra, at 31 (in the mid-I960s, the amount of income tax foregone, $ 5 billion, was enough to provide a 10% tax cut). Some have assigned much higher estimates to particular locales. See J. HEi.LERSTEIN & W. HELLERSTEIN, STATF, AND LOCAL TAXATION 981 (5th ed. 1988) (in 1963- 1964, "the value of exempt non-governmental property amounted to approxintately 22 percent of the assessed value of all taxable property in Illinois, 19 perecnt in Califomia, 36 percent in Florida, and 78 percent in Louisi- ana."). Accurate figares are difficult to obtahr because tax assessors do not generally bother to value precisely exempt property. The amount of exempt property has grown considerably over the past few decades, faster than the value of the tax base. See A. BALK, supra at 1; B. WEISBROD, supra note 8, at 62 (tlre number of exempt firms lras tripled in 20 years whereas for-profit funis have only doubled in number over the satne period); Gabler & Shan- non, suprq at 2536-38. The number of categories of federally exempt activities has grown from 90 to 260 since 1965. U.S. GENERAL ACCOUNTING OFFICE, TAX POLICY: COMPETITION BETWEEN TAXABLE BUSINESSES AND TAX-EXEMPT ORGANIZATIONS, BRIEFING REPOR'f TO THE JOINT COMM. ON

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'TAXATION 14 (Fcb. 1987) [hereinafter GAO, TAX POLICY]. Correspondingly, the nuniber of federally exempt entilies has doubled over the last 20 years, to 866,000. U131T Hearings, supra note 6, at 26. The charitable exemption specifically is by far the largest component of the private exentpt sector. Charita- ble organizations, now tmmbering 366,000, represent over two-fifths of all federally exetnpt entities and over half of the exetnpt sector's total receipts and assets (amounting to $ 114.6 billlon and $ 176.3 billion respec- tively). See GAO, TAX POLICY, supra, at 15. "[T]he broad range of mutual benefit organizations exeinpt under provisions other than section 501 (c)(3) and section 501(c)(4) accounted for only 10 percent of current operating expenditures of all nonprofits in 1984." UBIT Hearings, supra note 6, at 27.

ni0 See infra notes 48-52, 57-66 and accotnpanyitlg text (concerning various court and legislative challenges to hospitals' tax exemption). A few scholars have advocated or suggested the outright repeal of the exemption. See Betmett, Real Property Tax Exen:ption,s qfNon-Profrt Organizations, 16 CLEV.-MARSHALL L. REV. 150, 166 (1967) ("[A] solution would appear to be the abolition of all non-govermnental property tax exemptions, completely."); Clark, Does the Nonprofit Form Fit the Flospitat Industry, 93 HARV. L. REV 1417, 1476 (1980) (suggesting repealing property tax exemption for hospitals); Stitnsou, supra note 5(same).

nl l'1'he leading discussions include J. DOUGLAS, supra trote 8; THE ECONOMICS OF NONPROFIT INSTITU'1'IONS (S. Rose-Ackerman ed. 1986); B. WEISBROD, supra note 8; Ellman, Another Theory ofNon- profrt Corporations, 80 MICH. L. REV 999 (1982); Hansmamt, 7he Role ofNorrprofit Enterprise, 89 YAI,E L.J 835 (1980)_ See generally R. GASSLER, THE ECONOMICS OF NONPROFIT ENTFRPRISE (1986); E. JAMES & S. ROSE-ACKERMAN, THE NONPROFIT ENTERPRISF, IN MARKET ECONOMICS (1986); THE NONPROFIT SECTOR: A RESEARCH HANDBOOK (W. Powell, ed. 1987); Yoder, Ecoreomic Theories of For-Profit and Not for-Profit Organizations, in INS'1'ITU'fE OF MEDICINE, FOR PROFIT ENT'ERPRISE IN HEALTI3 CARE 19 (B. Gray ed. 1986).

n 12 Characterization of the tax exemption for charitable organizations and the tax deduction for charitable contributions as a "subsidy" raises certain issues that have remaincd at the core of debate among tax acadentics regarding the relationship of tax law to the exetnption and deduction. While most tax commentators accept the "subsidy" characterization, see, e.g., S. SURREY, PATHWAYS TO TAX REBORM 223 (1973); S. SURREY & P. MCDANIEL, TAX EXPENDITURES 219-20 (1985); Hoclnnatut & Rodgers, The Optirnal Tax Treatment of Charitable Contributions, 30 NAT'L TAX J 1, 2 (1977); Tlturonyi, Tax Expenditures: A Reasse.ssment, 1988 DUKE L.J 1155, others do not. For example, Boris Bittker has opined that the tax exomption is simply an out- growth of the inability to accurately rncasure the income of nonprofit organizations. As a result, Bittker finds the exemptiort and charitable contribution deduction consistent with a taxing system that attempts to measure income. For a discussion of Bittker's theory, see Infra notes 279-90 and accompanying text. See, e.g., Bittker, Charitable Contributions: Tax Deductions or Matching Grants?, 28 TAX L. REI! 37 (1972). See generally C. KAHN, PERSONAI. DEDUCTIONS IN TIIE FEDERAL INCOME TAX 88 (1960) (discussing rationales for the charitable eontribution deduction). As explained infi-a notes 286-90, the income nteasurentent theoty does not provide a completejustification for the curretrt scope of the exemption for charitable institutions. Therefore, this Article follows the predoniinant view that the exemption constitutes a subsidy, and seeks to justify the exemption on this basis. See infra note 69 and accompanying text.

nl3 See UBIT Hearings•, supra note 6, at 37 (Statetnent of Deputy Assistant Secretary of the Treasury O. Donaldson Chapoton) ("[A] comprehensive review of the standards and the rationale fot-tax exemption has never been undertaken."); id at 1864-65 (statentent of Prof. Harvey P_ Dale, N.Y.U. Scltool of Law) ("[W]e do not Itave any careful and compreltensive rationale for the scope and operation of the tax exentption. We do not have any satisfactory theory, legal or economic, to apply in tnaking judgments about it."); sce also supra note 8.

n 14 Utah County v. Intermountain Ilealth Care, IYU:., 709 P.2d 265 (Utah 1985).

n 15 See infrci notes 57-64 and accompanying text.

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n16 See infra notes 64 & 66, 151.

nl7 J. BENNETT & T. DILORENZO, UNFAIR COMPETI'fION: THE PROFI'I'S OF NONPROFITS 73 (1989) ("Although nonprofit hospitals comprise less than tliree percent of all nonprofit organizations, they dominate the sector's expenditures: In 1982, nonprofit hospitals accounted for more than half of all nonprofit- sector expenditures. . _ ").

n18 Presently, the figure that has the widest currency places the value of the exemption at $ 8.5 billion. I his Cooeland & Rudnev, I'ederal Tax Subsidiesjor Not-lbr-Proftt Hospitals, 1990 TAX NOTES 1559, 1565. nttmber represents the sam of the following estimates: federal income tax, $ 1.6 billion; tax-exempt bonds, $ 1.7 billion; deductible charitable contributions, $ 1.2 billion (total federal, $ 4.5 billion); state and local income tax, $ 0.4 billion; propei-ty tax, $ 1.2 billion; sales tax, $ 2.4 billion (total state and local, $ 4_0 billion). Id.; see also Baldwin, Legislatures, Agencies Debating Whether Not-For profit Hospitals Deserve Their Tax-exempt Status, MOD. HF.ALTHCARE, May 22, 1987, at 34, 37 (the sales tax exemption for hospitals atnounts to an annual loss of $ 60 million in Oklahoma and $ 400 million in Florida); Clark, supra note 10, at 1417 & n.1 (the exemption for hospitals results in an estintated annual loss of $ 1 billion in property tax revenues alone); Falcone & Warren, The Shadow Price of Pluralisrn: The Use of 7'ctt Expenditiires To Subsidize Hospital Care in the United States, 13 J. HEALTH POL., POL'Y & L. 735, 740-52 (1988) (by a rough, liberal estimate, the hospital exemption costs $ 3 billion a year in income and property tax, $ 1.8 billion of this in federal incotne tax); Friedman, in 11 ADVANCES IN Hattis & Bogue, Tax F,xemption and Community Benefits ofNot-For-Pro,fi't Hospitals, HEALTH ECONOMICS AND HEALTI-I SERVICES RESEARCH (1990) 131, 136-38 (value of exemption in 1983-1985 estimated between $ 4.7 and $ 7_3 billion); Yoder, supra note 11, at 66 n.9 (the federal income tax exemption cost $ 1.6 billion in 1984, based on the average norninal tax rate for the six largest proprietary hospital companies, but only $ 922 million based on the tax rate for-profits actually paid as a result of various defer- ments). However, as a result of recent cost containment nieasures in various public and private reimbursement programs, hospitals are becoming less profitable than they had been in the recent past, reducing the value of the income tax exemption. Still, Copeland & Rudney, supra, at 1565, observe that the exetnption would be worth $ 6.5 billion even if nonprofit hospitals had no surplus at all.

n19'1'his Article uses "proprietary" to designate privately-owned, for-profit institntions. Following the convention in the hospital industry, the term "voluntary" is used interchangeably with "nonprofit" to designate privately-owned institutions incorporated under state not-for-profit corporations codes. Govetmnent institutions are those owned or controlled by governrnent entities. In a typical ntetropolitan area all three types of hospitals often coexist.

n20 CONGRESSIONAL RESEARCII SERVICE, HEALTH INSURANCE AND THE UNINSURED: BACKGROUND DATA AND ANALYSIS 3 (May 1988). "In addition, there are millions of underinsured people, whose limited insurance puts them at substantial risk of having out-of-pocket expenses upwards of 10 per- . .. found that depending on the definition used, from 5 to cent of ttteir total income. 't'he best data on this topic 18 percent of the population under age 65 was underinsured." Yoder, supra note 11, at 116 n.l.

( n21 J. BENNETT & T. DILORENZO, .supra note 17, at 84 quoting the American Hospital Association's a five-year period). (AHA) claim that nonprofit hospitals gave $ 22 billion in free medical care to the poor over

Behavior: Legal Barriers n22 These developments are sutveyed in IIall, lnstitutlonal Conlrol of Physician 1988). to Health Care Cost Containment, 137 U. PA. L. RF.V. 431, 435-37 (

23 J. HEALTH & n23 Sullivan & Moore, A Critical Look at Recent Developments in Tax Exenrpt Hospitals, HOSP. L. 65, 66-71 (1990).

963 (1980). n24 Relman, T he New Medical-Industriat Complex, 303 NEW CNG. J MED.

Appx.335 Page 33 66 Wash. L. Rev. 307, *

n25 See I. HOLLINGSWORTH & E. HOLLINGSWORTH, CON"I'ROVERSY ABOUT AMERICAN HOSPITALS: FUNDING, OWNERSHIP AND PERFORMANCE 66-67 ( 1987) ("In 1985 HCA owned or managed 422 health care facilities, had revenues of $ 4.1 billion ... and managed hospitals in more than half a dozen foreigit countries.").

n26 See generally Rcltnatt, sa+pra uote 24.

n27 See C>ark, sv,nra note 10 at 1460-62 (detaihng the theoretical advantages ofproprietlty incentive in hospital care); infra notes 202-213 and acconipanying text. The gist of this debate, which is only caricatured in the text, is captured cogently in Yoder, supra note 11, at 3-4, especially in ttte exchange between Arnold Rehnan attd Uwe Reitiltardt reprinted in that volume, id. at 209, and in Scltlesinger, Martnor & Smithey, IVonprofit and For-ProfitMedical Care: ShiJldngRoles and Implications for Flealth Policy, 12 J. HEAI.TH POL., POL'Y & L. 427 (1987) and Marmor, Sclilesinger, & Sntithey, A New Look at Nonprofits: Healtlh Care Policy in a Competi- tive Age, 3 YALE J ON RLG. 313, 314-19 (1986) [hereinafter Mannor].

n28 Marmor, Schlesinger & Sntitliey, Nonprofit Organizations and Heatth Care, in THE NONPROFIT SECTOR: A RESEARCH HANDBOOK 221, 222 (W. Powell ed. 1987).

n29 7'his Atticle restricts its examination to the theory of the exemption conferred through L2 C. § exemption. 501(c)(3) and its analogues iu state law. In sttort, this Article attenipts to explain only the charitable Tluts, this Article does not address other grounds for granting tax exempt status to noncharitable organizations. For instance, sonte nonpi-ofits are considered "exentpt" from inconte taxes because tttey earn no income. These private, dues-supported organizations -- typified by labor unions, social clubs, and condominium associations -- are referred to as "mutttal benefit organizations" because they exist in order to allow their members to enjoy a benefrt provided more efficiently on a collective basis than when purchased individually. See Ellman, supra note 11, at 1032-42 (explaining the disthtction between charitable and mutual benefit nonprofits); Hansmamt, supra note 11, at 892-93 (sante); see also Bittker & Rahdert, supra note 8, at 304 (noting the inheent difficulty of ineasuring the "hicome" of many exempt entities). Their receipts do not constitute income because they rnerely pool already-taxed income prior to its collective consumption. As explained by one case, "where individuals have banded together to produce reereational facilities on a mutual basis, it would be conceptually erro- neous to inipose a tax on the organization as a separate entity. ... No income of the sort usually taxed ltas been generated; the money has simply been shifted frotn one pocket to another both within the same pair of pants.... [A]s to these furtds to organization does not operate as a separate entity." MeGlotten v. Connally, 338 F. Supp. 448, 458 (D. D. C. 1972); see also UB1T Hearings, supra note 6, at 34, 47. This Article also does not address tax exetnptions granted by states to attract profitable industries to certain cotnntunities, thereby stimulating the local econoniy and creating new jobs. This targeted form of exemption falls outside ttte scope of this Article because it is confetred on an ad hoc basis withottt regard to the charitable status of the enterprise. See, e.g., N. P_ REAL PROP. TAX LAW §§ 489-aaa, 489-ddd(1)(b) (McKinney 1984) (50% tax exemption for new industrial or commercial construction, phased out over ten years)_

n30 I.R. C. § 501(c)(3) (1989). The statute continues by defining an exempt organization as one, "no part of the net earnings of which inures to the benefit of any private sltareholder or individual, no substantial part of tlte activities of which is carrying on propaganda, or otherwise attempting, to influence legislation ... and which does not participate in, or intervene in .._ any political campaign on behalf of (or in opposition to) any candidate for public office."

n31 Bob.Iones Univ. v. UnitedStates, 461 U.S. 574, 586 (1983); see Treas. Reg. § 1.50I(c)(3)-1(d)(2) (1959) ("The tertn'charitable' is ... not to be construed as limited by the separate enumeration in section 501(c)(3) of other tax-exempt purposes which rnay fall within the broad outlines of'charity' as developed byju- dicial decisions "); B. HOPKINS, THE LAW OF TAX-EXEMPT ORGANIZATIONS 45 (4th ed. 1983) ("[T]he

Appx.336 Page 34 66 Wash. L. Rev. 307, *

terni'charitable' niay bc considered a generic term and, in its expansive sense, tnay be read to include'religious; 'scientific,"educational; and like purposes. ..."); P. TREUSCII, TAX-EXEMPT CHARI'I'ABLE ORGANIZA- TIONS 118 (3d ed. 1988) ("'[C]haritable' pmposes was a catch-all category for niost of the more specific purposes that were later added.").

n32 This concept of wliat constitutes a charitable organization also appears in the definition of "social welfare° organizations which are exempt under I.R.C. § 501(c)(4). See UBIT Hearings, supra note 6, at 46 (statement of O. Dona(dson Chapoton) ("The ternr'social welfare' as used in section 501(c)(4) is similar to 'charitable purposes' as used in section 501(c)(3) and there is a substantial degree of overlap between the two provisions."); Bittker & Rahdert, supra ttote 8, at 331 (same). Unlike charitable organizations exenipt under LR.C. § 501(c)(3), however, social welfare organizations are not eligible to receive tax-deductible donations. See I.R. C. § 170(c)(2) (defining a deductible charitable contribution). On the other hand, social welfare organizations are allowed to engage in certain political activities without sacrificing their exemption. See B. HOPKINS, supra note 31, at 309. But see P. TREUSCH, s•upra note 31, at 324-25 (excessive political activity may mean organization is no longer promoting social welfare); I.R.C. § 504 (prohibiting 501(c)(3) organization which has had its exempt status revoked due to excessive political activity fi-om qualifying as 501(c)(4) social welfare organization).

n33 Indeed, in about half of the states they are specifically enumerated along with chttrches and schools, See ALASKA STAT § 29.45.030(a)(3) (1990); ARIZ. REV, STAT. ANN. § 42271.A_5 ( Sttpp. 1990); CAL. RE[! & TAX. CODE § 214 (West 1987 & Supp. 1990); CONN. GF,N. STAT ANTL § 72-8](16) (West 1933); FLA. STAT ANN. § 196.197 (West 1989); GA. CODEANN. § 48-5-41(a)(5) (Harrison Supp. 1989); IIA1V REV. STAT. § 246-32(a) (Supp. 1985); IDAHO CODE § 63-105K (1989); KAN. STAT ANN. § 79-201 b (1989); LA. REV STAT. ANN. § 47:1703 (West 1990) (exernpting property owned by nonprofit entity organizcd for "health" putposes per Louisiana Constitution art. 7, see. 21); ME. REV. STAT ANN. ttt 36, § 652(1)(K) (1990); MD. TAX-PROP_ CODEANN. § 7-202(b)(1) (1986); MINN STAT ANN. § 272.02 (West 1989 & Supp. 1991); M(SS. CODE ANN ,¢ 27-31-1(f) (Supp. 1990) (exempting hospitals which maintain one charity ward); MONT CODE ANN § 15-6-201(1)(c) (1989) (exempting nonprofit health care facilities); N.J STAT ANN. § 54.•4-3.6(West 1986); N. Y REAL PROP. TAXLAW ' 420-a(1)(a) (McKinney 1984); N.C. GEN S74T § 105-278.8 ( 1989); N.D. CENT CODE § 57-02-08 (1983); OKLA. STAT. ANN. tit. 68, § 24050) (West 1966 & Supp. 1991); PA. STAT. ANN. tit. 72, § 5020-204(a)(3) (Pnrdon 1990); RL GEN. LAWS tiS 44-3-3(12) (1983); S.C. CODEANN. § 12-37-220(A)(2) (Law. Co-op. Supp. 1989); S.D. CODIFIED LAWSANN § 10-4-9.3 (Supp. 1990) (exenipting propetty used primarily for health care); TEX TAXCODEANN. § 11.18 (Vetnon Supp. 1991) (exempting charitable organizations providing medical care); WASH. REV. CODEANN. ,¢ 84.36.040 (1989); WIS. STAT ANN § 70.11(4tn) (West 1989); WYO. STA7: § 39-1-20I(a)(xxv) (1990). It is ironic, but fitting, that one of the first locations where their eharitable status has eotne tmder attack is Tennessee, the "Volunteer State." See Downtown Hosp. Ass'n v. Tennessee State Bd ofEqualization, 760 S. W. 2d 954 (Tenn. App. 1988).

n34 See, e.g., Board of Review v. Provident liosp. & Training School Ass'n, 233 ILI. 243, 84 N. E. 216, 217 (1908); Sisters ofThird Order ofSt. Francis v. Board ofRevievr, 231Il1. 317, 83 N.E. 272, 273 (1907).

n35 The history of the liospital industty presented in this section is drawn from the following sources: C. ROSENBERG, THE CARL OF STRANGERS (1987) (history of American hospitals); P. STARR, THE SO- CIAL TRANSFORMATION OF AMERICAN MEDICINE 146-76, 430-38 ( 1982); R. STEVENS, IN SICK- NESS AND IN WEALTH: AMERICAN HOSPI7'ALS IN THE TWENTIETH CENTURY ( 1989).

n36 "A cotporate ethos originating atnong the investor-owned chains has spread throughout the health-care system." Light, Coiporate Medicine for Profit, SCI. AM., Dec. 1986, at 38, 42. "Throughout the country voluntary hospitals are attempting to model themselves after for-profit hospitals." J. IIOLLINGSWORTH & E. HOLLINGSWORTH, supra note 25, at 129. "Bven the health care vocabutaty is changing, infused with businesslike terms...[such as] 'markethsg; 'market share,"industry,"prof7tability,' and 'productivity; to cite a few."

Appx.337 Page 35 66 Wash. L. Rev. 307, *

Jones, DuVal & Lesparre, Competitton or Con.science? Mixed- Mission Dilemmas of the Voluntary Hospital, 24 INQUIRY 110, 113 (1987).

n37 J. HOLLINGSWORTII & E. HOLLINGSWORTII, supra note 25, at 137-38. See generally Sloan, Valvona & Mullner, Identifying the Issues: A Statistical Profile, in UNCOMPENSATED HOSPITAL CARE: RIGHTS AND RESPONSIBILITIES 16, 27-28 ( 1986).

n38 See infr-a notes 236-41 and accon2panying text.

n39 The leader in this effort is David Seay, of the United IIospital Fund. See Seay & Sigmond, Community Beneftt Standard.s for Hospitals: Perceptions and Peformance, FRONTIERS IIEALTH SERVICES MGM"L, Spr. 1989, at 3; Seay & Vladock, Mission Matters, in IN SICKNESS AND IN IIEALTII: TI-IE MISSION OF VOLUNTARY HEALTH CARE INSTITUTIONS I(1988). See generally CATIIOLIC HEALTH ASSOCIA- TION, TIIE SOCIAI. ACCOIJNTABILITY BUDGE'1' (1989) (summary on file with Washington Law Revierv); AMERICAN HOSPITAL ASSOCIATION, COMMUNITY BENEFIT AND TAX-EXEMPT STATUS: A SELF-ASSESSMENT GUIDE FOR HOSPITALS ( 1988).

n40 'I'he following sources extensively discuss the history of the IRS rulings and their relationship to the history of the nonprofit hospital sector: Bromberg, Financing Health Care and the Effect of the 7'ax Law, 39 LAW & CONTEMP. PROBS. 156 (1975) [hereinafterBromberg, FinatacingHealth Care]; Bromberg, The Charitable Hospital, 20 CATII. UL. REV. 237 (1970) [hereinafterBrotnbet'g, Charitable. Hospitat]; Mancino, Income Tax Exemption of the Contemporary Nonprofit Hospital, 32 ST. LOUIS UL.J 1015 (1988); Note, Non- profit Hospitals and the Stale 7'ax Exemption: An Analysis of the Issues Since Utah County v. Intermountain Heaitlt Care, Inc., 9 VA. TAX REV 599 (1990).

n41 Rev. Rul. 56-185, 1956-1 C.B. 202, 203. See generally Colotnbo, Are Associations of Doctors T ax Ex- ernpt? Analyzing Inconsistencies in the Tax Exernption of Health Care Providers, 9 VA. TAX RF.V 469 (1990).

n42 7'ax Reform, 1969: Hearirrgs Before the Committee on Ways and Means, 91 st Cong., 1 st Sess. 1427 (1969) (statentent of lulius M. Griesman, attorney, AHA); see A. SOMERS, HOSPITAL REGIJLATION:1'HE DILEMMA OF PUBLIC POLICY 41 (1969) ("Thanks to Medicare, Medicaid, and numerous other public and private mechanisms for 5naneiug care for the indigent ztrd medically hidigent, in a few years free hospital care will approach the vanishing point."); Conunent, Federallncome Tax Exemption For Private Hospitals, 36 FORDHAML. REV 747, 764 (1968) ("[PJublic programs for mandatory hospitalization insurance, as well as the ever increasing coverage of private insurance plans, threaten to leave hospitals without patients who requirc free or below-cost care."). Observe, though, that this argutnent falsely assuines that a l ospital that experiences no demand for charity care would not meet the requiremettts of ttie 1956 ruling. To the contrary, see infra note 44.

n43 Rev. Rul. 69-545, 1969-2 C.B. 117. The timing of this ruling in relation to the legislative calendar in 1969 is curious, to say the least. After complaints by the hospital industt-y regarding the charity care require- inent of Rev. Rul. 56-185 surfaced during House hearings on the 1969 tax reform legislation, the House passed a version of tax reform legislation which included a specific exentption for "hospitals" in a revised § 501(c)(3). H.R. 13270, 91st Cong., 1st Sess. § 1010) (1969). Rev. Rul. 69-545 was issued prior to Senate debate on the tax reform bill, and when the issue arose in the Senate, the Finance Committee decided to delete this provision from the Sennte version of the legislation in light of the IRS action, and to reeonsider the issue in connection witlt up- coming debates on the scope of Medicare. See STAFF OF SENATE COMM- ON P'INANCE, 91st Cong., Ist Sess., REPORT ON MEDICARE AND MEDICAID PROBLEMS ISSUES AND ALTERNATIVES 55 (Cotnm. Print 1970). In this report, the staff severely criticized the breadth of the 1969 ruling, id at 58, but no fiirther legislative action was taken. I'his opaque legislative backgromrd sheds no light on whether Congress agreed with the 1969 ruling.

Appx.338 Page 36 66 Wash. L. Rev. 307, *

n44 STAFF OF SENATE COMM. ON FINANCE, 91 st Cong., 1 st Sess., REPORT ON MEDICARE AND MEDICAID PROBLEMS, ISSUES AND ALTERNATIVES 55, 58 (Couun. Prhtt 1970)_ 11 is possible to maintain, based ott a different reading of these ntlings, that they indicate very little shift in policy. "fhe 1956 niluig did not necessarily require large amounts of free care by all tax-exempt hospitals. As explained in Eas•tern Ken- tucky Wetfare Rights Ass'n v. Simon, 506 P.2d 1278, 1289-90 n.26 (1974), vacated on other grounds, 426 U S. 26 (7976):

[I-1]ospitals were required to provide free care only to the extent of their financial ability. Flospitals operating at a deficit would have no obligation under Ruling 56-185. In addition the Ruling qualified the "ftnancial ability" standard by providing: "The fact that its charity record is relatively low is not conchtsive that a hospital is not operated. ror... chartiaote pmposes....„ ,. ri tetay also sei a^iue carituigs wh;eh tt usas ;cr .mpraverr,ent, smd additions to hospital faeilities.... A nominal charity record for a given period of time, in the absence of charitable detnattds of the community, will not affect its right to continued exemption." Nevertheless, it is clear that the 1956 ruling would not have allowed hospitals to refitse repeated demands for treatnsent by uninsured patients if hospitals had the financial capacity to mect those demands. See Bromberg, Crtarity and Change: Catrrent Problems of 7az Exentpt Health and Welfare Organizations in Perspective, in TAX PROBLEMS OF NON-PROFI'r ORGANIZATIONS 1970, at 249,256 (1970) (recomitnig history of revenue agents denying exemption to hospitals under 1956 ntHng based on their lack of demonstrated charity care). In contrast, the 1969 ruling lets the hospital decide wltetlter to devote surplus revenaes to charity care or to hospital expansion. This Artiole therefore continues to treat these tulings as they have been anifornily characterized by other scholars in this field. See generally supra note 40.

n45 Rev. Rul. 69-545, 1969-2 C.B. 117, 118,

n46 Id.

n47 Rev. Rul_ 83-157, 1983-2 C.B. 94. For a more detailed discussion of the 1956, 1969, and 1983 rulings, see Colombo, supra uote 41, at 473-81.

n48 506 L:2d 1278 (1974), vacated on other grounds, 426 US. 26 (1976).

n49 Sirnon v. Eastern Ky. Welfare Rights Org., 426 U.S. 26 (1976). The Court found that the connection between the government's ru(ing and any possible refusal of service to this class of patients was too remote and speculative to constitute a case or controversy. It reasoned that hospitals migltt choose to treat these plahitiffs anyway, or that they might choose to forego the exemption (and tttus be ander n o duty to trcat)if the government were to adopt the plaintiffs' position. The Court held that these two possibilities were so likely as to render "mere speculation" the possibility that the plaintiffs woald be treated otity if the govenunent changed its position. This holding is so out of step witlt other precedents on causation in standing analysis that it is taken as establishing a sui generis rule that no one ottter thatt the taxpayer may chal lenge an IRS ruling. Compare United States v. Students Challenging Regulatory Agency Procedures (SCRAP), 412 U.S. 669 (1973) (standing exists for law students to challenge ICC's approval of a general, nationwide rate increase for railway freight based on the allegation that this action will lead to more titter in Washington, D.C. because it will raise the costs of recy- cling) with Allen v. Wright, 468 U.S. 737 (1984) (parents of black students have no standing to challenge IRS grant of tax exemptiott to racially discriminatory religious schools). See generally B. BITTKER, FEDERAI, TAXATION OF INCOME, ESTATES AND GIFTS Pl 15.9_4 (1981 & Supp. 1989).

n50 F,astern Ky., 506 F.2d at 1288-89; see also S'HARE v. Commtssioner of Revenue, 363 N. W 2d 47, 52 (Mirm. 1985) ("[M]ajor changes in the area of health care .. . have necessitated changes as well in definitional predicates...... ); Medical Center Hosp. v. City of Burlington, 152 Vt. 611, 566A.2d 1352, 1356 (1989) ("[W]e do not believe that we are _.. required to ignore the immense sociological and economic changes that have taken place in the health care professiou. ..."); cf. Utah County v. Inter'nrountain flealth Care, Inc., 709 P_2d 265 (Utah 1985) (changes in health care result in revoking charitable status)_

Appx.339 Page 37 66 Wash. L. Rev_ 307, *

n51 Eastern Ky., 506 F.2rl at 1288. As explained by the leading contrary opinion, ltospitals: argue that... the universal availability of insurance... make[s] the idea of a hospital solely supported by philanthropy an anachronism. We believe this argument itself exposes the weakness in the [hospitals ] position. It is precisely because such a vast system of third-party payers has developed... that the historical distitiction between for- prolit and nonprofit hospitals has eroded. Utah County v. Intermountain Health Care, Inc., 709 P.2d 265, 274 (Utah 1985); see also Hyman, The Conun- drum of Charitability: Reassessing Tac Exemption for Ilospitals, 16 AM J L. & MED. 327, 331 (1990) ("Most articles have presupposed that tax exemption for hospitals is desirable. . ."); id. at 379 ("We are ittvariably re- nlinded that tiie Botiservati've test is anachrOnistic.... Wl'iiie this is truey it does not ncee ssarlly follo:v that the clianged circumstances still merit a tax exemption. Instead, perhaps the exemption is as anachronistic as the reasons that originally gave rise to it. Things that were once tax-exempt can become taxable if circumstances change...... ); id. at 380 ("Tlre right question to ask is whether the exemptiou itself tnakes sense, and not whether the old beliefs about exemption are anachronistic.").

n52 See It

n53 E.g., ALA. CODE § 40-18 32(l1) (Supp. 1990); COLO. REV. STAT § 39-22-117 (Supp. 1990); CONN. GEN. S1AT. ANN. § 12-214(2) (West Supp. 1990); FLA. STAT. ANN. § 220_13(2)(h) (West 1989); GA. CODF. ANN. § 48-7-25 (Harxison 1989); IDAHO CODE § 63-3026 ( 1989); ILL. ANN. STAT. ch. 120, P2-205(a) (Smith-Hurd Supp. 1990);1ZAN. STAT. ANN. § 79-32,113 (1989); KY. REV. STAT. ANN. § 141.040(g) (Mi- chielBobbs-Merrill 1989); MF,. REY STAT. ANN. tit. 36, § 5102(6) (1990) (imposing tax only on cotporations taxable under the I.R.C., thereby adopting LR.C. § 501(e)(3) by implication); MD. TAX-GEN. CODEANN. § 10-104 (1988); MASS ANN. LAWS ch. 63, §30 (Law. Co-op. Supp. 1990); MICII. COMP. LAWS ANN. § 206201(1) (West 1989); MINN. STAT. ANN. ,§ 290.05 (West 1989); MO. ANN. STAT. § 143.441.2.(1) (Veroon Supp. 1990); NEB. REV STAT § 77-2714 (1986); NM. STAT. ANN. § 7-2-4 (Supp. 1990); N.D. CENT CODE § 57-38-09 (1983); OKLA. STAT ANN. tdt. 68, § 2359 (West 1991); ORE. REV STAT § 317.080 (Supp. 1990); IJTAH CODE ANN. § 59-7- l05(I) (a) (1987); VA. CODE ANN § 58. ]-401(5) (Supp. 1990); W. VA. CODE § 7 1- 24-5(1987). It is especially curious to note that Utah, which automatically confers an income tax exeniption on organizations meeting the requirements ofLR.C. § 501(c)(3) (and, by implication, the per se test), nevertlieless has refused to follow the per se rule for the property tax exemption. See inlra notes 58-62 and accompanying text. In addition, a number of state income tax statutes which do not specifically refer to the I.R.C. nevertheless adopt exeniption language virtually identical to LR.C. § 501(c)(3). E.g., ARIZ. REV. STAT. ANN. § 43-1201.4 (1980); ARK. CODE ANN. § 26-51-303 (1987); CAL. RF_V & TAX CODE § 23701(d) (West Supp. 1990); DEL. CODEANN tit 30, § 1902(b)(2) (1985); LA. REV STAT. ANN. §47:121(5) (West 1990); MISS. CODEANIV § 27-7-29(a)(3) (Supp. 1990); MONT. CODE ANN. § 15-31-102(1)(d) (1989); N H. REV STAT. ANN. § 77:8 (1971); N.C. GEN. STAT. ,¢' 105-1311.II(a)(3) (1989); VT STAT. ANIV. tit. 32, § 5877(3)(J) ( 1981).

n54 Ginsberg, The Real Property Tax Exeneption of Nonprofit Organizations: A Perspective, 53 7EMPLE L. g_ 291, 292 (1980) (every state lras a statute on the subject and all but seven have a constitutional provision).

n55 While the exact language sometimes varies (for example, use of the word "church" instead of "religious" or "benevolent" instead of"charitable"), and the statutory construction is sometimes oblique (Washing- ton, for exatnple, uses a separate statutory section for each type of exemptiott), all states except Maine and Ver- mont appear to follow this general regime in their propetty tax exemption statutes, and these states differ only in the omission of an exemption for general "educational" pttrposes. Maine's exemption statute, for exainple, con-

Appx.340 Page 38 66 Wash. L. Rev. 307, *

tains a litnited exemption for propeity owned by "colleges," but not schools generally. MF.. RF,V. STAl: ANN. tit. 36, § 652 (1990). Sitnilarly, Verniont exempts property owned or leased by "colleges, academies or other public schools" but does not appear to exempt property owned by private educational institutions. VT S'1'A7: ANN tit. 32, § 3802(4) (1981). See also W. WELLFORD & J. GALLAGHER, UNFAIR COMPETITION? THE CHALLENGE TO TAX EXEMPTION app. A (1988) (50-state survey of the laws of charitable property tax exemption); Cocmnent, Noreprofit Hospitals: The Relationship Between Charitable Tax Exemptions and Carefor Indigents, 43 SW. L.J. 759, 774 (1989).

n56 Rammell & Parsons, supra note 52, at 73-74. For a state-by-state analysis of propetty tax exemption laws as they apply to health care providers, see Taxation, in 2B HEALTH LAW CENTER, HOSPffAL LAW MANUAL 37-152 ( 1988).

n57 Rammell & Parsons, supra note 52, at 74. For example, in Hospital Utilization Project v. Pennsyl- vania, 507 Pa. 1, 487A.2d 1306 (1985), the Pennsylvania Supreme Court upheld the denial of tax exetnption to a nonprofit provider of statistical analysis of patiettt treatment and cost data to hospitals because the services were provided on a fee-for-service basis. According to the court, one element favoring the classification of an entity as a charity under Pennsylvania law is that the entity "[d]onate,s or renders gratuitously a substantial portion of its services." Id. at 1317.

n58 709 P.2d 265 (Utah 1985).

n59Id. at273.

n60 ld at 274.

n61 Id at 273.

n621d. at 276. Utah hospitals attentpted to reverse this decision through a referendunt initiative that would have declared nonprofit hospitals per se exempt, bnt the nteasure was defeated by a 50.1% to 49.9% vote. Salt Lake County subsequently revoked the exemption of four otlrer hospitals. See Jeppson, A Time_for Action by Not-For-Proftt flospitals, FRONTIERS HEALTH SERVICES MGMT., Spr. 1989, at 40, 41; Rammell & Par- sons, supra note 52, at 81.

n63 Callaway Community Hosp. Ass'n v. Craighead 759 S. W2d 253 (Mo. App_ 7988); St. Luke's Hosp, v. Board of Assessment Appeals, No. 88-C-2691 (Pa. C.P., Lehigh Co., Apr. 19, 1990); Dorvntown Hosp. Ass'n v. Tennessee State Bd ofF.qualization, 760 S. W.2d 954 (Tenn. App. 1988); Medical Center Ho.sp. v. City of Bur- lington, 152 Vt, 611, 566 A.2d 1352 (1989); see generally NORTI-I CAROLINA CENTER FOR PUB. POL'Y RESEARCH, COMPARING THE PERFORMANCE OF FOR-PROFIT AND NOT-FOR-PROFI l' HOSPI- TALS INNORTII CAROLINA 159-66 (1989); Greene, Governrnental Units Challenge Not-For-Proftts' Tax Exernptions, MOD. IIEALTHCARE, Dec. 4, 1987, at 67; Hudson, Not-For-Proflt Hospitals Fig{et Tax-Exempt Challenges, HOSPITALS, Oct. 20, 1990, at 32-37; Hyman, supra note 51, at 345-46; Pear, Tax Exernptions of Nonprofit Hospitals Scrutinized, N.Y. Tnnes, Dec. 18, 1990, at AI, col. 2, B17, col. 5 ("Local officials have tried to revoke tax exemptions from nonprofit hospitals in at least 12 states_")_ Pennsylvania appears to be the only state other than Utah with a legal climate hostile to hospital tax exemption, although its precedents are presently much cloudier_ In WestAllegherry Hospital v. Board of Property As- sessment, Appeals & Review, 500 Pa. 236, 455 A.2d 17 70 (1982), the coutt nplteld a hospital's exemption despite its low level of charity care. The same court, however, subsequently ruled that an organization providing adtninistrative support to hospitals does not eatn the exemption where the organization "has no ... open- admissions policy ...[and fails to prove that it] provides its services without regard to the [reeipient's] ability to pay." Hospital Utilization Project v. C'ommonwealth, 507 Pa. 1, 487 A.2d 1306, 1316 (1985). Following this apparent ittcottsistency, one Pennsylvania trial coutt has upheld a hospital's exemption, St. Lukes Hospital, supra,

Appx.341 Page 39 66 Wash_ L. Rev. 307, *

while another has revoked the exentption. Sclzool Dist. v, Hamot Medical Center, No. 138-A-2989 (Pa. C_P., Erie Co., May 18, 1990). HamotMedical Center•, however, presented ttnusually strong facts. 'The hospital failed to niaintain an open admissions policy of any kind. Moreover, the hospital violated the prohibition on private inurement by transferring earnings to profit-making subsidiaries and by paying hospital executives excessive compensation_ Nevettheless, the rnost recent decision denied an exemption to a diagnostic claiic solely on grotuids of charity care, obsetving that "the Institute has failed to prove that it donated a'substantial' pottion of its services." In re Pittsburgh NMR Inst., 557 A.2d 220, 224 (Pa. Commw. CY. 1990). Taxing authorities in Pittsburgh succeeded in collecting increased revenues frorn the Presbyterian- University Hospital without revoking its exemption. 'rhe hospital agreed to pay $ 11 million over 10 years for citv servlces. Conversation with Dan Pelligrini, City Attorney, Pittsbtn'gh, Pa. (Aug. 17, 1988) (notes on file with the Washington Law Review); see also Robinson, Via Donation or Tax, Cities Want More Revenues, HOS- PITALS, Mar. 20, 1989, at 55. Also, the Attorney General of Texas has sued Methodist Hospital of IIouston, seeking to revoke its property tax exemptiori. State v. Methodist Hosp. Sys., No. 494,212 (126th Jud. Dist. 'fravis County, Tex. frled Nov. 26, 1990); see also Taylor, Charity Begins in Court? Hosyital Sued in Novel Lawsuit, Nat'l L.J., Feb. 18, 1991, at 3, col. I(discussing State v_ Methodist Ilosp. Sys. and commenting: "This [case] represents a new legal avenue, a new hook for exarnining the charitable mission of a hospital.... Tl ere's no question everyone in the indushy will be watching this case").

n64 North Carolina Center for Pub. Pol'y Researclt, supra note 63, at 159-66 (sumtnarizing the challertges to hospital exemptions across the country and discussing state-by-state activity in detail); Baldwin, supra note 18, at 37 (discussing challenges to hospital excmption initiated by in the states of Florida and Oklahoma); Hudson, supra note 63, at 33 (same); I,arkin, Financial Success May Invite Local Tax Scrertiny, HOSPITALS, Oct. 5, 1988, at 30 (discussing cltallenges pending in at least 20 state conrts or legislatures); Robinson, F'ia Donation or 1'ax, Cities Want More Revenues, HOSPITALS, Mar. 20, 1989, at 55 (sante); Seay & Sigmond, supra note 39, at 4-5 ("C1u'rently, more than a dozen states have reexamined, or have begun to reexamine, thc basic tax-exemption policies for voluntary hospitals, as have ntmierous cities, counties, and other municipalities.") (citing California, Iowa, Kansas, Minnisota, Mississippi, Petutsylvania, Tennessee, Utah, Vermont, Virginia, Washington, and West Virginia); Comment, supra note 55, at 779 ("A 1988 survey ... reveals that at least nhie states ._. are re- evaluating charitable tax exemptions for nonprofit hospitals...... ). "In 1987, at least 13 states considered changes in the tax-exempt status of not-for-profit hospitals. Several states established study conunissions to look into the [issue]." NORTH CAROLINA CENTER FOR PUB. POL'Y RESEARCH, supra note 63, at 159. See generally Barker, Reexamining of501(c)(3) Exemption ofHospitals as Charitable Organizations, 1990 TAX NOTES 339, 346-47. Since 1923, Alabama has required ttospitals to meet a statutorily-defined level of charity care in order to receive a property tax excmption. See Gay v. State, 228 Ala. 253, 153 So. 767, 770 (1934). The current statutory provision exentpts up to $ 75,000 worth of property used exclusively for hospital purposes, if at least " 15% of the [liospital's] business" is the treatnient of charity patients. ALA. CODE § 40-9-1 (Supp. 1990). Apparently, Alabama hospitals rnust annually certify compliance with this requirement to be eligible for the exentption. Id. It is also noteworthy that "public opiniou is closely divided over whetlrer or not hospitals should pay taxes: 49 percent tltink they shotdd; 43 percent do uot." Seaver, Are Hospital.s Becoming Too Businesslike?, HOSPI- TALS, Peb. 20, 1990, at 86.

n65 N.Y. Times, July 15, 1987, at A2 1, col. I: [Congressntan Stark, a] key rnernber of a Cougressional tax-writing comniittee said today that the Federal tax exemption for nonprofit hospitals was probably unwarranted becausc they generally did not provide substantial arnounts of charitable care.... Mr. Stark, a Democrat, said it was unlikely that Congress would revoke the tax exentption for nonprofrt hospitals. But he said such hospitals such be required to demonstrate the benefits they provide to the comrnunity through charitable care. See also Sullivan & Moore, A Critical Look at Recent Developments in Tax Exempt Hospitals, 23 J_ HEALTH & HOSP. L. 65 (1990) QRS officials warning that hospitals that close ttteir emergency rooms or dump emergency patients are threatening their exempt status).

Appx.342 Page 40 66 Wash. L. Rev. 307, *

n66 In the current congressional session, Rep. Edward Itoybal, Chairman of the House Committee on Ag- ing, introduced the "Charity Care and Hospital Tax-Exempt Status Reform Act," H.R. 790, 102d Cong., 1 st Sess., 137 CONG_ REC. E395-97 (1991). 'I'his Bill would revoke a Itospital's exemption or impose an excise tax unless the hospital could show it returned 85% of the value of all federal, state and local exemptions to the eomntunity through uncompensated care, tmique couununity benefits or otlter services not provided by for-profit hospitals. For further dcscription and analysis of this Bill, see infra note 151. In addition, Rep. Brian Donnelly, a member of the House Ways and Means Committee and a ranking Democratic member of the Subcommittee on IIealtlt, is preparing legislation that would incorporate ideas expressed by'I'homas Barker, Rep. Domielly's legislative director, in an article published in July, 1990. See Barker, supra note 64. Barker suggests a return to a charity care standard for exempt hospitals, albeit a more flexible standard than originally contained in Rev. Rzel. 56-185, 1956-1 C.R. 202. Barker, szrrra note 64; at 350-5 1. Barker :*rould alsn permit exemption forhospitals that could detnonstrate "a significant and substantial corntnunity benefit," such as by being the sole eoannunity hospital as defined by Medicare. Id. at 351.

n67 See supra note 63 and accompanying text. Even in Utah, the itnpact of the Utah County holding has been severely diluted by the set of standards subsequently issued to implement this decision. UTAH STATE TAX COMMISSION, NONPROFIT HOSPITAL AND NURSING HOME CFIARITABLE PROPERTY TAX EXEMPTION STANDARDS (Dec. 18, 1990). T'hese standards count as charity care not only the charge-based value of free services, but,also the value of comtnunity service activities and the difference between the hospital's usual discomzted charges and the amount it receives from Medicare at d Medicaid. Id at 4. Moreover, these standards credit as part of a hospital's "gift to the community" the donations of time and money the hospital receives from the community. Id at 4-5. This latter provision absurdly views the exetnption as a tneans to reimburse hospitals for another subsidy they receive.

n68 See supra notes 51-52 and accompanying text_

n69 Sotne of these criteria have been suggested previously in Simon, The Tax Treatment ofNonprofit Or- ganizations: A Review of Federal and State Policies, in TIIE NONPROFIT SECTOR: A RESEARCH HAND- BOOK 67, 76-78 (W. Powell ed. 1987); J. JENSEN, sarpra note 3, at 148: A valid case for exemption should have at least tl2ree aspects. In the first place, the property seeking exemption should be used nt' rendering a service affected with a bona fide public interest. ... In the second place, the service deserving such subsidy must be incapable of behtg fostered adequately on a commercial, qzrid pro quo basis.... In the third place, the tax exemption metltod of subsidizing these services should not be used miless it can be done without serious disproportiou between the benefits and cosis to localities interested. See also S. SURREY, supra note 12, at 134; S. SURREY & P. MCDANIEL, supra note 12, at 72-83.

n70 Regan v. Taxation with Representation, 461 U.S. 540, 544-45 (1983) ("[TJax exemptions... are a form of subsidy that is adtninistered through the tax system...... ); see supra note 12. The contrasting view looks for ajustification of the exemption that would explain why c6aritable income or property is not in the tax base to begin with. See P. SWORDS, CIIARITABLE REAL PROPERTY TAX EXEMPTIONS IN NEW YORK STATE 200 (1981); see also Simon, supra note 69, at 75; infra notes 286-90 and accompanying text (developing further reasons for rejecthtg this tninority view).

n71 Gabler & Shannon, supra note 9, at 2544.

n72 A political cynic might contend tttat it is hopeless to formulate such a tlieory of charitable exemption because "charity" is nothing morc than an empty label that politicians place on wltatever activity they desire to subsidize, for reasous of political expediency, through the tax system rather than tttrough direct appropriations_ One might also take issue witlt this criterion less cynically by tnaintaining that the exemption is frequently the only way that deserving orgatuzations can obtaiu government support because legislators fear the voter approba- tion that attends direct fttttding. These argmnents are unconvincing for the following reasons.

Appx.343 Page 41 66 Waslt. L. Rev. 307, *

First, the fact that political expediency might describe political reality at sotne level should not deter the formulation of a more principled application of the exemption. Idealism aside, such cynical characterizations of the charitable exentption are largely inaccurate. Legislators rarely determine charitable status; the decision generally rests with taxing authorities. Even if politicians were to make this choice,they might choose to fund the worthwhi le activity in a direct fashion if a colterettt theoty of the exemption foreclosed a tax subsidy as an option. Where the legislature declined to subsidize the activity, and an unprincipled application of the exemption was the only available option, perhaps the activity does not deserve support. A tax subsidy is considered politi- cally expedient precisely because it disguises a spending decision from the legislators' political constituency. S. SURREY & P. MCDANIEL, supra note 12, at 104. If an informed constituency objects to the expenditure, then any forrn of subsidy is intproper. Witness, for instance, the pork bTn;el politics that transpired during the'I'ax Reform Act of 1986. J. BIRNBAUM & A. MURRAY, SHOWDOWN AT GUCCI GULCH 146-47 (1987).

n74 I.RC. §¢ 501(c)(3). State exemption statutes which follow the langu age of I.R.C. §501(c)(3) incotporate similar standards by implication. Other state property and income tax exemption statutes explicitly eontaiu the inurement prohibition. See, e.g., GA_ CODE ANN. § 91A-1102(a)(5) (Harrison 1989); HAW REV STAT. § 246-32(e)(1985);WIS. STAT. ANN. § 70-11(4ni) (West 1989). Even where the language is less precise, as in most state property tax exemption provisions, lack of private inurement is generally considered essential to "charitable" status. See e.g., In re Claim ofAssembly Homes v. Yellow Medicine County, 273 Minn. 197, 203- 04, 140 N. MC 2d 336, 340-41 (1966) (construing the words "ptirely public charity" as incorporating a prohibitiott against private inurement). See gene•ally 2B HEALTH LAW CENTER, .cupra note 56, at 21. The same is true for the restriction on political activity. See, e.g., Pennsylvania v. Ameriean Anti-Vivisecteon Soc^, 32 Pa. Commw. 70, 377 A.2d 1378 (1977) (since primary activity of organization was political lobbying, organization was uot a charity).

n75 L.R. C. § 511-14. States generally do not have their own versions of the unrelated business inconte tax contained in LR.C. § 511, atthough state law tnay provide that income of an exempt organization taxable under § 511 is also taxable at the state level. See, e.g, ALA. CODE § 40-18-32(c) (Supp. 1990); ARIZ. REV. STAT ANN. §43-1231 (Supp. 1990). See generally W. W SLLEORD & J. GALLAGHER, supra note 55, at app. A (surveying state tax exemptiott statutes).

n76 Professor Harvey Dale disagrees with tltis uttiversality criterion. Quoting the aphoristic wisdom of H.L. Mencken that "[f]or every complex problem, ttiere is a solution whiclt is simple, elegant,... aud wrong," he maintains that the exemption is a creature of history, not logic, and advocates a case-by-case approach to applying the exetnption that allows it to grow haphaz.ardly like a coral reef. UBIT Hearings, supra note 6, at 1860, 1864 (statement of Harvey P. Dale, Profess(ir of Law and Director, Study on Law and Philanthropy, N.Y.U. School of Law); see also H. Dale, Rationales for Tax Exemption 1(I'eb. 1, 1988) (unpublished tnanuscript) ("[N]o single rationale can or should be expected to explain orjustify tax-exempt status. 'I'he not-for-profit sector of our society is complex and varied; its lineage is ancient. It would be unreasonably simplistic to expect to capture its essence or justification within the compass of any theory."). This theoretical agnosticism may be convincing in assessing the universe of exempt organizations, as legislators award peripheral exeniptions for a variety of reasons unrelated to the charitable concept (such as to attract new industrial growth or to exempt organizations that do not earn income); see supra note 29. Dale's perspective, however, cannot suffice for the core charitable exeniption that entploys a structure purporting to define the scope of its benefits through the single conccpt of charity. Therefore, it demands a colierent, organizing rationale. It is possible that each limitation conuected with the exemption (described hi the preceding paragraph of text) can be sustained as a side constraint on the exemption, one whose justification is independent of the core rationale for the exemption. However, all these limitations are generally tltottght to derive from the concept of charity as that term has been developed through centm-ies of judicial decisions in the field of charitable trusts. See infra notes 97-107. This unitary construction requires that we search for a cohesive concept of what constitutes a charity and why it should be exempt. If no such unifyhig rationale for the charitable exemption exists, it should be abandoned and replaced by a structure that fortltrightly acknowledges whatever the charitable label is masking.

Appx.344 Page 42 66 Wash. L. Rev. 307, *

n77 This criterion does not seek to preserve 400 years of history tnerely for its own sake. Ratlter, it attempts to place history in its appropriate relationship to the charitable exemption.

n78. Treas. Reg. § 1. 5o1(c)(3)-I (d)(2) (1959).

n79. Bob.Zones Univ. v. United Staies, 461 U.S. 574, 586 (1983).

n80 Id at 588 ("The origins of [the] exemptions lie in the special privileges that have long been extended to charitable trusts."); Bittker & Ralidert, supra note 8, at 301; Liles & Blum, s•upra note 2, at 20-21; Thompson, The Unadministrability ojthe Federal Charitable Tax Exemption: Causes, E,j,Jects and Rernedies, 5 VA. TAX REV 1, 12-13 (1985). Further support for this propositiou lies in the fact that Congress pattemed the original income tax after the existing English model. Bob Jones Univ., 461 U.S. at 589 n.13 ("[T]he list of exempt organizations appears to have been pattetned upon English income tax statutes. ..."). And, in tlte celebrated case of C'omnzissioners v. Pemsel, 1891 App. Cas. 531 (II.L.), decided just three years before the 1894 Congressional enactment, the House of Lords declared that the satne concept of charity would prevail throughout British law, applying equally to the law of charitable trusts and the law of tax exeuy tion. See L. SIIERIDAN & G. KEE'I'ON, THE MODERN LAW OF CHARITIES 29 (3d ed. 1983) (charity has "[a] [c]ommon [m]eaning for [a]lI [p]ruposes"); id. at 299 ("Tltere is, in English law, only one definition of a cltarity. If an institution is a charity for purposes of general activity and adtninistration, it is a charity for urcoine tax purposes."); Bellmap, supra note 4, at 2031.

n81 Accord Mancino, supra note 40, at 1017-18 (observnig that academicians have overlooked the common law of charitable trusts); Tltotnpson, supra note 80, at 7(ntaintaining that IRS decisions have "blurred" the meariing of charity by depatting from this body of common law precedent).

n82 W. JORDAN, PHILANTHROPY IN ENGLAND 1480-1660, at 112 (1959). Jordan's discussion is typical of the reverential tones that trust law scholars use to describe the preamble. Id. at 112, 114 ("eloquent preatnble," "almost casual but beautiful wording," and "sought to state and to emtoble aspirations which had become and were to remain central to the structure of the liberal society").

n83 An Act To Redress the Mis-Employment of Lands, Goods and Stocks of Money Heretofore Given to Certain Charitable Uses (Statute of Charitable Uses), 1601, 43 Eliz., ch. 4, reprinted in 7 STAT. AT LARGE 43 (Eng. 1763). This preamble is widely quoted, both in the Middle English and in modem prose,by a number of secondary sotirces addressing charitable tiust and charitable exemption law. G.g., Bittker & Rahdert, supra note 8, at 331 n.81.

n84 That is, it is unclear whether any one of these purposes standing alone is charitable, or whether Parlia- ment meant to refer to a trust that pursues all three objectives. One might also question whether "impotent" only nteans disabled. The statute's only other reference to health care is peculiarly liniited to the "[m]aintenanec of sicke atid maymed Souldiers and marriners." Statute of Charitable Uses, 1601, 43 Eliz., ch. 4, reprinted in 7 STAT. AT LARGE 43 (Eng1. 1763).

n85 Bromberg, Financing Health Care, supra note 40, at 167 n.57.

n86 Langland, Vision oJPier's Plowinan, in THE VISION OF A PEOPLES CHRIST PIERS PLOWMAN 80 (F. Skeat ed. 1906), quoted in W. JORDAN, supra note 82, at 112; see also M. FREMON'C-SMITH, FOUNDATIONS AND GOVERNMENT 24 (1965); Bittker & Rahdert, supra note 8, at 331 n.81.

n87 1634, 10 Chas. 1, sess. 2, ch. 1, quoted in L. SHERIDAN & G. KEE'I'ON, supra note 80, at 30.

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n88 Several antecedents to the statute that provided tnore Ianited protection to charitable trusts confirin that by 1601 health care was an established charitable purpose. One act early in the reign of Hemy V created a charitable comntission to attenzpt to remedy the decay of hospitals that had been establislzed by wealthy benefactors "for the sustenance of impotent persons, lazars, witless men, poor women with child, and the poor generally." W. JORDAN, supra note 82, at 114. In 1572, Parliantent passed another act to assist benefactors "who wislted to found hospitals and almshouses" Id at 115. Futther, an act in 1597 "relieved founders of hospitals, alinshouses, and houses of conection" from the necessity of "obtaining a special royal license or an act of Par- liainent to achieve incorporation." Id, see also M. FREMONT-SMITH, supra note 86, at 26 (discussing the latter two statutes).

n89 Jack.ron v. Phillips, 96 Mass. (14 Allen) 539, 556 (1 S67).

n90 Ould v. Washington Ilosp. for Foundlings, 95 U.S. 303, 308 (1877).

n9l In re Res•ch's llrl! Trusts, 11969J 1 App. Cas. 514, 540 (P.C.).

n92 RESTATEMEN'T (SECOND) OF TRUS7S § 372 (1959); see 4A A. SCOTT & W. FRATCHER, THE LAW OF TRUSTS § 368 (1989) [hereinaiRcr SCOT1' ON TRUSTS] ( "So too, it is well settled that the promotion of healtli is a charitable purpose."); id. § 372 & n.l ("[a] trust for the promotion of health is a charitable trust," even though the statute inentions only soldiers and mariners; citing "numerous" cases); see also G. BOGERT, TRUSTS § 62 (6th ed. 1987); Bromberg, The Charitable Ilosplta( supra note 40, at 240, 244; Bromberg, Financing Health Care, supra note 40, at 167 (citing cases to show that "English law has long interpreted the charitable purpose enuinerated ut' the preamble . .. in the disjunctive, thereby permitting a cltaritable tnist to operate for the benefit of sick or aged persons without reference to tlieir fmancial condition")_

n93 Early English law developed a somewhat hostile attitude toward trusts (originally called "uses" as a consequeuce of their conveyance of legal title to a nominal owner "for the use of' anotber), because they originated in feudal titnes as devices for hiding land from creditors and the exactions of landlords. The fraud and confusion caused by these unrecorded separations of legal title from equitable title led to the 1535 Statute of Uses, which sought to abolish this device altogether by declaring that, for land transfers, the beneficiary holds legal title as well. But the statute failed under the strict construction of courts that continued to allow uses in personalty, and uses upon uses (in other words, a transfer of title to X for the use of Y, who holds for the use of Z). The terin "trust" arose in Chancery as a means for distinguislting enforceable from unenforceable uses. Nevertheless, trust law continued to irnpose numerous and technical restrictions on these legal instruments. G. BOGERT, supra note 92, at §§ 7-13. The more favorable treatment accorded charitable tiusts evolved from the special treatment that ecclesiastical courts accorded devises for religious purposes. The Chaneery courts carried on this tradition afler ttie Ref- onnation. L. SHERIDAN & G. KEETON, supra note 80, at 1-2; Persons, Osborn & Feldtnan, .supra note 2, at 1916-17.

n94 RESTATEMENT (SECOND) OF TRUSTS §§ 209-10.

n95 Id. § 365. Although it is sometimes misleadingly said that charitable trusts are relieved from the application of the Rule Against Perpetaities, most trusts are not affected by the Rule since they vest immediately upon the testator's death. See G. BOGERT, supra note 92, § 68. A related liniitation of greater intpottatrce derives from the law's general opposition to restraints on alienation: "A private ttust cannot be created so that it must continue for an unlimited period of time... and [so] a provision that the trust shall never terminate even t9tough all of the beneficiaries wish to terminate it... is invalid." RESTATEMENT (SECOND) OF TRUSTS § 365 cotnment a. This duratiottal restraint is the principal limitation from which charitable tnists are relieved.

n96 RES'I'ATEMENT (SECOND) OI' TRUSTS § 399.

Appx.346 Page 44 66 Wash. L. Rev_ 307, *

n97 The Mortmain statute respottded to concerns at the time that the Church was pressuring htdividuals to leave unduly large bequests to it at the expense of their disinberited families. This legislation invalidated cliaritable bequests of land that were not executed throngh rigid formalities more than one year prior to deatl . G. JONES, IIISTORY OF THE LAW OF CHARI7'Y 1532-1827, at 109-10 (1969)- To avoid these restrictions, "objects wltich were in daruger of being [stigmatiz_ed] as charitable often sought to divest themselves of this un- welcome status." !d at 128. Affected legatees maintained that challenged gifts were not "charitable," and courts, often struggling to uphold such giRs, begau to draw unprincipled distinctions regarding what properly should be deemed charitable,

n98 Morrce v. Durham, 10 Ves. 521, 7 Rev_ Rep. 232 ( 1804); see Scott, Trusts for Charitabte and Benevo- lent Purposes, 58 HARV. L. REV. 548 (7945).

n99 L. SIIERIDAN & G. KEETON, supra note 80, at 11; see G. JONES, satpra note 97, at 133 ("1'lte equity, or'spirit' of the preamble, as it was called, was elevated into the Delphic oracle of legal charity."); Persons, Osbom & Feldman, supra uote 2, at 1914.

nlOO Persons, Osborn & Feldman, supra note 2, at 1915 (quoting older edition of Keeton's treatise).

n101 1891 App. Ca.s. 531 (H.L.).

( clearly re- n102 Bob.7ones Untv. v. Unlted States, 461 U.S. 574, 589 (1983) "These stateinents [in Pernsel] veal the legal backgroutld against whicb Congress enacted the first charitable exemption statute in 1894. ...").

n103 Pemsel, 1891 App. Cas. at 583.

n104 Persons, Osborn & Feldman, supra note 2, at 1915-16.

1959). n105 RESTATEMENT (SECOND) OFTRU.STS § 368(f (

n106 Id § 374 comment c, conunent f; see also SCO7T ON TRUSTS, supra note 92, § 374.2.

note 92, § n107In re Cranston, [1897] 1 LR. 431, 446-47 (Ir. H. Ct.), quoted in SCO7%' ON TRUSTS, supra 374.7; see RESTATEMENT (SECOND) OF TRthS7S § 374 comment 1("[T]he mere facttlrat a majority of the people and the members of the court believe that the patticular purpose of the settlor is unwise or not adapted to the accontplislunent of the general purposes, does not prevent the trust from being charitable.").

n108 RESTAMMENT (SECOND) OFTRUS7S § 368 comrnent b, § 374.

nI09 See P. ATIYAH & R. SUMMERS, FORM AND SUBSTANCE IN ANGLO-AMERICAN LAW 5-L 1 (1987).

nI10 BLACK'S L.AW DICTIONARY 312 (3d ed. 1933) defines charitable purposes as those "for a general public use _.. designed to benefit them from an educational, religious, nioral or social standpoint."

Appx.347 Page 45 66 Wash. L. Rev, 307,'

n 11 I For instance, a tnrst to mahttain a public graveyard is valid, but one to maintain a particular tomb is not. RE'S7ATEMENT (SECOND) OF TRUSTS § 376 connnent a. For fiirtlter elaboration of this distinction, see Atiyah, Public Benefit in Charities, 21 MOD. L. REV. 138 (1958).

n112 See L. SHERIDAN & G. KEETON, supra note 80, at 32-50. See generally M. CHFSTERMAN, sa<- pra note 1, at 316 (discussing the connection between these organizatimual limitations and the requirernent of public benefit).

n113 Harrington v. Pier, 105 Wis. 485, 520, 82 N. W 345, 357 (1900); see also Ould v. Washington Hosp. for Foundlings, 95 U.S. 303, 311 (1877) (charity includes "anytliing that tends to promote the well-doing and well-being of social man"); Wilson v. FirstNat'1 Bank I64Iowa 402, 145 N. W 948, 952 (1914) ("The word charity,' as used in the law, ... includes substantially any scheme or effort to better the condition of society or any considerable patt thereof:")

n114 Conunent, Collaboration Between Nonproftt Universities and Connnercial Ente3prises: The Rationale for Exempting Nonprofit Universities ftom FederalIncome Taxation, 95 YALE L.J 1857, 1964 (1986); accord J. JENSEN, supra note 3, at 148 ("In a sense, all legitimate economic activities are affected with a public interest."); Ginsberg, supra note 54, at 312 ("The very existence of land, whetlter left in its natural state or developed, is a benefit to society."); Tltompson, supra note 80, at 14 ("[T]he catch-all category of charity -- putposes betie- ficial to the cotmmtnity -- is so broad, it can conceivable encompass almost any program to proinote social welfare. . . ."). The trust is one of the classic lessons taught by the fundamental turn in Constitutional jurisprudence that occurred earlier this century whe, after over half a century of Supreme Cottrt efforts to confine social and economic legislation to businesses "affected with the ptiblic interest," Munn v. Illinois, 94 U.S. 113, 126 (1877), the Court abandoned substantive due process scrutiny with respect to such legislation, observing, "there is no closed class or category of businesses affected with a public interest. . .." Nebbia v. New York, 291 U.S 502, 536 (1934). Attentpts to police the substautive limits of the exemption under the rubric of "public benefit" would be as flowed as the Suprenie Court's attempt to police the substantive wisdom of eeonomic and social legislatiou,

n115 SCOTT ON TRUSTS, supra note 92, § 368 ("The truth of the matter is that it is impossible to frame a perfect dcfinition of charitable ptuposes. There is no fixed standard to determine what purposes are charitable."); L. SHERIDAN & G_ KELTON, supra note 80, at 26 ("Judges long ago abaudoned the task of attempting to defuie what a charitable ptupose is."). For a particularly tortued attempt to tease some meaning o ut of the pubficbenefit concept hi the context of distinguishing between legitimate public interest law firms and those established to advance the interests of ntajor commercial firsm, see I Iouck, With Charity for All, 93 YALE L. .C 1415 (1984).

n 116 Persons, Osborn & Feldman, supra note 2, at 1909.

n117 See A. BALK, supra note I, at 86 ("It seems to have become progressively easier for altnost any organization that engages in sotne activity of social or cultural significance to make the tax-free list. ..."); Buch- ele, Justifying Real Property Tax Exemptions in Kansas, 27 WASHBURN L. REV. 252, 273 (1988) ("Almost every kind of organization not rnn for profit has sought to escape taxation as a charitable institution."); IIans- ntann, The T'wo Independent Sectors, supra note 8, at 4("[T]he exemptions have traditionally been read so broadly as to encontpass nearly all nonprofits of any financial significance.... In general, the words'ttonprofit' and'tax-exempt' have been coterminous."); Cotnment, supra note 7, at 1087 ("[A]lmost every kind of organization not ruu for profit and not exclusively a social or sporting club has sought to escape taxation as a charitable institution. The courts have ltad to flounder in a morass of strange facts. ...").

nl 18 See University of London v. Yarrow, 24 Eng_ Rep. 649 (CTz 1857) (upholding a trust to establish a vet- erinary institute).

Appx.348 Page 46 66 Wash. L. Rev. 307, *

n119 Even absent an established precedent in trust law, hying the exemption to the charitablc trust definition of charity would permit exeinption in cases where merely tlteorizing that if a tntst for the same purpose were established, it would provide sufficient public benefits to deserve protcction from the Rule Against Peipe- htities. See Warren, Krattenmaker & Snyder, Property Tax Exemptions for Charitable, Educational, Religloais and (3overnrnentalInstitutions• in Coranecticut, 4 CONN. L. REV. 181, 238 & n.212 (1971) (exemption for boy scout camp upheld because "an institution is charitable when its propeity and funds are devoted to such pruposes as would support the creation of a valid charitable trust;" citing si nilar holdings for dining rooms, women's resi- dences, museums and ttre like).

n120 An example pertinent to hospitals comes from the conversion of for-profit hospitals to a nonprofit status. There have been several recent instances where the owners of a proprietary hospital who wished to sell were tmable to find a willing buyer at a sufficient price, so instead they formed a nonprofit corporation to buy the assets of the hospital at theu- appraised price and to give back to the owners a managentent contract. Conver- sation with Richard McAlee, Esquire, Baltimore, Md. (Nov. 15, 1990) (notes on file with the Washington Law Review). It is easy to see how such a transaction might lead to abuse of the exeinption.

n121 Any other form of distribution might violate fee splitting and referral fee prohibitions. See generally Hall, Making Sense qf Referral Fee Statutes, 13 J. IIEALTH POL., POL'Y & LAW 623 (1988).

n122. In niost cases, an income tax exemption would notbe relevaut to a group of physicians because they usually organize in an cntity, suclt as a partaership or S corporation, that is not subject to a separate income tax. Instead, group eantings are taxed only to the individuals on a pass-through basis. See generally W. MCKEE, W. NELSON & R. WIIITMIRE, FEDERAL TAXATION OF PARTNERSHIPS AND PARTNERS P1.01(1) (Supp. 1989). Using an exempt entity, however, may permit doctors a tax advantage on earnings reinvested in capital equipment While depreciation dednctions would permit a tax-free recovery of equipment costs over time, in a taxable entity the value of the deductions will never equal the initial a8er-tax cost of the capital investment. Suppose, for example, that a typical group practice requires $ 1 million in equiptnent. One method for acquiring this equipment would be for the doctors to purchase it witlr afler-tax dollars. If the tax rate were 50%, the doctors would have to earn initially S 2.0 million to pay $ 1 million in taxes and have $ 1 million left for the capital investtnent. Over a period of years the doctors would receive $ 1 million in depreciation deductions that will permit the free recovery of the $ 1 million invested in equiptnent. The "extra" $ 1 million needed at the beginning, however, will not be recovered. Moreover, cost recovery is available onlyover time, meaning that the duduetions are worth less than the investment on a present-value basis. In a tax-exempt entity, however, only $ 1 niiilion in needed to invest $ 1 million. The "extra" $ 1 mitlion can Ylien be invested in still more equipment (nicer offices?) or else paid out to the doctors as additional "profits." Moreover, exemption may be important because structural Iitnitations on the partnership or S coiporation form of business may reqnire a "regular" corporate entity. S corporations, for example, are litnited to 35 shareholders, LR.C. § 1361(b)(I)(A) (1989), so a group practice witlr more than 35 doctors would need the exemption to avoid a separate cotporate tax.

n123 See infra notes 223-28 and accotnpanying text.

n124 Ilansmann, sup-a note 11, at 868: It is ... as if a foundation, tax-exetnpt and supported in part by public contributions, were to build office space and then lease it at cost, or less, to Wall Street law finns. One would not expect to see the lawyers in a hurry to have the foundation converted into an ord'ntary profit-making landlord. The exemption's influence on doctors' preferences under convcntional financial arrangements is evidenced by the different behavior of doctors when they desire to invest in hospitals. In those instances, they abandon the nonprofit ethic and the exemption subsidy in favor of organizing their own proprietary hospitals. See gerterally

Appx.349 Page 47 66 Wash. L. Rev. 307, *

Marmor, Schlesigner & Smithey, supra note 28; Relman, Dealing IT'ith Conflicts oflnterests, 313 NFW ENG. J. MED. 749 (1985).

n125'Ihe IRS refuses to exempt pttysician groups under the theory that they serve the private interests of doctors rather than the public's interest in health care; but this is transparently incorrect. As long as physician groups are willing to accept anyonc in the comunutity able to pay and in need of care, there is no distinction between the public quality of services delivered by physician groups or hospitals. It is true that group practices pay doctors handsome salaries; but doctors also earn handsome utconies from hospitals. Remuneration for services rendered should not defeat nonprofit or charitable status nnless the amount paid exceeds the fair market value of the services. See Colombo, supra note 41, at 492-98.

n126 See generally id. passim.

n127 Feder•ation Pharmacy Servs. v. Commissioner, 72 T.C. 687 (1979), crffd 625 F.2d 804 (8th Cir. 1980); see also Colotnbo, supra note 41, at 485-92, 512-21.

n128 Maryland property tax statutes, for example, specifically exempt property used for hospital putposes, and exernpt propetty used for general charitable purposes. MD. TAYPROP. CODF,ANN. § 7-202 (1986). A recent Maryland case nevertheless held that the property of an HMO was not exempt because the FIMO was not "charitable" despite its unrestricted membership (consisting at the time of sotne 65,000 Maryland residents). Montgornery County v. Group Health Ass'n, 308 Md 151, 517 A.2d 1076 (1986). Similarly, some states have taken the position that rental ofoffice space by hospitals to physicians for private practice violates exemption requirements, notwithstanding the fact that such space is used to provide general liealth care. See Greater An- chorage Area Borough v. Sisters of Charity of the House ofProvidence, 553 P.2d467 (Alaska 1976); (ienesee Hosp. v. Wagner, 47 A.D.2d 37, 364 N.Y.S.2d 934 (1975); Gifford Memorial Hosp. v. Randolph, 119 Vt. 66, 118 A.2d 480 (1955). Nursing homes sometitnes also face disparate state treatment. Fairviem Haven v. Department ofRevenue, 153 III. App. 3d 763, 506 N.E.2d 341 (7987) (no exemption tmless nursing hottte accepts some charity patients); Lutheran Home v. Board ofAssessment, 100 Pa. Commw. 244, 515 A.2d 59 (1986) (saine).

n129 Teachers' Insivance and Annuity Association/College Retirement Equities Fund (TIAA/CREF) is the life insurance and retirement atmuity company that serves most nonprofit educational institutions.

n130 See HOUSE COMM. ON WAYS AND MEANS, TAX REFORM ACT OF 1985, H.R. REP. NO. 426, 99t1i Cong., I st Sess. 664 (1985) (codified at 26 U.SC. § 501(m) (] 988)) (it is "inappropriate" to exempt atr "inlierently commercial" activity, such as selling insnrance "to the general public at a price sufficient to cover the costs of insurance"); UBIT Hearings, supra note 6, at 991 (statement of Gabriel Rudney) (discussing this legislative action).

nt 31 Indeed, overturning Rev. R¢d. 56-185, 1956-1 C. B. 202, is implicit in the pending Charity Care and Ilospital Tax-Exempt Status Reform Act, H.R. 790, 102d Cong., lst Sess., 137 CONG. REC. E395-97 (1991) (discussed infra note 151 and accompanying text).

n 132 See Buchele, supra note 117, at 273 ("The extended scope of humanitarian functions necessary to qualify for exemption must be defnted or limited in some way. Otherwise all property owners would ... claim tax exemption."); Fox, The Uneasy Law ofReal Estate Tax L'aemption.e in Pennsylvania, 39 (L PITT. L. REV. 175, 248-49 (1977) ("Although the rationale of the court is far from clear, it is apparent that the court was seeking to limit the extent of activities which could qualify as charitable ...[based] upon the court's view of ptblic policy."); Ginsberg, supra note 54, at 312 ("[O]f itself, the [public] benefit theory is too broad to be useful. --- [It] must be coupled with corollary propositions relating to the nature of the benefits _.- tltat would be useful to a court or tax assessor making case-by-case determinations of exempt status..."); Thompson, supra note 80,at

Appx.350 Page 48 66 Wash. L. Rev. 307, *

53 (1985) ("[T]he danger is that the charitable exemption will ... beconre an unliniited and undefinable concept."). Professor'I-hompson nrisperceives the nature of the problem; he maintains that the boundless nature of charity can be avoided by relying on "the common law legal concept of charity." Id. 'fhis Article, however, explains that the scope of charity at conunon law was also without bounds,

n133 For instauce the current position of the IRS, that nonprofit hospitals deserve the subsidy and nonprofit physician groups do not, Colornbo, supra note 41, at 492-98, does not resolve the exempt status of hospital/physician joint ventures that proliferate in the cnrrent reimbursement environnient. See Hall, supra note 22, at 493.

n134 It is possible to reach the per se exenipt position through routes other than the law of cltat'itable trusts. These alternate theories are discussed as variants of the community benefit theory. See infra notes 258-68 and accompanyhrg text (discussing the public trust variant); infra notes 269-76 and accompanying text (discussing the plow-back variant).

n 135 55 CONG. REC. S6728 (1917) (statement of Sen. Hollis). The Senator made these comments in reference to the charitable deduction, not the exetnption; but the Supreme Court has applied the same rationale to both as they are in pari materia. See Bob Jones Univ. v. United States, 461 ILS 574, 590 (1983).

n 136 See, e.g., McGlotten v. Connally, 338 F. Supp. 448, 456 (D.D.C. 1972) ("The ratioriale for allowing the deduction of charitable contributions has historically been that by doing so, the Government relieves itself of the burden of meeting public needs whicli in the absence of charitable activity would fall on the shoulders of the Government."); Legat v. Adorno, 138 Conn. 134, 83 A.2d 185, 191 (1951) ('"I'he grant of'tax exemption to ... hospitals ... encotu-ages and facilitates their performance of a govea-iunental duty whicit wonld otherwise have to be performed by the state."); H.R. REP. NO. 1860, 75t1t Cong., 3d Sess. 19 (1938) ("The exemption from taxation of rnoney or property devoted to charitable and other purposes is based upon the theory that the (iov- ernrnent is compensated for the loss of revenue by its relief from the financial burden which would otherwise havc to be met by appropriations from pnblic funds...... ); B. HOPKINS, supra note 31, at 6-7.

n137 709 P.2d 265, 269 (Utah 1985). However, the Utah court failed to consider the specific measure of deservedness required, as developed in the text that follows.

n138 See inf'ra note 151 (sununarizing the Charity Care and 1-tospital'I'ax-Exempt Status Reform Act, H.R. 790, 102d Cong., 1 st Sess., 137 CONG. REC. E395-97 (1991)).

039 J. BENNEI"f & T. DILORENZO, supra note 17, at 84 (quoting the AHA's clahn that nonprofit hospitals gave $ 22 billion in free medical care to the poor over a five-year period).

n140 Accord Hyman, supr•a note 51, at 361; see Rehnan, Are Voluntary Hospitals Caringfor the Poor?, 318 NE6f' ENG. .1. MED. 1198, 1199 (1988) (tax exetnption would be "troubling" and "hard tojustify" if nonprofits are not doing more for the poor than for-profits). It is insnfftcient to speak of nonprofit ltospitals doing their"fair share." See Yoder, supra note 11, at 113 ("It is, aecordingly, difticult even in theoty to provide a standar(i for determining wltether a particular hospital has done its'fair share' of charity care or, indeed, whether the noflon of'fair share' makes sense. ..."). The required standard is capable of quantification at a level independent of prevailing local demand for charity care. The measure of performance should not be fixed to local needs, but to the value of the exemption. Thus, even con- crete percentages, such as 3% of operating expenses required under the I-Iill-Burton Act, 42 C.1%.R. § 124503 (1979), or the 15% of revenues required by Alabama, supra note 64, are arbitrary unless based on a comparative estimate of charity care provided by for-profits.

Appx. 351 Page 49 66 Wash. L. Rev. 307, "

n141 Simpson & Lee, Nonprofit Community Hospital Tax Exemption: issues for Review 10 n. 14 (May 1987), reprinted in UT3IT Hearings, supra note 6, at 778 n.14. As one court criticized, "[t]hese'uncompensated care` patients ... are aggressively pursued by [the hospital] tltrough every avenue of the collection process. [Che hospital] has sued the very patients that it would now have this court deem objects of charity-" School Dist. v. Hamot Medical Center, No. 138-A-1989, slip op. at 14 (Pa. Ct. C.P., Erie Co., May 18, 1990).

n142 Accordingly, the term "charity care" generally signifies servicea for which the hospital requests no compensation. Tn cotttrast, "uncon pensated care" or "free care" signifies bad debts plus true "charity care." Some l ospitals atteinpt to elain "contractual adjustments" as charity care_ Contractual adjustments represent the difference between a hospital's norntal charges and the atnount the hospital agrees to accept from a note 52, at 80. Because for-profit hospitals treat the same See Ranunell & Parsons, supra tltird-party payor. the Hospital Industry, proportion of Medicare and Medicaid patients as nonprofits, see Sloan, Property Rights in in HEALTH CARE IN AMERICA 103, 135 (1988), and negotiate discounts with private ntsurance companies, these contractual adjustments generally are the same for both sectors. '1'hereforc, most autltorities disregard con- supra note 141, at tractual adjustments in these calculations. See Yoder, supra note 11, at 98; Simpson & Lee, Lewin & Associates, Settiug the Re- 778 n.14; Sloan, Valvona & Mullner, supra note 37, at 16. See generally cord Straight: The Provision of Uncompensated Care by Not-For-Profit Hospitals 28 (1988) (unpublished). Measuring the value of charity care --charges or costs, and if costs, average or marginal -- presents another complication_ Most stndies use the hospital's norinal charge structure, which represents the most generous measure of the hospital's sacrifice. Some analysts, however, complain that this measure of charity care dispro- pottionately benefits proprietary liospitals because they tend to have a somewhat higher mark-up of charges over costs. See Lewin, Eckels & Miller, Setting the Record Straight: The Provision of Uncornpensated Care by Not- For-profit Hospitals, 318 NEW ENG. J Mb:D. 1212, 1215 (1988). The altentative, however, is to use costs as a supra measure, in which case it would be inappropriate to use average rather than marginal costs. See Hyman, (responding to Lewin). Ttte note 51, at 361; Hytnau, Letter to Editor, 319 NEWENG. J. MED. 1486 (1988) more appropriate cost meastu'e -- marginal costs -- would greatly iucrease the level of charity care needed to justify the exemption. Therefore, nonprofits nsay have to tolerate the intperfection inherent in the clzarge measure. (One possible adjustment wonld involve discounting the charge measure by the hospital's average negotiated discount with insured patients, bnt this shotild have no great effect since both sectors grant approximately the same discounts.)

n143 J. HOLLINGSWORTH & E. HOLLINGSWORTH, supra note 25, at 106-07. The leading study supplying 3.7% of their care for found "no clear difference between for-profits aud not-for-profits," the former free in 1983 and the latter 4.2%. By comparison, the figure for public hospitals is 11.5%. Yoder,supra uote 11, for-profit hos- at 102 ( overall, the national data frni AHA surveys provide weak support for the hypothesis that to pay."). The nutnbers pitals do less than not-for-profit hospitals to meet the needs of paticnts who are ttnable were even closer when this stucly was repeated in 1985. U.S. GENERAL ACCOUNTING OFFICE, PUBLIC HOSPITALS: SALES LEAD TO BETTER FACTLITIES BUT INCREASED PATIENT COSTS 46 (June 1986) for investor-owtted hospitals; citing data fi'om (voluntary hospital sector provided 4.6% free care versus 4.3% to be 4.8% for nonprofits, 5.2% for for- AHA indigent care survey). For 1988, these numbers were estintated profrts. See U.S. GOVERNMENTACCOUNTING OFFICE, NONPROFIT HOSPITALS AN D TIIE NEED 30, 1990), reprinted in FOR BF.TTER S'TANDARDS FOR TAX EXEMPTION, REP. NO. 90-84, at 2(May see also Herzlinger & Krasker, Who MEDICARE & MEDICAID GUIDE P38,608 [hereinafter GAO REPORT]; 65IJARV. BUS. REV. 93, 103 (1987) ("[F]or-profits gave slightly nzore access to pa- Prafitsfrom Nonprofrts?, satpra note tients who cany little or no health insurance than did the nonprofits."); Sloan, Valvona & Mullner, 37, at 24.

n144 Thus the ditlerence in 1983, one year prior to the enactment of Medicare Diagnosis-Related Groups supra note 11, (DRGs), was 0.5% in favor of non-profits, but only 0.3% in 1985, one year after DRGs. Yoder, at 102. In 1988, the AIIA estimated that the non-profit percentage of total revenue attributable to uncotnpen-

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supra note 143, at sated care was .4% less than tbat of for-profit hospitals (4.8% versns 5.2%). GAO REPORT, 2.

n145 Lewin, Eckels & Miller, supra note 142, at 1213-14 (in Florida, North Car'ollna, Tetmessee and Vir- ginia, the uncompensated care burden is 50% to 90% higher at nonprofit hospitals than at investor-owned hospitals).

n146 Tlte IRS effectively applied the "open door" policy prior to the 1969 ruling by acknowledging in decisions under the 1956 ruling that the exemption would still exist even without demand for free care. See Com- ment, supra note 42, at 758. See generally supra note 44. Other exatnples of courts tnat adopt or suggest tire view that an open-door policy is sufficient include: Hart v. Taylor, 301111. 344, 133 N.F. 857 (1921); Wes•t Alle- gheny Hosp_ v. Board of Property Assessment, Appeals & Review, 500 Pa. 236, 455 A.2d 1170 (1982); Medical Center Hosp, v. Ciry ofBzrrlington, 152 Vt. 611, 566 A.2d 1352 (1989). "The Vermont court indicated clearly and succinetly that the main detenninant of a charitable hospital was the availability ratlier than the actual amottnt of fi-ee care." O'Donnell & Taylor, The Bounds ofChrrrity: The Cmrent Statns of the Hospital Property- Tax Exemption, 322NEWL'NG. J. MED. 65, 66 (1990).

n 147 The GAO Report found that "many [nonprofit] hospitals' admissions and transfer policies limit elec- tive care for those unable to pay." GAO REPORT', supra note 143, P23,526.

n148 One rnigltt contend that nonprofit hospitals relieve government burden eveu when they serve only paying patients because the government has an htterest in fostering the delivery of health care. This rationale ignores ttte deservedttess criterion. Nonprofits do not earn the exemption from paying patients unless their services are superior to those supplied by for-profits, a contention addressed as the "community benefit" theory. See lrilra Section III.C. The present discussion is restricted to the government btirden theory as it applies to free hospital services.

n149 Agnew v. Parks, 172 Cal. App. 2d 756, 343 P.2d 118, 123 (1959); Childs v. Weis, 440 S. W.2d 104 (Te.e. Ct. App. 1969). Prhtciple VI of the AMA Code ofMedical Etltics, however, suggests an ethical duty to noneniergency sihiations: "A treat emergency patients because it pertnits doctors to turn down patients only in physician shall,... except in emergencies, be free to chose whom to serve. ..." T. BEAUCIIAMp & J. CHIL- DRESS, PRINCIPLES OF BIOMEDICAL ETHICS app. II, at 332 (2d ed. 1983); see also May, Code, Cove- nant, Contract, or Philanthropy, HASTINGS CENTER REP., Dec. 1975, at 29.

n150 Thus, the GAO Report coucluded tttat "some [nonprofit] hospitals lack proactive goals or policies for uonemergency indigent care ._.[and] did not generally have strategic goals designed to expand or hnprove indigent access to care." GAO REPORT, supra note 143, P23,528. The deceptiveness of an "open-door" policy is documented by the track record of hospitals under the Hill- Burton Act of 1946, Pub. L. No. 79-725, § 601, 60 Stat. 1040 (codified as amended at 42 U.S.C. §§ 291, 291a (1989)). For a tinre, Hilt-Burton regulations required hospitals that received grants under the program to opt between providing 3% of their amtual operating costs as charity care and inaintaining an open door policy. 42 C.F.R. §§ 53.111, 53.113 (1973). Sixty percent of hospitals chose the open door option; yet provision of uncompensated care remained at vety low levels. Dowell, Hill-Bza-ton: The Unfulfilled Promise, 12 J. HEALTH POI.., POL'Y & L. 153, 157 n.16 (1987). For example, "[i]n Alabama, the 136'open door' facilities provided a total of $ 25,636 worth of uncoinpensated care, an average of $ 190 each." Id. In response to widespread evidence of a similar ilk, the government repealed the open door option in 1979. Id at 158,

n151 Expressed in terms of an equation wttere U[n] represents uncompensated care (charity care plus bad debts) provided by nonprofit hospitals, U[f] is the uncompensated care provided by for-profit hospitals, and T[n] is the tax relief enjoyed by nonprofit hospitals -- all in terms of a percentage of revenues - the tax exetnption is fLilly earned only if:

Appx.353 Page 51 66 Wash. L. Rev. 307, *

U[n] - U[f] > T[n] The Charity Care mzd Hospital Tax-Exempt Status Refortn Act, H.R. 790, 102d Cong., lst Sess., 137 CONG. REC. E395-97 (1991), proposes an approach that matches uncompensated care to the value of the exemption. The Bill, however, fails to require nonprofrt hospitals to exceed the base of uncotnpensated care provided by eqiuvalent for-profit hospitaLs. The Bill also requires only 50% of the exemption be earned through ancompen- satetl care, leaving the remainder to unspecified "comniunity benefits." Id. § 1(a). Curiously the Bill cotnpares nonprofit perforinance to for-profit in this second category of community benefits. '1'he following are the core provisiotts of this proposed legislation: (1) An organization which operates a hospital shall not be exentpt from tax under [§ 501] unless [it] (A) ... has an open-door policy toward Medicare and Medicaid patients attd ...(B) provides in a nondiscriminatory mamter suf$cient qualified charity care ancl provides sufficient qnalified commuttity benefits....

(2)(B)(i) The determination under paragraph (1)(B) shall be based on whether -- (I) the hospital's unreimbursed qualified charity care costs are 50 percent or more of the value of the hospital's exempt status for the taxable year, and (11) the hospital's unreimbursed qualified conununity benefits costs are 35 percent or more of the value of the hospital's exempt status for the taxable year. (ii) Por purposes of this subparagraph, the term "qualified charity care costs" means ttte aggregate of -- (1) the hospital's costs in provid'utg healtb care without charge to persons with no or a limited ability to pay or at a discount based on the ability to pay, (II) the hospital's costs in providing health care for which the charge was deducted as a bad debt, [and] (Ill) the excess of the hospital's costs in providing health cat-e to Medicaid patients over the reimbursements for such care_...(iii) [T]lie tenu "quali6ed connnunity benefits costs" means ... the hospital's unreimbursed costs in providing those coinmmtity benefits not custotnarily provided by hospitals which ar•e not exemptfi•om tax....

Id. (emphasis added)_ The Bill tlren prescribes a method for detennining each hospital's target percentage, based on a national average value of the exemption (federal, state and local). In addition, the Bill allows the IRS to itnpose an excise tax in the ainount of any hospital's shortfall, rather than denying it exempt stattts altogether. Jn attempting to account for 50% and 35% of the value of the exemption, die Bill does not require initially a justification for the remaining 15%, prestuning that nonprofits make up this difference throttgh otlter, intangible benefits not provided by for-profits. For informational purposes, the Bill requires hospitals to docutnent ammally "the cotnmunity benefits ... which are not customarily provided by [for-profit] hospitals... and which are not taken into account [elsewhere ht the Bill.]." Ia' § 1(b). This information would provide the basis for Congress to determine whettter this presumption slrould conthiue. Conversations with Gary A. Christopherson, Director, Health Logislation, House Select Committee on Aging (Oct. 11, 1990 & Jan. 7, 1991) (notes on file with the Washinegton Law Review). Proposals made by Thomas R. Barker, legislative director to Representative Brian Dotntelly, that will be the basis of legislation to be introduc ed this session,are also based upon the historic "relief from government burden" theory. Barker suggests that Congress adopt a modified charity care standard as ttte basic test for exemption, requirhtg that ltospitals show they devote "more than an insubstantial portion" of their revenues to charity care in order to receive exemption. Barker, supra note 64, at 350-51. To counter the argument that certain hospitals may be located in geographic areas where there is little need for charity care, Barker would give the IRS flexibility in impleinenthig the "more than insubstantial standard," suggesting as one approach for measuring charity care need ttte disproportionate patient percentages used by Medicare to detetmhie reintbursement rates_ Id. Barker would also pertnit ltospitals that flunk this test to qualify for exemption if they cotild demonstrate "siguificant and substantial community benefit," such as beit>b the sole community hospital as defined by Medi- care. Id. at 351. Unlike Roybal's Bill, however, which attempts to match the economie benefit of exemption to ttte cost of charity care, Barker's proposals essentially are a retunt to a cltarity care standard that has no relationship to the value of the exemption_ These proposals, therefore, suffer frotn the satne serious propottionality defects as current law, and would not meet the baseline test of requiring hospitals to dentonstrate that the incremental fi-ee care provided at least matches the economic benefit of exemption. In addition, the Utah State Tax Commission recently issued a set of guidelines implementing a charity care stattdard with which nonprofit ltospitals and nursing lton .es must comply for property tax exemption. See supra

Appx.354 Page 52 66 Wash. L. Rev. 307, `

note 67. Like the Roybal Bill, the Utah standards requn-e hospitals to prove that the value of the serviccs tltey return to the community equals the full value of the exentption. 'I'he Utah standards, however, suffer from two defects. First, the Utah staudards measure only the value of the property tax exemption. Second, they etnploy an overly generous measure of the value of cltarity care services. Id

n152 D. Falcone, America's National Health Insurance Program: The Political Economy of Tax Expendi- utres on Hospital Care 10 (Jan. 4, 1988) (uupublished manuscript) (whatever comparative advantage nouprofits have on free care, "the atnount uncovered will not offset even conservative estimates of hospital tax expenditures").

n153 The results of this study are confirmed by smaller-scale studies of individual or groups of hospitals. A study of 11 nonprofit and 4 for-profit hospitals in Utah found that nonprofits received an estimated $ 24 tnillion in tax relief while delivering a total of $ 15.7 million in uncompensated care in 1986, Pace Management Ser- vices, 1986 Financial/Charity/"Social Overhead" Performance of Wasatch Front [Utalt] Hospitals 3 (1989) (unpublished study perforined by private consulting firm). This aggregate fails to dedtict the proportionate amount of unconrpensated care provided by the for-profits. In this instance for-profits provided slightly inore sach cai-e (3.46% of net reveuue as against 3.21%), id. at 2. Thus, the precise comparison would reflect $ 24 million in tax assistance versus $ 0 of incremental fi'ee care. See also U.S. Genetal Accounting Office, Proposed Job Design: Nonprofit Hospitals' Charitable Role 7 (1989) (unpublished draft) ("[S]tudies examining hospitals in Texas and Florida showed that once adjustments had been ma(le for tax subsidies or income taxes paid, investor-owned hospitals provided as much, or slightly more uncompensated care than nonprofit hospitals."). A similar study of all 1'emtessee hospitals based on 1983 data reached the opposite conclusion, finding that "not-for-proftt hospitals contribute more in uncompensated care to the comntututy than proprietaries incur in the form of bad debts and taxes." Hospital Alliance of Tennessee, Comparative Economic Perforntance Among Tennessee's Proprietary and Not-For-Profit Hospital Sectors 4 (Nov. 1984) (unpubHshed report prepared by Booz-Allen & Hainilton, Inc.). However, this finding is tnisleadingly based on an aggregation of private nonprofit hospitals with gov- ernniental hospitals. Conversation with David Locke, Vice President, Hospital Alliance of Temressee, Inc. (Dec. 18, 1989) (notes on file with the Washungton Law Review).

n154 Simpson & Lee, supra note 141, at 778. 'I'Ite measure of charity care used is the excess of uncompensated care (valued at each hospital's standard charges) provided by nonprofits over that provided by for-profits. Lost taxes are based botlz on patient and nonpatient revenue. The figure for charity care does not account for the large discount (averaging 19%) that California hospitals give to most payors, nor does it account for the $ 16 milliou in gills aud subsidies that Califotnia nonproflts received in 1984-1985. Id. This study's measure of foregone taxes has been criticized for using the maximum corporate tax rate, unadjusted for tax credits and deferrals, which substantially reduce the income tax burden at most for-profit hospitals. Lewin & Associates, supra note 142, at 28. However, these flaws do not affect the study's estimate of property taxes foregone, and they are not sufficient to make up the fonr-fold differential between tax relief and cltarity care.

n155 Lewin, Eckels & Miller, sarpra note 142, at 1214.

n 156 Id at 1213-14 (tlte uncompensated care burden in several states is 50% to 90% higher at nonprofit hospitals tltan at investor-owned hospitals: 7.6% vs. 4.9% in Florida; 6.7% vs. 4.2% in North Carolina; 5.0% vs. 4,8% in Tetmessee; and 7.0% vs. 3.7% in V irginia); Sloan, Valvotta & Mullner, supra note 37, at 18 (Vanderbilt University Hospital provided $ 16 tnillion uncornpensated care in 1982 -- 13% of its gross inpatient revenue -- but since then it has adopted explicit limits on free care).

ni 57 These numbers are derived from data collected by the AHA, as reported in NORTH CAROLINA CENTER FOR PUBLIC POLICY RESEARCH, supra note 63, at 48. 't-he AI-IA declined to provide similar data for subsequent years.

n158 See supra noto 18. This estimate is based upon annual data fi'otn 1986 and 1988.

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n159 This formula assumes that nonprofits are relieved fronz approximately ttre same proportion of taxes as for-profits pay. This formula presents a fair approximation for income and property taxes combined because even though uonprofits may have proportionately less income than for-profits, nonprofits tend to have higher valued property than for-profits. See Hansmatm, The Effect of Tax F.xemption and Other Factors on the Market Share ofNonprofrt Versus Fbr-Profrt Firms, 40 NAT'L. T AX J 71, 80 (1987). Relman argues against crediting for-profits with their tax bills in making these free care comparisons because taxes do not result in inore bealtli care. Reltnan, Investor-Owned Ilospitals and Ilealth-Care Costs, 309 NEWENG. J. MED. 370, 371 (1983). The purpose of accounting for taxes in this discussion, however, is not to detertnine who provides the most care fur if,digeiits; instsad, it is to measure whether the excess in free care provided by nonprofits is sufficient to earn tax relief

n160 In terms of our previous equation, and adding the assumption that T[n] = T[fJ, the exemption is fully earned only if: U [n] > U[f] + T[f]

n161 For the four largestinvestor-owned multihospital companies (Hospital Corporation ofAmerica (HCA), Humana, National Medical Enterprise"s (NMB), and American Medical International (AMI)), in 1983, "the sum of income taxes and uncompensated care (5.6 percent of gross revenues) exceeded the 4.1 percent of gross revenues that not-for-profit hospitals accounted for as uncornpensated care." Yoder, supra note 11, at 114. Even this unfavorable comparison fails to account for property taxes paid by the proprietary hospitals, which would substantially increase the nonprofit deficit.

n162 A study of 11 nonprofit hospitals and 4 for-profits in Utah found that in 1986 the nonprofits provided only one-third the ainount of uncompensated care that for-profits incurred iu free care plus taxes (3.2% versus 10.3%, of net revenue). Pace Management Services, supra note 153, at 3. Data reported for 1984 by the NOR'I'H CAROLINA CENTER FOR PUBLIC POLICY RES7;ARCH, supra notc 63, at 168-91, revealed one county, Wake County, where 4.0% of the care reudered by the nonprofit hospitals was uncompensated but, for the investor-owned hospital, more than tliree titnes this amount -- 14.1"/0 of its gross patient revenues -- were attributable to taxes phis uncompensated care. For five selected states (California, Florida, Iowa, Michigan and New York), the GAO compared oncorn- pensated care by nonprofit hospitals with their estimated inconte tax liability and found that, by this nteasure, only 15% of the hospitals failed to pay back their exemption. GAO REPORT, supra note 143, P23,523. How- ever, this comparison failed to account for the value of the propetty tax exemption, the charitable deduction, or tax-exempt bond financing. It also failed to measnre nonprofit uncotnpensated care against a base from representative for-profit hospitals. The comparison therefore fails to report data relevant to the proper application of ttte govermnent burdett/charity care standard.

n163 This is suggested by the GAO finding that, wttett it atrayed individual hospitals by their peraentage of unconipensated care, the upper quartile provided from three to nine times greater free care than the lower quartile. GAO REPORT, supra note 143, P23,521. A sample of 1987 and 1988 data from four large nouprofit hospitals in Arizona found one tttat provided less net, incremental unconipensated care (measured against a state- wide average of six investor-owned hospitals, which was 3.0%) than the value of its property tax exemption, but tliree others that provided substantially more unconipensated care -- from 4 to 8 times the value of the property tax exemption. However, this study did uot attenipt to measure any otl er eomponeut of the value of the exemption. Data collected by Mark Hall in preparation for this Article (on file with the Washington Law Review).

n164 This does not mean that charity care cannot serve as a suffrcient standard. See infra note 198.

n165 The charity care theory is also defective because it would deny hospitals a fair oppottunity to nieet the standard in rate-regulated states where all charity care is automatically reimbtlrsed, either by being built into

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each hospital's rate base (aud therefore being explicitly passed on to other payers), or by being explicitly reimbursed from an uncompetvtiated care pool that is fiinded through surcharges on hospital charges. See G. ANDERSON, J. LAVE, C. RUSSE & P. NEUMAN, PROVIDING HOSPITAL SERVICES: THE CHANGING FINANCIAL ENVIRONMENT 151-52 (1989) (describing these methods of reimbursing charity care in New York, Massachusetts, New Jersey and Maryland). Moreover, the observation that "free care" by rate-regulated hospitals is not tntly uttcompensated reveals the weakness of the charity eare theoty even for unregulated hospitals, because unregulated ltospitals also pass on the costs of fi'ee care to other patients through their pricing structures. See Hadley & Feder, Hospital Cost Shifting and Care for the Uninsurerl, HL'ALTI-I AFF., Fall 1985, at 4; Kramon, Coaxing the Stanford Elephant to Dance, N.Y. Thnes, Nov. 11, 1990, § 3, at 1, col. 2(Stanford Medi- cal Center charges privately insured caesarean patients almost twice the cost of the operation to recoup the cost of ireating tnlinsured patieiits) The charity care tlieoty is also sometimes criticized because it might result in a hospital "jutnp[ingJ back and forth across the line of charitability from one year to the next." O'Donnell & Taylor, supra note 146, at 67; see also Medica7 Center Hosp. v. City nfBurlington, 152 Vt. 611, 566 A.2d 1352, 1355 (1989) (under titis approach, "uncertainry would reign, with taxability deteruthted on a yearly basis depending ou economic factors not within the control of any one person or organization"). This defect, however, is merely a matter of administration. It is not necessary to evaluate a hospital's exempt status each year, or even to determine exemption on a hospital-speciGc basis.

n166 See S. SURREY & P. MCDANIEI., supra note 12, at 72.

n167 At a tax rate of 34%, for example (the current tnaxinium corporate rate), an entity with net revenues of $ 1 ntillion receives a tax subsidy of $ 340,000, while nn entity with net revenues of $ 100,000 receives a sttb- sidy ofjust S 34,000.

n168 The first source to note this regressive effect was Note, Exemption ofEducation, Philantlropic and Religious Institutions frovn State Real Property Taxes. 64 HARV. L. REV 288, 294 (1950); see also Warren, Krattemnaker & Snyder, supra note 119, at 300.

n169 Suppose an entity receives a charitable exemption for providing liousutg for the urban poor. Rev. Rul. 70-585, 1970-2 C.B. 115. If its net revenues were zero because it uses its incotne to subsidize the housing, the value oftlre income tax exemption would be zero.

n 170 Alabama, for exarnple, perntits a property tax exemption only if the hospital demonstrates that 15% of its "business" constitutes free care. Eaclt hospital must certify annually to the tax commissioner that this test is tnet. ALA. CODE § 40-9-1(2) to -1(3) (Supp. 1990); Gay v. State, 228 A1a. 253, 153 So. 767, 770-71 (1934). The pending Charity Care and Hospital Tax-Exempt Status Reform Act, H.R. 790, 102d Cong., I st Sess., 137 CONG. REC. E395-97 (1991), proposes a niore elaborate version of this same approach. See supro note 151.

n171 Assume for example that Hospital A has $ 1 million in net revenue. The value of a tax exemption on this net revenue at current corporate rates is $ 340,000. It would be possible to design a system which eondi- tioned the exemption on the ttospital's ability to demonstrate that it provided incremental free care worth $ 340,000_ If this were done on an annual basis, the exemption would ntatch perfectly the proportionality criterion for this entity.

n172 To take an extretne example, a tax exemption would prove worthless to a nonprofit hospital that gave away so tnueh free care that its net revenues were zero. Even if these proportionality problen s could be overconte, the charity care theory is still defective in that there is no guarantee that hospitals receiving a subsidy will in fact devote the subsidy to indigent care. The subsidy comes in the form of an niirestricted grant. Indeed, one empirical study of a block grant program operated in New York concluded that unrestricted subsidies to hospitals "did not directly increase the amount of unconr

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pensated care....[The] hospitals retained the unrestricted subsidies, used them to purcliase goods other than uncompensated care, or both." K. Thorpe & C. Phelps, The Social Role of Not-For-Profit Organizations: Hospi- tal Provision of Charity Care 10, 13 (Dec. 15, 1989) (unpablished manuscript).

n173 See, e.g., 7'he Cliarity Care and Hospital Tax-Exernpt Status Reform Act, I-I.R. 790, 102d Cong., lst Sess., 137 CONG. REC. E395-97 (1991) (summarized supra note 151); St. Luke's Hosp. v. Board of Assess- ment, No. 88-C-2691 (Pa. Ct. C.P., Lehigh Co., Apr. 19, 1990) (adopting a higlily complex, legislative-type rule, to account for the value of community and charity services provided by a hospital); see atso supra note 64. Another corrective technique would be to replace the exemption with a tax credit, guaranteeing proportionate support to each hospital by allowing eactt to subtract the exact antount or a defnied portion of its anuuai charity care from its tax liability. BLa a tax credit is not just a minor repair; it is a repudiation of the exemption, because it replaces the exetnption with a system that is, in effect, simply anotlier moatis for adtninistering a direct subsidy. Moreover, unless the law contains a concept of a"refundable credit" -- i.e. provides a cash refund to entities with no tax liability -- the system would still suffer from proportionality problenrs. See generally S. SURREY & P. MCDANIBL, supra uote 12, at 108-11.

n174 See Note, Alternatives to the Univer,sity Property Tax Exenaption, 83 YALE L.J. 181, 184-85 (1973); accord Belknap, supra note 4, at 2033 ("[T]he City of Cambridge clearly is not giving the exemption [to Har- vard] as a quid pro quo for being relieved from a burden that it would otherwise have to assume.").

n175 For authorities advocating this alternative, see, e.g., Brannon & Strand, Alternative Approaches to En- 2361; Gabler & couragirag Philanthropic Activities, in FILER COMMISSION REPORTS, supra note 2, at note 174, at 181, Shannon, siipra note 9, at 2544; Stinison, supra note 5, at 423; Note, supra

(county nrust pay for n176 See Sioux Valley Hosp. Assn v. Yankton County, 424 N. W.2d 379 (S.D. 1988) emergency hospitalization of indigent); Blendon, Aiken, Freeinan, Kirkinan-Liff & Mtuplry, Lincompensated Care by Hospftals or Pasblic In.sarrance for the Poor, 314 NEtf ENG. J. MED. 1160 (1986). Also, a number of states have begun to subsidize indigent care througlt hospital rate regulation. See Dowell, State Health Insur- ance Programs for the Uninsza-ed Poor, 23 CLEARINGHOUSE REV. 141 (1989).

n177 See Warren, Krattenmaker & Snyder, s•upra note 119, at 301.

n178 See infra note 198.

n179 S. SURREY & P. MCDANIEL, s upra note 12, at 100-02 (observing that degree of administrative complexity is not a function of the method of subsidy); Warren, Krattenmaker & Snyder, supra note 119, at 296 (apparent simplicity of the tax subsidy is illusory since it is purchased at the price of a sacrifice in monitoring and accuracy).

n180 See Bellrnap, supra note 4, at 2033 ("[T]he quid pro quo explanation of tax exemptions ... is not adequate as a jus6fication of the privilege in some of the most intportant segments of the general area under discussion. It is evident that the tax exemption privilege has nruch deeper roots than the quid pro quo theory would admit."); Warren, Krattenmaker & Snyder, supra note 119, at 240.

n181 lndeed, throughout much of the long history of the exemption, religion has been deemed within the province of government. See supra note 5.

n182 L2C. § 501(c)(3).

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n183 Selknap, supra note 4, at 2033. Moreover, education may not, strictly speaking, be a goveroment "obligation," because the govemment is utrder no constitutional duty to affirmatively protect or enhance the welfare of its citizenry. DeShaney v. Winnebago County Dep't qfSocial Servs., 489 U.S. 789 (1989); Wideman v. Shal- lowford Community Hosp., Inc., 826I:2d 1030 (11 th Cir. 7987)_

N184 See Utah County v. Intermountain Health Care, Inc., 709 P.2d265, 269-70 (Utah 1985) (charity re- quhes a "gift to the comniunity" that "can be identified eitlter by a substantial irnbalance in the exchange between the charity and the recipient of its services or in the lessening of a government burden" (emphasis added)).

nt85 Or, in the special case of religion, it would have the power but for a specifrc preclusion. Ginsberg, supra note 54, at 308 ("It appears to he suffieient that the function benrg perfornied is one that might otherwise be perfornied at public expense.").

n186 Air Act To Redress the Mis-Employment of Lands, Goods and Stocks of Money Heretofore Given to Cettahi Clraritable Uses (Statute of Charitable Uses), 1601, 43 Eliz. 1, ch. 4, reprinted in 7 S'fA'i'. AT LARGE 43 (Eug. 1763).

ril 87 See supra note 82 and accontpanying text.

ri 188 An Act for the Relief of the Poor, 1601, 43 ELiz. 1, ch. 2, reprinted in 7 STAT. AT LARGF, 30 (Eng. 1763).

n189 See M. CHESTERMAN, supra note 1, at 56-57 ("[A ]ccording to the intentions of the Elizabethan legislature and the authoritative contemporary interpretation, the 1601 preamble's conccpt of'eharitable' contained a'public benefit' requirement calling for benefrt to the poor.... Without this, the Act's objective of light- ening the burden of parish poor relief .._ would not be achieved."); G. JONFS, supra note 97, at 22-23 (discussing the connection between the Elizabethan Poor Laws and the Statute of Charitable Uses); L. SHERIDAN & G. KEETON, supra note 80, at 8-9 (same); Adler, supra note 3, at 59, 80: 7'o prevent vagabondage aud begging the state undertook [in the Poor Law] to maintain only the poor and impotent, the ntterly helpless. Those in a position to pay have, therefore, no clainl on state support. In housing such inmates an institution is in no way relieving the state ot a burden which the latter has ever undertaken to bear. Relief of poverty was also the concept of charity that originally prevailed in IRS rulings during the first half of this century. See Eastern Ky. Welfare Rights Org. v. Simon, 506 F.2d 1278, 1286 & n.13 (D.C. Cir. 1974), vacated on other grouncls, 426 US. 26 (1976); Liles & 131urn, supra note 2, at 20-21. Finally, care for the indigent was at the core of the rationale for granting hospitals immiumity from tort liability in some states when the doctrine of charitable immunity still existed. See Ponder v. Fulton-DeKalb Hosp. Auth., 256 Ga. 833, 353 S. E.2d 515, 516 ("The proper staudard for an equal protection analysis of the charitable immunities doctrine is whether it bears a rational relationsltip to tlte public policy of care for indigent persons."), cert. denied, 484 U.S. 863 (1987); Marton v. Savannah Ilo.sp., 148 Ga. 438, 96S F,. 887, 887-88 (1918) (charitable inununity attaches only to treatment of nonpaying patients); Adams v. University Hosp., 122 Mo. App. 675, 99 S.YV. 453, 454 (1907) (the purpose of the chai-itable inununity is to prevent funds from being "diverted froin such kindly purposes" as "administering relief to those in need"). But see City ofRichmond v. Richmond Memorial Hosp., 202 Va. 86, 116 S'.E.2d 79, 83 (1960) ("[S]everal tort cases ... establish that hospitals ... are 'charitable' institutions despite the fact that they charge all who can afford to pay."); Southern Methodist Hosp. & Sanitorium v. Wilson, 51 Ariz. 424, 77 P.2d 458 (1938) (satne), overruled on other grounds, Ray v. Tuscon Medical Center, 72 Ariz. 22, 230 P.2d 220 (1951)_

n190 1891 App. Cas. 531 (ILL.).

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n197 See generally M. CHES1'ERMAN, supra note I, at 54-57 (discusshig the "distortion" of the charity concept that occurred during the eighteenth century).

n192 Stevens, Voluntary and Governrnental Activity, HEALTH MA'I'RIX, Spr. 1985, at 26, 28; see also Southern Methodist Ilosp., 77 P. 2d at 460-61 (charitable ltospital rendered "vety little free medical or hospital attendance ... to anyone"); City ofRichmond, 116 S.E.2d at 82 ("Tlie framers of the (1902) Constituti.on presumably larew that such charitable organizations as YMCA's, asylums, and hospitals customarily charge for services..."); J. I-IOLI,INGSWORTI-I & E. HOLLINGS WORTI-I, supra note 25, at 30 (at the time the IRS issued Rev_ RuL 56-185, 1956-1 C.B. 202, ahnost three-fourths of the patients at nonprofit hospitals were insured); id at 9" (u; 1935, voluntary hospitals "in a number of [sma11] midwestern cities provided only 10 percent of their services to nonpaying patients"); D. ROSNER, A ONCE CHARITABLE ENTERPRISE: HOSPITALS AND HEALTFI CARE IN BROOKLYN AND NEW YORK, 1885-1915, at 8-9, 36-61 (1982) (various economic and teclurological forces transformed New York hospitals from classic charities to business organizations durhig the 1890s); P. STARR, supra note 35, at 146 ("[I]n a nratter of decades, roughly between 1870 and 1910, liospitals moved ... frorn charities, dependent on voluntary gifts [to] market institutions, financed increasingly out ofpayments from patients."); id at 160-61 (at the turn of the century, "the old rhetoric of charitable paternalism was superseded by a new vocabulary of scientific managemerrt and efficiency"); R. S'I`EVENS, supra note 35, at 23 ("Ineorne from paying patients ... represented almost half of the budgets of nonsectarian private [non- pfofrt hospitals] in 1904 and almost three-fomths that of the'ecclesiastical' institutions _.."); Jones & Du Val, What Distinguishes the Voluntary Hospital in an Increasingly Commercial Health Care F,nvironment?, in SICKNESS AND IN HEALTH: THE MISSION OP VOLUIdTARY HEAL'I'H CARE INSTITIJ'I'IONS 201, 209 (1988) (in 1904, "as much as 43 percent of [nonprofit] hospitals'] income caine from paying patients and 30 percent from government. In fact, for much of their history, voluntary hospitals have had t(i strive to be businesslike in order to survive and prosper."); Mancino, supra note 40, at 1057. Paul StaiT further explains that voluntary hospitals did not evolve directly from almshouses as is often supposed; instead, the almshouses were the foundation of the public trospital system whereas the voluntary sector arose from thc rnore particular desires of ethnic and religious groups. P. STARR, sttpra note 35, at 150, 169-72,

n193 Roberts, A Positive Model ofPrivate Charity andPublic Transfers, 92 J. POL. ECON. 136, 141 (1984) ("[p]rivate charity in the United States is approxirnately zero" in the sense of helping the poor; only 10% of donations go to "social services" and wily a fraction of that amouut goes to the poor); ici. at 147 & n.147 (in England after 1660, "payments under the Poor Law became almost everywhere the ordinary source of relief for htdigence with private charity a supplernentary source of varying importance, called on for great effotts only in tintes of extraordinary distress").

n194 Note, Hospitals, Tax Exetraption, and the Poor, 10IIARE C.R.-C.L. L. REY 653, 679 (1975) (emphasis added).

( n195 See Utah County v. Interntountaln Ileatth Care, Inc., 709 P.2d 265, 282 (Utah. 1985) Stewart, J., dissenting) ("Charitable hospitals need not be self-liquidating.").

n196 For holdhrgs and statements to this effect in the context of hospitals, see Southern Methodist Ho.sp & Sanitarium v_ Wilson, 51 Ariz. 424, 77 P.2d 458, 462 (7938) ("If the purpose of the institutiott is one which is recogiized in law as charitable, _.. we think the institution is properly characterized as a charitable one, notwithstanding the fact that it charges for most, if not all, of the services which it niay rendar . .."), overruled on other grounds, Ray v. Tuscon Medical Center, 72 Ariz. 22, 230 P.2d 220 ( 1951); Evangelical Lzdheran Good Sanzaritan Soc y v. Board of County Comm'rs, 219 N. W 2d 900, 909 (N:D. 1974) ("[A]n institution which is engaged in the charitable purpose of supplying care and attetttion to the aged ... does not lose its charitable character. .._ because it has never provided care for a patient on a free basis . .."); In re Resch's Will 7S-usts, [1969] 1 App. Ca.s. 514, 544 (P.C.); RF,S"PATEMSNT (SECOND) OF TRUSTS § 376 comment c (1959); SCOTT ON TRUST,S, supra note 92, § 372.

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n197 See B. HOPKINS, supt-a note 31, at 80-83; Simon, supra note 69, at 85 (property tax exemption ]tis- torically applied to "scltools for the sons of gentlemen").

n 198 Rejecting free care as a necessary standard for the exemption does not necessarity preclude its serving as a sufficicnt standard. If the test is both properly fonnulated and met by a particular Itospital (i.e., the hospital demonstrates that it dispenses an inerenzental level of charity care eqnal in dollar value to the value of the exeniptions), granting the exemption is not bad public policy, despite the several possible reasons why one migltt have qualms about the govermnent supporting a nonprofit ittstitution that subsidizes the poor solely frotn sales to paying patients. In the hospital context, one tnight object that this form of redistribution through cross- subsidization, which, in contrast with govertmtent taxation, conceals frorn patients and insurers their support of a system that cares for the poor by "taxing" the sick. See P. FELDSTEIN, HEALTH CARE ECONOMICS 268- 69 (1979) (criticiziug hospital internal cross-subsidization); Phelps, Cross-Subsidies and Charge-Shifting in Amerlcan Xospitals, in UNCOMPENSATED HOSPITAI. CARE: RIGHTS AND RESPONSIBILITIES 108 (1986) (same); Clark, supra note 10, at 1438-39, 1467 (describing as "elitist" the "niinigovennnent" model of ttospital exemption which fosters redistribution of ineome through covert "taxation," effectively "disenfianchis- htg" the public); Posner, Taxation by Regulation, 2 BELL J. ECON. & MGMT. SCI. 22 (1971) (seminal discussion of the econonric effect of hidden taxation)- However, this form of redistribution by voluntary private transaction, unlike govermnent taxation, is not coerced- Moreover, if the hospital did not treat the poor, its prieing behavior for paying patients would not necessarily be any less itrational or exploitive. It would only tnake different use of the profits. The second basis for concern abont goventment support for private redistributional schemes is that suctt schemes may not be stivctured to yield optimal benefits, and may deter the government frorn undertaking this fiutction in a superior fashion. For instauce, to the extent government relies on private hospitals to meet the healttt care ueeds of uninsured patients, it fosters an irrational public health policy that treats mentbers of this population only when medical cortditions dcteriorate to a very severe level. Nothing, however, prevents the government from requiring hospitals to meet part of their free care obligation in an outpatient setting that offers preventative and primary care services. Indeed, the Utah County Tax Commissioner bargained for this precise solution in negotiating a settlement with the hospital compatty involved in the Utalt County case. Tolchht, Tlos- pitals Use Charit}, To Fend OfjTax Collectors, N.Y. Times, May 3, 1988, at C3, col. 1(" For reasons not altogether altruistic, Interntounta.in IIealth Care Inc. recently opened a clinic here to treat homeless men and women (it] began providing health care at a local soup kitchcn and at a center for Indochinese refugees [a]nd it expanded health services on Indian reservations and for the rural poor."). The third criticism of using the charitable tax exemption to support free care dispensed by private hospitals is that the exemption allows the govetmnent to shift to private industry its responsibility to subsidize this care directly. See Yoder, supra note 11, at 195 ("Ensuring adequate Itealth care is a societal obligation, and governtnent sltould make provision for its fmancing when private coverage is Iacking."). 'I'he government, however, does directly fund ltealth care for the poor at soine level. Even if greater govcrnment involvement existed, there would always be a role for private hospitals to play, for instance in treating transients, illegal aliens, and otheis who may fall tlifough the cracks of govertmtent prograrns. See Sager, Prices of Equitable Access: The New Massachusetts Clealth Insurance Law, 18 HAS'17NGS CENTER REP. 21 (1988) (Massachusetts provides coniprehensive health care coverage largely by using the tax system to impose the responsibility for healtli insurance on private employers)-

n199 Perhaps the most f'orcefitl statement of the cotmnunity benefit theory, ntade in the context of religious institutions, is that nonprofit institutions promote vahtes: such as benevolence, charity, generosity, love of otir fellowtnen,... attd all those comely virtues and amia- ble qualities which clothe life 'in decent drapery' and iutpart a chartn to existence,._. furnish a sure basis on which the fabric of civil society can rest, and without which it could not endure. Take from it these supports, and it wotdd tumble into chaos and ruin. Anarehy would follow order and regularity, and liberty, freed from its restraining influence, would soon degenerate into the wildest license, wliich would convert the beautifirl earth into a howling pandemonium, fit only for the habitation of savage beasts and more savage men. Trustees ofthe First Methodist Epi.scopal Church v, City ofAtlarttq 76 Ga. 181, 192-93 (1886). Of like tnutd, but of less apocalyptic manner is Bellmap, supra note 4, at 2033-35:

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The ti-ue explanation, and the only principle that affords a contplete justification covering the entire field of [cliaritable] exemptions ... is that govemment relieves from the tax burden religious, educational, and charitable activities because it wisltes to encourage them as representing the highest and noblest aehievements of mankind[,] ... activities which by conunon undersCanding are agreed to rate among the highest in the scale of social values. Professor Atkinson provides auother, more measured, but particularly clear description of this view (which is not his own): Charities are said to provide what I will call "metabenefits ," benetits thatderive not from what product is produced or t'o whom it is distributed, but rather from how it is produced or distributed. Traditional theory has identified two ways charities provide such "metabetieftts." In the first place, they are said to deliver goods and services more efficiently, more huiovatively, or otherwise better tltau other suppliers. In the second place, their very existence is said to protnote pluralism and diversity, whicit are taken to be inherently desirable.... This theot-y rests on the fairly explicit premise that not only particular goods and services, but also particular modes of supplying them, can be identified as especially good for the public under neutral principles administrable by a govermnentagency,thelnternal Revenue Service,subjecttojudicialreview. Atkinson, Altruism in Nonproftt Organizations, 31 B.C.L. REV 501, 605-06n.266 (1990); see also YVa1z v. Tax Comm'r, 397 U.S. 664, 672-73 (1970) ("[C]ertain entities that exist in a]tarmonious relationship to the community at large, and that foster its 'moral or mental improvement; should not be hilribited in their activities by property taxation.... The State has an affirmative policy that considers these groups as beneficial and stabIlizing in- 1luenees in conununity life _.."); cf E. JAMES & S. ROSE-ACKERMAN, supra note 11, at 3 (proposing a view of nonprofits that "emphasizcs the independent role of ideology as a ftmdainental justification for [tlreir] existence and a basic explanation of their behavior"); id at 51: We believe that a key feature of nonpro6t production is ideology. ...[M]any organizations are nonprofit because their fouirders have a set of strongly felt beliefs which motivate them more than money alone. The kind of services they chose to produce [and] the consumers who prefer these services ... are directly tied to the founders' beliefs.

n200 The leading advocates of this position are AMLRICAN HOSPITAL ASSOClATION, supra note 39, Seay & Slgnion, supra note 39, at 3; Seay & Vladeck, supr•a note 39; see also Falcone & Warren, supra note 18, at 735-36 ("[P]luralism in health services delivery is desired and has a price which Americans .-. have agreed to pay via tax expenditures ..."); Horwitz, Corporate Reorganization: The Last Gasp or Last Clear Chance for the Ta.x-Exempt Nonproftt Hospital, 13 AM. J L. & MED. 527, 558-59 (1988) ("[C]otnmitment ... to service, rather than to profit, even if greater in spirit than in deed, may be enough to warrant retention of the nonprofit concept."). See generally Ilyman, supra note 51, at 363-76 (explaining and critiquing this position).

n201 Yoder, supra note 11, at 182.

n202 The proposed Charity Care and Hospital Tax-Exempt Status Reform Act, H.R. 790, 102d Cong., 1st Sess., 137 CONG. REC. E395-97 (1991) (discussed supra note 151), adopts this approach to justiiying up to lialf the value of exemption. Similarly, the proposals of'1'homas Barker, described, .supra note 151, would make community benefit an explicit alternative for exemption, pertnitting hospitals who failed the charity care standards to qualify for exeniption if they could demonstrate a"significant and substantial community benefit" by serving, for example, as the sole cominunity hospital as defined by the Medicare statutes. Barker, supra note 64, at 351. Barker, however, would not accept as conununity benefits certain services cuiTently touted as such by nonprofit hospitals, such as weight loss clinics, "stop smoking" clinics, or eholesterol-screening clinics operating at local shopping malJs. Barker observes that hospitals often make money on such services, which at the very least provide free advertising for the hospital and its physicians. Id

n203 Seay & Vladeck, supra note 39, at 6-7.

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n204 Id. Examples of services that are usually unprofilable include burn units, trauma centers, and neonatal intensive care. ld.

n205 AMFRICAN HOSPITAL ASSOCIATION, supra note 39, at 36-38. Nonprofit sceptics, however, dis- credit the deservedness of these services, observing that inany are undertaken primarily for marketing purposes. See supra note 202.

n206 Jones & Du Val, supr•a note 192, at 230 ("['f]he voluntary hospital embodies a set of values in llealth care thathelps quicken the conscience of the community concerning the sick and poor and inspires a vision of :vhat medici.n,e and health care can acsomplish R>r mankind, beyond what the marketplace demands . . ."); Wik- ler, The Virtuous Hospital: Do Nonprofit Institutions Have a Distinctive Moral Mission?, in IN SICKNESS AND IN IIEALTH: THE MISSION OF VOLUNTARY HEALTH CARE INSTITUTIONS 127, 142 (1988) ("Nonprofit hospitals are often regarded as better for society than for-profit hospitals precisely because they as- pire to, and often do, achieve vutue.").

n207 For the same reason, this tlteory addresses the universaliry criterion by seeking to justify both types of exemption. It also has the potential to explain a number of the resnictions on these exetnptions such as the prohibition on lobbying and the restraint on unfair competition, beeause these restrictions are apparently designed to protect the public's interest. 'I1tis theory also comports with the historical consistency theory to the extent that it draws from the notion of public benefit that exists in charitable trust law. See supra note 110 and accotnpanying text,

n208 Over the past fifty years, the relative mix of these tltree sectors has retnained remarkably stable, as follows (in number of beds): public (govemmental) liospitals -- 20% to 25%; voluntary hospitals -- around 70%; proprietary hospitals -- from 5% to 10%. J. HOLLINGSWORTH & E. HOLLINGSWORTH, supra note 25, at 20-21.

n209 For an historical overview of nonprofit dominance, see Marnior, supra note 27, at 321-25.

n210 P. FELDSTEIN, HEALTH CARE ECONOMICS 198, 218 (2d ed. 1983) ("[IfJ it is immoral to profit from siclmess, why then can people profit frotn hunger and the need for shelter?"); IIansmann, supra note 11, at 880-81; Sloan, supra note 142, at 109 ("[M]ost physicians, dentists, optometrists, and pharntacists work for proprietary firms, that many nursing homes are for-profit, [and] drug and medical devices are ntanufactured by such firms . . .").

n211 See In re Advisory Opinion to the House of Representatives Bill 85-H-7748, 519 A.2d 578 (R.I. 1987) (upholdiug the constitutlonality of pi-oposed legislation that would deny licenshtg to publicly traded health care facilities); Bays, Why Most Private Hospitals are Nonprofit, 2 J. POL'Y ANALYSIS & MGMT. 366, 367 (1983) (the National Labor Relations Act explicitly exempted nonprofit liospitals until 1974); id at 377 ("[H]ospital planniug agencies appear to have a bias against for-profit hospitals, according to anecdotal evidence."); ict ("[i]n some states[,] ... Blue Cross originally refused reimbursetnent to for-profit hospitals or reimbursed them at a lower rate than ... nonprofit hospitals," a pattern that the original Medicare reimbmsement fortnula copied); Foster, Hospitals and the Choice of Organizational Forrn, 3 FIN. ACCOUN"1'ABILITY & MGMT. 343, 353-54 (1987) (discussing various barriers to entry by for-proflts); Hall, supra note 22, at 509-17 (discussing the inhibiting effect that the corporate practice of medicine doctrine has on proprietary enterprise in health care); Marmor, Schlesinger, & Smithey, supra note 28, at 224-27 (discussing the preferential treatment nonprofits receive frotn the Hill-Burton hospital construction program and frotn Blue Cross/Blue Shield); Steinwald & Neuhauser, The Role of the Proprietary Flospital, 35 L. & CONTEMP. PROBS. 817, 835 n,27 (1970) (documenting the preferential treatment nonprofits receive frorn hospital planning agencies); Note, The Qualiry of Mercy: "Charitable Tor-ts" and 1'heir Continuing Irnrnunity, 100 HARV_ L. REV 1382 (1987) (documenting the modified survival of charitable tort itnmunity for nonprofit hospitals). See generally Clark, supra note 10, at 1474.

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Empirical evidence fails to either confirm or refiite the hypothesis tlrat the exemption alone accounts for a significant portion of nonprofit hospital market share. The only study on point concluded, using 1975 data, that the property tax exemption has a modest differentiat effect (accounting for 6.3% of the nonprofit market share in an average state) while the corporate tax exemption has almost no effect. Ilansmann, supra note 159, at 76-77. The quality of the data supporting these findings, trowever, fails to meet standard tests for statistical significance. Id.

u212 IIanstnann, 7he Evolving Law of Nonproftt Organizations: Do Current 7'rends Make Good Policy?, 39 CASE W. RES. L. REV. 807, 814 (1989); see also Foster, sarpra note 211, at 353-54.

n213 Clark, supra note 10, at 1447. Clark does not squarely endorse these terms -- he uses tltem only to characterize what he describes as ttre "exploitation hypothesis;" but lre is clearly more sympathetic to this hypothesis than the competing "fiduciary hypothesis." An even rnore forthright critic is Hyman, .supra note 51, at 374 ("By disguising thernselves as non-exploitative agents, the nonprofrt hospitals add deceit to their offenses."). Herzlinger and Krasker are perltaps the most notorious critics of nonprofits. They claim to document that "nonprofits have not fulfilled their social promise" and "do more to maximize the welfare of the ptiysicians wlro are their main consumers." Herzliuger & Krasker, supra note 143, at 104. Further, ttrey contend that "rnany emotional protests against for-profits may be attempts by the medical profession to preserve a cozy arrange- rnent." Id. To the extent that this study relies on empirical findings rather than on theoretical assuniptions, it has been subject to sharp attack. .See, e.g., Reinhardt, Flawed Methods Cripple Study on Not-1 or-Profits, HOSPI- TALS, Apr. 20, 1987, at 136 (suggesting that this study would not meet the standards required of "a Princeton undergraduate [who] proposed to perforni this sort of analysis" and accusing the authors of "beud[ing] empirical findings to preconceived notions"); N.Y. Titnes, Apr. 2, 1987, at DI, col. 2, D8, col. 5("The autltors' bias for privatization screams out from every page of the study. I'm concerned by the appareut attempt to propagate personal bias in the guise of science." (quoting health economist Uwe Reinhardt)). There is, liowevcr, no dispute that Herzlinger and Krasker accurately reflect a respectable theoretical position.

n214 Another "negative" theory for nonprofrt preference on the part of physicians posits simply that physicians benefit frorn the exemption itself, as well as fi-om other preferential forms of social subsidy such as volunteer labor and research fanding. Bays, supra note 211, at 377 (these various subsidies "lower the total cost of the complernentary hospital inputs aud therefore increase the price that plrysicians can charge" across the board). Because this dteory is derivative of otlier pi-cferential phenomena discussed elsewhere, see supra note 211, it is not given independent treatment here, although it may represent the most couviucing reasou for the nonprofrt preferences of doctors. See supra notes 120-24 and accompanying text.

n215 See generally P. FELDSTEIN, supra note 198, at 212-23.

n216 Pauly & Redisch, The Not-Por-Proftt Hospital as a Physicians' Cooperative, 63 AM ECON. REV 87 (7973); see also Blumstein & Sloan, Antitrust and Hospital Peer Review, L. & CONTFMP. PROBS., Spr. 1988, at 7, 19-20.

n217 Bays, supra note 211, at 377 ("[P]hysicians as a group prefer nonprofrt hospitals not because they are allergic to the notion of profit, but because restrictions against for-proCtt trospitals have been otte way of controlling entry."); Clark, supra note 10, at 1436-37, 1441-47. This explanation is flawed on two connts. First, to a large degree, doctors prefer not to be involved in hospital financial matters. Thus it has been said that they use their influence purposefully to avoid the day-to-day details of hospital management. Hall, supra note 22, at 440. Second, to the extent doctors do desire control, private standards of hospital accreditation -- on which the medical profession has a major influence -- guarantee laagely the same degree of control over both types of hospitals. Id, at 528-30; Majone, Profe.ssionrdisnv and Nonprofit Organizations, 8 J. HEALTH POL., POL'Y & LAW 639, 654 (1984). Even absent these standards, there is no solid documentation that nonprofit hospitals give more managerial control to doctors. See P.

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STARR, supra note 35, at 165 ("Oddly enough, proprietary hospitals [during the first half of the century] were oue of the main ways of resisting corporate domination and establishing professional control."); Alexander, Mon'isey & Shortell, Physician Participation in the Adzninistration and Governance ofSystem and Freestanding Hospitals: A Comparison by 7^pe of (hvnership, in INS'fITUTE OF MEDICINE, FOR PROFIT ENTERPRISE IN I-IBALTII CARE 402, 408 (B_ Ciray ed. 1986) (for-profits "appear to have greater piiysician representation on hospital goveiuing boards").

n218 Lee, A Conspicuous Production Theory ofllospital Behavior, 28 S. ECON. J. 48, 49 (1971).

n219 Newhouse, Toward a Theory ofTvonprofri Instiiutions: fin Economic Iviodei oj a Ilospidui, 6"v A13 ECON. REV 64, 64-65 (1970).

n220 Id. at 69, 70, 73. This theory camtot completely explain the predominance of nonprofit hospitals because at bottom the mafiageriai rnotives it posits are not fundamentally cfifferent than those prevailhig at proprie- taiy hospitals. The theory of managerial prestige attributes hospital behavior to that which pleases doctors, because the size and quality of a tiospital's inedical staff is the principal determinant of its prestige. See Lee, supra note 218, at 49 ("In order to attract and maintain physicians, [nonprofit] hospitals are responsive to the demmid of their medical staffs."). But the size and quality of the medical staff also determine a hospital's ptrofitability, so one would expect largely the sanie physieian-pleasing behavior from both sectors. Another branch of the inanagerial behavior theory is based on the observation that the convention of separate billhtgs for doctor and hospital services tnasks the economic reality that the patient is paying a joint price for a single product. Accordingly, doctors have an incentive to prefer the otganization that charges the least, leaving ntost of the joint price for them to capture. Nonprofits are thought to price lower, at least for hospital services that have a la ge physician participation such as surgery, because they are less concenied about profit mar- gins. See Bays, supra note 211, at 372; Hansmann, supra note 11, at 866. This explanation assumes, however, that nonprofits are less interested in making ntoney than for-profits. In fact, nonprofits also desire to earn a surplns; they simply have different "utility fanctions,° i.e., different uses for the money, such as facility expansion. See P. FELDSTEIN, supra note 198, at 215-18. It also assumes that market constraints have traditionally operated to cap the total price for the "joint product." In fact, the hospital price historically has imposed no constraint on doctors' charges because independent sources of reimbursement have not been sufficiently price sensitive,

n221 The strongest application of this "trust theory" for the existence of nonprofit euterprises explains why donors choose to make contributions exclusively to nonprofits when thcy desire to supporttraditional charitable services such as disaster relief and care for the poor. Hansmann characterizes donors as "purchasing" these relief services for others, and observes that, as a consequence of the third-party nature of this transaction, dottors are not in a position to monitor whether and how effectively the desired aid is rendered. See generally Hans- mann, supra note 11. Red Cross, for instance, is in the business of "selhng" disaster relief services to conh-ibutors for delivery to third-patty beneficiaries. As the contributors generally have no way of determining the quality of Red Cross's relief services or whether such serviccs actually are performed, the "consumer" (the contributor) catmot engage in comparative sltopping. As a result, the consumer is better off buying such services from a nonprofrt entity, since the prohibition on the distribution of profits by a nonprofit to private individuals (the prohibition against private inurement) gives the consumer some assurance that the money "paid" for the service will actually be used for the service. This trust explanation also holds for two-party commercial transactions in which consnmers purchase services for thetnselves that are difficult to evaluate because of the intaugible nature of the services. Prontinent examples include child care and education. See B. WEISBROD, supra note 8, at 6, 23; Hansmann, supra note 11, at 862-72. As these services are typically purchased on behalf of someone else in the fantily, they too are not pure two-patTy transactions, which niay partially explain the diffictilty of monitoring these services. Krashinsky,

Appx.365 Page 63 66 Wash. L. Rev. 307, *

Transaction Costs and a Theory of Noiaprofrt the Organization, in TIIE ECONOMICS OF NONPROFIT IN- STITU"1-]ONS 114, 117 (S. Rose-Ackerman ed. 1986). For a partial rebuttal of the ttvst theory and a development of a theoty that explauts the existence of niutual benefit organizations, the other ntajor categoty of nonprofits, see generally Ellntati, supra note 11.

n222 See Atrow, Uncertainty and the Welfare Econotnics of Medical Care, 53 AM. ECON. RE'V. 941 (7963). Health care is difficult to monitor because of its inherently cotnplex and qualitatively subjective nature, and because an individual patient rarely has an opportunity to experience how an alternative provider would have treated the same aihnent. See B. WEISBROD, supra note 8, at 46. It niigltt also be observed that healtlt care is usually purchased ttirougit thu-d-party ttansactions, by virtue of the paytnent coming from the insurauce cotupany, but this is an inappropriate characterization for these purposes because the insurer merely indenmifies the patient (or hospital) for the choice of care made and does not itsel f make the purchase. However, to the extent that insurance companies are becoming increasingly selective in which hospitals to cover, as through so- called "prefetTed provider organizations" (PPOs), then perhaps there is some merit to this third-party characterization.

n223 See Hansmamr, supra note 11, at 866-68; Newhouse, supra note 219, at 72.

n224 Majone, supra note 217, at 639,

n225 Id at 640.

n226 See D. YOUNG, IF NOT FOR PROFIT, FOR WHAT? (1983) (developing this sorting theory in some detail).

n227 Majone, supra note 217, at 654. The same point is made with ncgative entphasis as follows: [P]rofit-making organizations do not possess the appropriate characteristics required for the social control function in the healtlr care system. This is so mainly because the decision-making mechanism in profit-tnakiug organizations is inherently at cross putposes with the unique characteristics of the health care segment of society -- namely, the unusual and personal nature of the physician-patient relationship and the centrality of health and disease to individuals and to society. Nonprofit organizatious, on the other hand, do seem to possess -- at least potentially -- the social control mechanism required to protect individual patients aud society.

(ireenlick, Profit and Nonprofrt Organirations in Health Care: A Sociological Perspective, in IN SICK- NESS AND IN HEAL"I'H: THE MISSION OF VOLUNTARY HEAI.TH CARE INSTITUTIONS 155, 175 (1988)_

n228 Majone, .supra ttote 217, at 654 ("Professionals in for-profit organizations must submit to managerial controls, enforced by a central monitor who is responsible to the stockholders and is niotivated to overrule the professionals whenever their interests and attitudes come into conflict with the goal of profit maximization.").

n229 B. WEISBROD, supra note 8, at 88 ("Public policy can be devised simply to permit nonprofit organizations to exist; to permit nonprofits to compete with for-profit firms; to provide for public subsidies for nonprofits; or to provide for specific forms of subsidies...").

n230 E.g., Falcoue & Warren, supra note 18, at 740 Qustifying the exemption because "Americans have demanded pluralism in hospital care," as if the issue were whether nonprofit hospitals should exist at all); Gug- genheimer, Making the Casefor Vo&rntary Health Care Institution.s_ Policy Theories and Legal Approaches, in

Appx.366 Page 64 66 Wash. L. Rev. 307, *

TN SICKNESS AND IN IIEALTH: THE MISSION OF VOLUNTARY HEALTIS CARE INSTITUTIONS 35, 36-41 (1988) (defending the exemption merely by observing why nonprofit hospitals should exist); Horwitz, szr pra note 200, at 558-59 (arguing for "retention of the nonprofit concept," again, as if the issue were whether nonprofit hospitals should be banned).

n231 Hyperbolic fears, sometimes expressed as "complete proprietary corporate control over the distribution of American health care," are entirely unfounded. Dolenc & Dougherty, DRGs: The Counterrevolution in Financing Health Care, HASTINGS CENTER REP. June 1985, at 19, 27. "[T]he American people never came close to giving up their voluntary community hospitals and private medical practitioners for an investor- dom:nated, professional management stracture whnse goal baa bncn t.he maximization of profit." Ginsberg, For- Profrt AQedicine: A Reassessment, 319 NEW ENG. J MED. 757, 760 (1988); accord Manuor, supra note 27, at 348 ("Both sides view the recent growth of the for-profit sector as foreshadowing a system-wi(le transformation -- and perhaps even a cotnplete conversion to proprietary auspices -- of the hcalth indnstry. In fact, it seems quite unlikely that such radical changes will occur."); id at 320-33 (rise of proprietary hospitals is only a minor fluctuation in cyclical pattent that has prevailed throughout the century); Seay, Vladeck, Kramer, Gould & McCormack, Holding Fast to the Good: The Future of the Voluntary Ho.spital, 23 INQUIRY 253 (1986) (for- profit hospitals continue to operate at the industry's periphery; no major change in their relative numbers for 20 years). The hysteria over for-profit medicine has resulted more from the rapid consohdntion of proprietary hospitals into large corporate chains than from an absolute increase ht their proportion of the market. Even the consolidation phenomenon is overstated because nonpro6ts have more than twice as many beds in corporate chains as for-profits, a number that has almost doubled since 1970. Yoder, s•upra note 11, at 27-30.

n232 Professor Jensen made this point over 50 years ago: [T]he service deserving [a tax subsidy] niust be incapable of beitrg fostered adequately on a counnercial, quid pro quo basis. ... Transportation is a necessary public service, but it is not, ordinarily, necessary to subsidize it. The state has no interest in extending it beyond the point where the beneficiaries will pay for it. Jensen, supra note 3, at 148.

n233 See S. SURREY & P. MCDANIEL, s•up-a note 12, at 82.

n234 See supra note 221 and accompanying text.

n235 The Minneapolis Star once asked facetiously: "Is just being a'nice guy' cnough to get you on the property-tax free list?" A. BALK, supra note 1, at 81; see also Stone, stipra note 9, at 45.

n236 Yoder, szipra note 11, at 191.

n237 J. HOLLINGSWORTH & E. HOLLINGSWORTH, .supra note 25, at 111-14; Yoder, supra note 11, at 76-77 (nonprofits are somewhat less costly, controlling for size and patient mix, but the annual increase in costs for the two sectors is the same); id. at 138 ("Evidence now available does not support the fear that for-profit health care is incompatible with quality of care, nor the belief that public ownership might provide some assm-- auce of quality."); Schlesinger, Marmor & Snritltey, supra note 27, at 437; Sloan, supra note 142, at 130 ("In summary, empirical research to date suggests that for-profit and voluntary hospitals are quite similar in terrns of accounting cost "); id. at 132 ("Considering results frotn all of the studies, it appears that efficiency differences between private not-for-profit and for-profit hospitals are stnall, at most."). A recent study, Irowever, found that mortality rates were significantly higlrer at for-profit hospitals in 1986 (121 deaths per 1,000 patients, versus 114 for nonprofits). Hartz, Krakauer, Kuhn, Young, Jacobsen, Gay, Mucnz, Katzoff, Bailey, & Rimm, Hospital Characteristics and Mortality Rates, 321 NEWENG. J. MED. 1720, 1720 (1989). There is soine question, though, whether this study properly adjusts for severity of illness. See Green, Wintfeld, Sharkey, & Passman, The Importance of Severity oflllness in Assessing Hospital Mortality,

Appx.367 Page 65 66 Wash. L. Rev. 307, *

263 J. A.MA. 241 (1990) (HCFA's mortality data, on which the prior study was based, "does not adequatcly account for patient severity").

n238 See J. HOLLINGSWOR'1'H & E. HOLLINGSWORTH, s•upra note 25, at 86, 116 ("An analysis of the behavior of hospitals in the three sectors [including public hospitals] during the past fifty years detnonstrates that they have become increasingly shnilar. The differences that persist are srnall in comparison with the vast differences that existed fifty years ago."); Ermann & Gabel, Multihospital Systems: Issues and Ernpirical Findings, 14EALTH AFF., Spr. 1984, at 50 (review of over 400 studies and articles; conclndes that the two sectors are largely the satne); Horwitz, supra note 200, at 531 ("1'he nonprofit hospital offers, looks like, acts like, and inii- tates he for-profit hospital in every way except for the disnibution of excess revenue ..."); Marmor, supra note 27, at 334-39,

n239 The GAO fotmd that a majority of both types of hospitals offered a wide range of community services, but that nonprofits are modestly inore likely to do so than for-profits. GAO REPORT, supra note 143, at 4. However, nonprofit hospitals "were equally likely to charge a fee for community services [and] more likely to cover the costs of providing the services." Id

n240 See generally J. HOLLINGSWORTH & E. HOLLINGSWORTH, supra note 25.

n241 Sloan, supra note 142, at 138-39.

n242 E.g., Relnian, supra note 159, at 372: Now that we appear to be on the threshold of a new era of prospective payment, htcentives will probably change, and the profitability of the investor-owned hospitals niay come to depend on their ability to control costs rather than on... the manipulation of prices. It will be interesting to see what happens then.

n243 See J. HOLLINGSWORTH & S. HOLLINGSWORTH, supra note 25, at 128-29 (nonprofits and proprietaries both respond to reintbursement limits with automated ntanagement, elimination of uuprofitable services, diversification, aggressive marketing, and reduced charity care); Friedtnan & Shortell, The Financial Per- formance ofSelected Investor-Chvned and Not-For-Profit Sy.stem Hospitals Before and After Medicare Prospec- tive Payrnent, 23 IIFALTH SF,RVS. RES. 237 ( 1988) (ownership type had no independent effect on initial hospital response to Medicare paymont reform).

n244 As explained in Ertnann & Gabel, supra note 238, at 59: The studies suffer fi-om one serious metltodological flaw. [Multi-hospital] systerns do not randonrly choosc where to locate, but self-select into favorable tnarket areas ... with lower Medicaid and indigent patient loads. Systems also purchase or build hospitals witlr certaiu services and size, avoiding large tertiary care hospitals with heavy research and teaching commitments. Studies which compare an experimental group (system hospitals) with a matched control group (independent hospitals) tnay find no differences simply because the tnatching process eliminated hospitals providing different services or teaching programs.

n245 See J. HOLLINGSWORTH & E. HOLLINGSWORTH, supra note 25, at 108-10; Schlesinger, Mar- mor & Smithey, s•upra note 27, at 437; Shortell, Monison, Hughes, Friedman, Coverdill & Berg, 1 he Effects of Hospital Ownership on Nontraditional Services, 5 HEALTH AFF., 97, 101 (1986) (nonprofits provide 50% more "alternative services" than for-profits; for-profits offer 60% fewer unprofitable services than nonprofits).

n246 J. HOLLINGSWORTH & E. HOLLINGSWORTH, supra note 25, at 109 (only 1% of for-profits have residency programs, conipared to 22% of nonprofits); Yoder, supra note 11, at 142.

Appx.368 Page 66 66 Wash_ L. Rev. 307, *

n247 See Yoder, supra note 11, at 142-43 (observing tttat lower level of research tnay be due to past re#usal of funding sotirces -- hicluding the National Institutes of Health, the nation's largest source of biomedical research funds -- to sttpport for-profit institutions); id. (in the last couple of years, suice this discrimination has ceased, "investor-owned hospital compauies have greatly increased their involvement in education and research"); id at 145 (wlien for-profit hospitals have tried io the past to acquire teaching hospitals, they met with intense opposition; citing Ilospital Corp. of Atnerica s attempt to buy IIatvard's McLean Hospital); Haosznann, szrpra note 159, at 80 (suggesting that differences in locational preference may result from the exemption itself simply because the property tax exemption makes higher-taxed, inner-city land more attractive to nonproftts than to for-profits); Simpson & Lee, supra note 141, at 780 (conceming unprofitable services, "given the well- docutnented excess hospital capacity in the (J.S., we are skeptical of any argmnent that maintaining services for which there is insufficient demand constitutes a public service"); id. (superior educational and research pi-ograms do not earn the exemption because they receive substantial independent support froni public sources).

n248 Seay & Sigmond, supra note 39, at 30.

n249 Indeed this statement of the community benefit standard describes precisely, althotigh in soniewhat foreign terminology, what for-profit hospitals do when they sell their services to the community. See Utah County v. Intennountain Health Care, Inc., 709 P. 2d 265, 276 (Utah 1985): [Tlie defendant hospitals] confuse the element of gifl to the community ... with the concept of commnnity benefit, which any of countless private enterprises might provide. We have no quarrel with the assertion tttat [the ttospitals] meet great and important needs of persons within titeir conununities for medical care. Yet this .. . cannot be the sole distinguishing characteristic that leads to an automatic property tax exeniption.... Such a "usefulness" rule would have to be equally applied to for-profit hospitals ... which also provide medical services to their patients.

n250 Bittker & Rahdert, supra note 8, 332-33; see also R. STEVENS, supra note 35, at 354 ("[H]istory has shown that these words [cotmnunity, voluntary and charity] have long had vague, emotive meanings. They have expressed a rhetoric of intention ... rather than any exact program or method."); Bronlberg, Chartitable Hospi- tal, supra note 40, at 248-51 (characterizing the comruunity benefit standard as "existential"); Ginsberg, supra note 54, at 315 ("It would be difficult to state a vaguer test tltan'other purposes the accomplishment of whicir is beneficial to the community'.."); Wikler, supra note 206, at 153 ("Hospitals ... aspiring to virtue face further problems in defining and calibrating virtuous character. It is an elusive concept."); Reitiltardt, Charity at a Price, N.Y. Times Book Rev., Aug. 20, 1989, at 14 (The "ideals of private charity and voluntarism ._. act as the opiate of the American public, deluding a basically decent people into believing that _.. deeply troubling social problems requiring whole dollars for their solution can ... be adequately addressed with just two bits' worth of trickle-down generosity...... ). Even defenders of the exemption concede that "self-satisfaction and self- righteousness ... is perhaps att occupational hazard" among nonprofit hospital administrators, who tend to "have an almost reflexive belief in the itilterent superiority of voluntary healttt care." Seay & V ladeck, supra note 39, at 4-5.

n251 See generally Dripps, Delegation and Due Process, 1988 DUKE L.J 657; Pierce, The Role of Consti- tutional and Political Theory in Administrative Law, 64 TEY L. ItCV. 469 (1985); Schoenbrod, The Delegation Doctrine: Could the Court Give It Substance?, 831LIICH. L. REV 1223 (1985); Symposiunt, The Uneasy Con- stitutional Status of the Adrninistrative Agencies: Part 1, Delegation of Powers to Adrninisd-ative Agencies, 36 AM U L. REV, 295 (1987). The Supreme Court recently observed that such a role is particularly troubling with respect to the religious exeznption because "inquiry into the particular contributions of each religious group 'would introduce an element of govertunental evaluation and standards as to the wortlt of particular social welfare programs, thus producing a kind of continuing day-to-day relationship which the [first amendment] policy of [rel'igious] neutrality seeks to nrinimize."' Texas Monthly, Irzc_ v. Bullock, 489 (LS 1, 22 n.2 (1989).

n252 Persons, Osbom & Feldntan, saepra note 2, at 1942 (IRS is forced to beconte the "arbiter of the public good"); Warren, Ksattenmaker & Snyder, supra note 119, at 302, 309 (describing as "legislative abdication" the

Appx.369 Page 67 66 Wash. L. Rev. 307, *

decision to leave these important social policy decisions to the lowest level of the adtninistrative echelon); see Fox & Schaffer, Tax Policy as Social Policy: Cafeterra Plans, 1978-1985, 12 J. HEALTII POL., POL'Y & LAW 609, 633, 653 (1987) (exploring this phenomenon in the coutext of tax deductions for health insurance).

n253 See Thontpson,supra note 80, at 56 (accusing the IRS of having decided "to abandon completely any attempt to administer the exemption and [having decided to] treat cases on an ad hoc, nonanalytical basis ... using definitional strategies based on subjective, unatticulated factors rather than on objective, verifiable criteria").

n254 Rev. RuL 69-268, 1969-1 C_B_ 160; Rev_ Rul. 85-710, 1985-2 C.B. 166; see Colombo, supra note 41, at 514-17,

n255 Hospitals need not provide any free care except in the enietgency room, nursing homes may refuse uninsured patients at the outset but may not discharge patients for failure to pay, public interest law firins ntay receive compensation for only ltalf the costs of their services, consutner credit counselittg agencies must discount all their services, and grocers serving low-income customers may not charge anything. See B. HOPKINS, supra note 31, at 104 (describing IRS's "illogical and unfair discrhuination" am(ing activities that may charge fees for their services); Persons, Osborti & Feldman, supra note 2, at 1940, 1941, 1949 (discussing various rulings and noting a "considerable degree of ad hoc line-drawing by the IRS ... in this area"); Simon, supra note 69, at 85,

n256 The two principal aspects of this crisis are uncontrollable health care inflation and 35 niillion people without any public or private insurance coverage. M. HALL & I. ELLMAN, HEALTH CARE LAW AND ETHICS IN A NUTSHELL 3-6 (1990).

n257 See supra notes 78-80 and accotnpanyutg text.

n258 Guggetiheimer, supra note 230, at48-49; Seay & Vladeck, supra note 39, at 15-17.

n259 Ellman, supra note 11, at 1006 n.22 (collecting cases). Heightened conununity responsiveness by nonprofit hospitals is appareut in West Virginia where nonproftts must draw 40% of their goveming board members from designated gronps that represent the community at large. The court that sustained this measure against an equal protection challenge brought by the nonprofits (who clainted it discriminated in favor of for- profit hospitals) relied 'nr part on ttte observation that the tax exemption compensates nottprofrts for this organizational burden. American Haip. Ass'n v. I3ansbarger, 600 FSupp. 465, 473 (N.D.6KV 1984), affd, 783 F.2d 1184 (4th Cir.), cert. denied, 479 U.S. 820 (1986).

n260 The West Virginia statute for hospitals is limited to that activity and that state. See also Ellman, supra note 11, at 1006 n.23 (discussing the "unusual" Califomia nonprofit law that adopts a special standard of self- dealing).

n261 Ellman, s•upra note 11, at 1006 n_25; Hansmann, Re(orming NonproftCorporatron Law, 129 U. PA. L. REV. 297, 567 (1981).

n262 Ellman, supra note 11, at 1006 n.22.

n263 Stern v. Lucy Webb Flayes Nat'1 Training Sc/tool for Deaconesses & Missionaries, 381 F.Supp. 1003, 1013 (D.D.C. 1974). The distinction between trnsts and corporations recognizes "the fact that corporate directors have many areas of responsibility, while the traditional trustee is often charged only with the management of the trust funds and can therefore be expected to devote more time and expertise to that task." Id at 1013. It niay also

Appx.370 Page 68 66 Wash. L. Rev. 307, * simply recognize the fact that it is rational to give the founder of a charity a choice between two organizational forms, one that is more flexible bnt less protective than the other.

n264Id.

n265 See C. HAVIGHURST, HEALTH CARE LAW AND POLICY 209 (1988); Karst, The Efftciency of the Charitable Dollar: An Unfalfidled State Responsibility, 73 IIARP. L. RLV. 433, 436 (1960) (charities lack any "initerested ... individual to call the charitable fiduciary to account"); cf Hansmann, supra note 262, at 568 (arguing for stricter trust standards for nonprofits because "ttie patrons of a nonprofit are generally nmch less able to look out for themselves tttan are the shareholders in a business corporation"). A pritne example of such a compensatory rule is the authority of state attorneys general to chal lenge nonprofits for breach of their dttties. A second example is a prophylactic rule against self-dealing transactions by nonprofit directors. See Ellrnan, supra note 11, at 1007-08.

n266 Wikler, .s•upra note 206, at 148: Tr-ue, bondholders do not vote, but since institutional behavior must be geared toward nteeting the expectations of future bondholders, the interests and wishes of the investor comtnunity influence hospital beltavior without a direct vote. For most intents and purposes, then, voluntary and for-profit t ospitals have become more or less the same.. . .

n267 See supra notes 236-41 and accompanying text.

n268 See J. HOLLINGSWORTH & E. HOLLINGSWORTH, supra note 25, at 64 ("[I]n the past two decades it has become increasingly clear that voluntaty and public hospitals have similar motives. Their desire is to acquire reserves, a forin of profit, which have becotne an itnportant source of capital expansion in the past."); Yoder, supra note 11, at 86, 185, 202 n.7 (in several recent years, nonprofit income was proportionately greater than for-profit income); Chang & 1'uckman, 7he Profrts ofNot-F'or-Profct Ilospitals, 13 J. HEALTH POL., POL'Y & L. 547, 549-50 ( 1988) (nonprofits can ed 14_8°/u frorn Medicare in 1985 versus 17.9% by proprietary hospitals).

n269 Levinsky, Letter to the Editor, 318 NGW ENG. J ML•'D. 1486 (1988); Mancino, supra note 40, at 1070-71; see Seay & Vladeck, supra note 39, at 17-18.

n270 Atkinson, supra note 199.

n271 Id. at 629.

n272 Id at 619.

n273 In addition, this theory fails ttie historicat consistency and universality criteria. It is not Itistorically correct becatise it contradicts the established understanding that "charitable" encornpasses a smaller set of activities than do all nonprofits; otherwise the very complex structure that differentiates among the various fornis of tax exemption, see Sirnon, supra note 69, would be largely redund

Appx. 371 Page 69 66 Wash. L. Rev. 307, *

n274 Id. at 630. He continnes: "I must admit my suspicion that the question of itilterent goodness inay not be subject to proof, in the case of either altruism or other proposed desiderata_" Id.

n275 See supra notes 50-52 and aecotnpanying text_

n276 This is not to say that these questions require a negative answer. Indeed, the donative theory of exemption presented in this Article shares tnuch in common with Atkinson's altruism theory. Both theorios advocate subsidizing activities motivated by altruistn. But, a careful developntent of why this is appropriate reveals precisely what counts as a donation. For instance Atkinson incorrectly cotmts as a donation the forced retentiott of earnings by nonprofits, a point developed in a subsequent article. See M. Hall & J. Colontbo, The Donative Theory of the Charitable Exemption (fortltcoming).

n277 E.g., Gergen, 77ae Case for a Charitable Contributions Deduction, 74 VA. L. REV 1393 (1988); McDaniel, An Alternative to the Federal Income 'I'ax Deduction in Support ofPrivate Philanthropy, in'I'AX IN- ST11'UTE OF AMERICA, TAX IMPACTS ON PHILANTIIROPY (1972).

n278 See supra note 11.

n279 Less ambitious, but still useful, theoretical discussions of the federal exetnption are found prior to Bittker's work in Persons, Osborn & Feldman, supra note 2; Belknap, supra note 4; and after his work in J. DOUGLAS, supra note S, ch. VI]I; Dale, supra note 71; Simon, supra note 69; Stone, supra note 9; see also infr^a note 291.

n280 Most diseussions of the property tax exemption focus narrowly on the details of particular statutoty and decisional law of an indivi

n281 Bittker & Rahdert, supra note 8.

n282 See id. at 308.

n283 Id. at 310 and auttiorities cited therein_

n284 See supra note 29.

n285 See generally Bittker & Rahdert, supra note 8, at 307-14.

n286 Hansmana, The Rationale.for Exempting Nonproftt Organizations from Corporate Income Taxation, 91 YALE L.Z 54, 59-61 (1981). "[N]ot-for-profit organizations can and do make ptrofits ... in the custoniaty accounting sense of the terrn. Indeed, in 1984 the average total net margin ... of U.S. hospitals, most of which are not-for-profit, was 6.2%. ..." Yoder, supra note 11, at 9.

n287 According to Bittker and Rahdert, "The exemption... is neither a special privilege nor a hidden subsidy. Rather, it reflects the application of established principles of income taxation to organizations which .._ do not seek profit." Bittker & Rahdert, satpra note 8, at 357-58. Contra notes 12, 70, .supra, and accompanying

Appx.372 Page 70 66 Wash. L. Rev. 307, *

( text; see also note 12, supra; cf. Thuronyi, Tax Expenrlirures: A Rea.rs•essment, 1988 DUKE L.J. /!55 stressing the subsidy nature of tax looplioles).

n288 Oue could construct a variant theory that attenrpts to justify the property tax exemption based on tax, as opposed to social, policy. That theory would hold that tax equity requires taxation accordhig to the ability to pay, and propetty devoted to charitable purposes is least able to pay; but such a theory would not survive scrutiny either. See Warren, Krattenmaker & Snyder, supra note 119, at 289-91 (articulating, but rejecting, this theory). Essentially, this theory is an alternate explanation for the relief-of=poverty theory that was rejected in Sec- tion III because (1) it is too narrow to satisfy the major categories of the exetnption, which extend beyond relief of the pooi, aiid (2) tile exeiliption is regressi're under this theery since it'y'ro`.'ides the most relief to the vuealthl- est organizations. See supra notes 190-98 and accompanying text.

n2891ror instatrce, if the exemptiott exists because the entity has difficulty measuring income, why should it matter whether the entity is, for example, engaged in legislative lobbying (an activity whiclt ordinarily would deny an entity exempt status under § 501(c)(3))7 Nevertheless, the theory does have the advantage of explaining ttie tax on unrelated business income, to the extent that "unrelated" might be taken to mean "easy to measure" under this definition of who is a charity,

n290 The donative theory developed in Section IV, infra, suggests that Bittker's theory is actually closer to the mark than this (and his) description portrays. The primary difficulty in applying traditional concepts of income to charities lies in liow to characterize donations to the institution. Thus, to the extent Bittker's theory supports exemption for only donative nonprofits, it is consistent with the donative theory. However, his theory fails to account for the use of the exemption as a subsidy, and it fails to explain why a subsidy should be given to donative nonprofrts. As a result, it fails to identify which nonprofits, in borderliue situations, should be classified as charitable.

n291 After Hansmann's work, the literature renrained essentially silent on this topic until Atkinson, supra note 199. Atkinson's theoty, which deserves coequal status with these earlier "academic theories," is not discussed here because his analysis relates to the cominunity benefit theory. See supra notes 269-76 and accompanying text.

n292 Hansmann, supra note 287, at 72-75.

n293 Id at 76-85.

n294 See supra note 234 and accompanying text.

n295 See generally D. COHOD>JS & B. KINKEAD, HOSPITAL CAPITAI. FORMATION IN THE 1980s (1984)_ 'l1ris sitttation may change, tliough, as a result of sweeping limitations in public and private health insurance. See J. HOLLINGSWORTH & L. HOLLINGS WORTH, supra note 25, at 40-42. On the other hand, continaing a capital subsidy would defeat the putpose of these reimbursement reforms, namely to eliminate excess duplication and force hospitals to operate tnore efficiently_

n296 Hanstnatu s theory also requires identification of those activities that are more efficiently provided by the nonproflt fornt. See Hansmann, s•upra note 287, at 66, 85-89. This detenn¢iation is no easier under Hans- mann's theory than under the community benefrt theory discussed supra Section III.C.

n297 Hansmann, supra note 287, at 92.

Appx.373 Page 71 66 Wasb. L. Rev. 307, *

n298 See id. at n.113 (discussing direct capital subsidies to hospitals through the Hill-Btuton hospital construction fundhrg program dtuing the 1950s and 1960s); Schratnm, The Legal Identity of the Modern Hospital: A Story ofGvoZving [ra[ues, in IN SICKNESS AND IN HBALTH: THE MISSION OF VOLUNTARY HEAL'1'H CARE INSTITUTIONS 65, 74 ( 1988) (one-third of hospital construction in 1980 was supported by tax-exempt municipal bonds; in 1985, the $ 30 billion in hospital bonds aceounted for nearly 20% of all municipal bond sales).

n299 Buchele, supra note 117, at 272-73, suggests that a single, conlprehensive theoty is not necessary because these various theories, althouglt individually flawed, fit togetlier in a pattern of concentric circles that adequately explain ihc aniverse of chariu.ble exempt orga n.zations. Thus, at the center, it does not make sense for the government to tax itself by including public facilities in the tax base. As an extension of this logic, the government does not tax private facilities that provide scrvices the govertnnent would otherwise have to assume. In the outer ring of the circle, the government does not tax "humanitarian activities" serving a governtnent interest. Buchele admits, though, that the circle of "humanitarian activities" is far too broad. He also does not address the failure of the government burden theory (the secon(i ring) to meet the propottionality criterion. These and other defects are uot offset by the concentric namre of the theories.

n300 Several major antecedent works, however, poiut the way to this theory. Professor Hansmann's ac- knowledgement that the exemption is justified for donative nonprofits comes closest to the donative theory of exemption. Hansmann, supra note 11, at 887-889. However, Hansmann's rudimentary discussion fails to capture important aspects of the justification for subsidizing donative nottprofits through tlte tax system rather than througJt direct governntent grants, fails to tie the donative exemption to the law of charitable tntsts, and fails to demonstrate the ability of the donative theory to integrate all inajor components of the taxation of charitable organizations. Economist Burton Weisbrod, whose work also influenced tltis theory, more thoroughly establishes the theoretical groundwork for subsidizing donations, but he does so in the limited context of tt e charitable deduction. He does not extend his cxplanation to the exemption, and does not incotporate the cominon law concept of charity. Another major work upon wlticlt the donative theory relies, but which also falls short of reeognizhtg the full dimensions of the theory, is that of James Douglas. See J. DOUGLAS, supra note 8; see akro note 290, supra (ackttowledging the contributions of Bittker and Rahdert to this theory). Finally, Professor Atkinson's work also stresses the role of altrnisnt. His theory is directed principally to categorizing the types of altruism that exist in nonprofit organizations; he does not develop a normative argument to explain why the exentptiou should attach to altruistic activities. See supra notes 272-76 and accompanying text. As a consequence, Atkinsou's work departs from ttte donative tlteory developed in this Article by extending the exemption to essentially all legitimate nonprofits.

n301 Leading discussiotts of the public goods ttteory of the existence of nunprofit entet'prise include B. WEISBROD, supra note 8, at 59-60; B. WEISBROD, 7'HE VOLUNTARY NONPROPIT SECTOR (1977); Gergen, supra note 277, at 1397-99; Hansmann, supra note 11, at 848; Krashinsky, supra note 221, at 119-21.

n302 See P. SWORDS, supra note 70, at 217-21 (discussing public goods nature of poverty relief, education, and cultural activities); Roberts, supra note 193, at 139 (characterizing redistribution to the poor as a "public good" for which the "private solution is inefficient"). See gerieral[y J. DOUGLAS, supra note 8, at 57-58 (observing that the Stantte of Charitable Uses contains several obvious instances of public goods).

n303 See generally B. WEISBROD, supra note 301, at 53-61; Weisbrod, Toward a Theory of the I%luntary Non-Profit Sector, in ALTRUISM, MORALITY AND ECONOMIC THEORY 171 (E. Phelps ed. 1975).

n304 One might attempt to turn the governtnent failure explanation against the donative theory by maintaining that this line of pnblic choice analysis would validate a decision by a majority of the electorate to support another theory of the exemption to support extending the exeniption to an industry (say, hospitals) that does not

Appx.374 Page 72 66 Wastt. L. Rev. 307, *

meet the donative criterion. However this observation is um'esponsive to the issue at hand because it is made at a metalevel of analysis that considers whether the charitable exemption should be abandoned attogether, or whether there are other distinet categories of exemption other than charities. 'fhis Article takes the charitable exemption as a given-for it is the form of the exemption that the electorate has in fact validated-and proposes a theory of exemption and a concept of charity that best explain its function.

n305 The positive-voter line would be more vertical; the negative line would be lower and tnore horizontal

n306 Confirmation of the relationship between government failure and donative behavior comes from observing wlsether rapid drops in donative activity follow sharp increases in government spending. Several econoniists have posited that government spending has a "crowding out" effect on donations, such that as govcrnment spending increases, the need for charities to solicit donations, and the willingness of donors to give, di- minishes. See, e.g., Abrams & Schntitz, Tize Crotivding-OzR effect ofgovernmental Transfers on Private, Chari- table Contributions, in THE ECONOMICS OF NONPROFI7' INSTI'I'UTIONS 303 (S. Rose-Ackerman cd. 1986)_ One study confirms this crowding-out thesis with data relating to the drop in giving to social welfare services following the governnient's New Deal programs that grew out of the Depression. Roberts, supra note 193_ However, other studies have found less crowding out effect than theorists have posited. See Andreoni, Giving and Impure Altrui.rm: Applications to Charity and Ricardian Equivalence, 97 J. POL. ECON. 1447 (1989).

n307 B. WEISBROD, supra note 8, at 29-30.

n308 MeDattiel, supra note 277, at 174 ("The deduetion for charitable contributions is simply a mechanism whereby the federal government matches private donations to charity. ...'I'he taxpayer is denominated the paying agent for the government's share and is given ttre rigltt to designate where that share will go.").

n309 B. WSISBROD, supra note 8, at 30 ("Tax subsidies therefore represent, nr effect, cotttributions from low demanders to stimulate the high dernanders to contribute.").

n3 10 Id. at 29 (tax subsidies "increase the amount of output the donor can buy for any given donation").

113 11 The property and income tax exemptions are currently administered in a sitnilar fashion. Only the portion of property and income related to an exempt purpose qualify for exempt status. This is the function of the unrelated business ineotne tax contained in I.R.C. §§ 511-14 (1989).

n312 In fact federal tax law already distiuguishes among levels of donative support in administering the charitable deduction. It allows individuals to deduct contributions up to 50% of their adjusted gross income (AGI) for donations to clturches, schools, hospitals, niedical research entities, and any other entity which receives a"substantial part of its support" frotn public contributions or the government. I.R.C. § 170(b)(1)(A)(vi) (1980). In contrast, the maximum deduetion for contributions to other charities is limited to 30% of AGI_ 'fhe regulations establish one-third of receipts as a safe-harbor for nteeting this "substantial [donative] support" test. Treas. Reg. § 1.170A-9(e)(2) (1973). A similar kind of "sliding scale" could be designed for the tax exemption, permitting full exetnption for entities which receive over one-third of their income from public support, and something less than full exemption for otlter entities, diminishing to zero exemption where there is only negligi- ble public support.

n313 Person, Osborn & Feldman, supra note 2, at 1911; id. at 1945 (discussing "unselfish giving" as central to the charitable concept).

n314 See Atkinson, supra tiote 199, at 628-30 (taking the worth of altruism as a given).

Appx.375 Page 73 66 Wash. L. Rev. 307, *

015 Legal and historical precedent also confirm the government failure component of the donative theory. 'fhe core of this rationale is contained in the Supreme Court's explanation that "charitable exemptions are justified on the basis that the exempt entity confers a public benefit -- a benefit which the society or the comniunity may not itself choose or be able to provide, or which supplements and advances ttie work of public institntions already supported by tax revenues." Bob.Tones Univ. v. United States, 461 US. 574, 591 (1983). The govertunent failure rationale is further confirmed by the history of the charitable exeinption, which has its strongest application to religion, the doniinant form of charity througlrout the ages. As summarized supra note 5, in ancient Egypt, Greece and Rome, temptes were exempt because it was thought beyond the power of man to tax gods -- an extreme form of government failure. 'I'lie religious exemption carried over into medieval England for the simple reason that there was no centralized govertmient capable of imposing a tax. In the American colonies, which were established as theocracies, churches were not taxed because no government thinks to tax itself. After the constitutional adoption of the separation principle, though, the religious exentption is justified by the prohibition on government supporting religion's wotYltwhile activities in any more direct tnan- ner. See Wa1z v. Tax Commo'n, 397 IJ S. 664 (1970) (upholding constittttionality of charitable exemption applied to religion). 7'he government failure theory is but a weaker version of this modern rationale applied to foi-ms of gcrvernmental incapacity other than direct prohibition of funding.

n316 See gene-ally notes 78-134 and accompanying text.

n317 See supra notes 78-80 and accompanying text.

1018 In re Cranston, [1898] 1 I.R 431, 446 (Ir. H. Ct.).

n3 19 Not only must tax law retain the element of a gift, but, because a tax exetnption entails a public subsidy ratlier than just the protective fiinetion served by the tnist law, see supra notes 107-08 and accompanying text, the decision by a single donor to sacrifice personal assets is not enough to justify an exemption. Rather, the tax law must in some manner identify activities which the public ht general has chosen to support.

n320 In addition to the obseivations made in the following text, trust law reinforces the public goods component of the donative theory because the legal concept of public benefit that defines charitable trusts seems to captiu'e the same notion as the economic concept of positive extentalities that describes the market failure inherent in public goods (tliose for which the benefits to others are much larger than the benefits captured by the piice charged to an individual purchaser). See J. DOUGLAS, sup-a note 8, at 19.

n321 Modern Englistr quotation taken froin Persons, Osbom & Feldman, supra note 2, at 1913.

n322 Jackson v. Phillips, 96 Mass. (14 Allen) 539, 556 (1867) (emphasis added); see also BLACK'S LAW DICTIONARY 212 (5th ed. 1979) (defining "charitable" as "every gift for a general public use").

n323 In re Resc6 s Will Trusts, [1969] 1 App_ Cas. 514, 540 (P.C.) (emphasis added).

n324 E.g., RESTATEMI:NT (SECOND) OF 1'RUST § 372 (1959) ("A tnist for the promotion of health is charitable."). Also, the element of gift is fundamental to tort law's former willingness to clothe charities with iininunity: "'If an organization for charitable purposes founded upon the bounty of otlters who supply funds for the purpose of administering relief... may have its funds diverted from such kindly purpose, would it not inevitably operate to close the purses of the gencrous and benevolent who now do much to relieve the suffering of mankind?"' Dille

Appx.376 Page 74 66 Wash. L. Rev. 307, `

v. SI. Lzike's Hosp., 196 S. W.2d 615, 617 (Mo. 1946) (quoting Adams v. University Hosp, 122 Mo. App. 675, 99 S. W 453, 454 (1907)).

n325 In 1988, religion received 46.2% of all gifts, amounting to $ 48.21 billion. Education receivcd $ 9.78 billion. GIVING USA, THE ANNUAL REPORT ON PHILAN'fHROPY FOR THE YEAR 1988, AT 9( 1989).

n326 461 U S. 574 (1983).

tt327Id. at 586.

028 ,5ee supra note 33.

( n329 See generaliy W. W ELLFORD & J. GALLAGHER, supra note 55, at 134 "Many states take into account the level of charitable support an organization receives in deterinining whether it is charitable.").

n330 202 Va. 86, 116SE.2d 79 (1960).

n331 Id. at 82; see id at 80 "[Slonie 33,000 individuals and businesses contribu[ed] approximately $ 4,000,000 in the fund-raising campaign."). Similarly, the Nebraska Supreme Court, which is often cited for its classic statement of the per se view, see Young Men's Christian As,s'n v. Lancaster County, 106 Neb. 105, 111, 182 N. 6V 593, 595 (1921), observed in St. Elizabeth Ilosp. v. Lancaster County, 109 Neb. 104, 189 N. W. 981 (1922), that the entity in question was founded from tnany stnall donations, and that the hospital was run by nuns who contributed their services for free. "Charitable gifts and gratuitous services are contributed to the welfare of society." St. Elizabeth Hosp., 189 N. W. at 982; see also Southern Methodist Hosp. v. Wilson, 51 Ariz. 424, 77 P.2d f458, 460-461 (1983) (hospital charitable despite rendering "very little free medical or hospital attendance to anyone," but "tlre propertywhich it took over [when it converted to charitable status] was heavily burdened with debt, and ... there were various contributions made froin time to time amounting to forty to fiity thousand dollars in all"), overruled on other grounds, Ray v. Tucson Medical Center, 72 Ariz. 22, 230 P.2d 220 (1951); Fredericka Home for the Aged v. San Diego County, 35 Ccr7. 2d 789, 221 P.2d 68, 71 (1950) (citing fact that 35% of income of entity came from endowments and donations as evidence of charity); In re Appeal of Sunny Ridge Manor, Inc., 106 Idaho 98, 675 P.2d 813, 816 (1984) (notuig paucity of donations in denyutg exetnpt status); Mayo Found v. Commissioner ofRevenue, 306 Minn. 25, 236 N. W 2d 767, 773 (1975) (noting inr- portance of support by "benevolent contributions" to assessment of charitable status); Oregon Methodist Ilomes, Inc. v. Horn, 226 Or. 298, 360 P.2d 293, 303 (1961) (home for aged not exempt, in part because "there are uo gifts of tand and buildings; no endownrent fitnd; no gil4s front outsiders to offset the operating losses"); In re Prange's Will, 208 If'is. 404, 243 N W. 488, 491 (1932) ("A hospital wltich pays no dividends aud is largely suppotted by donations is a charitable institution."); ef. Utah County v. Intermountain Health Care, Inc., 709 P.2d 265, 273 (Utah 7985) (level of donations impottaut factor in detcrmining charitable status).

n332 Persons, Osborn & Feldman, supra note 2, at 1947-48. For example, Harding Hosp. v. United States, 505 F.2d 1068, 1077 (6th Cir. 1974), used the lack of charitable donations to support ttte denial of exempt status for a specialized psychiatrie hospital. The lack of contributions was also noted by the Eightli Circuit in denying an exemption to a nonprofit pharmacy. Federation Pharmacy Servs•. v. Cotnmissroner, 625 F:2d 804, 808 (8th Cir.. 1980); see W. WELLFORD & J_ GALLAGHER, supra note 55, at 97 (1988) (n(iting a nuntber of federal cases outside the health care field in which lack of charitable donations was a contributing factor to denial of exemption); see also Fides Publishers Ass'n v. United States, 263 F.Supp. 924 (N.D. Ind. 1967); Ea.ster Iloatse v. United States, 12 Ct. Cl. 476 (1987); EST qfHawaii v. Commissioner, 71 7'C. 1067, 1081 (1979); B.S. W Group v. Commissioner, 70 T C. 352, 359 (1978); Bromberg, F'inancing Health Care, supra note 40, at 180.

n333 S'ee W. WELLFORD & J. GALLACHER, sarpra note 55, at 95-97; Note, Religious Noriproftts and the Commercial Manner Test, 99 YALE L.J 1631, 1632, 1640 (1990).

Appx.377 Page 75 66 Wash. L. Rev_ 307, *

n334 LR.C. §50I (m) (1989). Congress had in mind the 501(c)(3) exemption for the Teacher's Insurance Annuity Association and the § 501(c)(4) exetnption for Blue Cross/Blue Shield. See'1'AX REFORM ACT OF 1985, H.R. REP_ NO. 426, 99th Cong., 1 st Sess., at 663 (1985).

n335 UBITHearings, supra note 6.

n336 Bob Jones Univ. v. United States, 461 U.S. 574, 586 (1983).

n337 Although the IRS possesses the authority to intetpret atid exercise the charitable exemption consistent with the donative theory presented in this Atticle, it is pertiaps undesirable for the IRS to implement such a major change on its own initiative.

n338 See supra Section III.C.

n339 See supra note296.

n340 B. WEISBROD, supra note 8, at 7("An organization that relies on donations to aid the poor must tai- lor the form of that aid to the wants of prospective donors, who are, in effect, the economic dentanders of the organization's service.").

n341 For similar reasons, the subsicly uuder tlie sales tax excinption for pur•chascs is also proportionate to the level of douations.

n342 Generally, gifts arc not considered as income to the recipient. I.R.C. § 102 (1989). Even if they were, they would likely be entirely offset by the expense entailed in the organization's provision of its services for flee. Therefore, purely donative and commercial nonprofits that potentially earn taxable inconte, such as education and the performing arts, analysis of the proportionality criterion is more complex because the relationsbip between the indicium of dersevedness and the level of subsidy may turn on whether donations are devotedto capital ot- operating costs. A nonprofit that applies its contributions to capital funding needs is likely to generate more revenues. Schools with the largest endowments are thus likely to have the most tuition-paying stndents because they will have the largest facilities. However, there still may not be a positive relationship to taxable income because even donated capital assets generate depreciation expenses to offset the enhanced revenues, donations applied to operating costs can paradoxically result in less taxable income since funds spent on the otganization's revenue-producing activities are deductible as business expenses probably generate no operating smplus. 'Che fact that they need to solicit donations indicates that, over the long run, their business receipts are less than their expenses.

n343 See supra notes 166-169, 185 and accontpanying text,

n344 See supra note 310 and accompanying text.

n345 Thirty-four states and the District of Colombia grant nouprofits exemption ffom paying sales taxes. ALA. CODE,¢ 40-23-5(m) (Supp_ 1990); ARIZ. REV. S'fAT. ANN. § 42-1321(5) (1980); ARK. CODEANN. § 26-52-401(21) (Supp. 1989) (exempting sales to hospitals); COLO. REV. STAT. § 39-26-114(1)(a)(17) (Supp. ( 1990); CONN GE'N. STAT. ANN. § 12-412(5) (West Supp. 1990); D.C. CODE ANN. § 47-2005(3) 1990); F'LA. STAT. ANN. ,¢ 212.08(7)(m) (West 1989); GA. CODE ANN. § 91 A-4503(g) (Ilarrison Supp. 1989); HAW. REV. STAT 237-23(8) (Supp. 1989); IDAIIO CODE § 63-3622o (Supp. 1990); ILL. ANN. STAT. ch_ 120, P441(b) (Sinith-Hurd Supp. 1990); IND. CODE ANN. § 6-2.5-5-25(a)(1) (Bums 1989); KAN. STAT ANN. § 79-3606(6)

Appx.378 Page 76 66 Wash. L. Rev. 307,

(1990); (1989); KY. REV. STAT. ANN. § 139.470 (Baldwin 1990); IVIF.. REV STAT ANN. tll. 36, § 1760(16) ML). TAX-GEN. CODE ANN. § 11-204 (Supp. 1990); MASS. ANN LA WS ch 64H, § 6(e) (Law. Co-op. Supp. 1990); MICH. COMP. LA WS ANtV. § 205,54a (West Supp. 1990); MINN. STAT. ANN. § 297A.25 (West Supp. 1991); MISS. CODE ANN. § 27-65-111(a) (1972); MO. ANN. STAT § 144.030.2.(19) (Vernon Supp. 1990); NEB. REV. .STAT. § 77-2704 (1986); NJ STAT ANN § 54:32B-9(b)(1) (West 1986); N.M STAT ANN § 7-9- 29 (1990); N. Y. TAX LAW,¢ 1116(A)(4) (CONSOL. 1987); OHIO REV CODE ANN. § 5739.02 (Anderson Supp. 1989); PA. STAT. ANN. tit. 72, § 7204 (Purdon 1990); R.I. GF,N. LAWS,§ 44-18-30 (Supp. 1990); SD. (1989); CODIFIED LA WS ANtV § 10-45-10 (1989); TENrV. CODE ANN. § 67-6-322(a)(8) 7EX TAX CODE ANN. § 151.310(a)(1) (Vernon Supp. 1991); UTAH CODE ANN. § 59-12-104(8) (Supp. 1990); Y"T. STAT ANN. tit. 32, § 9743(3) (Supp. 1990); VA. CODE ANN. § 58.1-608 (Supp. 1990); WIS. STAT. ANN. § 77-54(9a)(f) (West 1989); WYO. STAT. § 39-6-405(a) (1990). Delaware, Moutaua, New Hantpshire and Oregon do not have a sales tax at all.

n346 Donative nonprofits also raise revenue from sales, strch as tuition paid to schools and ticket sales by the performing arts. Most value-added taxes howcver do not include such services in the tax base. Even if they did, an exemption would still fail the proportionality criterion discussed in the following text,

n347 Only seven states provide general exetnptions for sales by charitable organizations. ARK. CODE ANN. ,¢ 26-52-401(3) (Supp. 1989); IND. CODE ANN. § 6-2.5-5-26(a)(1) (Burns 1989); IOWA CODE ANN. § ( 422.45(3) (West 1990); N.J. STAT. ANN. § 54: 32B-9(b)(1) (West 1986); N. Y. TAX LAW § 1116(a)(4) Consol_ (1981). 1987); UTAHCODEANN. § 59-I2-104(8) (Supp. 1990); VT. STAT ANN. tit. 32, § 9743(3)

n348 B. WEISBROD, supra note 301, at 3, 80-81, 93-98: [Using 1969 data,] we find that the nine particular services/facilities -- out of a total of tltirty-one -- that had beon judged a priori to be primarily private in character are found disproportionately in the for-profit hospitals, while the twenty-two services that had been judged to have the greatest degree of collective-good quality are found disproportionately in the governtnental and voluntary nouprofrt hospitals.... See also Weisbrod, supra uote 303, at 193.

n349 See supra notes 203-05, 245-47 and accompanyiug text. However, the superior performance record of nonprofits in treating indigent patients is not nearly as clear_ See supra notes 143-45 and accompanying text.

n350 For no apparent reason, statistics on giving as a percentage of ltospitat revennes are imprecise, but the discrepancies are immaterial for present purposes. The National Association of Hospital Developrneut (NAIID) reports that, in 6scal 1987-88, its 1,425 member hospitals received 1.6% of their "total budgets" (expenditures) from cash donations. Telephone conversafion with Ron Childress, NAHD Communications Manager (Jan. 22, 1990) (notes on file witli the Washington Law Revie»); see also G. ANDERSON, J. LAVE, C. RUSSE & P. NEUMAN, supra note 165, at 147-48 ("[B]y 1985, philattthropy represented less than 1.3 percent of funds ttsed for hospital care. ..."); Yoder, supra note 11, at 100, table 5.2 (in 1983, nonprofit hospitals received 0.4% of revenues from contributions -- $ 370.9 million in all); Herzlinger & Krasker, supra note 143, at 95 (donations antounted to only 1% of total hospitat expenses in 1983, from a selected sample of nonprofit chain hospitals); UBIT Hem•ings, supra note 6, at 183 (statement of Marion R_ Fremont-Smith, Independent Sector) (2% of 1982 hospital revenne came from private contributions); id at 996 (statement of Bradford H. Gray, Institute of Medi- eine) ("Charitable contributions used to be an important source of funds for hospitals, but they have now declined to less tttan one-half of 1 percent of hospital revenues. ...")_ Scattered information from itidividual hospitals confirrns these national aggregates. In 1988, SamCor, one of the southwest's largest nonprofit chains, raised less than one-half of one percent of its revenues froni donations. 1988 SAMCOR ANNUAL REPOR7' 19, 28 ($ 2,156,000 in donations out of$ 560,611,000 in total operating receipts). A group of I I nonprofit hospitals in Utah received app roximately 1% oftheir 1986 revenues from donations and endowment income, Pace Managetnent Services, supra note 153. Vanderbilt University Hospital received $ 259,000 in gifts in 1987, as against $ 237 million in revenues budgeted for 1988, a ratio of

Appx.379 Page 77 66 Wash. L. Rev_ 307, *

one to one thousauid. Vanderbilt tJniversity Medical Center: Facts 1988 at 5 (copy of patnphlet on file with the Washington LawReview).

n351 J. HOLLINGSWORTH & E. HOLLINGSWORTH, .supra note 25, at 29 (in 1904, voluntary hospitals received 36% of revenucs &om gifts); id at 92 ("During the late 1920s almost tliree-quartcrs of capital for hospital constniction came from philantlu'opy...... ).

n352 Rosner, Heterogeneity and Uniformity: Historical Perspectives on the Voluntary Ilospital, in IN SICKNESS AND IN HEALTI3: THE MISSION OF VOLUNTARY HEALTII CARE INS'I'ITUTIONS 97,93 (1988). Strong confirntation of the role of religious uid ethnic ideology and the influence of societal heterogeneity on the pattern of hospital developinent cotnes from a cross-national study that found that "in all countries with one prevalent religion, hospitals were run by the government, ... but where competition existed among religious groups, they retained control of hospitals to protect and extend their sphere of influence." P. STARR, supra note 35, at 176 (describing study in W. GLASER, SOCIAI, SETTINGS AND MEDICAL ORGANIZA- TIONS: A CROSS-NATIONAL STLJDY OF THE HOSPITAL (1970)).

n353 P. S'rARR, supra note 35, at 169-70, 173; Clark, supra uote 10, at 1458.

n354 J. IIOLL.INGSWORTII & E. HOLLINGSWORTH, supra note25, at 5-6, 24-25, 37.

n355 See Foster, supra note 211, at 348-50,

n356 D. COIIODES & B. KINKEAD, supra note 295, at 23; J. HOLLINGSWORTH & E. ... HOLLINGSWORTH, supra note 25, at 37 ("By 1981, philantluopic contributions to ltospitals [were] less than one-fourth of the level when Medicare began."); Yoder, .supra note 11, at 55 (philantltropy, as a percentage of funding for hospital construction, decreased from 21°/a in 1968, to 10% in 1973, to 6% in 1978, to 4% in 1981); Foster, supra ttote 211, at 350-51. See generally J. Tercnzio, A Survey of the History and Current Out- look of Philanthropy as a Source ofCapital for the Needs of the Health Care Field, in HEALTH CARE CAPI- TAL: COMPETITION AND CONTROL (1978).

( n357 See. F. Sloan, J. Hoerger, M. Morrisey & M. Hassan, The Demise of Hospital Philanthropy Jan. 1989) (developing and documenting this "erowding ont" thesis) (unpublished mamtscript on file with the Washington Law Revieu).

56. n359 Dyer, Hospitals Saw Patient Margin Vanish in 1988, HOSPITALS, May 5, 1989, at

n360 The same lack of donative support for certain non-hospital health care providers (such as HMOs, physician practice associations, nonprofit pharmacies, and nursing homes) indicates that the IRS's current posture of atteinpfing to deny exemption to these entities may be the right result reached on the wrong analytical grounds. In a prior article, Professor Colombo argued titat the IRS could not consistently adhere to a per se theory of exemption for liospitals while continuing to deny exentption to these other health care providers_ See generally Colombo, satpra note 41. The remedy for this inconsistency suggested in that article, to extend the exemption to all legitimate nonprofit providers of health care services, was premised on the continuation of the per se theory of exemption. Id. at 523. That article also recognized, however, that reconsideration of the fundamental basis of the exemption offers another solution. Reevaluation of the exeniption resolves the inconsistency by denying exemption to all forms of commercial health care enterprise.

Appx.380 Page 78 66 Wash. L. Rev. 307, *

n361 The 1,425 member hospitaLs of the National Association ofIIospital Development received $ 1.90 billion cash donations in fiscal 1987-88, an average of $ 1.3 million each. Telephone conversation witlt Ron Chil- dress, NAHD Conimunications Manager (Jan. 22, 1990) (notes on file witlt the Washington Law Review).

n362 W. WELLFORD & J. GALLAGHER, supra note 55, at 29: A conunon misconception ... is that once there was a golden age when charitable orgauizations in the tJnited States raised funds almost exchtsively through the generosity of the public and the benevolence of a few great phi lantliropists.... Even before the Civil War, charities relied to sotne extent on fees to support activities and prograrns rangiug from publication and distribution of religious tracts to organization and maintenance of food relief for the poor. After the Civil War, fees played a central role in expanding educational and medical services, in initiating school lunch and work trainitig progranis, and in developing social casework programs. See id. at 45-46, 58-59.

n363 See Foster, supra note 211, at 351, table I (during the post-war era until 1968, philanthropy provided from 20% to 30% of hospital construction funding); supra note 351. Another indication that this level is appropriate is the test currently used for giving more favored status to sonie charities for purposes of capping the level of contributions that individuals inay deduct in computing their income tax. Individuals inay deduct up to 50% of their adjusted gross income for contributions to charities that receive at least one-third of their support from the public; but only up to 30% of their income for charities that receive less than one-third of their support from the public. See supra note 312- For further development of the appropriate threshold, see M_ Hall & J. Co- lombo, '1'he Donative Theory of the Charitable Exetnption (forthcoming).

n364 See J. HOLLINGSWORTH & F. HOLLINGSWORTH, supra note 25, at 30 (very little giving to hospital operathig budget, or even to a general endowment; instead, donations are usually for specified purposes, such as to endow a particular service or facility). This approach of subdividing hospitals into service units is consistent with the approach often taken of apportioning the property tax exemption according to the particular assets or operations of an entity that are allocated to charitable purposes_ Using donative support as the measure of cliaritable apportionment solves the difficult problent of evaluating which assets are so used.

n365 For instance, while this Article was behig written, the hospital that successfully defonded an attack on its exempt status hi Medical Center Hospital v. City of Burlington, 152 Vt. 611, 566 A.2d 1352 ( 7989), ran the following quarter-page advettisement in the Burlington (Vt.) Free Press, Sunday, June 4, 1989, at D 10: When our children hurt, we all hurt. [Picuues of four bandaged and ill infants] Help theni. Give generonsly. ... Your money buys equipment and programs for MCIIV's children's cancer clinic, burn prevention progratn, poison center, and intensive care nursery. See also UBIT Hearings, supra note 6, at 938-39 (statement of Shriners Hospitals for Crippled Children) (in 1987, 22 hospitals provided "totally fiee hospital care for children in need," as a result of $ 140 ntillion of gills and $ 279 million of endowrnent income),

n366 The 1983 reform of the Medicare payment system for hospitals (known as the "DRG" reirnbursentent system, for "diagnosis-related groups") might facilitate suctt an accounting process because it fotms the basis for measur'mg revenues on a service-specific basis. Vladeck, Medicare Tlospital Paytnent hy Diagnosis-Related Groups, 100 ANN. INT. MED. 576 (1984). Thus, a hospital niight be able to exempt a portion of its patient care revenue by demonstrating that it receives substantial donative support for a burn tmit and a neonatal intensive care unit, without having to separately incorporate these nitegral parts of its operation.

n367'fhe present Article presents only the basic contours of the donative theory. Full understanding and implementation of tlie theory require consideratiou of additional theoretical and practical issues. 'fhe theoretical issues that remain include: Should the donative tlteory count all contributions even if they are motivated bysel-

Appx. 3 8 1 Page 79 66 Wash. L. Rev. 307, *

fisti or evil ends? Is the theory based purely on efficiency grounds or does it inclnde a moral ditnensioci? Miglrt it be used to justify an exemption foi- all nonpi-ofrts under the argrunent that every nonprofit donates its earnings to itself? Does the donative theoryjustify other elements of the charitable tax exemption -- sucti as the exemption's restriction to uonprofit entities, the limitation on political activity, and the uiuelated business incotne tax -- or are ttiese side constraints that are unconnected to the core theory? Other issues center around practical problems that exist in the implementation of the donative theory: What shotild be the required quantum of donative support? Should it be measnred on an industry or on an institution-specific basis? When and how otlen in the life of the institution should it be measured? Sliot ld the exemption apply different tneasures to different sources of donations, such as foundations, bequests and large donors? Do bants count? Donated labor? Will the donative theory encourage more fund raising abuse? These issues await our sequcl. See M. Hall & J. Colombo, The Donative Theory of the Charitable Exemption (forthcominig).

Appx.382 Page 1

^ LexisNexis

LEXSEE 17 I,OY. CONSUMER L. RF,V. 395

2005

17 Loy. Consumer L. Rev. 395

LENGTII: 9891 words

ACCESS TO HEALTH CARE SYMPOSIUM ARTICLE: Are We Getting Our Money's Worth7 Charity Care, Coin- munity Benefits, and 7-ax Exemption at Nonprofit Hospitals

NAME: By JackHanson *

SIO:

* Jack Hanson is a research analyst with the IIospita7 Accountability Project of the Service Etnployees In- ternational Union in Chicago. Before taking up this position in 2003, Mr. Hanson taughtphilosophy -- includutg courses in business ethics and health care ethics -- at Dartmouth College and at the University of Massachusetts at Amherst.

SUMMARY: ... Introduction: Nonprofit IIospitals and Access for the Uninsured ... Resurrection Health Care, Chicago's second- largest private nonprofit hospital system, operates nine hospitals in the Chicago tnetro area and is sponsored jointly by two Catholic religious orders. ... The situation is even worse with respect to Chicago's largest private nonprofit hospital systern and the Illinois health care niarket leader, Advocate Health Care, which operates eight hospitals in thc Chicago tnetro area and is affiliated with the United Church of Christ and the Evangelical Lutheran Church in Ameriea. ... Ac- cess to health care for low-incoine and uninsured people is shrhiknig in this country. .._ Most importantly, though, the Illinois law does not actually require a nonprofit hospital to devote any resources at all -- let alone sonic specific proportion of its resources every year -- to charity care or other coinmtmity benefit programs. ... And, in Illinois, a recent eotut decision addressing the toquirements for charitable exemption frotn property tax suggests tttat unreitnbursed Medicaid and Medicare costs do not count as charitable expenditures_ ._.

TEXT: [*395] I. Introduetion: Nonprotit Hospitals and Access for the Uninsttred Nearly 45 million people in this country -- 15.6% of the total population -- have no healtlt insurance. n I As many as 70 million inore Americans are underinsured, n2 That's 115 million people -- roughly 40% of Americans -- who lack adequate healtlt coverage, n3 In Illinois, 1.8 million people have no health insutance, including some 495,000 Chica- goans -- almost one-fifth of the city's population. n4 Ready access to quality, affordable health care is not available to most of the uninsured and underinsured. A trip to the hospital can be financially devastating for someone without adequate health insurance_ In fact, a rec-ent study by researchers from the Harvard School of Public Health revealed that medical bills are a leading cause in about half of all personal bankruptcies in the United States. n5 1'here is, in short, a powerfiil economic incentive for a huge number [*396] of people to seek medical care only in einergencies, if even ttien. Nonprofit hospitals have a special obligation to help alleviate this problem by providing "charity care" -- fi-ee and reduced-price liealth care services for those who catmot afford to pay.

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However, several recent developments ltave raised questions about whether nonprofit Itospitals are fulfilling that special obligation. n6 Patt II of this article otitlines the policy considerations that underlie tlre special obligation of nonprofit hospitals to provide charity care- Part III examines, against the backdrop of those policy considerations, recent national criticism of nouprofrt liospital behavior and, on a local level, the poor perfo mance of Chicago's two largest nonprofrt hospital systems. Finally, Part IV of this article sketches sorne avenues for actiou to rectify that situation.

11. Social Contract / Public Expectations: Tax Exemption and Community Benefits Nonprofit hospitals were originally organized around a rnission to serve the health needs of the poor. n7 At the start of the twentieth century, private charities and beneficent groups around the country -- many of which were affiliated with religious organizations -- began tc establish community hospitals to provide :nedical care tn families tlna le to pay for doctor visits at home, where most primaty health care was provided. n8 In recognition of their charitable missions and of the important public benefits to be gained, these hospitals were granted special stattts as nonprofit organizations. n9 Today, the majority of private hospitals in the United States -- roughly eighty-five percent - ai-e nonprofits owned and operated by private organizations, nany of which maintain their affiliation with religious groups. n10 Al- though they no longer provide care exclusively to the poor, nonprofit hospitals are still expected to serve a charitable mission. nil [*397] Nonprofit hospitals differ from government-run public hospitals and from private for-profit hospitals in several ways. Only public hospitals are directly funded by taxpayer dollars, while both for-profit hospitals and private nonprofit hospitals rely heavily on income from their day-to-day operations -- thouglt, typically, a significant proportion of operating inconte is federal and state tnoney collected froni Medicare and Medicaid. n12 For-profit hospitals are also able to raise capital through the issuance of stock, but nonprofits are not. However, unlike for-profits, nonprofit hospitals have access to tax-exempt bond debt and tax-deductible eontributions. nl3 Another significant diffcrettce between for-profit and nonprofit hospitals is that nonprofits typically enjoy exemption fi-om a wide range of taxes and fees, from federal and state income taxes to state and local property and sales taxes to mnnicipal sewer and water fees. n14 In order to pay for pnblic schools, police and fire protection, and other mmilici- pal services, commuuities must levy higher taxes on individuals and for-profit businesses to recoup the revenue lost by excrnpting nonprofit hospitals from taxes. The basic idea behind exempthig these institutions from the taxes levied on for-profits is that nonprofit hospitals provide public health benefits that would otherwise have to be provided by some level of government. n 15 Charity care is the most important among the community health beneffts that nonprofit hospitals are expected to provide, but other free or reduced-price goods and services that promote public health [*398] and welfare -- such as health education and wellness programs, disease screenings, and public health outreach initiatives -- may also qualify as conimunity healtlt benefits. Providing real coimuunity health benefits is not snnply a matter of donating goods and services to people in the community, though. The Access Project, a respected national initiative to improve health care access, explains that community health benefits, properly understood, are "the unreimbursed goods, seivices, and resources provided by healthcare institutions that address community-identified health needs and conceins, particularly those ofpeop/e who are traditionalty uninsured and undensesved " n16'fhis poiut is accepted by the nonprofit hospital industry as well. Both the Catholic Health Association and VHA Inc_, two leading national associations of nonprofit hospitals, recognize that a genuitie community benefits program "irnplies collaboration with a'cnmmunity'to'benefit' its residents -- particularly the poor, miuorities, and other underserved groups ...." n17 In short, the preferential tax treatment afforded nonprofit hospitals amounts to an investinent of public resotirces in support of their cbaritable missions. In return, nonprofit hospitals are expected to provide benefits to the community that are equal to or greater in value than what the comnninity gives up by exemptiug them from taxes. And they are expected to actively involve members of affected communities in the planning, development, and implementation of community benefit progratns.

IH. Recent National and Local Controversies Concerning Nonprofit Hospital Behavior In exempting nonprofit hospitals from taxation, governnient is, in effect, contracting to purchase from the private sector goods and services that are supposed to address iinportant community-identified health needs. As with any other purchase that we nrake, collectively or individually, it utakes sense to ask whether we are getting onr inoney's worth. The relevant questions with respect to any particular [*399] nonprofit liospital are:

Appx.384 Page 3 17 Loy. Constuner L. Rev. 395, *

Does the value of the hospital's cotnmunity benefit progratns equal or exceed the value of its preferential tax treatment?

Does the hospital involve community members in the connnunity benefits plamiing process?

If the answer to either of these questions is "no," then the cotnniunity is not gett ing what it is payutg for - - and it thus ltas a right to demand more fronz that hospital. Concern over whether nonprofit hospitals do in fact provide social benefits sufficient to justify their preferential tax treatment has grown over the past two decades. One study, now 10 years old, suggests that anywhere from 20% to 80% of nonprottt° nospnais' ^• ,fail :' to pror,ue""'..- ^ ^.ûû..,nit y.. ..^be°ef`" commensurate with w.. r.h,...their tax..... ^wr...e,â^ inne; der_._b nPn.3inoar. nuow } e value of cominnnity benefits is calculated. n18'I'his growing concern has led local officials and cotmnunities across the nation to review the tax exemptions enjoyed by nonprofit hospitals. At least elevett states have enacted legislation requiring nonprofit hospitals to conduct cotnnttinity health needs assessments and to develop community health benefit plans in return for state and local tax exemptions, n 19 Texas has gone even further, enacting legislation in 1993 that requires each nonprofit hospital in the state to provide charity care at least equal in value either to the Itospital's state and local tax subsidies or to four percent of the hospital's net revenue. n20 Similarly, the Utah Suprente Court has interpreted that state's coustitution as requh-ing nonpro6t hospitals to provide charity [*4001 care equal to the value of their propetty tax exemptions. n21 Recently, the business practices of nonprofit hospitals have also come under scrutiny from national polieyntakers and health care advocacy groups. In June 2004, for instance, the U.S. House Ways and Means Cornmittee launched a broad, ongoing examination of the federal tax-exempt status that nonprofit hospitals atid other nonprofit organizations enjoy. n22 The Committee began looking into whether the behavior of nonprofit hospitals -- including their beltavior toward those patients who are unable to pay for care -- differs in any significant way from that of for-profit hospitals. n23 When he announced the Comrnittee's urterest in these tnatters, Chairman Bill Thomas (R-Calif.) noted that, in the face of mounting budget deficits, revoking the nonprofit stutus of organizations that behave like for-profits represents "an enormous area of potential revenue" for the federal government. n24 Meanwhile, in the courts, several groups have filed class action lawsuits against nonprofit hospitals across ttie comnry alleging not only that these hospitals fail to provide adequate levels of charity care, but also that they charge uninsured patients inflated prices for care and use overly aggressive collections practices against those who cannot afford to pay. In November 2003, attorneys in Chicago, acting on research conducted by the Hospital Accountability Pro- ject, a research and advocacy initiative of tlte Service Employees Interuational Union ("SEIU"), pioneered the tactic of filing class action suits on behalf of former patients against nonprofit hospitals that shirk their duties to the cotnmunities iu which they operate and, specifically, to the nninsured. n25 Another SEIU advocacy initiative in New England filed a similar suit against two Connecticut nonprofit [*401] hospitals shortly thereafter. n26 Eventually, Richard Scntggs, the Mississippi attorney famous for spearheading the legal attack on U.S. tobacco companies in the 1990s, took up the cause. n27 Between June and December 2004, Sentggs coordinated the filing of at least 49 federal class action lawsuits charging approxintately 370 nonprofit hospitals in 25 states witlt mistreating uniusured patients by, atnong other things, failing to provide adequate charity care. n28 Though federal judges have since dismissed a number of these lawsuits as a matter of law, Scruggs and his team ltave vowed to re-file theni in state courts. n29 In Illinois, the state Department of Revenue, at the request of the Chainpaign County Board of Review, revoked the property tax exetnption of nonprofit Provena Covenant Medical Center in Champaign-Urbana ut February 2004. n30 The Board docutnented that the hospital, instead of providing charity care to eligible low-income uninsured patients, routinely used aggressive debt collection tactics against those who could not pay their bills. n31 The comments of Chairman Stan Jenkins explaining the Board's action against Provena Covenant are worth quo6ng at length:

Hospitals that enjoy the benefits of exempt stahis -- benejits which in no manner derive froin a right in any sense but are, rather, a gift fi•om public treasuries -- need to unmistakably recognize that ttte term "charitable purpose" as applied to a conmtunity hospital ... coanotes an involved, p-oactive presence both in their cotn nunities in general and with respect to their patients in particular_ A tax-exempt "charitable hospital" has a "charitable pmpose" that is not evidenced simply by virtue of a beautifully [*402] crafted set of corporate mission statetnents. Instead, "charitable purpose" tnu,st be an ongoing state of action, nt particular action pursuant to the fundamental purpose of any "charitable hospital" in regards to proactively assisting human beings each day in respect to meeting their medical needs and, to

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the extent necessary and possible given hospital resources, assisting them in paying for services thus rendered.... n32 As the decision currently stands, Proveua is liable for over $ 1 ntillion in annual propetty taxes on multiple parcels of land. Provena is appealing the decision. n33 And, with the Provena appeal still pending, the Champaign County Board of Review recently recommended revocation of the property tax exemption of Champaign-Urbana's other major nonprofit health care provider, the Carle Poundation HospitaL n34 That recornmendation is now being considered by the Illinois Dcpartinent of Revenue. Chicago communities, too, have begun to call for greater accountability and, specifically, for increased charity care and community benefit spending frotn their nonprofit hospitals. Chicago's two largest private liealth care providers -- Advocate Health Care and Resurrection Health Care - ltave come under scrutiny aud received barsh critieism for failing to firlfill their charitable missions. n35 What makes the criticism of Resurrection and Advocate especially interesting is that, in these two cases, unlike most other recent cases, solid information has been coinpiled that shows just how far short of their ctraritable obligations these nonprofrt hospital systems fall. Resurrection Health Care, Chicago's second-largest private nonprofit hospital system, operates nine hospitals in the Chicago metro area and is sponsored jointly by two Catholic religious [*403] orders. n36 According to research conducted by the Americau Federation of State, Cotuity, and Mmiicipal Employees, Resurrection enjoyed an estimated $ 72 million in savings from tax exemptions and fee waivers in 2002, but provided charity care to patients worth only $ 6.5 million during the same period. n37 Resurrection also reports that it provided a variety of free and reduced-price community services in fiscal year 2002 at a total cost of $ 30.4 million. n38 But, eveu when all of these expenditures are factored in - aud, in fact, some of them probably shotild not be counted as genuine connnunity benefits expenditures n39 -- Resurrection's total spending on charity care and cotnmunity benefit programs in 2002 comes to $ 36.9 million. Simply put, Resutrection Health Care gives back to Chicago coinmunities, at best, just a little over half of what it receives in tax breaks and other subsidies. 'Phe situation is even worse with respect to Chicago's largest private nonprofit hospital system and the Illinois health care market leader, Advocate Health Care, which operates eight hospitals in the Chicago metro area and is affiliated with the Uuited Church of Clirist and the Evangelical Lutheran Church in America. n40 According to extensive research conducted by the SEIU Hospital Accountability Project, the average armual value of Advocate's prefereitial tax treatment during the four years from 1999 through 2002 was between $ 73.9 million and $ 85 million. n41 Yet, Advocate's own reported [*404] spending on charity care and community benefit programs during the same period averaged just $ 35.9 million per year, n42 The distttrbing fact is that, at best, Advocate returns to Chicago communities less than half of the tax savnrgs, charitable contributions, and other subsidies that it enjoys as a nonprofit, putatively charitable htstitution. There is a growing sense among legislators, public interest groups, health care access advocates, govermnent officials, and ordinary citizens across the country that the public is not getting what it is paying for from nonprofit hospitals. This sense is borne out by the available evidence in those communities where hard data have been compiled_ Indeed, it seerns that Chicago taxpayers are the victims of a particularly grand swindle perpetrated by ttteir two largest private nonprofit hospitat systetns. And all of this is taking place at a time when the ranks of uninsured Americans, aiready staggeringly large, are swell'urg. Access to health care for low-income and uninsnred people is sttritdcing in this eountry. But what can and should be done about it?

IV. Ilolding Nonprofit Hospitals Accountable The best solution to America's current health care woes -- not only to the problems of access to care for the poor and unutsured, but also to the broader problems of skyrockcting health care costs and disappointing outcomes -- is the implernentation of a rationally-structured, national single-payer healtlt plan. A growing number of policy experts and advocacy groups have, over the past decade, ntade an increasingly compelling case for the desirability and viability of swne sat of single-payer national health system. n43 However, such a plan is probably not feasible in the current national political cliniate. Short of coniprehensive reform of the entire American health care delivety system, commuuities and governments can -- and should -- demand greater accountability and greater fidelity to charitable mission from the nation's thousands of nonprofrt hospitals. [*405] Grassroots organizing at the community level and legislative action at the local and state levels offer the tnost direct and effective means for ensuring that we get what we are already paying for. n44

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A. Grassroots Community Organizing It is impoitant to remember that, hz return for their valuable tax exernptions and related perks, nonp-ofit hospitals are expected to provide health benefits to the local eommzrnities in whieh they operate. So communities already have the right -- perhaps even the responsibility -- to actively patticipate in the plamting and implementation of their local nonprofit hospitals' community healtlt benefit programs. Unfortanately, too many comnnnlities have done little or nothing to exercise this rigltt, and too rnany nonprofit hospitals are qitite happy to leave cotnmunity niembers out of the process. But nonprofit hospitals are sensitive to public criticism and keenly aware of the value of maintaining a positive public iinage, especially in the current climate of widespread dissatisfaction with the bealth care system. Comtnuuity advocacy groups, particularly in areas with large uniusut'ed populations, need to add nonprofit hospital accountability to their is- SUe agen(ta5. These groups Can aild 31i0ilid IiiSiSt iil&i iheir local hospitals disclose mt07mati0.: about tlte provision of charity care and other community health benefits; request seats at the community benefits plamxing table; and, wltere it is discovered that a ttospital is not fulfilling its obligations, demand tnore from that hospital. This approaclt has been surprisingly effective in the Illinois cotnmunities where it has been tried. In Champaign- Urbana, for exatnple, it was a local health care justice advocacy group -- Champaign County Health Care Consumers ("CCHCC") -- that nioved ttte local tax review board to investigate Provena Covenant Medical Center's uncharitable beliavior and, ultimately, to recornmend revocation of the hospital's property tax exemptions. n45 This, in tum, led to significant changes in the management team at Provena Covenant and to a partnership between ttte hospital and CCHCC, along with other comnttinity groups, that is working to refotin the hospital's charity care, pricing, and eoltec- tions practices. n46 [*406] Similarly, wlien a coalition of community groups on Chicago's north and nortliwest sides discovered that one of their neighborhood nonprofit hospitals, Advocate Illinois Masonic Medical Center, was failing to live up to its charitable tnission, they organized a community health benefits task force attd took their concerns public, enlisting the help of public officiats_ n47 The task force demanded and won inclusion in the Illinois Masonic community benefits planning process, though the hospital continues to resist itnplementing substantive reforms of its charity care practices. n48

B. Legislative Action As noted above ut Part IIl of this article, several states have enacted legislation aimed at eliciting better inforniation and securing greater and more appropriate public health benefits from ttonprofit hospitals. Illinois reeently joined these ranks with the passage, in August 2003, of the Illinois Cotnn unity Bcnefits Act. n49 But the Illinois law illustrates -- all too plainly -- how a poorly crafted community benefits law does little to farther the cause of greater hospital accountability. Though the lllinois law does require nonprofit hospitals to file conunmiity benefit plans and reports of expenditures with the state attorney general -- and this is a step in the right direction -- the law, aecordntg to the Illinois Attorney General's interpretation of it, does not require hospitals to actively involve members of affected communities in the development and implementation of benefit plans, nor does it require hospitals to conduct focused community health needs assessments. n50 Even worse, the law sets back the cause of full and mean- htgful disclosure because it allows hospitals to repot2 as cotmnunity benefit expenditm-es a variety of expenses that should not be counted as such, including bad [*4071 debt, Medicare and Medicaid shortfalls, and, remarkably, the value of the ttours spent by hospital employees who vohtnteer in the community on their own time -- wltich is not even an expense incun'ed by ttte hospital. n51 In addition, the law, as interpreted by the attorney general, allows multihospital systems to avoid disclostire of community benefit expenditures at individual hospitals, wttich makes it difficult for comniuniry groups to deterinine exactly how much coinmunity support their patticular local hospital provides. n52 Most importantly, though, the Illinois law does not actually require a nonprofit hospital to devote any resources at all -- let alone sonte specific proportion of its resources every year -- to charity care or other eotmuunity benefit pro- granzs. n53 In fact, a hospital can be in full compliance with the Illinois law, yet provide no charity care or any other free or reduced-price goods or services. In stark contrast, the Texas community benefits law mentioued above in Part III of this article explicitly requires nonprofit hospitals to devote significant resources to providing free eare for uninsured and indigent populations. n54 The'rexas law thus provides a mncli better model of effective community benefits legislation. In order to secure greater nonprofit hospital accountability, a legislative solution, whether implemcnted at the state level or at the municipal level, must establish specific community benefit spending requirements; empower an appropriate goveinment agency or regulatory body to monitor compliance; and set out real penalties -- such as revocation of tax exemptions -- for noncompliance. n55

V. Conclusion

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Private nonprofit liospitals are an essential component of the health care delivery system in the IJnited States. And they are the very webbing of the health care safety net, such as it is, for the huge [*408] number of Americans who lack adequate health insttrance. In support of the charitable mission that they are supposed to serve, nonprofit hospitals enjoy exetnption froin a wide range of taxes, access to tax-exempt financutg, and access to charitable donations -- all of which amounts to a considerable investment of outside resources in these private institutions. However, as uonprofit hospitals have come under increased scnitiny, there is a growing sense, at both the national and local levels, that the public is not getting from nonprofrt hospitals all that it is paying for. Until such time as compreliensive reforin of the American health care system becomes a real political prospect, communities, govemments, and ordinary citizens must demand greater accountability and greater fidelity to charitable mission from nonprofit hospitals. Grassroots community tnobilization at the local level and carefully crafted accountability legislation at the state or local levels offer the ntost promising opportttnities for seetuhtg those ends. [*409] Appendix I -- Federal and State Tax Exemption Regttlations

A. Federal Guidetines Nonprofit hospitals qualify for exemption from federal taxes under Section 501 of the Internal Revenue Code. n56 Part (c)(3) of that section exempts the following sorts of organizations from inconie tax:

Corporations, and any community chest, fund, or foundation, organized and operated exclusively for religious, charitable, scientifre ... purposes ... no patt of the net earnings of which inures to the benefit of any private shareholder or individual, no substantial pait of the activities of which is carrying on propaganda, or otherwise attempting, to influence legislation ... and which does not participate in, or intervene in ... any political campaigtt on behalf of (or in opposition to) any candidate for public office. n57 According to a 1956 IRS revenue ruling intended to clarify the application of this regulation to liospitals, "the only ground upon which ahospital may be held to be exentpt under section 501 (c)(3) of the Code is that it is organized and operated primarily for educational, scientific or public charitable purposes. Usually the ground for exernption is that it is organized and operated for public charitable purposes." n58 T'his ruling goes on to state that, in order to qualify for exemption, a hospital "tnust be operated to the extent of its financial ability for those not able to pay for the setvices rendered and not exclusively for those who are able and expected to pay." n59 Simply put, the 1956 IRS ruling required any nonprofit hospital to provide charity care as a coudition on maintaining its tax-exempt status. n60 [*410] After the creation of Medicare and Medicaid programs in 1965, nonprofit hospitals began to receive compensation from federal and state govermnent for many services that fonnerly would have counted as charity care, n61 In recognition of this change, the IRS in 1969 issued a new ruling that set out a less restrictive "community benefits standard" for hospital tax exemption. n62 The 1969 ruling suggests that, in order to rnaintain its tax-exempt status, a hospital need only demonstrate that its "use and control ._. are for the benefit of the public and that no part of the income of the organization is int ring to the benefit of any private individttal nor is any private interest being served." n63 So the 1969 ntling -- which remains the controlling federal guideline today -- says that a nonprofit hospital qaalifies as an institution of public charity and is thus oxenrpt from federal tax provided that it returns significant benefits to the camnuniry in whiclr it operates. Charity care is no longer consictered the only such benefit, though, and the provision of cltarity care is no longer specifically mandated. Medical research, health education programs, conimunity outreach initiatives, and the maintenance of an emergency rooni open to all are now recognized as qualifying comtnunity benefits, among others. n64

B. Illinois State Guidelines In Illinois, as in many other states, a nonprofit cotporation that qualifies for exemption from federal income tax as a charitable organization under Section 501(c)(3) of the Intemal Revenue Code also thereby qualifies for exemption frotn state income tax. n65 This holds for nonprofit hospitals as well as for other nonprofit organizations. However, under Illinois law, the fact that a nonprofit hospital is recognized as an exempt organization by the federal government is not sufficient to qualify it for exeniption from state sales tax and local propetty taxes. Exemption from sales tax is granted to a nongovernmental organization only if it is "a corporation, society, association, foundation, or institution organized and operated [*411] exclusively for charitable, religious, or educational purposes." n66 Simi- larly, a nonprofit hospital is exempt from property tax only if it qttalifies as au "instittition of public charity" and the

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property in question is "actually and exclusively used for charitable or beneficent purposes, and not leased or otherwise used with a view to profit." n67 These requirements for sales and property tax exemption are, it turns out, quite demanding. The point is brought home by the guidelines, set out hi a 1968 decision by the Illinois Supreme Court, for assessing whether an organization is genuinely au "institution of public charity":

(1)the bertefits derived [fiont the operations of the organization] are for an indefinite number of persons;

(2) the organization has no capital, capital stock or shareholders;

(3) fiinds arc derived mainly from private and public charity, and the finrds are held in trust for the objects and purposes expressed in the charter;

(4) the charity is dispensed to all who need and apply for it, and does not provide gain or profit in a private sense to any person connected with it;

(5) the organization does not appear to place obstacles of any character in the way of those who need and would avail themselves of the charitable benefits it dispenses. n68

These guidelines remain the core of the standard for property and sales tax exemption in Illinois, and have becn reaf- firmed by other state court decisions in the inteivening thirty-seven years, n69

[*412] Appendix 1I -- W tiat Does and Does Not Count As A Community Benefit Expenditure

Not every donated or under-reimbtased good or service tttat a nonprofit hospital may want to claim as a comniunity health benefit should be counted as such. Indeed, some health care industry expetts suggest that cltarity care is the only legitimate community benefit. n70 But, even if it is allowed that spending on goods and services otlter than charity care can count as genuine community benefit expenditures, there are sonie cominonly claimed expendihires that clearly do nQt cotmt. Foremost among these is bad debt. Hospital bad debt is "uncollectible charges, excluding contractual adjustments, arisiug from the failure to pay by patients whose health care has not been classified as charity care." n7l Ac- cording to the industry standard community benefits repotting handbook put out by the Catholic Health Association and VI-IA Inc., bad debt is not a genuine connnunity bencfit and should not be comrted as such. n72 Bad debt is simply the cost of doing business in auy industry. In the health care industry, it is a cost borne by for-profit providers as well as nonprofit providers. n73 And bad debt is certainly not a measure of the free or discounted care that a nonprofit hospital intentionally and voluntarily provides to those in ueed. n74 Nonetheless, some nonprofit hospitals and hospital systems attempt to get away with includ'nig bad debt in [*413] their reporting of community benefit expenditures, typically by lumping charity care together with bad debt and reporting the whole sum as "uncompensated care." n75 On a related note, wlten claimed as a community benefit expenditure, clrarity care should be valued at cost, rather than at charge. n76 This point, too, has been recognized and accepted by the nonprofrt hospital industry for some time, n77 even though certain hospitals continue to inflate their reports of spending in this area by reporting charity care as "charges foregone," which values ttie care at the inflated prices listed on the hospital's chargemaster. n78 Many nonprofit hospitals also conflate spending on community benefit programs with spending on marketing programs. It is often difficult to distinguish a free service that provides a genuine community liealth benefit fi-om a market- htg program that generates revenue, and hospitals routinely take advantage of tltis difficulty to inflate their reports of conununity benefit spending. n79 For example, providing free blood pressttre testing may be, in part, a conununity benefit, but it also serves as advertising for a hospital and potentially generates uew paying business. Likewise, a free inforniational session on new weight loss surgery techniques may provide useful health inforination to certain nienibers of the community, but it is also an opportunity for the hospital to market the new surgery to paying customers. Many for-profit hospitals also [*414] engage in such activities, presumably for good business reasons. n80 So, unless a nonprotit hospital provides a line-item breakdown of its spendulg on specific programs and activities -- which, unfortunately, most nonprofit hospitals still do not do -- it is impossible to tell how mach of ttiat hospital's spending on free and reduced-price public programs goes toward genuine co nmunity benefit activities, and how much goes toward programs that mix comniunity benefits with marketing.

Appx.389 Page 8 17 Loy. Consumer L. Rev. 395, *

Finally, many nonprofit hospitals repott unreimbursed Medicaid and Medicare costs -- the difference between cost of care aatd govenunent reimbtvsement for services provided to Medicaid and Medicare patients -- as cornmunity benefit expenditures. But the rationale for doing so is dubious at best. hi those states where there is a Medicaid or Medicare shortfall, every Medicaid and Medicare provider, whether for-profit or nonprofit, bears the burden of low reimbursements. n81 What's more, both the federal and state governments typically disburse additional payments to hospitals in order to offset the costs of providing care to Medicaid and Medicare patients. n82 Tax exemptions were never intended to serve that pttrpose. And, in Illinois, a reeent conrt decision addressing ttie requirements for charitable exemption from property tax suggests that umeimbursed Medicaid and Medicare costs do not count as charitable expenditures. n83 All of this indicates that a uonprofit hospital's unreimbursed Medicaid and Medicare costs sltould not be counted as spending on community benefits.

[*4151 Appendix Ill -- Estitnating the Value ofYreferential Tax Treatment A fiill accounting of the value of tax-exempt status to a nonprofit hospital requires capn.iring five different categories or sonrces of value.

A. Federal and State Income Tax Savings While for-profit hospitals pay federal and state income taxes on their yearly earnitigs, nonprofits do not pay taxes on their "surplus revenues" -- and many nonprofit hospitals do post annual revenue surpluses. To calculate a tiospital's total state and federal income tax savings, apply the federal and state tax rates paid by for-profit hospitals (available frorn the IRS and from the state department of revenue) to the total surplus revenue or "income" repotted by the hospital on its annual audited financial statement. Though this approach does not take into account the changes in business behavior and accounting practices that might occur sttould a uonprofit hospital be subject to income tax, it is a standard approach used by experts researching the value of hospitals' nonprofit status. n84

B. State and Local Sales Tax Savings In many states, including Illinois, nonprofit hospitals enjoy exemption fi-om state and municipal sales and usc taxes on the purchase of supplies that they use in the course of normal busaiess operations. n85 To calculate the value of a hospital's sales and use tax savings, multiply the system's annual expenses on supplies, as reported in the IRS form 990 filing, by the sales tax rate in the municipality where the hospital is located, which is available from the state department of revenue or froni local government. Because some hospital systems ltave hospitals in different municipalities and different inunicipalities often have differcnt sales tax rates, it may be necessary to calculate separately the savings at each of a system's individual hospitals and then sum those figures to arrive at the overall savings for the system. In addition, some states, [*416] including Illinois, have lower sales tax rates for tnedical supplies. n86 In such a case, because it is typically not possible to tell fi-om a hospital's IRS for-m 990 disclosures what proportion of its supply expeuditures would have been subject to the inedical tax rate and what proportion would ltave been subject to the general sales tax rate, it may be necessary to express that hospital's annual sales tax savings as falling somewhere within a range.

C. Local Property Tax Saviugs Illinois tax law, like ttie law in many states, provides that property owned and used by nonprofit hospitals is exempt from property taxes, n87 In places where some government assessing body maintains official assessment records on snch property, calct lating the value of a hospital's property tax exemptiotts is an easy n atter: simply take the assessed values of the ]tospital's property, as recorded by the assessing body, and apply the fonnula for calculating property taxes in that locality to determine what ttie tax bills would have been if that propetty had been taxed. tn places such as Cook County, Illinois, where assessment records for exempt property are not available, tttere are a couple of other ways in which one can estimate property tax bills. n88 One way is to obtain, from a consultant or private assessor, an independent assessineut of the value of the hospital property in question, and then apply to that assessment the formula for calculating property taxes. But private assessors and consulting serviees can be expensive. Alternatively, if there are some for-profit hospitals operatutg in the community in question, then one can determine from public tax records what tlle for-profit hospitals in that area pay in p'operty taxes per hospital bed and multiply that figure by the total number of beds at the nonprofit hospital in question to get an estimate of the nonp-ofit's property tax liability.

Appx.390 Page 9 17 Loy. Consnmer L. Rev. 395, '

[*4171 BD. Saviugs from Access to Tax-Exempt Debt Investors are willing to lend to tax-exempt bond issuers -- such as nonprofit hospitals -- at lower interest rates than those at which they lend to issuers of taxable debt -- such as for-profit hospitals -- because investors do not pay income tax ou the interest they eant from tax-exempt bonds. n89 To estimate the value of this savings to a nonprofit hospital, calculate the difference between the interest rates on taxable and tax-exempt bonds at a given point in tinte (available from futancial publications or bond rating agencies) and multiply that differential by the total amount of bond debt that the hospital has outstanding at that time (as disclosed in the ltospital's annual audited financial statement). n90

E. t.'haritable i-on[ribution; As nonprofit organizations, donations to nonprofit hospitals are tax-cleductible for the donors. Most such hospitals thus receive contributions and gifts that they wottld, presumably, not receive if they were for-profit operations. To de- termiue the amiual vatue of contributions to a nonprofit hospital, simply take the amount of charitable contributions as reported in the bospital's IRS form 990 filing. Some nonprofit hospitals set up notninally independent charitable foundations to solicit contributions, in which case it will be necessaiy to identify those foundations and to obtain their IRS form 990 filings. n91 Two notes of caution here: First, some hospitals with nomiually independent foundations may report (some of) the same charitable contributions on both the hospital's and ttie foundation's IRS form 990 filings. If it cannot be deterntined in a particular case whether this is happenhig, it is best to avoid double counting by inctuding only those contributions uiade to one source. Second, include only the reported amount of "direct public support" -- that is, contributions and gifts made directly to the hospital or fotmdation by private individuals, corporations, and other foundations. Do not include grants that ttte hospital or foundation received from governinent agencies, because for-profit ltospitals also receive govertunent &rant money and, therefore, this is arguably not an [*418] advantage enjoyed uniquely by uonprofit,s in virtue of their special status.

F. Other Savings Many nonprofit ltospitals also receive additional subsidies at the local level such as free or reduced-price water and sewage service. Whether it is possible to accurately determine the monetary value of such savings will depend on what information is available to the public at the local level.

Legal Topics:

For related research and practice materials, see the following legal topics: Healtlicare LawBusiness Administration & OrganizationTax ExemptionsIlospitalsHealthcare LawBusiness Adminisu-a- tion & OrganizationTax ExemptionsNonhospital OrganizationsPublic Health & Welfare LawHealthcareGeneral Over- view

FOOTNO'I'ES:

nl Lee Scheier, Busted, CIII. TRIB. MAG., Jan. 2, 2005, at 15-16.

n2 Id.

n3 Based on figures froin the U.S. Census Bureau August 2004 Current Population Smvey.

n4 GILEAD OUTREACH AND REFERRAL CENTER, Nmnbers and Neighbors -- A Detailed Descrzption of Illinois' Uninsured, at 3 (Apr. 2005).

N5 David Himmelstein et al., Itlness and Injury as Contributors to Bankruptcy, HEALTH AFFAIRS web exclusive, at W5-63 (Feb. 2, 2005).

Appx.391 Page 10 17 Loy. Consumer L. Rev. 395, *

n6 See discussion infra Part III.

n7 William Gentry & Jolm Penrod, The Tax Benefits ofNot-For-Profrt Hospitals, NATIONAL BUREAU OF ECONOMIC RESEARCH (Feb_ 1998), at 3.

n8 Id.

n9 Id.

n10 Sean Nicholson et al., Measuring Corntnunity Benefits Provided by For-Profrt and Nonprofit Hospitals, 19 HEALTH AFFAIRS, at 168 (Nov./Dec. 2000).

n11 Id.

n 12 See Alice Noble, Andrew Hyams, & Nancy Kane, Charitable Hospital Accountability: A Review ofLe- gal and Policy Initiatives, 26 JOURNAL OF LAW, MEDICINE & E'I'HICS 116, 117-118 (1998) (outlining the changes in hospital fmancing that have occurred over the last 60 years); and Nancy Kane & William Wubben- horst, Alternative Funding Policier for the Uninsured: Exploring the Value of Hospital Tax F.,xernption, 78 MILBANK QUARTERLY 185, 196 (2000) (suggesting that levels of partieipation in the Medicaid progratn are similar for for-profit and nonprofit hospitals).

ni 3 Michael Morrisey, Gerald Wedig, & Mahuiud Hassan, Do Nonprofit Hospitals Pay 7heir Way?, 15 HEALTH AFFAIRS 132 (1996).

n14 See infra App. I(discussing the legal conditions on qualifying for exeniption from federal, state, and local taxes in Illinois).

05 Gabriel Aitsebaomo, The Nonprofit Hospital: A Call for New National Guidance Requiring Minimum Annual Charity Care to Qualify for Federal Tax F,xemption, 26 CAMPBELL L. REV 75, 84-85 (2004). See also Jack Burus, Are Nonprofit Hospitals Really Charitable?: Taking the Question to the State and Local Level, 29 IOWA.L CORP. L. 665, 676-677 (2004) (discussing the prominence of the "quid pro quo" theory as an explanation of the policy considera(ions behind the tax exemptions of nonprofit hospitals).

n16 Natalie Seto & Bess Karger Wesikopf, THE ACCESS PROJECT, Community Benefrts: The Need fim Action, an Opportunity for Iiealtlrcare Change, at 2 (2000) (etnphasis added), available at www.accessproject.orgipublications.htm.

n17 CA'rHOLIC HEALTH ASSOCIATION OF TIIE UNITED STATES AND VIIA INC., Community Benefit Reporting Guidelines and Standard Definitions, at 7 (Dec. 2004) (emphasis added), available at www.vba.com/publicpolicy/public/communitybenefit.asp.

08 J.P Cleutent, D.G. Smitb, & J.R.C. Wheeler, What Do YYe 1Vant and What Do We Ciet,lrom Not for- profrtHospitals7, 39 IIOSPITAL AND HEALTH SERVICES ADMINISTRATION 159 (1994).

n19 See COMM UNITY CATALYST, Free Care: A Compendium ofState Laws, available at www.communitycatalyst.org (Sept. 2003) (providing an overview of state laws govetnuig nonprofit hospital free care and community benefits). See also COALITION FOR NONPROFIT HHALTH CARE, Redefining the

Appx.392 Page 1I 17 Loy. Consumer L. Rev. 395, *

Community Benefit Standard: Sta1e Law Approaches to Ensuring the Social Accountability ofNonprofrt Health Care Organizations (July 1999) (discussing in greater depth the laws in eigl.it states).

n20 Charity Care and Community Benefits Requirements for Charitable Hospitals, TEX. TAX CODE ANN. § 11. 1801 (West 2005).

n21 Noble, Hyams, & Kane, supra note 12, at 120-121.

n22 U:S. Y.:;LSE OF REPTLESF,NTAT1VEC C.C;y;nnflTEE ON WAYS AND MEANS, Pricing Practices ofHospitals: Hearing before the Subcommittee on (hhersight (Jttne 22, 2004) (opening statements of Rep. Bill 1'homas, chairman), available atlrttp://waysandmeans.house.gov/hearings.asp.

n23 Id.

n24 Jeff Tieman, Examining F,xemptions: House to re-evaluate tax status of not for profits, MODERN IIEALTHCARE, Mar. 8, 2004, at S.

n25 Kelly Quigley, Uninsuredpatients sue Advocate, CRAIN'S CHI. BUS., at www.crainsclticagobusiness.com (Nov. 19, 2003); Francine Knowles, Madigan backs suit against Advocate, CHI. SLJN-TIMES, July 5, 2004, at 49, 53; Kari Lydersen, Weird Charity, CHI. READER, July 9, 2004, at 8, 10.

n26 Diane Lewis, Union Sues 2 Conn. Hospitals Over Use of Free-Care Funds, BOSTON GLOBE, Dec. 17, 2003, at C3.

n27 NOT-FOR-PROFIT HOSPITAL CLASS ACI'lON LITIGAI'ION SITE, at www.nfplawsuit.com (providing comprehensive information regarding the Scruggs lawsuits).

n28 Id.

n29 See Mississippi Nonp•ofit Hospital System Shuns Proposed Charity Care Settlement, 14 BNA HEALTH LAW REPORTER 513 (Apr. 14, 2005) (mentioning the Scruggs 6rm's plans to move its litigation to state courts).

n30 Lucette Lagnado, Hospital Found 'Not Charitable; Loses Its Status as Taz Exempt, WALL ST. J., Feb. 19, 2004, at B l.

n31 Id

n32 James Unland, Champaign Couniy, Illinois, Gets the Hospitallndustry's Attention by Revoking the Property Tac Exernption ofa Local Catholic Hospital, HEALTH BUSINESS AND POLICY, at 5 (Apr. 2004), available at www.healthbusinessandpolicy_com.

n33 Lucette Lagnado, A Nonprofit Ilospital Fights to Win Back Charitable Halo, WALL ST_ J, June 29, 2004, at B 1.

Appx.393 Page 12 17 Loy. Consumer L. Rev. 395, *

n34 See the Champaign Connty Board of Review's April 2005 recotmnendation to the Illinois Departtnent of Revenue, available at w-,vw.co.cliaiiipaign,il.us/BOR.htm-

n35 Ionathan Colur, Uncharitable?, NEW YORK TIMES MAG., Dec. 19, 2004, at 51.

n36 See RESURRECTION IIEALTH CARE, Aboart Us and Loeations, available at www.reshealth.org (providing basic information about the coryoration's hospitals and faith sponsors) (last visited May 8, 2005).

n,. n .. _r. .r. . . r- .. a he P:-..... !`.. . . ^ r Resur.ecrron de^rrea:r ^a^ e. t.ea^ ^rgs beforc t„t <^ ce„r,...r ^ „mm ftee ofthe Ch icago Ctf`,r f.eun w (..ov. 29, 2004) (statement of Henry Bayer, executive director, AFSCME Council 31) (discussing estimates of the value of tax exemption for 2002),

n38 2002 I.R.S Fonn 990 for the Resurrection Health Care System.

n39 See infra App. II (discussing why certain expenditures that are often reported by nonprofit hospitals as cotnmunity benefit expenditures should not be counted as such).

n40 See ADVOCATE HEALTH CARE, About Us andAdvocate Locations, available at www.advocateltealth.com (providing basic information about the corporation's hospitals and faith sponsors) (last visited May 8, 2005).

n41 SEIU HOSPITAL ACCOUNTABILITY PROJECT, Negtecting Ta.cpayer Health -- HowAdvocate Health Care's $ 40 Million Community Benefits Shor4fall Hurts Chicago (Oct. 2004), available at www.hospitaltnonitor.org. See also infra App. III (discussing approaches to calculating the value of nonprofit hospital preferential tax heatment)_

n42 SEIU HOSPITAL ACCOUNTABILITY PROJEC'I', supra note 41,

n43 See PHYSICIANS FOR A NATIONAL HEALTII PROGRAM, Proposal of the Physicians' Working Group for Single-Payer National Health Insurance (Aug. 2003), available at www.pnhp.org (arguing that, because increniental changes in the current U.S. health care system catmot solve its rnany and serious shortcorn- ings and contuiued reliance on market-based reform strategies will only exacerbate those shottcotnings, a move to a national health system is the only way to protect the interests of all patients).

n44 See THE ACCESS PRO.IECT, at www.accessproject.org (compiling some excellent informational resources and a variety of guides on how to tiold nonprofit hospitals accountable to their charitable missions) (last visited May 8, 2005).

n45 Lagnado, supra note 30, at B I.

n46 James Unland, Scrutiny ofNot for-Profit Community liospitals' Exempt Status Targets Their Pric- ing/Collection Practices, Charitable Purposes and Finances Resultlrig in Significant Local, State and National Events that Now Challenge Hospital Management and Boards, HEALTH BUSINESS AND POLICY, at 2 (July 2004), available at www.healthbusinessandpolicy.com.

n47 SEIU I-IOSPITAL ACCOUNTABILITY PROJECT, supra note 41, at 10-1 l.

n48 Id.

Appx. 394 Page 13 17 Loy. Consumer L. Rev. 395, *

n49 Coinmunity Bettefits Act, 210 ILL. COMP. STAT. 76/1 (WEST 2005).

n50 Community Beneflts Act, 210 ILL. COMP. STA'1'. 76/20(a)(3) and 76/15 (West 2005). See also STATE OF ILLINOIS OFFICE OF THE ATTORNEY GENERAL, Cornmunity Beneftts Act Compliance In- formation (Feb. 4, 2004), at 2, avarlable at www.ihatoday_org/issues/payment/charity/defin.ltttnl(discussing the requirements for compliance with the Comniunity Benefits Act).

n5l Coimnuni y>enefits Act, 210 ILL. CG"r3P. STAT. 76/10 (West 2005) and STATE OF Ir T.IN9IS OF- FICE OF TIIE ATTORNEY GENERAL, .supra note 50, at 3,4.

n52 STATE OF ILLINOIS OFFICE OF THE ATTORNFY GEN ERAL, supra note 50, at 1.

n53 Cotnmunity Benefits Act, 210 ILL. COMP. STAT. 76 (West 2005) (failing to mandate expenditures on community benefit programs).

n54 Charity Care and Community Beuefits Requirements for Charitable IIospitals, TEX. TAX CODE ANN. § 11.I801 (West20o5).

n55 See Noble, Hyams, & Kane, supra note 12, at 131 (recomntending a model "Cotinmmity Benefit Ac- countability Act" that includes these feahtres, aniong others).

n56 Noble, Hyams, & Kane, supra note 12, at 118.

n57 I.R.C. § 501 (West 2005).

n58 Rev. Rul. 56-185, 1956-1 C.B. 202.

n59Id.

n60 Aitsebaomo, supra note 15, at 87-88.

n61 Noble, Hyams, & Kane, supra note 12, at 118. Burns, supra note 15, at 669,

n62 Aitsebaomo, supra note 15, at 88-89

n63 Rev_ Rul. 69-545, 1969-2 C.B. 117.

n64 Noble, Hyams, & Kane, supra note 12, at 118.

n65 Illinois Income Tax Act, 35 ILL. COMP. STAT, 5/205 (WEST2005).

n66 Illinois Use Tax Act, 35 ILL. COMP. STAT. 105/3-5(4) (WEST 2005); Illinois Retailers' Occupation Tax Act, 35 ILL. COMP. STAT. 120I2-5(11) (WEST 2005).

Appx.395 Page 14 17 Loy. Consumer L. Rev. 395, *

n67 Illinois Property "I'ax Code, 35 ILL. COMP. STAT. 200/15-65 (VJEST 2005).

n68 Methodist Okl People's Home v. Korzen, 39Il1. 2d 149 (1968).

n69 Alivio Med. Cen. v. ILI. Dept. of Rev., 299 111. 3d 647 ( 1998); Riverside Med. Ctr. v. Ill. Dept. of Rev., 342111. App. 3d 603 (2003); Eden Retirement Ctr- v. 111. Dept- ofRev., 213 Ill. 2d273 (2004).

n70 See Sustm Sanders, The 'Common Sense' of the Nonprofat Hospital Tax Exemption: A Policy Analysis, I4 JOURNAL OF POLiCY p NA I.YSrS p 1•rD MAN.4GFMENT 446 (1995) (arguing fo,- linking tax exemptions to nonprofit hospitals' provision of direct charity care),

n71 CATIIOLIC HEALTH ASSOCIATION OF THE UNITED STATES AND VHA INC., supra note 17, at 12 (emphasis added).

n72 Id at 37.

n73 MarkHall & John Colombo, The Charitable Status ofNonproflt Hospitols: loward a Donative Theory of Tac Exemptlon, 66 WASH. L. REV. 307, at 347 (1991). See also Frank Sloan, Commereialisrn in Nonprofct Hospitals, 17 JOURNAL OF POLICY ANALYSIS AND MANAGEMENT 234 (1998) (arguingthatnonprofit hospitals do not differ significantly from for-profit hospitals with respect to quality of care provided, amount of uncompensatcd care provided, and adoption of new medical technologies).

n74 See Bums, supra note 15, at 681 (arguing that "writing off bad debt after the fact should not be considered charitable because it is not altruistic and it mitigates the benefit conferred on society_ Charity care, when in the fomi of bad debt, can fmancially cripple indigent patients.").

n75Icd at 673. See aLso, e.g., the "Financials'section of the "System Report" in ADVOCATE HEALTH CARE, 2003 Annual Report, available atwww.advocatehealth.comisystetn/about/reports/ar2003/index.html (claiming that "Advocate provided rnore than $ 218 million in uncompensated care and community benefit programs and services" in 2003); and RESURRECTION HEALTH CARE, Resurrection Health Care: Fulfilling Our Charitable Commitrnent (June 14, 2004), available at www.reshealth.org/aboutus/newsmedia/press_info.cfin (claiming that, in 2003, Resurrection fulfilled its charitable commitment by providing "approxiinately $ 124.5 million in uncompensated care to patients").

n76 See Clement, Smith, & Wheeler, supra note 18, at 164.

n77 CATHOLIC HEALTH ASSOCiA'l ION OF TI-IE UNITED S7'ATES AND VIIA INC., supra note 17, at 12.

n78 See, e.g., ADVOCATE HEALTH CARE, Advocate Health Care Network and Subsidiaries Consoli- dated Financial Statements -- Years Ended December 31, 2003, 2002, and 2001, at 12 (reporting "charges foregone for services and supplies provided to the community..." as part of the corporatioii s benefit provided to the coinmmnity [emphasis added]).

n79 Thomas Buchmueller, Hospital Community Benefrts Other Than Charity Care: Implications for Tax Exemption and Public Policy, 41 HOSPfTAL AND I-IEALTH SERVICES ADMINISTRATION 461, 464 (1996).

Appx.396 Page 15 17 Loy. Consutner L. Rev. 395, *

n80 Buclunueller, supra note 79, at 464-65.

n8I See Kane & Wubbenhorst, sespra note 12, at 196 (arguiug that evidence suggests ttiat there is no significant difference between for-profit and nunprofit hospitals in their levels of participation in the Medicaid program).

n82Id. at 186.

n83 R:ver.side M.erL Ctr. v. dl. Dept. ofRev., 342 IIl. App. 3d 6D3 (2003).

n84 See, e.g., Mon-isey, Wedig, & Hassan, supra note 13, at 134-135 (defending this approach to estimating the value of nonprofrt hospital income tax savings).

n85 86 ILL. ADM. CODE 130 § 2005(m) (2003).

n86 See ILLINOIS DEPAR'1'MENT OF REVENUE, Frequently Asked Questions -- Sales Tax, available at www.ittax.couilBusinesses/Faq/rotfaq.html (discussing the different sales tax rates for different goods and services in Illinois).

n87 Illinois Property't'ax Code, 35 ILL. COMP. STAT. 200/15-65 (WES'I' 2005).

u88 In addition to the two approaches mentioned here, still other approaches to estimating the value of property tax exemptions are discussed in Gentry & Penrod, supra note 7, at 27-30, and in Kane & Wubbenltorst, supra note 12, at 192-194.

n89 See Morrisey, Wedig, & Hassan, supra note 13, at 132.

n90Id at 135.

n91 See Kane and Wubbenhorst, siipra note 13, at 195 (raising the difficulties posed by donations to norni- nally independent foundations).

Appx.397 Page l

LexisNexis^

15 of 162 DOCUMEN'1'S

Spriug, 2009

61 Baylor L. Rev. 357

LENGTH: 76384 words

Article: The Physician's Right in § 15.50(B) To Buy Out a Covenant Not To Conxpete in Texas

NAME: Mike Kreager*

BIO: * Mike Kreager obtained a J.D. and L.L.M. (in taxation) from Southern Methodist University Law School. He is the founding shareltolder of The Kreager Law Firm in San Antonio, Texas.

SUMMARY: ... 'IYre criteria for enforceability of a covenant not to conipete provided by Section 15.50 of tt is code and the procedures and remedies in an action to enforce a eovenant not to compete provided by Section 15.51 of this code are exclusive and preempt atry other criteria for enforceability of a covenant not to cotnpete or procedures and rernedies in an action to enforce a covenant not to cornpete under corntnon law or otherwise and include preliminary determinations made prior to final enforcetnent of a covenant. ... 7'he court based its exception to the general rule that unenforceability is not a defense to tortions interference on the theory that an unenforceable covcnant is a restraint of trade and violates public policy. ... The Act perntits the covenant if the boundaries on its duration, geographic coverage and proscribed activity - the covenant's restrietions - are reasonable for the etnployer's interest to be protected, witich in this discussion are the referral sources. ... The permissible extent of the geographic boundary protecting an employer's referral sources highlights the itnportance of the eovenant's relationship to the employer's protected interests, in this case, the referral sources. ... Even though the Act lists arbitration in the buyout clause as the second of two alternate solutions, the proper buyout price for an enforceable covenant can be best explained in the context of the arbitration buyout covenant. ... As pointed out previously, Colorado and Delaware have statutes that, although prohibiting physician covenants, perniit the inclusion of liquidated dainages, which are akin to the Texas buyout right. ... Regardless of the source of the accounting infonnation, tlre determination of lost profits requires a determination of the revenue and expense associated with the physician's services to the employer's patients because of the competition. ... The employer's overbead includes: office rent; commercial general liability; worker's compensation and casualty insurance pretniums; advertising and promo- tional expenses; salaries and benefits of staff not dedicated solely to supporting the physician's services, such as staff to schedule patients and to code, bill, and collect for services rendered on behalf of the employer; the employer's professional expenses to attorneys and accountants; state taxes imposed on the employer as a taxable entity; federal income taxes imposed on the ernployer as a taxable entity; state property taxes imposed on the employer's real and personal property; and equipment costs, among others, but should exclude direct expenses associated with other etnployed physicians, such the other physicians' salaries, benefits, CME, and malpractice premiunts. ... Fortunately for employers and physicians, the buyout clause actually solves the necessity of an agreement between the pat-ties to arbitrate, and the parties may avail themselves of the additional procedures contained in the Arbitration Act. ... The courts justified the decision not to ineorporate the Beer Law's arbitration section based on an additional section in the Beer Law that allows the parties to file a lawsuit over the same issues that can be arbitrated. ... A version of the stipulated buyout covenant that appears frequently in a physician employtnent agreement reads as follows, with the wording of the buyout right and the buyout print italicized: After this Agreement ternninates, Pltysician shall have the right and option (ttie "Buy-Out Op- tion") to btry out and tenninate the non-competition covenants set forth in this Section under the following procedures:

Appx.398 Pagc 2 61 Baylor L. Rev. 357, *

(i) If Plrysician wishes to exercise the Buy-Out Option, Physician shall, withitt 30 days after this Agreement terminates, give the Entployer written notice of Physician's uttent (the "Buy-Out Notice"). ... (b) A covenant not to compete is en- forceabie against a person licensed as a plrysician by the Texas State Board of Medical Examiners if such covenant complies with the followutg requirements: (1) the covenant nzust: (A) not deny allow the physician to request and receive access to a list of the patients, and their contact information, whotu he the physician had seen or treated within one year two years of tenninatiott of the contract or employtnent; (B) provide access to medical records of the physician's patients npon authorization of the patient and any copies of medical rccords for a reasonable fee as established by the '1'exas State Board of Medical Examiners under Section 159.008, Occupations Code ; and (C) provide that any access to a the list of patients, and their contact information, or to the patients' medical records, after termination of the contract or employment shall not require such list or records to may be provided in the same format different that that in which the records are tnaintained except by niutual consent of the parties to the contract; (2) the covenant must provide for a buy out of the covenant by the physician at a reasonable price by one of the following means, which inay not be waived prior to the termination of the contract or employment or, at the option of either party, as determined by a mutnal agreed upon arbitrator or, in the case of an inability to agree, an arbitrator of the court whose decision shall be binding on the parties; and (i) tlre covenant may state a reasonable buy out price or the means of calculating a reasonable buy out price; or, (ii) the covenant may allow either party to request an arbitrator to deterrnine a reasonable buy out price promptly after the termination of the contract or employment; and (3) the covenant may contain additional reasonable provisions to promote or effect the buy out if the provisions are not contruy to the purposes of this Act; and, (4) the covenant must not prolubit provide that the pliysician will not be prohibited frotn providing eontimting care and treatment to a specific patient or patients during the course of an acute illness even after the contract or employment has been terminated. ... (c) If ttte court finds the covenant based on the determination of the trier of fact is found to be ancillary to or part of an otherwise enforceable agreement but contains lirnitations as to tin e, geographical area, or scope of activity to be restrained that are not reasonable and itnpose a greater restraint than is necessary to protect the goodwill or other business interest of the protnisee, the court shall refonn the covenant to the extent necessary to cause the limitations contained in the covenant as to titne, geographical area, and scope of activity to be restrained to be reasonable and to impose a restraint that is not greater than necessary to protect the goodwill or other business interest of the promisee and enforce the covenant as reformed, except that the court may not award the promisee datnages for a breach of the covenant before its reformation and the relief granted to the proinisee shall be limited to injunctive relief. ... If the primary purpose of the agreement to which the covenant is anci I lary is to obligate the promisor to render personal services, the promisor establishes that the promisee knew at the tinie of the executiou of the agreement that the covenant did not contain limitations as to time, geograpbical area, and scope of activity to be restrahied that were reasonable and the limitations imposed a greater restraint than necessary to protect the goodwill or other business interest of the promisee, and the prornisee songht to enforce the covenant to a greater extent than was necessary to protect the goodwill or other business interest of the promisee, the court may award the promisor the costs, including reasonable attortiey's fees, actually and reasonably incurred by the proinisor in defending the action to enforce the covenant.

TEXT: [*359] "Today, we view the idea of human capital - the sum of education, ttatural talent, training and experience that comprise the wellspring of future earnings flows - as fundamental to the understanding of major shifts in the global economy." nl 1. Prologues

Much uncertainty and fntstration is experieuced when drafting and interpreting covenants not to compete concerning physicians practicing medicine in Texas. ln fact, these sentiments led to the writing of this Article. n2 Before discussing the specific topics listed in the table of contents, the following transcript of abbreviated, fictional telephone conversations between various physicians and their respective attorneys introduces the conflicting interests that can arise between the former employer and the departing physician, between a prospective employer aud the newly recruited physician, and between the fortner employer and the prospective employer. These competing interests in the employtnent relationship underlie ntany of the difficult issues that evolve from physician covenants. It is Monday morning, and your client, Dr. Jones, a surgeon with Surgical Associates, is on the telephone. "Mike, I absolutely hate this practice. I've been here three years, I've worked hard, and I don't see any real oppornt- nity to make money. It was [*3601 fine at first, when I tnet new doctors, but ttow I get plenty of referrals fix surgeries.

Appx.399 Page I1 61 Baylor L. Rev. 357, '"

ployer's offices for thirty days notifying the patients of the physician's departnre, the publication of the sarne notice in the newspaper, and notice to the Texas Medical Board confirmitig that the physician complied with the rule. n122 'fhe net effect of the rule is to give the physician [*392] access to the information and to inform both the physician's patients and the public at large of the physician's separation from the practice- n123 If both the Act and the Texas Medical Board Rule require the employer to furnish its patient list information to the departing physician, to the extent it pertains, then one tnight question if the etnployer has a protectable interest in the physician's patient list. No Texas appellate case seems to have addressed whether a legitimate bushtess interest in a "customer base" can be protected by a covenant when the employer is compelled by law to disclose the list, thereby impairing its confidentiality. 024 An employer's counsel might well argae in support of the covenant's protection that the requirement to provide the information to the physician does not mean that the physician has the right to use the list conipetitively. 'rhe pliysician, post-employinent, is contractttally obligated by the confidentiality paragraphs ofthe employment agreement to keep the list confidential and to not reveal it to anyone else. For example, the physician, upon separation from the employer, will be provided with the information that satisfies both section 15.50(b)(1)(A) and Texas Medical Board Rule 165.5, but mere possession of that confidential information does authorize the physiciatt to disclose it to his or her subsequent eniployer. Perltaps a close second in priority of information is that an employer will want to prevent a departing physician from using its information pertaining to referral sources. n125 Refetral sources to medical practices can vary, but common examples are physicians in ottter medical specialties who refer patients to the entployer, and to the pltysician while etnployed, for treatment. n126 [*3931 The htformation pertaining to the referral network is highly valuable to the employer, as the network constitutes the wellspring for the continuing flow of new patients to the employer's practice. n 127 The employer cultivates referring physicians through various marketing efforts and by leading seminars to educate referring physicians abont the etnployet's medical practice. n 128 Once cultivated, the eniployer will maintain strong ties with the metnbers of the referring network to facilitate on-going referrals. 029 Unlike patient lists, no statutory or regulatory mandates are intposed on the etnployer to furnish the list of refenal sources to the departing physician. As the physician has access to the referral database during employment, protecting against the disclosure and subsequent use of'this database falls squarely within the type of business interests that the Texas Suprenie Court considers worthy of protect3on by a coveuant. n130 Moreover, [*394] employers will introduce the new specialist physician to its referral sources in order for the new specialist physiciau to gahr acceptance in the medical community. n131 Prudent employers will establish unifortn office and employment practices to safeguard its database on refetral sources. n132 These practices inclade practice-wide confidentiality agreements with all employees, including adniinistrative and support staff, and restricting access to employees who have a need to know ttte information, n133 Marketing plans and business procedures are good exatnples of other confidential inforniation that an employer may seek to protect by a covenant. If specific types of information that enhance an employers competitive position exist, the employer should include a description of the specific information in the confidentiality portion of the covenant. Many medical groups develop sophisticated procedures in marketing their services and competing for medical business, and this inforntation should be described 'ni the covenant in sufficient detail to show its iniportance to the entployer. For exatnple, if the employer has developed a system for following patients that is not used by other medical practices, the systetn should be generally described as post-encounter follow-up procedures. Fee scltedules used by the employer can contain information that gives it a competitive advantage. This advantage is particularly prominent in largc practice settiugs where the employer's size in the relevant market [*395] gives it bar- gaining leverage with the payors, like insurance conrpanies, in negotiating reimbursement levels for patient claims_ This information, however, applies to private, as opposed to govemment-sponsored, payment plans. The private payors are predominantly insurance companies offering a variety of health eare insurance products. When compared to all sources of payment of health care claims, a vety small percentage of patients pay for their health care without government or insurance company assistance- n134 The fee schedules of government-sponsored health care plans are not a secret. Medicare pays physicians' clainis for services to patients according to a preset fee schedule adopted annually by the Center for Medicare and Medicaid Ser- vices (CMS) of the U.S. Departnteut of Health and Hunian Services. n] 35 Private payors, such as ittsurance eotnpanies

Appx.400 Page 12 61 Baylor L. Rev. 357, *

offering general indetnnity, PPO, and I-IMO coverage, often base their reimbursoments on Medicare's fee schednle or a niultiplier of it. Knowledge of the reimbursenient rates that the private payors contracted witlt the employer could give the physician a competitive advantage if the physician chooses to coinpete with the employer. The point of this discussion is to question the utility of blanket descriptions that include the proverbial kitchen sink. Attorneys drafting covenants tend to believe that Iisting as many types of infoimation as possible will enhance the enforceability of the covenant in the future without regard to whether the inforrnation is actually used by the employer. However, over-inclusion of non-essential types of information may lead a court to consider the covenant urueasonable, as its protections are not tied to business interests specific to the employer. To date, no court has focused on the enforceability of a covenant in an einployment agreement witli a long [*396] list of protected business interests, many of which are interests uz the aiisiraet but tioi in fact. As previously mentioned, often the typical physician employment agreement will include a laundiy list of items that the employer contends are confidential by their inclusion, such as training, patents, trademarks, eopyriglits, designs, methods, and processes. Sotue of these items may not even exist. And if they do exist, the covenant is not truly needed if the intellectual property is protected through federal and state patent, tiadetnark, and copyright laws giving the owner the right to enjoin an infringer, 036 and state secrecy laws, which make disclosure illegal. Training can be deceptive. Physicians undergo extensive clinical training after cotnpleting medical school through approved residency programs, and often a physician will undergo even further training in a fellowship program. Resi- dency training is also a prerequisite to a physician joining a hospital's medical staff and to obtaining privileges to admit patients to the hospital. Moreover, it is the physieian's particular skill, developed independenfly by the physician during his or her residency tranting, which attracts patients to the physician. n 137 Without question, physicians who become employed directly from residency training or froin active duty service in the armed forces will benefit from the private practice experience of the employer and its other physician einployees. However, this process of adapting to private practice fails to rise to the level of a legitimate business intcrest. nt 38 More likely, the inclusion of training in the laundry list of protected uiformation is a tioldover from the Texas Supreme Comt cases that led to the legislature's [*397] passage of the Act. Specifically, those cases held that training associated with a common calling did not justify the enPorcement of a covenant. n139 On the other hand, under those decisions, specialized, technical traiuing by an employer would support a covenaut. n140 The mere listing of training in the employment agreement no longer justifies the protection of a covenant under the Act. Light made it clear that the legitimate business interests to be protected by a covenant were confidential infornia- tiou aud goodwill. If an employer instructs a physician in skills not possessed wben the physician became employed, such as techuiques not generally known iri the medical specialty, the instniction coustitutes confidential information worthy ofproteetion.'I'he employer in that situation should describe the information that will be imparted to the pliysician, such as advanced plastic surgery techniques. n 141 The foregoing exaniples are not given tnerely to encourage more precise drafting, but also to illustrate the effect that poorly-described employer interests might have on the buyout price. To the extent that the information of the employer included in the eniployment agreement which the coveuant is to protect is vague, all encompassing, or nonexistent, the arbitrator determining the buyout price of that covenant should disregard the information as having no monetary value. [*398] In addition to protecting confidential information, an employer may also use a covenant to protect the employer's goodwill. Goodwill is considered intzugible, as it is the additional value a business has above its physical assets, cash, and accounts receivable. 042 An employer can demonstrate goodwill in its medical practice. Its records can demonstrate the flow of new patients to the practice prior to the employment of the physician. This historical flow of patients will provide quantifiable evi- denee that the medical practice has goodwill that is worthy of protection. While the new patient flow is circumstantial evidence of goodwill, the employer will want to identify the reasons its rnedical practice is able to attract new patients. One of these reasons may be marketing efforts to "brand" the employer's niedical practice hi the cotnmunity it serves_ Another reason for an employer's ability to attract patieuts might be its employmant of another "star" physician to whom the patients, and persons refening them, desire to entrust their care. In these iustances, an employer has goodwill that deserves protection by a covenant. n143 Goodwill of the employer must be distinguished from the goodwill of the physician. A pliysician can develop a professional reputation while employed by the employer that demonstrates his or her ability to attract patients to the em-

Appx.401 Page 78 61 Baylor L. Rev. 357, *

grams accounting for 34_1%ofthe total. http://www.cros.lilts.gov/NationalHcalthExpendData/ 02 National- HealthAccountsHistorical.asp#TopOfPage.

n135. The Centers for Medicare and Medicaid Services are expected to fund $ 800 billion of the United States' healthcare costs, which were $ 2.2 trilliott in 2007. Alex Berenson & Reed Abelson, Weighing the Costs of a Look Inside the Heart, N.Y. Times, June 29, 2008, at AI, 18-19.

n136. 35 US.C. § 281 et seq. (patents); 17 U.S.S. § 101 et seq. (copyrights); 15 U.S.C. § 1051 et seq_ (trademarks); see also Tex. Pen. CodeAnn. §31.05 (Vemon 2003) (tlreft of trade secrets); Hyde Corp_ v. Huffi- nes, 158 Tca. 566, 314 S. W.2d 763, 771-72 (1958) (discussing trade secret treatment of an invention that was also the subject of a patent application).

n137. floddeson v. Conroe Ear, Nose & Throat Assocs., P.A., 751 S.W.2d 289, 290 (Tex. App. - Beanmont 1988, no writ) ("The record sltows that refeiring physicians are govenied by the skills and qualifications of the receiving physician, rather than his associations. [The employer] did not impart trade secrets, specialized training or confidential information to [tlte physician_]").

n138. Hasp. Consultants, Inc_ v_ Potyka, 531 S.W.2d 657, 662 (Tex. Civ. App. - San Antonio 1975, no writ) (discussing in a pre-Act case decided before Hill that employer's general training did not justify an interest to be protected by a three year, fifty mile covenant against emergency room physician) ("We're unwilling to hold that general knowledge, skill or facility acquired through training or experience while working for an employer become the "property' of the employer. Such knowledge and skill appertain exchisively to the employee, even though they were acquired by ou-tlre job training which was expensive and costly.").

n139. Hiti, 725 S. W.2d at 172 (noting ttiat the restricted franchisce was already skilled in the business covered by the franchise agreement) ("Finally, the covenant is oppressive to the promissor, Hill. Not only has he lost his franchise and investntent therein, he is now prevented from using his previously acquired skills and talent to suppolt hini and his family in the county of their residence. We recognize that a man's talents are his own. Absent clear and convincing proof to the contrary, there cnust be a presumption that he is not bargained away tt e future use orthose talents."); Cujakti v. Bw•kett, 772 S.W.2d 215, 217 (Tex. App. - Dallas 1989, no writ) (refusing to enforce employer's covenant against fornter veterinarian employee) ("Tlie [Texas Supreme] Coutt has suggested that a cotnmon calling consists of activities that do not require extensive, highly sophisticated training in a complex field.").

n] 40. Hd{l, 725 S. W.2d at 171 ("In employee covenants, the special trahsing or knowledge acquired by the employee throngh his eniployer is valuable consideration and often enhances the value of the employee to other firms. To allow employees to use or sell this valuable training or knowledge upon leaving a firm would create a disincentive for employers to train or educate eniployees."); DeSantis v_ Wackerthut Corp., 793 S.W.2d 670, 681 n.6 (Tex. 1990)_

n141. Intermountain Eye & Laser Ctrs., P.L.L.C. v. Miller, 127 P.3d 121, 729 (Idaho 2005) (discussing the split among state courts and ltolding ratlier experienced and skilled gained by the physieian while employed justifies a covenant); see also Harlan M. Blake, Entployee Agrcements Not to Compete, 73 Harv. L, Rev. 625, 652 (1960).

n142. Peat Manvick Main & Co. v. Haass, 818 S. W.2d. 381, 389 (Tex. 1991) (Cornyn, J., dissenting); Swin- nea v. ERI Consulting Eng'rs, Inc., 236 S•.W 3d 825, 837 (Tex. App. - Tyler 2007, no pet.) ("Goodwill is generally understood to mean advantages that accrue to a business on account of its name, location, reputation and success.").

Appx.402 Page 1

L^^^sN^xK

LEXSEE 18 J CONT'EMP HEALTH L & POLY 467

Summer, 2002

18 J. Conterrip. HealtFa L. & Pofy 467

LENGTH: 11686 words

COMMENT: HEALTHCARE JOINT VENTURES: PUSHING TAX-EXEMPT LAW TO THE L1MI'I'S?

NAME: By Eileen M. Newell*

BIO: * J.D. 2001, The Catholic University of America, Columbus School of Law; B.B.A. 1998, Saint Mary's College, Notre Dame, IN. The author thanks her family for their inspiration and encouragement, Professor Karla Simon for her guidance and George Rendziperis, Esq. for his assistance with the preparation of this article.

SUMMARY: For the less fortunate, hospitals provided health services when the wages of a private physician could not be paid. ... In ttre general law of charity, the promotion of health is cousidered a charitable purpose. ... Thus, an exempt healthcare provider must conduct a substantial portion of its business activities to provide a benefit to the community, which in this case is the promotion of health. ... In the first, the IRS was coutettt with the purcltase of a 62.5 percent interest in a I.LC by two exeinpt healtlicare organizations because physicians, who did not serve as officers or directors in either organization, owned the remaining interest. ... The nonprofit agrees to award grants to promote the health of the community, including healthcare to those that catinot afford it, with the profit it receives from the joint venture. ... First, the goven- ing documents explicitly demand that the LLC operates its hospitals to further the "charitable purpose by protnoting health for a broad cross section of the conununity. ... In Redlands Sargical Services v. Commissioner, a tax-exempt hospital, Redland Health Systems, created a wholly-owned subsidiazy that entered iuto a general partnership with a for- profit etitity. ...

TEXT: [*4671 Introduction

Numerous organizations operate liospitals, clinics or associations, bringing all aspects of healthcare to a broad sector of the cornnutnity, n I Hundreds of these entities operate hospitals as nonprofit entities, on a tax-exempt basis, 112 usually providing, at a minimum, emergency care to the entire community regardless of an individual's ability to pay. n3 In addition, countless organizations and associations provide research aud education in the healthcare field. While healthcare organizations are not the only classification of tax-exempt organizations, n4 healtltcare providers are at an ['"4681 increased risk of losing the exempt status, due to the high-profile nature of its industry. n5 Undoubtedly, the laws regarding nonprofit organizations and tlie tax-exempt status, n6 which may or may not be granted to a nonprofit organization, have a treniendous impact on the adtninistration of healthcare. Often, a nonprofit organization is willing to contract with a for-profit entity in order to generate the funding necessary to provide healthcare to the community. n7 In such a relationship, for-profit organizations are attempting to decrease costs and increase revenue, which ultimately provides a greater rate of return for investors. Regardless of the entity's philosophy behind offering its services, healthcare providers try to find the most efficient and effective tneans to

Appx.403 Page 2 18 J. Contemp. Healtli L. & Pol'y 467, *

operate their facilities. As a restilt new combinations of johtt ventures and alliances between nonproIIt and for-profit entities etnerge, coinmonly in the fornt of a [*469] partnership or a limited IiabiLity contpany (L.LC). n8 Initially, the Internal Revenue Service n9 was hesitant to allow these agreements, fearing it would compromise the integrity of the tax-exempt status. n10 After realizing the prohibition on these ventures was hiudering the success of nonprofit entities in the world of big business, the Service reconsidered its posiuon. nl l Consequently, nonproCt ttospitals and clinics began to form partnerships to survive in the world of managed healthcare. The structures of these ventures have taken various fortns, including "wltole hospital" and "ancillary" joint ventures. n12 With recent holdings by the IRS and the courts, the boundaries of these vcntures are only now being deterntined; tlrus, providing uncertainty to those who wish to enter into these agreements.

This Comment addresses the effect ofjoint veiituros oii the tax-exempt status of nonpraRt heaithuatet-iiities. n13 Section I provides an overview of the requiretnents foi- tax-exemption, as laid out in the Internal Revenue Code (IRC). Section II discusses the reluctance of the IRS to pertnit exempt organizations to enter into joint ventures with non- exempt entities. Section II then summarizes the brief, but controversial, history ofjoint ventures. Section III gives a detailed analysis of common healthcare joint ventnres. Section IV addresses the recent attempts to limit johrt [*470] ventures, thus affecting the ability of nonprofit and Itealthcare organizations to remain competitive in the industry. 1. Tax-flxemption for Healthcare Providers

Section 507 (c)(3) of the IRC, provides att exemption from federal income tax for organizations that promote a charitable, scientific or educational purpose. n14 From the initial enactment of this section, hospitals have been viewed as traditional charities and have qualified for the exeniption. n 15 ln the Nineteenth Century, the wealthy enjoyed the luxuty of a "house-call" from the local physician, wlro generally worked out of the home. nl6 For the less forhtnate, hospitals provided health services when the wages of a private physician could uot be paid. n 17 The generosity and benevolenee of charitable donors fttnded hospitals. n18 Unfortunately, hospitals were ttot lmown for providing extensive medical serviees_ In ntany cases, the hospital was a place to provide comfort for those sick uid close to death. n19 However, the hidigent had no other alternative. As medical technology developed during the Twentieth Century, so did the need for collective resources. n20 Ptty- sicians turned to hospitals as a way to share equipment and hurnan resources. Consequently, hospitals evolved into the primary location for healthcare. n27 Since many physicians moved their practices to hospitals, patients were expected to pay for hospital services, even in charitable hospitals. Regardless of this change, Itospitals have generally continued to provide some level of care to those who can not afford it. n22 Medical technology and practices were not alone in this evolutionary process. Notably, the ideological concept of charity was transformed from [*471]"relief of the poor" n23 to "conununity benefit." n24 Yet, tliroughout this change, the idea of providing Itealthcare services as a form of charity went unquestiotted. In the general law of charity, the promotion of health is considered a charitable purpose. n25 Clearly satisfying the exempt purpose requirentent, a healthcare provider must also meet the other requirements outlined in Section 501 (c)(3) in order to receive and tnaintain the exetnpt status. n26 Iu addition to merely having an exetnpt purpose, the organization's primary activities must be designed to accont- plish that purpose. n27 Therefore, exempt eutities must be "organized and operate exclusively" so that the public or charitable interest prevails over any private interest. n28 The assets of the organization rnust be substantially used to further the charitable ptupose. Thus, an exempt healthcare provider must conduct a substantial portion of its business activities to provide a benefit to the community, which in this case is the promotion of health_ Another requirement for tax exemption under the Code is that no private shareholder or individual may inure a benefit n29 froin the otganization's net earnings. n30 A "private shareholder or individual" is a person having a personal and private interest hi the activities of the organization. n31 If an exempt organization violates the private benefit or [*472] private inurement restriction, its tax-exempt status may be revoked. n32 Joint ventures bring additional attention to the possibility of exenlpt healthcare providers violating this proltibition. "The private inurement doctrine forbids ways of causing incotne or assets of a healthcare organization from flowing away from the organization and to or for the benefit of one or more persons wifli some significant relationship to the organization." n33 If ajoint venture is not carefiilly structured between a for-profit entity and an exetnpt entity, n34 the actions of the exempt organization may be providing additional benefits to a private individual, n35 inclttding but not litnited to the for-profit entity and its officers and directors.

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As the demand for providing quality healthcare at lower costs increases, Itealtlicare providers are hunitig to large- scale operations in the hopes of ineeting this demand, while still maintaining a stable financial situation. Joint ventures provide a conunon solution to the economic and fiscal problems faced by both for-profit and nonprofit entities. The agreements between these two organizations must satisfy both the desire and expectation of income by the for-profit investors and the requirements laid out at Section 501(c)(3) for the benefit of tite uonprofit entity.

["473] II. The Evolution of Nonprofit Joint Ventures

Prior to 1982, the IRS prohibited nonprofit entities from entering into an agrecinent with for-profit entities. n36 This per se incompatibility ruie was reasoned on two priticipies. n37 First, the maximtzatiou of ihe hnanciai lutcrests ofthe for-profit partners would be viewed as the primary motivation driving the nonprofit's actions, because the nonprofit has a legal duty to do so, serving as a general partner. n38 Hence, the organization would be in direct violation of Section 501(c)(3), which requires exclusive operation in furtherance of its exenipt purpose. n39 Second, the niere fact that a for- profit entity would share in the net-profits of a joint venture's activities is hr violation of the prohibition of inuring private benefit. n40 Withont a prevailing charitable purpose, the otganization would lose its tax exetnption. Frn-therntore, the exempt organization would be serving as a general partner in the joint venture. Because a general partner is exposed to unlimited liability, not only is the investment in the johtt venture at risk, but also all of the assets of the exempt organization. n4l '1'his additional exposure accentuates the concern of the IRS, the donors of the assets, n42 and the eommunity at large. If au exempt organizatiou does not want to assume the risks that accontpany a general partner, it can invest as either a limited partner or a non-managing investor. n43 In this role, the exempt organization does not have a fiduciary obligation to the for-profit partners and does not risk [*474] unlimited expostire of its assets. n44 An exeinpt organization may invest in a partnership that does not advance its charitable purpose as long as the interest is "insubstantial" to the exempt organization's overall investments or activities. n45 If the activity does not relate to the organization's exempt purpose, the organization niay be obligated to pay tax on any hlcome received_ n46 Wliile it is possible for an exempt organization to be a limited pattner in a joint venture, additional uncertainty arises when the exenrpt organization is a general partner. A. Perinissibility of Joint Ventures

When the Nintli Circuit affirmed the'I'ax Court's holding in Phnnstead Theatre Society v. Comtnissioner, n47 the IRS was forced to reconsider its absolute ban on joint ventures. n48 In Plunistead, difficulties in raising funds for its exernpt activities caused a nonprofit theater company to enter into a litnited partnership as the general pattner with several for- profit investors that were serving as limited partners. n49 The limited partners had the majority share of the net earnings, but this detail had no hnpact on the court's holding. n50 The court was convinced that the transaction was performed at atm's length and was no niore incurring a private benefit than contractual percentage agreenients previously approved by tlie courts. n51 Ultimately, the theatre company's control over the activities of the joint veuture became the factor that allowed joint ventures to occur. "The limited partners liave no control over the way [the notiprofitJ operates or manages its affairs, and none of the limited parhiers ... is an of$oer or director of the [charitable organization]." n52 Although the facts of Plumstead involve a theater company, the holding can be applied to the [*4751 stractures of all joint ventures entered into by exempt organizations, including healthcare entities. If a nonprofit entity is able to dictate that the activities of the joint venture be cliaritable, a for-profit investment in the capital accounts should be merely incidental to the 501(c)(3) stattis. B. Facts and Circumstance Test

As a result of the court's holding in Plumstead, the Seivice adopted a fact and circumstance analysis of the newly foim- uig joint ventures. The analysis is based on a two-prong test. n53 First, the activities of the partnership must be in furtherance of the tax-exempt purpose. n54 A nonprofit entity must contuiue to earn its tax-exetnpt status by conducting activities that bencfit the conununity. The tax-exemption is not in jeopardy solely because an organization distributes a portion of its profits to private investors. The second prong examines the exempt organization's flexibility in the partnership agreement to operate exclusively in furtherance of its charitable putpose. n55 Through this prong, the IRS de- termines the impact of the exempt organization's control over the activities of its ventures and the extent of the inurement to private investors.

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This new approach to nonprofit and for-profit business agreements changed the stracture of healthcare organizations. Through the issuance of a series of private letter tulings an(I general counsel memoranda, the IRS has permitted these agreements ut either partnerships or other forms of joint ventures involving nunterous healtlrcare related activities. An ambulatoty surgical center, a substance abuse treatment center, magnetic resonance imaging (MRI) services, an acute medical rehabilitation hospital, a gastroenterology laboratory and a kidney dialysis and n'eatment center werejust some of tttc business entities that emerged as a result of for-profit and nonprofit participation. n56 In 1992, the IRS published examination guidelines to be nsed by agents [*476] dming hospital audits to detertnine if the organization is meeting both the connnunity benefit standard and limiting the private inurnment. n57 In serving the comtmmity, ltospitals should have the following attributes: (1) an "open staff policy"; (2) a full-time emergency room opento everyone; n58 (3) acceptance oflvfedicare and Medicaid; (4) availabiGty ofnon-emergency services; and (5) overall connnunity involvement. n59 According to the IRS, these five policies that may be implemented by a healthcare provider are the favorable factors needed to satisfy the first prong of the facts and circumstance test. The guidelines also iucluded the following factors that would indicate private benefits: (1) researcli obligations benefiting the private parties and not the public; (2) "excessive compensation"; (3) "loan agreements at less tltan prevailing interest rates;" and (4) "supplies or services are provided ... at preferred tenns" by the charitable organization, n60 '1'hese situations give a for-profit investor benefits from the activities performed by the nonprofit partner. The question remaius as to what extent these factors must be met. C. Need for Control

After implementing the facts and circumstance test, the IRS consented to joint ventures between nonprofit and for- profit entities. Housing Pioneers v. Commissioner n61 marks the first limitation to the IRS condoned joint ventures. In Housing Pioneers, the charitable healthcare organization participated as a one percent general partner in a limited part- nersltip with for-profit investors. n62 The court never reached the analysis regarding the second prong of the test, the control of the agreement, becanse the agreement never passed the first prong. n63 The agreement failed, "because its proposed activities included at least one [*477] non-exempt purpose which was "substantial in nature."' n64 While this case may seem irrelevant to healthcare organizations, which traditionally have provided charitable services, the holding allowed the IRS to switch its focus front the first prong to scrutinizing the factors of the second prong of the facts and circumstance test. Witltin tltree years, the IRS began to examine the need Por control in two private letter rulings regarding ftealthcare providers. n65 In the first, the IRS was content with the purchase of a 62.5 pereeut interest in a LLC by two cxempt healtheare organizations n66 because physicians, who did not serve as ofticors or directors in either organization, owned the remaining interest. n67 The purchasing agreement called for an arrn's length transaction and proportionate allocations of the LLC "s eatnings and liability. n68 In addition, the LLC had policies and guidelines for the operation of the outpatient dialysis center, which constituted its business activity. n69 In the second letter ruling, however, the IRS had sonic concern with the nonprofit's lack of control as provided in the partnership agreement. n70'fhe organizations agreed to amend the agreement, which gave the charity substantive authority and revoked a security agreement, thus conrpromising the prohibition on private inurement, n71 After these changes the exempt status was no longer in danger. n72 Tluough the release of private letter rulings n73 and atulit guidel'nies, the IRS has continually expressed the importance of the exempt organization's ability to control the activities of any venture in which the assets of the charity are invested. This is especially true when the exempt [*478] organization serves as the general partner in a newly formed partnership n74 or the managing member of a LLC. III. Detailed Analysis of Common Hospital Johtt Ventures

Joutt ventures have been common place aniong healtheare-providing entities. "Because the healthcare sector of the economy has been the most dynatnic area involving [exenrpt organizations] on a large scale, many of the new and different types of joint venture transactions have involved tax-cxempt healehcare organizations." n75 To understand fully the nonprofit's ability to control the organization, the stntctural details of a particular transaction can be a significant factor hi the IRS's fitture tnling. "Whole-hospital joint vettttues," as indicated by the number of requests for private letter ntlings received by the IRS, n76 and "ancillary joint ventures" have emerged as popular arrangements forthe joint ventures.

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A. Whole Hospital Joint Venthues

In a whole hospital joint venture, the exempt entity is able to contribute its assets to the joint venture, provided its goal is to further the tax-exempt purpose of the entity. n77 In many cases, the hospital's assets will be transferred to the newly formed etttity. The for-profit orgauization manages the day-to-day operatiorts of the venture, n78 while the nonprofit does not take part in healthcare services. However, the nonprofit entity does receive distributions based on its percentage of ownership in the venture_ n79 The nonprofit organization contributes additional capital to ensure the performance of the charitable healthcare aims. n80 The nonprofit maneuvers its assets to further its tax-exempt ptupose tlirough its positions on ttte board of directors of the newly formed venture. The for-profrt organization receives assets necessary to mn a hospital at a[*4791 reasonable rate of teturn. n81 A whole hospital joint venture can be a beneficial velticle to the success of hoth the for-profit and nonprofit entities. The IRS addressed the whole hospital venture in Revenue Ruling 98-15. n82 This was only the second reveaue ruling issued addressing liealthcare entities since 1986. n83 Consistent with the faet-aud-ch-cumstance analysis that emerged in this area, the ruling is cotnprised of two joint venture scenarios. n84 The fust situation describes an agreement that meets the IRS expectations for ajoint venture uuder 501(c)(3). n85 The agreenient described in the second situation falls short of satisfying the expectations of ttte IRS. n86 If an organization has facts synonymous with eitlter situation described in the ruling, then the maintenance or revocation of its tax-exempt statns can be easily inferred. However, uncertainty arises wlien the fact pattens fall somewhere in the middle. n87 '1'he two proposed situations begin with similar fact patterns. A tax-exempt hospital forms a LLC with a for-profit corporation in the hopes of obtaining additional funding to serve the eormmtinity. n88 To do so, the nonprofit contributes its hospital assets and other operating assets in return for an ownership interest proportional and equal to the contribution in the newly formed LLC. n89 A for-profit entity, willing to finance the hospital, expects to earn a reasonable rate ofretum on its investment. It also contributes assets in exchange for a proportional and equal interest. n90 The eamings and distribution of the LLC are made in proportion to the ownership interests. n91 The nonprofit agrees to award grants to promote the health of the cominunity, including healthcare to those that cannot afford it, with the profit it receives from the joint [*4801 venture. n92'flie legal and financial arrangement, stated above, is common to both situations found in the ruhng. n93 In contrast, discrepanciesexist between the two situations, which are significant enough to warrant revocation of tax-exetnpt status. The difTerence appears in three areas: goveruance, management, and decision-making authority. n94 While the board of goveuance shall consist of both for-profit attd uonprofit appointees in both scenarios, the significant factor is the number of governors each owner can appoint. n95 In situation one, the governing board consists of tllree nidividuals chosen by the nonprofit partner and two individuals chosen by the for-profit partner. n96 The nonprofit has an outright majority of the board. In situation two, the governing board coitsists of three delegates from each owner. n97 "Because [tlte nonprofit] will share control of [the LLC] with [the for-profit], [tlie nonprofit] will not be able to initiate programs witliin [the joint ventnre] without the agreement of at least one goveniuig board member appointed by [the for-profit]." n98 Convinced that the for-profit entity will put its business enterprise before the tax-exempt purpose, the Service hetd the sh-ucture of the board threatened the "furtherance of an excmpt purpose" requirement. n99 In situation two, presented with an equal number of board mentbets from or appointed by each partner, the tax- exempt organization has the authority to strike down any provisions asserted by its for-profit counterparts. n100 How- ever, the nonprofit does not mauatain enough control because "a majority controlled board can htitiate actions in furtherance of the charitable purpose while an evetily divided board cannot." n101 The requirement of a ratio in favor of the exetnpt organization indicates the [*481] importance in ensuring that the joint venture will exist to provide eommunity benefit and not private gain. In both situations, the day-to-day management of the LLC will be detetmined through a management agreement. n1021n sifuation one, the contracting compauy cannot be related to either owner, and the ability to renew the contract is done only with mutual consent of both owners. n103 fIowever, the management agreement in situation two is sornewhat different. Instead of an arm's length agreement, a subsidiaty of the for-profit entity provides the day-to-day operations of the LLC. n104 Furthermore, the "renewal" provision places the discretion in the hands of the subsidiary. n105 The Service eontends that control is to be a deciding factor throughout the entire structure of the organization. Thus, the actual operation of the joint venture, in addition to the board of governance, nzust be controlled by the nonprofit. n106'fhe charitable purpose niust be the primary motivation behind ttte actions of the LLC. n107 To be sure that

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the operating management cotrtributes to this purpose, the nottprofit must have the capability to control the management company. 008 Control in this sense can be determined through factors such as the independence of the company, n109 the ability to remove the eompauy for cause and the length of the contract, n110 The greater the control, the more secure the exempt status will be. The decision-making authority of the first LLC is limited in several capacities. First, the governing docuntents explicitly demand that the LLC operates its hospitals to further the "charitable purpose by promoting health for a broad cross section of the community." nl l l Second, [*4821 this duty to the community prevails over the duty to the owners regardurg financial returns. n112 Without the former provision, the "[LLC] will be able to deny care to segments of the community, such as the indigent." nl 13 This latter provision directly confionts the concern regard'uig a duty to increase profits forthe investors that tue Service expressed in rmmsteaa. nr 14 Furthermore, the decisions that must be handled by the board of governance, not the management company, are lintited in the second situation. Both situations require approval by the board for budgets, distributions of earnings and the selection of key executives. However, the first situation requires that any acquisition or distribution of facilities, contracts above a certain dollar amount and changes to the services offered be presented before the board of governance, n115 thereby providing the nonprofit witlt additional control of the management company and the activities of the organization. While the second situation includes a provision for the board to decide "unusually large contracts," uncertainty arises as to which contracts actually tneet that requirement. n 116 The relevant facts and ciretunstances outlined in Revenue Ruding 98-15 will give nonprofit entities sotne guidance as to "participation in [a] partnership [that] furthers a charitable purpose, and .., pemiits the excinpt organization to act exclusively in furtherance of its exempt puipose and only incidentally for the benefit of the for-proGt parmers." n 117 However, guidance is not provided for factual pattems that fall between these two scenazios. B. Ancillary Joint Ventures

Generally, aucillary joint venttifes are not as complex as whole hospital jonit ventures. In this type of venture, a nonprofit entity transfers assets to be used in the newly formed healthcare facility, or coutributes funds for its establishment. n118 While ttie nonprofitretains other assets to operate [*483] other healthcare facilities, n119 the for-profit maintains the same role as in a whole-hospital joutt venhtre. The for-profit investor merely contributes cash equal to the nonprofit's asset contributions. n 120 With an ancillary joint venture, the nonprofit's activities do uot focus on the joint venture. "Tlte activity condncted by the exempt organization tlirough the joint venture arrangement is generally not the sole activity of the exempt organization, and it may not be a substantial part of the organization's activities." nl2l The nonprofit does not deposit all of its assets into the newly formed entity and it maintains an additional outlet to conduct activities in fiirtlterance of its exempt purpose. In Redlands Surgical Services v. Commissiouer, n122 a tax-exempt hospital, Redland IIealth Systems, created a wholly-owned subsidiaty that entered into a general partnership with a for-profit entity. n123 The general partncrsltip owned an interest as geueral partner in a limited partnership that operated an ambulatory surgical center. In summary, the subsidiary of the tax-exempt hospital "owned 46 peroent n124 of a 61 percent n125 interest in an antbulatory surgical center." n126 The subsidiary served merely as a shell to hold tlie joint venture for the hospital. The only asset the subsidiary tteld was an interest in the surgical center; likewise, tlte surgical center was the subsidiary's only source of income. n127 Furthermore, the hospital's president perforined double duties as the president of the subsidiary, nl28 The court examined the claim under a fact and circumstances analysis [*484] and denied the organization's peti- tion for tax-exempt status. n129 The lack of an obligation toward a charitable purpose by the general partnership dis- couraged the court froin issuing a favorable holding for the joint venture. n 130 In addition, the joiut venture failed to give the nonprofit the ability to control the voting power or any otlter device that would ensure furtherance of the charitable purpose. 031 Similar to situation two in Revenue Rzding 98-15, n132 the day-to-day operations were controlled by the for-profit partner. n133 Futally, the agreement between the for-profit and nonprofit contained competitive restrictions and market advantages that indicated a profit-making agenda and not a eotiununity benefit, n134 As the court stated, "[it] is difficult to conceive of a siguificant charitable purpose that would be fitrthered by such [restrictions]." n135 Specifically, the court indicated that no factor was determinative, holding that: "'I'aken in their totality, these factors compel the conclusion that ... [tlre charitable organization] intpennissibly serves private interests." n136 Conclu- sivc(y, the totality of the circumstances was the key factor in the court deciding that the organization never held itself out as charitable. n137

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While Revenue Ruling 98-15 is only enforceable upon whole hospital arrangentents n138 and the Redlands Case has a direct impact on ancillary ventures, n139 the two recent developments can be taken together to exarnine the Ser- vice's and the courts' position on the future of tax-exemption in the healthcare arena. i1140 Conclusion

For the past twenty years, the tax-exemption law has reflected an [*485] understanding of the importance of prosperity in the healthcare indnstry. "The growth of private arid ernployer-provided health insurance and the introduction ...of government programs such as Medicare and Medicaid altered the econornics of the healthcare sector and transformed the Anierican hospitaL" n141 To reflect this trend, the Service and the courts have allowed joint ventures between nonprofits and for-proiiis to form witir few restr ict ons. i i 42 Revenue Ruling 98-15 aiid Redlai:ds set the lim tations on thc government's willingness to allow a metamoiphosis of the tax-exemption law in a traditionally charitable industry. n143 It is true that a joint venture between a for-profit and nouprofit can be successful while the nonprofit tnaintains its exempt status. Revenue Ruling 98-15 provides a"safe liarbor" ht sihtation one. n144 The IRS will accept entities that arrange the venture witlt similar governance provisions to situation one. n145 IIowever, the arrangements that do not appear to rnatch this structure have no guarantees. In reality, the whole-hospital ventures have been structured as a cross between these two exarnples. 'I'hus, the format of the currently issued guidance provides little assistance to entities contemplating a joint venture. ""The good example and the bad example are so far apart that it leaves most of the real world deals somewltere in between."' n146 For example, most joint ventures of this type use a management company connected witti a for-profit entity, as seen in situation two. n147 "It is the expertise and success record of the for-profit companies that is being sougltt in these ventures." n148 In addition, the requirement that the nonprofrt's tnembers be a majority of the board of directors is unrealistic. Cur- rent transactions typically have equal representaeion or require a[*486] supennajority vote. In either case, the tax- exempt owner, witli only a standard majority, lacks the power to control the board as is reccmmended by the provisions of Revenue Ruling 98-15. n 149 This lack of certainty has already had an irnpact in the busuiess world. A wholc-hospital joint venture between Co- lumbia/HCA Healtltcare Corporation, a for-profit entity, and the Arlington Healtlicare Systems, a nonprofit, was can- celled because the IRS failed to issue an approval of the transaction. n150 While approximately twenty-four whole- hospital joint vent nes are in existence, half involve Columbia as the for-profit investor; n151 presumably, mariy take a similar form to the Arlington joint venture. Given the level of scrutiny proclaimed in Revenue Ruling 98-15, many ventures will not survive the fact-and-circurnstauce analysis, which must be extremely favorable to the nonprofit entities. n152 While the issuance of the ruling was a gesture of guidance, n153 the only direction actually provided was a "golden ticket" n154 hidden in a set of unascertainable facts. If the recent litigation is supposed to help exempt organizations, there will be much disappointment. In Redlands, the Tax Court, with au affnniation on appeal, allied with the IRS as it examined a nonprofit's ability to rnaintain effective control over its operations. n155 The court did not take as strict a position as the Service, clioosing instead to look at the totality of the circumstances, tlius allowing more room for joint ventures to take place. n156 Nonetheless, an organization must again attempt to weigh the specific factors n] 57 the court addresses with no real understanding as to the characteristics needed to satisfy the requirements of 501(c)(3). [*4871 The reasoning behind the agreements between both for-profit and nonprofit organizations allows each entity the most effective way to meet their financial necds. As suggested by the nutnber of requests for private letter rulings regarding joint ventures from the IRS indicates that parties believe this type of arrangement will be beneficial to both sides. n 158 llnfortunately, a failure in attempting to form ajoint ventrire can further add stress to the finaucial burden already experienced by nonprofits. Millions of dollars are invested in creating the joint venture, which ultimately may be thrown away because of an adverse decision by the IRS or the courts. n l59 In light of Revenue Ruling 98-15 and Redlands, the attractiveness of the arrangement has dirninished. n 160 The nonprofit will have a difficult time finding a for-profit entity that is willing to surrender control of the venture without receiving coinpensation for its sacrifice. Purchasing the control needed under the current analysis will greatly reduce the fmancial rewards the nonprofit was seeking to reap. n161 Through both Revenue Ruling 98-15 and Redlands, nonprofit entities have a clear understanding of what not to do. n162 The borders outlining what will constitute an appropriate activity under the tax-exempt provisions have been established, and it is clear that certain agrcements will lie outside those borders. However, by not providing a more detailed locatiori of that perimeter, healthcare entities are forced to blindly choose to be in or out. As a result, sonie joiut

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ventures will not be formed, some nonprofit entities will convett to for-profit entities, and some 501(c)(3) organizations will lose their exentpt status. By not taking a clear position, the IRS and the courts have indicated that tax-exemption is a reward for those who work to clearly add a benefit to the conununity. With understanding that healthcare entities need to be operated effectively and effrciently, thus requiring additional resources, private investors may be able to save the nonprofit healthcare organizations. However, it cannot be done at the expense of thcir tax-exemption status.

Legal Topics:

For related research and practice materials, see the following legal topics: Busuress & Corporate LawJoint VeptuiesFormationBusiness & Corporate LawJoint VenturesManagement Duties & LiabilitiesHealthcare LawBusiness Admhiistration & OrganizationTax ExemptionsNonhospital Organizations

FOOTNOTES:

ni. In 1997, the National Taxonomy of Exempt Entities ("NTEE") classified nearly sixteen percent of all nonprofit charitable organizations as health organizations. These health entities, collectively repmted assets and revenue totaling in value of $ 506,640,000,000 and $ 395,165,000,000. See Paul Arnsberger, Charities and Other'1'ax-Exempt Organizations, 1997, Statistics of lacome Bull. 50 (2000).

n2. To encourage the operation of certain activities that benefit the commtmity, the Internal Revenue Code provides for exenzption from incotne tax ou iucotne generated fi-om designated exempt activities, See J.R.C. 501 (West 2000),

n3. See Rev_ Rul. 69-545, 1969-2C.B. I 11. However, an emergency room is ttot an absolute requiremeut for tax exemption. See also Rev. Ru(. 83-157, I983-2 C.B. 94, statiug that the lack of an emergency room would not preclude the eligibility for tax-exeinpt status if an emergency room would be unpractical because the specialized nature of cettain hospitals.

n4. The NTEE breaks down the Nonprofit Charitable Organization sector into ten categories: (1) arts, etd- tLire, and humanities; (2) education; (3) environment, animals; (4) health; (5) human services; (6) inteinational, foreign affairs; (7) mutual, membership benefit; (8) public, societal benefit; (9) religion related; and (10) unknown, unclassified. See Arnsberger, supra note 1, at 50.

n5. See "I'homas K. Hyatt & Bruce R. Hopkins, The Law of Tax-Exempt Healthcare Organizations 1.1 (John Wiley & Sons 1995).

n6. While these two ternzs, "nonprofit" and "tax-exetnpt", are used as synonyms, a difference does exist. The term "nonprofit" generally refers to section of the state law in wliich an organiz.ation seeks incorporation. Almost all states have enacted a form of nonprofit corporate law. See James J. Fishman & Stephen Schwarz, Nonprofit Organizations 64 (2d ed. 2000). The term "tax-exempt" deals specifically with organizations that have received an exemption from a form of taxation by federal and state officials. Although most tax-exempt organizations incorporate as nonprofits, a nonprofit is not automatically tax-exentpt. 'I'o gain tax-exempt status for federal iuconte tax purposes ander I.R.C. 501, an organization must file Form 1023 with the Internal Revenue Ser- vice. See I.R.S. Publication 557 (Rev. July 2001), Tax-Exempt Status for Your Organization, Cat. No. 46573C, 2.

n7. Additional and more specific reasons for a nonprofit to enter into a joint-venttue include:

To grant physicians a stake in a new enterprise or service...; to bring a new service or medical facility to a needy area; to share the risk that is inherent in anew enterprise; to pool diverse areas of inedical expertise; to attract

Appx.410 Page 9 18 J. Contemp. Health L. & Pol'y 467, *

new patient admissions and referrals; to persuade physicians not to rcfer patient elsewhere; and to ensure that physicians do not establish a competing healthcare provider.

See Michael I. Sanders, Joint Ventures Involving Tax-Exempt Organizations 5(John Wiley & Sons 2000).

n8. Even though partnerships and limited liability companies (LLCs) are treated as flow-tlirough entities for tax purposes, the LLC may be a more attractive optiou, shrce the investor is not personally liable for the actions of the LLC. Similar to a corporation, the investor is ouly liable for the actions of the LLC up to the atnount invested. See Unif. Ltd. Liab. Co. Act 303 (1996).

n9. The Internal Revenue Service will be referred to as "IRS" or "The Service."

n 10. The IRS serves as guardian on behalf of the community for assets that are donated to charitable organizations.

nl l. See Off. Mem. 19225, LL-7-80 (Mar. 13, 1980)_ See also Gen. Couns. Mem. 39,005 (June 28, 1983).

n12. These types ofjoint ventures will be discussed in detail in Section III of this article_

n13. While this Cotnment deals only with the tax exemption granted by the Internal Revenue Service, an exempt organization should also examine the treatntent ofjoint ventures witlt for-profit entities by state and local governments. 'Phe state and local govermneuts provide tax exemption to a qualifying nonprofit for taxes they impose, such as, but not limited to property tax and state income tax. See generally Kenneth D. Chestek, Are Hospitals Purely Public Charities?, 7 Assessment J.2 (2000),

n 14. LR. C. 501(c) (3) (1994).

n15. James J. Fishnian & Steplren Schwaz, Nonprofit Organizations 384 (2d ed. 2000).

n16. See generally Cliestek, supra note 13, at 24.

n17. See id.

n18. See id.

n19. See id.

n20. See generally Chestek, supra note 13, at 24.

n2l. See Id.

n22. See Rev. Rul. 69-545, 1969-2 C.B. 111, supra note 3.

n23. See Rev. Rui. 56-185, 1969-2 C.B. 202. An organization's ability to provide relief to the poor is a key factor in determuiing its tax-exempt stattts.

Appx. 411 Page 10 18 J. Contemp. Healtlt L. & Pol'y 467, *

n24. During this time, Medicare and Medicaid progranis commenced, greatly affcctiug the heafthcare industry and the role of the government and charities as providers. See also Lastern Kentucky We[Jare Rights Organi- zation v. Simon, 506 F.2d 1278 (1974); Sanders, supra note 7, at 329; Gvn. Covins. Mem. 39,862 (Nov. 21, 1991).

n25. See Restatement (Second) Trusts, 368, 372 (1957).

n26. See Rev. Rul. 69-545, 1969-2 C.B. 117.

n27. Treas. Reg. 1.501(c)(3)-1(c)(1) (1986).

n28. Treas_ Reg. 1.501(e)(3)-1(d)(1) (ii) (1986).

n29. "Private inurement" is an impressible transaction involving an individual inside the organization, such as a director, manager or any related party receiving assets frorn the organization in anything less than an atm's length transaction. See United Cancer Council v. Comm'r, 165 l:3d 1173 (7th Cir. 1999). "Private benefit" is the term used when an exempt organization operates substantially to benefit outside private interest. See generally An¢. Campaign Acad. v. Comm'r, 92 T:C. 1053 (1989).

n30. SeeLR.C 501(c)(3)(e) (2001).

n31. See Treas. Reg. 1.501(a)-(1)(c) (2001).

n32. See Ancolte Psychiatric Ctr. v. Comm'r, 98 T. C. 374 (1992). The IRS may impose an excise tax in addition to or in place of the revocation of the exempt status. Under the IRC, ' mtetmediate sanctions" are iinposed on organizations that engage in and its managers who autltorize an excess benefit transaction. The Intermediate sanctions can be very steep. Persons who engage in these prohibited activities with a 501(c)(3) orgatiiration are taxed on twenty-five percent of the amount of the excess benefit received. "I'his tax may increase to two hundred percent if the transaction is not corrected. A manager is subject to a ten percent tax, if he authorizes a transaction that he knows is an excess benefit transaction. See ZR C. 4958(a)(1)-(2), (b).

n33. Hyatt & Hopkins, supra note 5, 4.1, at 56.

n34. An exempt organization participating in ajoint venture ntay be engaging in private im.u-ement if the for-profit partner receives additional compensation or allocations of the profits, e.g., if a physician receives a reduced rental rate, or if a hospital does not receive adequate consideration on the sale of its assets. "I'his list is not exhaustive. See Sanders, supra note 7, at 342.

n35. Gen. Couns. Mem. 39,862 (Nov. 21, 1991). "The inurement prohibition serves to prevent anyone in a position to do so front siphoning off any of a charity's incorne or assets for personal use." Id.

1980), n36. See generally Plumstead Theatre Society v. Comm9; 74 T.C. 1324 ( aff'd, 675 F_2d 244 (9th Cir. 1982). The Tax Court found that a tax-exempt organization serving as a general partner was " no inore uitrusive or indicative of private interests than [a] coutractual percentage arrangement." Id at 1334,

n37. David M. Plynn, Tax Corut's Decision in Redlands Provides Limited Endorsement for IRS Position on Joint Ventures, 91 J Tzs'n 241 (1999).

Appx. 412 Page 11 18 J. Contentp. Health L. & Pol'y 467, *

n38. See id at 242.

n39. See Gen. Couns. Mem. 36,293 (May 30, 1975).

n40. See Flynn, supra note 37, at 241.

n4l. See Rev_ Unif. Partnership Act 306 (1997); See also Unif. Ltd. Parttrersl ip Act 303, 403 (1976 as amended 1985).

n42. A taxpayer may deduct charitable contributions donated to organizations, which are granted exeinption rmder Section 501(c)(3). See I.R.C. 170 (2001).

n43. See generally Michael Sanders, New Horizon for Nonprofits: How to Shucture Joint Venhtres with For-Profits, Bus. L. 'foday, Aug. 9, 2000, at 53.

n44. See id.

n45. See LR.C. 513; 7}•eas. Reg. 1.573-1(d)(2) (2001).

n46. See I.R.C 511(a)(1); Treas. Reg. 1.511-1 (2001). A tax-exempt entity has an obligation to pay tax on ineonte that is generated from an activity that is ut related to its exempt purpose. This tax is connnonly known as mirelated business income tax (UBIT).

n47. See Plunrst'ead, 74 T C. 1324.

n48. Id.

n49. Id.

n50. See id. at 1328.

n5I. See id at 1334, (citing Braadtvay Theatre League afLynchburg, Va. v. United States., 293 f:Supp. 346 (YY D_Ya.1968)).

N52. See id.

n53. See Gen. Couns. Mem. 39,005 (June 28, 1983).

n54.Id.

n55. See id.

n56. See Priv. Ltr. Rul. 94-07-022 (Nov. 22, 1993); Priv. Ltr. Rul. 88-17-039 (Jan. 29, 1988); Priv. Ltr. Rul. 85-21-055 (Feb. 26, 1984); Priv. Ltr. Rul. 88-33-038 (May 20, 1988); Priv. Ltr. Rul. 93-52-030 (Oct. 08, 1993); Priv. Ltr. Rul. 93-08-034 (Nov. 30, 1992); Priv. Ltr. Rul. 91-05-029 (Nov. 06, 1990); Priv. Ltr. Rul. 88-33-038

Appx. 413 Page 12 18 J. Cotrtemp. Health L. & Pol'y 467, *

(May 20, 1988); Pi-iv. Ltr. Rul. 90-35-072 (June 07, 1990); Priv. Ltr. Rul. 88-20-093 (Feb. 26, 1988); Priv. Ltr. Rul. 87-05-089 (Nov. 07, 1986).

n57. See IRS Exempt Organization Examination Guidelines for Hospitals, Amt 92-83, 1992-221R.B. 59. 333 (June 1, 1992).

n58. An open emergency room is not required but often hel.ps. See id. aud see also Rev. RuL 83-157, 1983-2 C.B. 94.

n59. See IRS Bxempt Organization Examination Guidelines for Hospitals at 333.1.

n60. See id. at 333.2.

n6 1. See HousingPioneers v. Comm'r, 65 7:C.M 2191 (1993), affd, 49 E3d 1995, ainended by 58 R3d 401 (9th Cir. 1995).

n62. See Housing Pioneers v. Comm'r, 58 F.3d 401, 403 (9th Cir. 1995)_

n63. See id,

n64. ld at 402.

n65. See Priv. Ltr. Rul. 96-37-050 (June 18, 1996); Priv. Ltr. Rul- 97-36-039 (June 9, 1997).

n66. See Priv. Ltr. Rul. 96-37-050 (June 18, 1996).

n67.Id.

n68. Id.

n69. Id.

n70. Priv. Ltr. Rul. 97-36-039 (June 9, 1997).

n71. See id.

n72.Seeid.

n73. The IRS is bound only to the holding in the Private Letter Rulings for the individual to whotn the ntling was issoed. While private letter ntlings may not be cited as authoritative, these letter rulings provide an un- detstanding to the IRS's position on a certain issue. See I.R.C. 6110 (k)(3) (2001).

n74. See discussion supra Section lf-

n75. Flynn, supra note 37, at 242-

Appx.414 Page 13 18 J. Contemp. Health L. & Pol'y 467, 1'

n76.Seeid.

n77. See 1'homas K. Hyatt & Bruce R. Hopkins, The Law Of Tax Exempt Healthcare Organizations, 2000 Cumulative Supplement 104 (John Wiley & Sons, Ine. 2000).

n78_ See id.

n79. See id.

n80.Id.

n81. Id.

n82. See generally Rev. Rul. 98-15, 1998-1 C.B. 718.

n83. See Hyatt & Hopkins, supra note 77, at 104-105.

n84. See Rev. Rul. 98-15, 1998-1 C.B. 718,

n85_ See id.

n86. See id.

n87. See Hyatt & Hopkins, supra note 77, at 110.

n88. See Rev. RuL 98-15, 1998-1 C. B. 718.

n89. See id.

n90.Seeid.

n91. Id. at 719.

n92. See id.

n93. See Douglas M. Mancino, New Ruling Provides Guidance, Raises Questions for Joint Ventures Involv- inig Exempt Organizations, 88 J Tax'h 294 (1998).

n94. See id.

n95. See generally Rev. RuL 98-15, 1998-1 C.B. 718.

n96. See id.

Appx. 415 Page 14 18 J. Conteinp. I-Iealth L. & Pol'y 467, *

n97. See id.

n98. Id.

n99. Id.

n100. See generally Rev. Rul. 98-15, 1998-1 C.B. 718.

n101. Bntce John Shih & Daniel K. Settlemayer, Joint Ventures Rev. Rul. 98-15: Don't Apply Blindly, 10 HealthL. 8, 12 (1998).

n102. See Rev. Rul. 98-15, 1998-1 C.B. 718.

n103. See id.

n104. Sec id.

n105. See id.

n 106. See gcnerally Michael I. Sanders, New Horizon for Nonprofits, Bus. L. Today, Aug. 9, 2000 at 53.

n107. Treas. Reg. 1.501(c)(3)-(1)(c)(1) (1986).

nIOS. See Rev. Rul. 98-15, 1998-1 C.B. 718.

n109. The Service, presumably, would not ltave any probleni if the management compauy was related to the nonprofit.

n110. In the second situation, the contract would run for ten years before the nonprofit would have the chance to exert any substantive influence.

n111. Rev. Rul. 98-15, 1998-1 C.B. 718.

n112. See id.

n 113. Id. at 721.

n114. See Phtmstead Theatre Society v. Comniissioner, 74 T C. 1324 (1980), affd, 675 F.2d 244 (9th Cir. 1982).

n115. Rev. Rul. 98-15, 1998-1 C.B. 718, 721.

n116. See id.

Appx. 416 Page 15 18 J. Contemp. Ilealth L. & Pol'y 467, *

nt 17. Rev. Rut. 98-15, 1998-1 C.B. 7I8 (citutg Plutrutead, 74 T.C. 1324, and ITousing Pioneers v. Commfs- sioner, 65 T C.M 2191 (1993)).

n118. See Fistiman & Schwarz, supra note 15, at 494.

n119. See id.

n120. See id.

n121. See id.

n122. Redlandc S'aetgical Serviccs v. Consnsr, 113 T C. 47 (1999).

n123. Id at 48. The subsidiary, Redlands Surgical Services, was formed to enter the general pat-tnership, in the hopes of limiting the liability exposure.

n124. Id. at 50. SCA Centers, a publicly traded, for-profit entity, owned the remaining fifty-four percent in- terest_

n125. Id at 49. The remaining tliirty-nine percent of the limited pattnership was owned by Intand Surger-v Center Limited Partnership, an entity consisting of thirty partners who were physicians on the staff of Redlands Hospital..

n126. Stanley G. Andeel, 'I'echniques in Forming and Representing PhysicianlBnsniess Joint Venture, SE66 Al.l-ABA 199, 228, Feb. 17, 2000.

n127. See Redtands, 113 T.C. at 65_

n 128. Id.

n129. See id.

n130. See id. at 78-79.

n131. See id at 79.

n132. See Rev. RuL 98-15, 1998-1 C.B. 718,

n133. See Redlands, 113 T.(:. at 81-82.

n134. See id at 88.

n135.(d at 89.

n136.Id at93.

Appx. 417 Page 16 18 J. Contcntp. Health L. & Pol'y 467, *

n137. See id.

n138_ See Rev. Rul. 98-15, 1998-1 C.B. 718. The enforceability of Revenue Rulings upon the IRS is contin- gent on the facts presented. A variation, such as a different type ofjoiut venture, may lose its binding effect.

n 139. See Redland.s, 113 T. C. at 47.

n140. See Rev. Rul. 98-15, 1998-1 C.B. 718; See also Redlands, 113 T.C. at 47.

n 141 _ Fishinan & Schwartz, supra note 15, at 384.

ril42. The Service maintained tltatnet revenue joint ventures were private inureinent per se and thus prohibited tax-exempt organizations from participating_

n143. See Rev. Rul. 98-15, 1998-1 C.B. 718; see generally Redlands, 113 T. C. at 47.

n144. See Rev. Rul. 98-15, C.B. 1998-1.

n145. Revenne Rulings bind the IRS to ttie position that it takes in the revenue provided that the facts are mirror images.

n146. Barbara Yuill, Healthcare: Uuwind Of Columbia Joint Venture in Vnginia a First But Likely Not the Last, Experts Say, Daily'fax Repoit, Feb. 12, 1999, at.l-2_

n147. See Hyatt & Hopkins, supra note 77 , at 109.

n148. Id.

n149. See id.

n150. See Yuill, supra note 146, at J-1.

n151.Seeid.

n152. See id.

n153. See Hyatt & Hopkins, sapra note 77, at 110,

n154. See Willy Wonka and the Chocolate Factory (Warner Bros. Farnily Entertainment 1971). A fantous candymaker, Willie Wonka, randomly hides five golden tickets in candy bars. If a child finds a golden ticket wrapped around the candy bar he purchased, he wins a tour of Woidca's candy faetoiy and the possibility of in- heriting Itis candy fortune.

n155. See Redlands Surgical Services v. Commissioner, 113 T C. 47, 92 (1999).

Appx. 418 Page 17 18 J. Contemp. I3ealth L. & Pol'y 467, *

n156. See Id at 92-93 (finding that effective control could be reached without voting control; however, the totality of circumstances must be exaniined).

057. See discussion nxfra Sectiou III, Part B.

n158. See Yuill, supra note 146, at J-2.

n159. See id.

n160. See Rev. Rul. 98-15, 1998-1 C.B. 778; See also Redlands, 113 T.C. at 47.

n161. See Yuill, supranote 146, J-2.

n162. See Rev. Rzal. 98-15, 1998-1 C.B. 778; See Redlands, 113 T C. at 47.

Appx. 419 THE SOCIAL TRANSFORM.aTu >n OF AMERICAN MEDICINE

sic Books, Inc., Pei6lishers New York

Appx.420 To the Memory

of My Father

Library of C:ongress Cataloging in Publication Data

Starr, Paul, 1949- The soeial transformation of American medicine.

Includes bibliographical references and index. i. Medical care-United States--History. 2. Social medicine-United States-History. 3. Physicians- United States-History. I. Title. (DNLM: i. History of inedicine, Modern-United States. WZ 7o AA, S7s1 BA395.A3S77 1982 305'.961'0973 81-68412 ISBN 0-465-07934-2 (cloth) ISBN 0-465'07935'0 (paper) .. .

10 g 8

Appx.421 ;ion y so- any pre- r ad- iical CHAPTER FOUR li('es

Iwt]7 sion, .tion tally ions anci twl- rket pro- onc istic• and nnc. orn FEW institutions have undergone as radical a metamorphosis as have hospitals in their rnodern history. In developing from places of dreaded impurity and exiled human wreckage into awesorne citadels of science and bureaucratic order, they acquired a new rnoral identity, as well as new purposes and patients of higher status. The hospital is perhaps distinctive among social organizations in having first been built primarily for the poor and only later entered in significant numbers and an en- elasses. As its funo- tirely different state of mind by the more respectable from the underlife of t^ons were tran sformed it emerged, in a sense, IcSciety to become a regular part of accepted experience, still an occa- tn for anxiety but not horror. h t Lhe nioral assrmi1 ationf the hoso I ^ital came at the enu of e rune redefinition and incorporabtiodn^nt ^ arsth century with its scientific ±ine. We now th' m k fo hos italsp as the inost visrble em o imen dical care in its technically most sophisticated form, but before iit hundred years, hospitals and medical practice had relatively lit- earliest origins in preindustrial with each other. Prom their hospitals had been primarffy religious and charitable institu- tetrding the sick, rather ttran medical institutions for their cure. po from the eighteenth century they played an impor tant

Appx.422 The Reconstitution of the Hosp 146 A Sovereigra Profession medical care in America, with consq part in medical education and research, systernatic clinical instruction even today. In Europe and most otb( and irrvestigation were neglected in Arnerica until the founding of tients enter a hospital, their doctors t Johns Ilopkins. Before the Civil War, an American doctor might con- to the hospital staff, whoform ^sePaT' in practice without setting foot on a tentedly speud an entirc career profession. 13ut in the United ..tat^s' hospital ward. The hospital did not intrude on the worries of the typical tients into the hospital, where they c practiLioner, nor the practitiorier on the routine of the hospital. rangeinent complicates hospital adi But in a matter of decades, roughly between 187o and rgro, hospitals people making vital decisions are noi rrroved from the periphery to the center of inedical education and med- it also may encourage more private r- ical practice. From refuges rnainly for the homeless poor and insane, patients than exist where patients ar, they evolved into doctors' workshops for all types and classes of pa- pital physicians.' tients. From charities, dependent on voluntary gifts, they developed The terms "public" and "private" r into rnarket institutions, financed increasingly out of payments from pa- (its visibility to other people) an(i to tients. What drove this transformation was not sirnply the advance of relation to the state). In both of thes science, important though that was, but the demands and example of has generally had a more privar an industrializing capitalist society, which brought larger numbers of ican hospitals not only have privatc' people into urban centers, detached them frorn traditions of self- more private space for the treatiner sufficiency, and projected idcals of specialization and technical compe- and elsewhere typically off end to he tence. The same forces that prornoted the rise of hospitals also brought while American hospitals about changes in their internal organization. Authority over the con- accommodations. The economic org duct of the institution passed from the trustees to the physicians and States also reflects a less public conc adrninistrators. Nursing became a trained profession, and the division a centralized system of hospitals und of inedical labor was refined and intensified, as conceptions of eificient oped a variety of institutional forn and rational organization prevailing elsewhere in the economy were hospitals-with both public and p: applied to care of the sick. The sick began to enter hospitals, not for under independent nianagement. ' an entire siege of illness, but only during its acute phase to have some the late nineteenth century did no' work perforrned upon thein. The hospital took on a more activist pos- tion. Both internally and as a syste ture; it was no longer a well of sorrow and eliarity but a workplace for relatively loose structure because c the production of health. hospitals and of most hospitals fro' The effects of this change rippleci outward, altering the rclationship changed radically, private interest: of doctors to hospitals and to one another and shaping the development iyere preserved and even strengtl of the hospital system as a whole. Once the hospital became an integral and necessary part of rnedical practice, control over access to its facilities became a strategic basis of power within the medical community. The tight grip that a narrow elite long held over hospitals no longer seemed tolerable to other physicians, who responded by forming their TRANSFORMATI( 'fIIB INNER own institutions or pressing for access to established ones. Under financial pressures and the threat of increased competiLion, the older liospitals gradually opened tlreir doors to larger numbers of practitioners, IYospitals Before and After i creating a wider network of associations stratifying and linking together The reconstitution of the hospit the profession in new and unexpected ways. tution of medical science ratlier I The access that private practitioners gained to hospitals, without be- tion on the lines of a business rathi coming their eniployees, became one of the distinctive features of

Appx.423 147 The Roconstitution of the Hospital FeS3207d medical care in America, with consequences not fully appreciated truction even today. In Europe and most other areas of the world, when pa- (ling of tients enter a hospital, their doctors typically relinquish responsibility ht con- to the hospital staff, who form a separate and distinct group within the )ot on a profession. But in the Unitod States, private dontors follow their pa- typical tients into the hospital, where they continue to attend them. This ar- al. rangement complicates hospital administration, since niany of the iospitals he institution's employces. Yet d med- people making vital decisions are not t it also may encourage more private relationships between doctors and in.sane, patients than exist where patients are attended solely by salaried hos- s of pa- pital physicians.' veloped "public" and "private " refer both to individual experienee iom pa- The terms institutions (th 'ance of (its visibility to other people) and to the structure of eir relation to the state). in both of these senses, hospital care in America mple of has generally had a more private character than it has elsewhere. Amer- ibers of ican hospitals not only have private doctors;their architecture creates of self- Hospitals inore private space for the treatment of patients. in Europe compe- and elsewhere typically offer more of their care in large open wards, brought while American hospitals tend to be smaller in size, with more private he con- accommodations. The economic organization of hospitals in the United ans and States also reflects a less public conception of their function. instead of division a centralized systern of hospitals under state ownership, Arncrica devel- .>.fficient oped a variety of institutional forins-a kind of "mixed econoniy" in iy were hospitals-with both public and private institutions of several kinds not for under independent management. The institutional transfornration of /e SOrne the late nineteenth century did not lead to any higher-level coordina- vist pos- tion. Both interiially and as a system, American hospitals have haci a lace for relatively loose, structure because of the autonomy of physicians froin hospitals and of most hospitals from tlre government. While hospitals :ionship clianged radically, private interests, as well as the interests of privacy, ^)pment integral were preserved and even strengthened.2 ts facili- munity. longer ig their INNEII TRANSIvORMATION rr Ilnan- Tlt1's r hospi- tioners, 71f7vpitnls 13efore and After z870 ^gether finition as an insti- t.f-±cx,>ustitution of the hospital involved its rede welfare, its reorganiza- `^i' itjr`dlctl scienec rather than of social iout be- and its reorientation it+ linr<.s of a business rather than a charity, ures of

Appx.424 The Recor 148 A Sovereign Profession to professionals and their patients rather than to patrons and the poor. porations wE abstract exis I state the changes rather sharply for emphasis; they need to be quali- took place it fied in some particulars. Well before 1870 private voluntary hospitals oldest corpc in America emphasiz.ed active niedical treatment and received some conducted !- paying patients; well after igro they rernained legally under the controi character; tl of trustees as charities rather than profit-making firms. But as hospital identity and care turned into a sizeable industry at the end of the nineteenth centu- were taken ry, medical activism, professional dominance, and an orientation to the the later Mi market became rnuch more pronounced and widespread, even in voluntary institutions. And large numbers of new hospitals were estab- ized. Essent personnel I lished, the majority as business enterprises. The late nineteenth century in America was a period of economic rule."6 In a were tlte fir expansion and rapid institutional development that saw not just an in- character.'I crease in the number of organizations of all kinds, but also a renovation "substitute in their structure. The growth of business corporations, as Alfred Ghan- dler has pointed out, was accompanied by the emergence of a salaried sick. "The r of the colot management and the multiunit finn. The rise of hospitals, as of universi- flected its c ties, offers a study in the penetration of the market into the ideology historians, i and social relations of a precapitalist institution. As the university became more actively concerned with preparing students for practical ca- rived" rath. reers, it rnoved from gentlemanly to utilitarian values and accorded Later alr more prominence and autonomy to its professors. As the hospital ad- became rm vanced in its functions from caretaking to active treatment, it shifted Early hosp patients e, in its ideals from benevolence to professionalism and accorded its physicians greater power. In orienting their efforts to newly inarketable ser- moral statr within thc vices, both institutions became less concerned with moral supervision into tlieir t and turned more squarely to professionals to carry out their new pro- and wife, f ductive functions.3 Set in a wider historical frame, the reconstitution of the hospital be- 1'rom housi who have longs to the general movement in social structure from "comrnunaP' other insli to "associative" relations. As Weber made the distinction, conux{imal relations refer to the bonds of families and brotherhoods and other ties have conv The modc of personal loyalty or group solidarity; associative relations involve eco- its CfinltUl nornic exchanges or associations based on shared interests or ends.' The shift from the wmmunal to the associative has taken place in two ways. sti'l.lctur(' Not only have the household and community given up functions to for- rnal organiz.ations; the organizations theniselves have also changed. In- y,rsted, ri• stitutions that were once pricnarily communal have become increas- V iiIs [-ii l a ingly associative. This has been true historically even of corporations. Rltit^YM.ti. ^^ ft^r iJu• ^i^ The concept of the corporation was originally applied to monasteries, Ihray rrcr+ towns, and universities, where rnembers were related to each other riot vuoush- tl by owning things in common but by living and working together. Cor-

Appx.425 eign Profession The Reconstitution of the Hospital 149 porations were communities. Only later did the corporation take on an :rons and the poor. abstract existence as an entity for doing business.5 This sarne evolution y need to be quali- took place in the developinent of hospitals, which include some of the voluntary hospitals oldest corporations in continuous existence. Medieval hospitals were ind received sorne orders and had a strong communal 1 under the control conducted by religious or knightly character; those who worked there were bouncl together in a common ms. But as hospital identity and belonged to a conimon household. "Even when hospitals . nineteenth ceritu- were taken over from the ecclesiastical authorities by inunicipalities in i orientation to the "they were not secular- pread, even in vol- the later Middle Ages," writes George Rosen, ized. E,ssentially, the hospital was a religious house in which the nursing spitals were estab- personnel had united as a vocational community under a religious rule."6 In a different way, the alnishouses of colonial Ainerica, which eriod of economic were the first institutions here to care for the sick, retained a communal saw not just an in- character. The colonial alinshouse, David Rothman writes, provided a at also a renovation "substitute household" for people without a horne who were poor or ms, as Alfred Chan- The residents were a family, not inmates." Even the architecture :gence of a salaried sick. " of the colonial almshouse, which resembled an ordinary residence, re- ritals, as of universi- flected its conception as a household. In the language of architectural t into thc ideology historians, its social structure, as well as its architectural form, was "de- ; the univcrsity be- rived" rather than "designed."T mts for practical ca- Later almshouses and hospitals, with a distinctly public architecture, ilues and accorded becanie more bureaucratic than familial in their intcrnal organization. As the hospital ad- hospitals had a fundarnentally paternalistic social structure; their reatment, it shifted Early patients entered at the sufferance of their benefactors and had the I accorded its physi- moral status of children. The staff, who often resided as well as worked xly marketable ser- within the hospital, were subject to rules and discipline that extended r moral supervision into their personal lives. A steward and matron, who inight be husband out their new pro- and wife, presided over the hospital family. As the hospital has cvolved from household to bureaucracy, it has ceased to be a liome to its staff, c of the hospital be- wllo have come to regard themselves as no different frorn workers in from "comnrunal" other institutions. In their relation to patients and the public, bospitals :inction, commtuial Iwve come to rely less on charity and more on payrnents for services. loocls and other ties The modern history of the hospital has seen a steady stripping away of aations involve eco- its communal relations as it has more closely approached the associative erests or ends." The structure of business organizations. u place in two ways. of Atnerican hospitals, Ilenry Sigerist once sug- up functions to for- 'Thc development gvntc,+d, recapitulates in shorter time the historical phases of European ve also changed. In- itoNpiteds." First came the almshouses and similarly unspecialized insti- ve become increas- ltiticrns, .voc-ving general welfare functions and only incidentally caring en of corporations. Flu.+ sick. Founded as early as the seventeenth century in America, tied to nionasteries, y received dependent persons of all kinds, mixing together promis- ed to eactr other not 'tttily t hc aged, the orphaned, the insane, the ill, the debilitated. Next -king together. Cor-

Appx.426 The Recow A Sovereign Profession 150 stigma than tl appeared hospitals serving the sick but slill limited to the poor; finally, members of tl in the nineteenth century, hospitals serving all classes of society tals a rnore att emerged. In other words, the almshouse metamorphosed into the niod- able, their ma ern hospital first by becoming more specialized in its functions and then rehensible ca by becoming more universal in its use. In 1752 the Pennsylvania Hospi- the incurablc tal in Philadelphia becarne the first perxnanent general hospital in wicked and r America built spocifically to care for the sick; it was followed by New enabled the I York Hospital, chartered in 1771, but not opened until twenty ycars and to keep ( later, and the Massachusetts General Hospital, opened in Boston in 18z1. could be dirc These were later to be, called "vohmtary" liospitals-voluntary because on the hospit they were financed by voluntary donations rather than by taxes. cal staff, sinc( The establishment of these first hospitals did not signal the decline to students i of the almshouse. On the contrary, ahnshouses becanxe more important But, most in the nineteenth century than thcy had been in the eighteenth. In the the tradition colonial period, the almshouse was a secondary response to poverty and tals were col illness. As I indicated earlier, the colonists preferred to provide relief perience clu to the poor in their own hornes, or to pay neighbors for taking care of fliern °the si the feeble and the sick. Institutions were a last choice, to be used for of sciencc n strangers or especially onerous cases. But after about 18z8, there was acute diseas a shift in policy as states abolished honie relief =atli alrnsh ousg opposition, 4 it only duriug periods of econoTnic distress). By makinb about the.ir the only source of governmental aid to the poor, legislatures hoped to cording to restrict expenditures for public assistance. Often squalid and over- only higher crowded, a place of sharne and indignity, the alrnshouse offered a niini- hospital. 1 n rnal level of support-its function as a deterrent to poverty and public Dr. W. Gill' assistance ruled out any amenities. Deterioration and neglect were state of pr.r comnron. Reformers, especially after the Civil War, devoted much of ta su:dtics, % their effort to splitting up the undifferentiated almshouse and sending and thc; iiu orphaned children, the insane, the blind, and the sick to institutions spe- thcr wasto cifically concerned with their problems. In a nurnber of cities, public ly. Iloalritul hospitals evolved out of alnxshouse infirmaries. The Philadelphia Alms- ing thc= viCl house became Philadelphia General Hospital; Manhattan's Bellevue rrUdy to n Hospital grew out of the New York Almshouse; the Raltlmore County Up ti, tht Almshouse became part of the Baltimore City Hospitals.9 paro ol pWI, Early American charity hospitals developed in a complementary rela- hOsli+trtlN x+ tion to previously establislxed almshouses and public hospitals. They ketfli, licr91 were an attempt not only to separate out some of lhe sick from the poor i:irUn{{i+r. 4 and dependent, but also to provide a somewhat better alternative for 0 iW Ioun, the more respectable poor with curable illnesses, as well as a haven for t liinnl=; occasional well-to-do people in special circumstances. Voluntary institu- , I tions, like the Pennsylvania and Massachusetts General Hospitals, were ;tiltln.-,, generally kept cleaner and better rnaintained and had less of a moral 'The Reconstitution oT the Hospital 151 n Profession stigma than the almshouse, although they were still not widely used by he poor; finally, members of the midcile and upper classes.t0 Anxious to give these hospi- asses of society tals a more attractive identity and to make thein safer and more accept- d into the rnod- able, their managers and physicians excluded dangerous or morally rep- ,tetions and then rehensible cases. The contagiously ill they sent to the pesthouse, and well as those whom they thotight nsylvania lIospi- the incurable and chronically ill, as eral hospital in wicked and undeserving, they sent to the almshouse. Such exclusions ollowed by New enabled the hospitals to restrict the itumber of patients they admitted .til twenty years and to keep down the reported mortality rates, since the hopelessly ill in Boston in 18z1. could be directed or transferred elsewhere before they becanie a blot oluntary because on the hospital's good name. This practice was encouraged by the median by taxes. cal staff, since the hospital would be less useful as a source of instruotion ignal the decline to students if it filled up with chronic cases. more irnportant But, most of all, the exclusion of undesirable cases served to combat hospi- ighteenth.In the the traditional image of the institution ^'ecessities. Early se to poverty and tals were considered, at best, unhappy to provide relief perience during the Revolutionary War, Benjamin Bush had called d that the progress for taking care of them "the sinks of human life in an army " and hope .e, to be used for of science would go so far "as to produce an abolition of hospitals for it i828, there was acute diseases." Many early attempts to build hospitals aroused public terally reinstating opposition, especially frotn thoso who lived in the vicinity. Skepticisni ng the alntshouse about their vahie was far froin irrational. Mortality after surgery, ac- islatures hoped to cording to data from English hospitals published around 1870, was not ;qualid and over- only higher in hospitals than at home, but it rose with the size of the ,ise offered a mini- hospital. In an essay awarded a prize by Harvard University in t876, joverty and public Dr. W. Gill Wylie could write that civilization had not yet reached "that and neglect were state of perfection where hospitals can be dispensed with." Accident devoted much of casualties, victims of contagious epidetnies, soldiers, honieless paupers, house and sending and the insane required hospital care. But to extend hospitals any fur- to institutions spe- thor was to encourage pauperism, idleness, and the breakup of the farni- cr of cities, public Iy. llospitals, Wylie Iliotight, "tend to weaken the fainily tie by separat- Plriladelphia Alms- iug the sick from their homes and their relatives, who are often too ahattan's Bellevue r,4ady to relieve themselves of the burden of the sick."11 Baltiniore County 01) to the time Wylie wrote, hospitals had beenformedmainly to take pltals y cttt-ir of people who did not fit into the system of family care. The earliest nnplementary rela- buospitals were built chiefly in ports or river towns-Philadelphia, New commeree where rlic hospitals. They iurk, Boston, New Orleans, Louisville---centers o f le were likely sick from the poor tgars were likely to he stranded sick or where peop d working and living alone. Institutional charters and appeals tter alternative for t^ foun well as a haven for ftuuls alluded to the needs of such people. In 181o, when Doctors e of the s. Voluntaryinstitu- ,jEtckson and John C. Warren circulated a letter to som interest them in eral Hospitals, were lttcaal and most influential citizens" of Boston to had less of a moral

Appx.428 152 A Sovereign Profession a hospital, they men6oned, as cases in need, journeymen mechanics living in boarding houses, widowed or abandoned women, servants, and others who had no adequate housing or kin to care for them. Whiie ouly scattered figures are available, isolated individuals seem to have been disproportionately represented aniong patients in general hospitals.19 The inipulse for founding the early hospitals typically came from physicians who struck up alliances with wealthy arrd powerful sponsors. Doetors had an interest in creating hospitals as a rneans of developing medical education and as a source of prestige. The status and inHuence they derived from hospital positions were of such value to thern that they gave their services to the hospitals without pay. In fact, at the founding of the Pennsylvania Hospital in 1751, three doctors were so eager to serve as its staff that tliey volunteered to provide all medieines for three years at their own expense, as well as free services.'a But in spite of the advantages doctors derived from hospitals, thcy could not establish them independently under their own control, for lack of funds and because of distrust of their motives. Particularly distrustful were the sick poor, who feared they rnight be used foi- surgical experiments or, in the event of death, turned over to medical students for dissection. Needing capital and legitiniacy, the doctors were obliged to seek out the sponsorship of inerchants, bankers, lawyers, and political leaders, who could contribute money and lead subscriptiori carnpaigns. As a result, there developed an organizational structure in which boards of managers, trustees, governors, or commissioners, rather than physicians, retained the final decision-making power in private as well as public hospitals. This arrangement had its direct antecedents in En- gland, but it would not have been reestablished in American communities unless strong forces continued in its favor. So long as doctors could not get hospitals to yield a return on the needed investment, their dependence on sponsors was unavoidable. In Reading, Pennsylvania, in the late r86os, local physicians interested in founding a dispensary and hospital quickly realized, according to a history of the Reading Hospital, "the importance and necessity of obtaining the cooperation of certain citizens representative of the professional and business interests" of the city. Exercising great care, they chose representatives of "bench and bar, banking, the iron, lumber, publishing and brewing industries, as well as railroad and navigation, and of course, the political representatives of city, state and federal government." The local historian who describes these choices then perspicaciously remarks, "The men engaged in these pursuits-because of their wealth and professional standing-were bound up with the interests of the community in innumera- ble other ways. Churches, schools, charitable organizations, and all the

Appx.429 The Reconstitution of the Hospital 153 reign Profession intricate network of commnnal intercourse found expression tluough rnen mechanics liv- these leading and responsible citizens "À Such are the advantages of rnen, servants, and having a ruling class. or them. While only F'or the sponsors of hospitals, the benefits were various. As so often seem to have been happens to the rich and successful, by serving a social interest, they general hospiLals.12 te 6at!9f 3 gernlln(: could advance their OWn. No don'Ot, hi/spiûii iaeited y ally came from phy- sense of religious obligation to the helpless; the institutions might also powerful sponsors. bring about an improved standarcl of inedical practice by giving young neans of developing physicians experience working under supervision with the poor; and status and influence they might even prove a sound investment for the community by re- value to them that storing to productive labor people who might otherwise becoine public pay. In fact, at the charges. These were the kinds of considerations-the manifest funr ree doctors were so tions, as sociologists say-tliat dominated the rhetoric of motivation. At ,rovide all medicines another level, not to be overlooked but not to be exaggerated either, ec services.13 I3ut in hospitals also conferred a certain amount of power on their trustees ,itals, Lhey could not through management of the endowment, the letting of contracts, pa- trol, for lack of funds tronage in appointments, and even the admission of patients. In the arly distrustful were nineteenth centary, the trustees or managers entered directly into the surgical experiments detailed operation of hospitals, including decisions that now would be udents for dissection. seen as strictly medical. To gain entry to a "free bed"---one that was ^ obliged to seek out privately endowed and required no payinent-a patient gencrally and political leaders, needed a letter from a trustee or subscriber who previously had contrib- n campaigns. As a re- uted to the hospital. Thus the links between the donor and recipient in which boards of of charity were soinetimes quite explicit and personal. The sponsorship rather than physi- of hospitals gave legitimacy to the wealth and position of the donors, in private as well as just as the association with prominent citizens gave legitimacy to the t antecedents in F.n- hospital and its physieians. Hospital philanthropy, like other kinds of American cornmuni- charity, was a way to convert wealth into status and influence. George long as doctors could 1'ernpleton Strong, a Wall Street lawyer active in founding St. Luke's investment, their de- Ilospital, noted in his diary in May 1859, after John Jacob Astor liad de- ling, Pennsylvania, in cided to donate $t3,ooo, "If he and Whitney and the other twenty or iing a dispensary and thirty millionaires of the city would do such things oftener, they would the Bead'uig Hospital, never feel the difference, and in ten years would control the course of -ooperation of certain Ihings in New York by the public confidence and gratitude they would ;iness interests" of the hain."15 An exaggeration witliout question, but not without soine truth tatives of "bench and to it: witness the later philanthropy of the Rockefellers. Charity, too, arewing industries, as pays dividends. Besides softening public hostility toward accumulated e political representa- weath, it also helps secure status within an upper class, which is likely ie local historian who to be the chief reference-group of the donor. Membership on the marks, "The men en- hoards of hospitals and other private institutions became an iniportant Ynd professional stand- incl zx of social position. In New York City, according to a historian of nmunity in innumera- fts Jcwish community, Jews' Hospital (later Mt. Sinai) developed within ânizations, and all the

Appx.430 154 A Sovereign Profession T1i a few years after its founding in 1852 into "the most important Jewish an( organization in the city." The hospital's annual public dinners were the ofi most lavish ever held among New York Jews, and the success of the scl city's rising German Jews in secnring seats on the hospital's board soon vei after it was created signaled the end of their subordination to the rnore no established English and Porttrguese Jewish elite.'s thi Despite the various indirect incentives to contribute, donations and url bequests generally did not cover the costs of voluntary hospitals. The he institutions turned instead to their patients for funds, requiring them as to pay at least part of the cost of their treatrnent. At the Pennsylvania Hospital between 1751 and 1850, according to one stndy, 70 percent of the mcntal pafients had their treatinent paid for, compared with 39 percent of the medical patients and none of the maternity cases."These figures may not have been typical, but the pattern probably reflects the diminishing proportion of persons in each category from niiddle-class, or at least self-supporting, families. Perhaps the presence of paying patients took away some of the traditional odium that had hung about the hospital. In America, the identification of hospitals with the pauper class was never as absolute as in Europe. Qn hospital wards, paying and free patients were treated together, while some wealthier individuals paid for private roorns apart from the rest. I-Iowever, even these few private patienLs paid no fees to physicians. A tradition liad been established in n both publie and voluntary hospitals that physicians were not supposed h to take money for work there. As a charity, the hospital lay outside the theater of production and exchange. 1- v c The Making of the Modern Hospital Primarily because of increased concern for cleanliness and ventilation, hospitals began to emerge from obloquy and disrepute evcn before any major technological advances had been made. During the Civil War, hospitals were no longer the sinks of human life thatI3enjamin Rush had mourned during the Revolution. The Union built a vast system of over tgo,ooo beds by the last year of the war and treated niore than a million soldiers with a mortality of only eight percent. While the germ theory of disease was yet to be fully forrnulatcd, hospital authori- tics had beeded some of the lessons of i7orence Nightingale, who through improved hygiene had reduced the death rate from forty to two percent at the British military hospitals in Scutari during the Cri- mean War.Le Two developments after the Civil War--one in organization, the ottier in medical knowledge-furthered the tendencies toward order

Appx.431 155 The Reconstitution of the Il.ospital ereign Profes.rion and cleanliness already at work. The first was the professionalization ost irnportant Jewish of nursing, beginning with the establishment in 1873 of three training blic dinners were the schools in Ncw York, New Haven, and Boston. The second was the ad- id the success of the vent of antiseptic surgery, first announced by Joseph Lister in 1867 but hospital's board soon not generally adopted for another ten or fifteen years. Together with :dination to the more the growth of demand from the middle and upper classes because of 6 urbanization and changes in family structure, these developments ibute, donations and helped to produce a deep change in the character of hospitals as well untary hospitals. The as sm increase in their nuniber.* inds, requiring them Before the r87os, trained nurses were virtually unknown in America. At the Pennsylvania IIospital nursing was a menial occupation, taken up by women of the study, 7o percent of lower classes, some of whom were conscripted from the penitentiary r, compared with 39 or the almshouse. The movement for reform originated, not with doc- tternity cases." These tors, but among upper-class wonien, who had taken on the role of probably reflects the guardians of a new hygienic order. In New York, the impetus came ry front middle-class, frotn wotnen in the State Charities Aid Association, who in 1872 formed resence of paying pa- a committee to nionitor the conduct of public hospitals and alms houses. tt had hung about the They represented, in the association's own hurnble words, "the best with the pauper class class of our citiz.ens as regards enlightened views, wise benevolence, ^ards, paying and free experience, wealth, influence, and social position." At Bellevue, the thier individuals paid women found patients and beds in "unspeakable" condition; the one ven these few private nurse for a surgical ward slept in the bathroom, the hospital laundry td been established in had not bad any soap for weeks, and at night no one attended the pa- ns were not supposed tients except the rats that roatned the floors. Though some doctors ap- ospital lay outside the proved of the ladies' desire to establish a nurses' training school, which would attract the wholesome daughters of the middle class, other medical nien were opposed. Plainly threatened by the, prospect, they objected that educated nurses would not do as they were told-a remark- able cornment on the status anxieties of nineteenth-century physicians. eanlincss and ventila- 13ut the women reformers did not depend on the physicians' approval. id disrepute even be- When resisted, as they were at Bellevue in efforts to install nurses on :iade. During the Civil thc maternity wards, they went over the heads of the doctors to tnen an life that Benjamin of their own class of greater power and authority.'s (Florence Nightin- Dnion built a vast sys- gale, who had friends high in the English government, had followed war and treated rnore exactly the same course in reforming her country's military hospitals.) ;ht percent. While the Ptofossional uursing, in short, emerged neither froili medical discover- ated, hospital authori- i41e nor fi-oni a prograin of hospital reform initiated by physicians; outsid- ice Nightingale, who cFr:z s;tw the need first. Eventually, of course, physicians came not only ath rate from forty to ing t1 iu`copt but to rely ori trained nurses, who proved essential in carry outari during the Cri- twat th^ more complex work that hospitals were taking on. The new in the Pamily, in organization, the +I'or the impact on hospitals of urbanization and changes idencies toward order

Appx.432 156 A Sovereign Profession Th nurses' training schools also provided a source of cheap labor in the forrn of unpaid student nurses, who becarne the mainstays of the hospital's labor force. (Graduates went into private nursing, if they found work.) The three training schools of 1878 became 432 by rgoo, and r,rag by 1910.20 Like nursing, but even more so, surgery enjoyed a spectacular rise in prestige and acconiplishrnent in the late i8oos. Before anesthesia, surgery was brutal work; physical strength and speed were at a premium, so important was it to get in and out of the body as fast as possible. After Morton's demonstration of ether at the Massachusetts General Hospital in 1846, anesthesia came quickly into use, and slower and rnore careful operations became possible. But the range and voluine of surgery remained extremely limited. Infections took a heavy toll in all "capital operations," as major surgery was so justly called: The niortality rate for amputations was about 40 percent. Very rarely did the surgeon pen- etrate the major bodily cavities, and then only in desperation, when every other hope had been exhausted. Operations were so infrequent that a surgeon's colleagues considered it a privilege to be brought along to help out even in the niinor chores. Surge.ry had a small repertoire and it stood far bebind medicine in the therapeutic arsenal.21 Change came slowly after Lister's work on antisepsis was published in 1867 because it was inherently difficult to reproduce. Many sm-geons tested out his carbolic acid spray but found they were still plagued by fatal infections; carrying out antiseptic procedures demanded a strict- ness-an "antiseptic conscience" it would later be called-they could not at first appreciate. Lister's method was not generally adopted uritil around 188o, soon after which it was superseded by aseptic techniques. (While antisepsis called for use of disinfectants during surgery to kill microorganisms, asepsis relied on sterile proce(Iure to exclude them from the field of operation.) With control over infection, surgeons could begin to explore the abdornen, chest, and skull, but befo^e they could do much good, a variety of new techniques had to be developed and mastered by the profession. It was not actually until the 18gos and early igoos that surgery began to take off. Then, in a burst of creative excite- ment, the amount, scope, and daring of surgery enormously increased. Improvements in diagnostic tools, particularly the development of X- rays in 1895, spurred the advance. Surgeons began to operate earlier and more often for a variety of ills, many of them, like appendicitis, gallbladder disease, and stornach ulcers, previously considered medical rather than surgical cases. At the turn of the century, the main field of surgical invention was the abdoenen. The Midwestern virtuosos Wil- liam and Charles Mayo, who had done only 54 abdoniinal operations

Appx.433 overeign Yrofession The Reeonstitution of the Hospital 157

of cheap labor in the between 1889 and 1892, recorded 612 in rgoo and 2,157 five years later. rnainstays of the hospi- A report by William Mayo on 105 gallbladder operations was rejected nursing, if they found by a proniinent medical journal in 1899 because the total was thought te 432 by rgoo, and 1,129 implausible; five years later the same journal reprinted an article by Mayo describing the results of a thousand such operations.2^ In the early oyed a spectacular rise igoos, surgery continued to expand, as thoracic surgery and surgery of Before anesthesia, sur- the nervous and cardiovascular systems developed. sed were at a premium, Growth in the volmne of surgical work provided the basis for expan- as fast as possible. After sion and profit in hospital care. But first certain impediments to the use usetfs General Hospital of hospitals had to be renioved. Before rgoo the hospital had no special lower and more careful advantages over the home, and the infections that periodically swept I volume of surgery re- through hospital wards made physicians cautious about sending pa- eavy toll in all "capital tients there. Even after the danger of cross-infection had been reduced, led: The mortality rate the lingering iinage of the hospital as a housc of death and its status as ay did the surgeon pen- a charity interfered with its growth. Both patients and physicians had in desperation, when grounds to be wary of hospitals. Many people objected to losing the pri- ons were so infrequent vacy and control that they might have had at home; as ward patients, ^ge to be brought along the poor had no say in choosing their physicians. And though practition- had a small repertoire ers might have liked to refer more patients to hospitals, they were often ^eutic arsenal.-' afraid that doing so would mean losing the fee, and perhaps the case, ntisepsis was published because the staff might offer treatment without charge on the hospital roduce. Many surgeons ward. It took tune to establish new understandings about professional y were still plagued by fees and control over patients. So at first, ether anci antisepsis were tresdemanded a striet- adapted to the home and "kitchen surgery" continued. But performing be called-they could surgery in the home becarne steadily more inconvenient for both the ;enerally adopted until surgeon and the fainily, as the procedures became nrore dernanding by aseptic techniques. and more people moved into apartments. And the more busy surgeons during surgery to kill btmcatne, the ntore costly was the lost time in traveling to the patient's !dure to exclude them hotne. To aecomrnodate desires for privacy and fears of the hospital, feetion,surgeonscould ttutny surgeons first moved their operations to private "medical hoard- but before they could ittg ttouses," which provided hotel services and nursing. In the suburbs I to be developed and ptti sniall towns, doctors built small hospitals under their own owner- ntil the 18gos and early surgery had now made hospital care profitable and permitted airst of creative excite- t2 fto open institutions without upper-class sponsorship and legitima- enormously increased. AFter rgoo, as the old prejudice died out, most surgery moved in- :he development of X- irspilals.^' igan to operate earlier grfutter pressure for admission, hospitals began to hmrt cate to , like appendicitis, gall- acute periods of illness, rather than the full course. Although ly considered modical .311, beginnings Ameriean hospitals had concentrated their ef- entury, the main field tirable patients rather than chronie invalids, average stays had lwestern virtuosos Wil- t0e=n long, as much as a month or more. At the Massachusetts abdominal operations leispital, the average stay for free patients dropped below four

Appx.434 A Sovereign Profession 1-58 cc weeks for the first time in i886; ten vears later, the hospital began re- a( porting the average length of hospitalization in days rather than weeks. At Boston City Hospital, the average stay fell from z7 days in 1870-71 to 17.8 days thirty years later. At the Bridgeport Hospital in Connecti- cut, it dropped from 32 to 13 days between rgoo and rgzo. By 1923 general hospitals in America had an average lenglh of stay of 12.5 days; a half century later they would average about 72' The growing emphasis on strrgery and the relief of acute illness brought about a redefinition of purpose in sorne of the older charity hospitals. Active medical and surgical treatment supplanted religious and moralistic objectives and became the overriding mission. In New York City, a charitable soeiety of wealthy ladies concerned abut the "unob- trusive sulferings" of former slaves opened a Home for Worthy, Aged, Indigent Colored People in 1842. In 188z, "in view of the thoroughly organized medical departnient," the home changed its name to the Colored Home and Hospital. It became the Lincoln Hospital and Home in 19o2 as it opened its doors to white patients and local physicians, and simply Lincoln liospital in j925 when it was turned over to the city. From a paternalistic charity providing custodial care to poor and deserving blacks, it had turned into a general hospital providing acute care to the poor of all deseriptions.^ A sirnilar shift frorn moralistic to medical objectives took place at Children's Hospital in Boston, whose evolution Morris Vogel has described. When the hospital was founded in 186g, its managers announced that "while endeavoring to cure, or, at least to alleviate" the diseases of poor children, they also desired "to bring them under tlic influence of order, purity and kindness." The hospital was initially concerned not so much with medical intervention as with providing an alternative home for children who were neglected, a salubrious haven where they would be nursed, fed, kept clean and safe, and receive what its managers at one point referred to as a "positively Christian nurture." So anxious were they to isolate the children from outside influences that they restricted visiting hours to one relative at a timey'between eleven and twelve o'clock, weekdays only, thereby judiciously barring working parents from frequent contact with their children. Medical concerris beeame steadily inore important during the 187os, when an outpatient department was opened, but the real turn toward rnedical activisrn came the following decade, as orthopedic surgery advanced. In 1883 the number of surgical patients exceeded medical patients for the first time. Moral uplift disappeared from official statemcnts of the hospital's objectives as fhe treatment of disease and injury became the chief con-

Appx.435 159 The Reconstitution of the Hospita7 A Sovereign Profession cern. And instead of treating the poor only, the institution began to later, the hospital began re- admit children from all classes2e e generally accepted, the social origins of on in days rather than weeks. As hospitals became mor fell from 27 days in r870-71 their patients changed. We have no systematic socioeconomic data, al- geport Hospital in Connecti- though scattered statistics for particular hospitals suggest that by the a rgoo and 1920. By 1923 gen- early twentieth century the occupational distribution of their adult pa- length of stay of 12.5 days; a tients became more nearly like that of the population. Perhaps the out 7.24 clearest evidenc.e of the shift caine in the architecture of hospitals- The d the relief of acutc illness changing ratio between wards and private rooms reflected the chang- sorne of the older charity hos- ing social balance. Few class distinctions could be more sharply dV^tc ent supplanted religious and eated. While ward patients were attended by the hospital staff, p rriding mission. In New York patients were attended by doctors of their choice. Ward and private s concerned abut the "unob- patients usually received two different kinds of food, and ward patients d a Home for Worthy, Aged, were often not permitted to see friends and relatives as frequently as , "in view of the thoroughly were private patients. General hospitals built before r88o consisted al- ne changed its name to the most entirely of wards, with only a few private rooms. Large wards, as Notes on Ho.r- Lincoln Hospital and IIome Florence Nightingale pointed out in her influential book nts and local physicians, and permitted more efficient nursing: A single niglit nurse corild at- pitals, r wards often patients each. was turned over to the city. tcnd forty patients in one ward but notfo u istodial care to poor and de- Large wards, Nightingale also argued, improved ventilation, simplifie,d sral hospital providing acute discipline and reduced construction costs.2' But despite these advantages, by rgo8large wards had declined to only 98 percent of the beds ical objectives took place at in hospitals designed that year, while single rooms now accounted )lution Morris Vogel has de- for nearly 40 percent. Ttiese trends continued over the next two dec- d in 1869, its managers an- ades?" New intermediate accommodations, semi-private rooms, were or, at lcast to alleviate" the built for the midd1e classes, who were widely believed to have been A "to bring them under the neglected by hospitals. Hospitals had gone from treating the poor for Che hospital was initially con- the sake of charity to treating the rich for the sake of revenue and only ition as with providing an al- belatedly gave thought to the people in between. eglected, a salubrious haven As hospitals came to use more of their beds for surgery and the treat- an and safe, and receive what tttant of acute ilhiess, they had less room for recuperating patients, who ^)ositively Christian nurture." iyc w discharged earlier, sometimes to newly built convalescent homes. i from outside infiuences that An a rtssult, the boundary between staff and patients in hospitals, once ve at a time, between eleven IPscents and the less seriously ill, now became more t14iasc+d by conva . d k ^are of each other; the y judiciously barring working , In the alrnshouse, the inniates ha ta en a required the Pennsylvania Hospital, as of inany others, . children. Medical concerns ntil rules of washing and ironing, and cleaning the he 187os, when an outpatient it7ta to help in nursing, irn toward medical activism iis, l;ut as general hospitals beeame more strictly devoted to acute by employees of the c surgery advanced. In 1883 ,silcrh functions were taken over complete ly e Sialoc Function of the Hospi- medical patients for the first q{{ttrv, l3y r9o7. in an essay on "Th s hospital career is [a il statements of the hospitaPs F4_rltcsr eould complain, "At no point in hi injury became the chief con•

Appx.436 The Reconstitution 0 16o A Sovereign Profession iary hotel, restaurant, ar patient] looked upon as anything but a rnedical subject. He entcrs the tained. The old rhetoric I hospital because he is sick, he is treated as a phenomenon of niedicine a new vocabulary of scien and surgery, and is discharged `cured; "improved,' or 'no hospital case' of this may have been mo His social status, one might say, is studiously ignored." The patierrt's role cal change was one fitrlhe was being reduced to Parsons' "sick role-" Not considered responsible hold to bureancracy'' for their infirmities, the sick are released from daily obligations in ex- The principal answer t chaaage for which they are obliged to submit to treatment and try to get we1l.29 These presunrptions did not obtain in almshouses, where the be greater payments by crease in costs, but tt ey sick were often seen as responsible for their infirmities, not released people were now cotning from all obligations, and not expected to get well. A complete dispensa- the real value of hospital tion frorn all duties came only in the fully bureaucratized hospital. This thern away. The hospitals meant higher costs, since attendants had to be employed to do the work cians who objected to th( previously done by patients. As thc functions and standards of hospitals changed, construction and afford to pay a doctor at hospital. Between ign at operating costs both increased. The typical hospital of 1870, S. S. Cold- creased froml8 to 45 pe water wrote in 1905, had cost about 15 cents per cubic foot and allowed, if liberal in its proportions, about 6,ooo cubic feet per patient. It had rose from 20 to 24 perce only rudimentary heating and plumbing and usually was not fireproof. ties, according to a sun Medicine, hospital finan In 1905, such a hospital, Goldwater estimated, could be built at zo cents of the hospitals were eve per cubic foot, or $r,zoo per bed. But because of new technological and States as a whole in 1922 legal requirements for hospitals, the prevailing costs per cubic foot ac- eent of the ineome of tually ran about 40 cents and the number of cubic feet per patient had counted for 17.7 pcrcen risen to u,ooo. As a result, ttie cost per bed was now $4,400 instead of 5•7 percent; and all oth $x,zoo.30 In addition, the greater emphasis on acute care intensifred hos- Changes in organizati pital work, requiring rnore employees and higher operating costs per tion of power and autho patient. Hospital budgets soared beyond the capacity of charity to meet diminished, while the t them. parent in control over a Because of the higher costs it brought, the intcnsification of hospital care required charitable institutions to put ttteir finances on a new foun- trustees as well as the d ing poor to accept, but a dation. A crisis in hospital finance in New York City in 1904 brought tions, the trustees' role the problem to public notice, forcing the press, the rnakers of policy, conflict, five n and the institutions'themselves to explore the available alte,rnatives." tinuing The private hospitals coulrl turn to the governnient for more aid, but the (ktspital in New York city was already facing increased costs for its own trospitals, and no one, pt)wcr of approval in dropped the provision in those days, proposed going hat in hand to Albany or Washington. th4+ power of trusteM a They could also turn to the public for more voluntary contributions and ZIUit+tty forgotten.'° organize a concerted fund drive, but this source, too, proved insuffi- "Che devolution of dc. cient. A third response was to call for greater efficiency and stricter tuort! geireral change (i busirtess methods in hospital rnanagement. 1'he old charity hospitals )f organizations in th had been managed on an almost informal basis. Now they had become of a salaried nnu large organizations and there was a denrand for niore careful account- 1,411cC in univcrsifi ing, more specialized labor, and better coordination of the various auxil- ft+'ttfcsscus

Appx.437 The Reconstitution of the Hospital 161 Pvereign Profession iary hotel, restaurant, and laboratory services that a hospital mairt- subject. He enters the tained. The old rhetoric of charitable paternalism was superseded by >nornenon of inedieine a new vocabulary of scientific management and efficiency. While much (I,' or `no hospital case.' of this may have been more talked about than acted upon, the ideologi- red" The patient's role cal change was one further signal of the hospital's transition from house- considered responsible hold to bureaucracy.'2 (laily obligations in ex- 'Phe principal answer to the hospitals' financial diffictilties proved to ) treatment and try to be greater payments by patients. New conditions brought on the in- almshouses, where tlie crease in cosis,r-- uut « they also enlarged the potential for incord since tfirtnities, not released people were now coming to hospitals who could afford to pay, an 1. A complete dispensa- the real value of hospital care had increased, charges would not drive .icratized hospital. This theni away.'The hospitals were also encouraged to irnpose fees by Iiy- nployed to do the work cians who objected to the free services being given patients could a afford to pay a doctor at home, but avoided all charges by gg to ngecl, construction and hospital. Between rgn and 3921 in New York, ward paying patierits in- )ital of 1870, S. S. Gold- creased from 18 to 45 percent of the total number and private patients cubic foot and allowed, rose from 20 to 24 percent, while charity cases declined. By the twen- ect per patient. It had ties, according to a survey sponsored by the New York Academy of ually was not fireproof. Medicine, hospital finances in thc city had become secure; two fifths ,uld bc built at 2o cents of tlie hospitals were even reporting budget surpluses?' For the United new technological and States as a whole in rg22, receipts from patients amounted to 65.z per- ropriations ac- costs per cubic foot ac- income of general hospitals. Public app cont of the )ic feet per patient had counted for 17.7 percent; endowment income, 3.6 percent; donations, now $4,400 instead of 7 percent; and all other sources, 7.8 percenta4 rte care inteirsified hos- Changes in organization and fmancing gradually altered the distribu- ier operating costs per tlon of power and authority in hospitals. The trustees' sphere of control acity of charity to nieet diminished, while the physicians' sphere expanded. The shift was ap- parenl in control over adniissions. Originally, at voluntary hospitals the tensification of hospital I rustcae.s as well as the doctors took part in de.ciding who of the deserv- nore strictlyaS finances on a new foun- (ng poor to accept, but as hospitals became t c of a con- k City in 1904 brought lictnh, the trustees' role in adaritting declined. In 1875, part ;, the makers of policy, 1.1tiulnK conflict, five nienibcrs of the medical staff at Presbyterian ' 3vailable alternatives.3' {(tmpiltd in New York resigned because of opposition to the trustees Hospital in 1897 ,ntfortnore aid, but the of approval in admissions. The Boston City {'tntvict n hospitals, and no one, tliolzprad thc provision that trustees niight admit patients. Elsewhere klbany or Washington. d donors to noniinate patients to free, beds was (l;rA; pinvEr of trustees ati ntary contributions and rltjicfly {atgotte.nrr' ce, too, proved insu(ii- aking power to physicians reflected the I'Itct ddrvohttion d of'n decision-m the structm'e efl'iciency atid stricter tr:d change (to which I have aiready allu e 1' he growing irnpor- e old charity hospilals Fations in the late nineteenth century-t Now they had become a±alarlod management in corporations, of administrators and rnore carefulaccount- a In unive.rsities, of salaried editors and professional reporters tion of the various attxil-

Appx.438 i6z A Sovereign Profession The Reconst:itution of the Ilospi on newspapers, of civil servants in government. In hospitals, the trust- cians in cities where it flourishes as ees could no longer enter into the details of management; the more losses."M common patte,rn was for the executive of thc hospital to resolve all ordi- While patterns of organization varie, nary questions and to turn to the board only at irrtervals on major mat- teenth-century hospitals was typically ters of policy.as Unlike corporatiorrs, however, hospitals saw authority a consulting staff, composed of older ar devolve more upon outside professionals, the rnedical staff, rather than had no regular duties; a visiting or atter upon its own salaried management. This peculiarity of oreanization physicians who supervised treatment; arose because of the special role that outside doctors came to play in doctors in training who carried out thi the prosperity of the institution: They had replaced the trustees as the pensary staff that saw outpatients. Of chief source of income. Wlien hospitals relied on donations, the trustees cians were the most important. They g were vital. But as hospitals came to rely on receipts from patients, the ods of three or four rnonths a year, a doctors who brought in the patients inevitably became more important on each physician; while allowing, as to the organization's success. "a nruch larger rmmber of inedical m there may be from the rianre of being I3ospitals paid none of these doctors cians gave their services for a year or room, board, and experience; the di THE TRIUMPH OF THE PROFESSIONAL COMMUNITY hope of obtaining appointments as themselves known to patients, who r The growing importance of hospitals to medical practice posed a se- offices. T'he visiting staff provided its 1 vere problem for most members of the profession. While the few physical facilities, opportunities to speciali cians who held hospital appointments were gaining a more decisive the community invested in hospital role, niost practitioners were cut off from access to hospitals. In 1873, leagues, which might opcn the way b when the first national survey of hospitals was undertaken, the total fessional recognition.4° During the pe number of visiting physicians was estimated at 580; the data were tal appointments became more doubtlessly incomplete.31 If, however, there were twice as many, the indispensable for surgical practice a proportion of American physicians with hospital privileges would still But while their economic value im have come to only about 2 percent. In the 1870s, this rrarrow monopoly inained concentrated among a small was of relatively small consequence to most doctors since the few hospi- practitioners resentment of hospital noted tals then in existence were used almost entirely by the poor. But as late in 1894, the Medical Record as 1907, after hospitals had grown enormously in number and irnpor- growth of hospitals "critically, not to tanee, a pliysician surveying his colleagues in the Bronx and Manhattan bitrary" treatment they received at t found that only about io percent held hospital positions. "The rest," he took advantage of their desire for I wrote, "are entirely excluded without rhyme or reason from hospital out di theni with as little return as p practice, and cannot enjoy even a share of the benefits derived frorn private surgical work. Even well-to such a eonnection." Exclusion now "seriously handicapped" a physi- °paying perhaps nothing," because I cian. Moreover, it was unfair to patients to deny thear the choice of vate fe.es to be taken. "The spread their own family doctor when they entered a hospital. "On the one throw a larger amount of medical hand we have a public educated to avail itself of the facilities of a hospi- corporations . . . [inaking] the few sk tal in severe illness, and on the other hand a cast-iron regulation which dent."" closes the doors of the hospital to the majority of practitioners. This `sys- '1'hc widely resented rule forbidd tem' has made such striking inroads on the earning capacity of physi- vale patients, which had been esta

Appx.439 !)ereign Profession The Reconstitution of the Hospital. 163

In hospitals, the trust- ciaivs in cities where it flourishes as to entail enormous pecuniary magement; the more losses."3" ,ital to resolve all ordi- While patterns of organization varied, the medical staff of late nine- tervals on rnajor mat- teenth-century hospitals was typically arranged in four distinct groups: )spitals saw authority a consulting staff, eomposed of older and distinguished physicians, who lical staff, rather than had no regular duties; a visiting or attending stafY, inade up of the active arity of organization physicians who supervised treatnrent; a resident or house stafl of young ,tors canie to play in doctors in training who carried out the details of treatment; and a dis- ^d the trustees as the pensary staff that saw outpatients. Of these groups, the visiting physi- onations, the trustees cians were the most important. They generally served for rotating peri- ots fro3n patients, the Gds of ihree or four months a y2 , system that reduced the hnrden ame more important on each physician, while allowing, as one surgeon pointed out in 1885, "a much larger number of inedical nien to derive whatever advantage there may be from the name of being connected with the institution,9 Hospitals paid none of thesc doctors for their work. The house physicians gave their services for a year or eighteen months in exchange for room, board, and experience; the dispensary staff gave theirs in the WMUNITY hope of obtaining appointments as visiting physicians and to make themselves known to patients, who miglrt then come to their private practice posed a se- offices. The visiting staff provided its labor in return for access to surgi- aVhile the few physical facilities, opportunities to specialize, prestige, the use of capital that ng a more decisive the cominunity invested in hospitals, and regular contacts with col- o hospitals. In 1873, leagues, which might open the way to referrals, consultations, and pro- idertaken, the total fessional recognition.40 During the period hetween t87o and igio, hospi- 580; the data were tal appointments became more valuable as hospitals became twice as many, the indispensable for surgical practice and specialization advanced. civileges would still Bat while their economic value increased, hospital appointments re- s narrow monopoly nrained eoncentrated among a small professional elite. Ainong general since the few hospi- practitioners resentment of hospitals was widespread. In an editorial he poor. But as late in r894, the Afedical Record noted that most doctors looked upon the umber and impor- growth of hospitals "critically, not to say coldly." They resented the "ar- Dnx and Mauhattan bitrary" treatment they received at the hands of hospital managers who ons. "The rest," he took advantage of their desire for hospital affiliation "to get as rnuch ason from hospital out of thein with as little return as possible" The hospitals were killing efits derived from private surgical work. Even well-to-do patients might enter hospitals, licapped" a physi- "paying perhaps nothing," because the hospital rules permitted no pri- hem the choice of vate fees to be taken. "The spread of the hospital is thps tending to itnl. "On the one tlirow a larger anzount of medical work every year into'the hands of 'acilities of a hospi- corporations ...[making] the few skilful, the many unskilful and depen- i regulation which dent."" titioners. This `sys- 'I'he widely resented rule forbidding physicians to take fees from pri- capacity of physi- vate patients, which had been established at the older voluntary hospi-

Appx. 4 4 0 164 A Sovereigtz Profession

tals, began to die out at the turn of the cenlury. In t88o, according to Henry Burdett, no American hospitals permitted fees. But by 1905 a writer in the Boston Medical and Surgical Journal cottld report that of 52 hospitals surveyed in New England, only five, among them the Massachusetts General Hospital, continued to deny physicians the right to charge for services to private paticnts. In genei-al, hospitals were now permitting physicians to charge patients in private rooms, but still barred fees for ward patients. Ilicreasingly, they were a>Iso allowing physicians not on their staff to treat paying patients in unused private rooms. But ambignities and di$'ieulties persisted; in 1904 a hospital journal reported that whether patients in private rooms had to compensate physicians for their services was still "not clearly defined." In a typical sitnation, "a doctor who is not on the staff sends a patient to the hospital, and, perhaps before he has made his first visit the hospital authorities have intimated to the patient that if she will accept the services of a member of the staff she can have such without charge. It makes no difference how well able the patiertt may be to pay, the staff physician makes no charge, and the physician who had previously been in charge loses the patient and the fee which would liave been his had the patient been treated at home."42 Private practitioners protested vehemently against this sort of "pationt-stealing" by the hospital staff, insisting that hospital authorities abide by the profession's code of ethics and guard their proprietary interests. They also wanted adherence to the professional vow of silence and noninterference. Without such cooperation, patients inight hear disparaging remarks about their doctor's ability, or tnembers of the staff might revise the diagnosis and plan of treatment. In sending patients to hospitals, private doctors risked not only losing the fee, but possibly discrediting the image of conipetence they were trying to maintain. From their viewpoint, unless the staff cooperated, the manageinent of impressions was much more vulnerable in the hospital than in the home. Physicians started asking why they did not cotnpletely control hospitals. "Is it not about time the professional rnind began to dominate in the control of these institutions?" asked a physician iip`the Journal of theArneriean Medical Association in r8o2. "Fairly estiznated, do not our services justly entitle us to a voice in all professional questions in and out of the hospital, second to none, even to that of those benevolent individuals, charitable organizations or religious societies that founded these institutions?" Bayard I-Iolrnes, a protninent Chicago physician and socialist, also writing in the AMA's Journal, formulated "the hospital problem" for his colleagues in the following te.rms:

Appx. 441 Sovereign Profession The Reconstitution of the Hospital 165 iry. In r88o, according to When the industrial revolution of the seventeenth century began it found Europe peopled with indcpendent tradesmen. _.. Now we find the homeless, itted fees. But by 19o5 a tool-less dependent machine operators far removed from the people who fur- )urnal could report that nish a market for the standardized product of their toil. The hospital is essen- ly five, among them the tially part of the armamentarium of medicine.... If we wish to escape the thrall- 3eny physicians the right dom of commercialism, if we wish to avoid the fate of the tool-less wage worker, reral, hospitals were now we cnust control the hospital 42 private roonis, but still Oddly enough, proprietary hospitals were one of the main ways of y were also allowing phy- resisuu.g corporate domination a*-?d establishing professional control. ients in unused private Some sinall private hospitals were built by individual surgeons for their d; in 19o4 a hospital jour- own cases; others were joint ventures. To supply enough patients to :)oms had to compensate make the bospitals profitable, eompeting doctors often had to combine -1y defined." In a typical their efforts. "No other profession," wrote the leader of a group of eight a patient to the hospital, physicians who incorporated a hospital in a town in upstate New York, the hospital authorities "has liad such cruel jealousies and such costly strifes. These differences accept the services of a are being abandoned and rnust be to niake the... hospital ... a success." charge. It makes no dif- The creation of doctor-controlled hospitals was easiest in small towns pay, the staff physician throughout the country and in the citics of the West, where trustee- eviously been in charge dorninated institutions had never been f'ounded. In the early years of been his had the patient the century, more proprietary than charitable hospitals were being built. They were opened mainly by physicians who ha(i no hospital priv- against this sort of "pa- ileges elsewhere, or who had positions but felt the hospitals wcre not hat hospital authorities providing adequate accomtnodations for their private patients- The in- rd their proprietary increased competition from these new enterprises cateriug to the middle fessional vow of silence and upper classes forced the older voluntary hospitals to make adjust- n, patients might hear merits because of the threatened loss of clients and revenue. The pri- or members of the staff nt In send'rng patients vate hospital, a writer noted in 1903, had "taught the larger hospital that rig the fee, but possibly it must open its doors to all reputable physicians."{' By 1907 there was a movement-"none too strong, perhaps," com- >re trying to maintain. "but enough to ^d, the management of ruented the editor of the Natiotial Hospital Record, e hospital than in the show in which direction the current is moving"-to open up hospitals lo doctors not formerly on their staffs. "Experience has proved conelu- npletely control hospi- sively that 'the open door' to the hospital is a benefit, not only to the began to dominate in rank and file of doctors, but to the bospital. It pays in dollars and cents." ician in the Journal of Not everyone was convinced; a few voices even urged movement in y estimated, do not our the opposite direction. A number of critics had lorig maintained that ional questions in and American tiospitals were, if anything, too loose for the good of their pa- d of those benevolent tts and their own budgets. European hospitals, conducted by a small, example of more disciplined and societies that founded ntanent medical staff, stood as an observed Arpad Ger- Chicago physician and )nocnical organization. In American hospitals, mulated "the hospital fr+r, with a rotating staff of visiting physicians and changes every year ms: Itt thw house staff and student nurses, "you can only wonder that clraos

Appx.442 i66 A Sovereign Profession The R

and waste are no greater than they actually are." Since the services of Brookl, the visiting staff were gratuitous, there was no way to regulate their David hours or rnake stire they gave each patient adequate attention. "Medi- propor cal men who complain that the hospitals are not converted into a free cent. Iv and general stamping ground for every one having a doctor's diplotna," rising c Gerster declared, "will naturally be disgusted by further restrictiug the revent number of those who will have charge of hospital facilities. 'I'hey niust itospit', be shown, however, that the hospitals do not exist mainly for the indis- rgzl an criminate benefit of the medical profession, but are here, fa•st, for the were t benefit of the patients, and secondly for that of the connnuziity. Restric- the, pri tion of the number of those who attend at our hospitals is the condition no hos sine qua non of economic reform."45 courte Gencral practitioners naturally saw closed staffing as a way to main- most t tain privilege rather than quality. Physicians excluded from city hospi- out of tals in Louisville and Cincinnati petitioned against the "unjust and un- climbe demoeratic" control of the institutions by a "ring" of monopolists; in Whi New York, a tmmber of them organized "physicians' economic soughl leagues" to fight on their behalf. "We all know, only too well, the as par great scramble for hospital association," a doctor told a meeting of one the re such league in 1915. "A physician not in the coterie of a hospital staff quiret pulls every wire to get one and not succeeding, starts another coterie al8liat to establish another hospital. A crooked politician would blush with "oper shame to be seen in the company of some of our physicians did he meml know to what extent of knavery they have gone to get on a hospital reput staff." Partisans of the excluded noted that hospitals served to educate laws, doctors and advocated extending privileges to all members of the pro- Also i fession on the grounds that those isolated from hospitals could not stand keep up with new advances.ac the C The decisive consideration proved to be financial. Voluntary hospitals with had multiplied in great numbers and many had fallen seriously into ward debt. As the industry trade journal explained, hospitals would fail with- l;v, out support from local physicians. "If favorably disposed toward the they hospital, the physician can very frequently recotnrnend that a'Mtient ciart.s be transferred to the hospital even where the distinct need of this trans- cortlf fer does not exist." A rgog guide to hospital administration noted, "'I'hc sioti I income froni private patients depends largely upon the medical staff." born If the staff had "large and profitable" practices, "then a sufficient utu't- aniount of money can easily be rcalized to defray the entire running Whe• expenses of the institution, supplying the care not only for the private thvy patients, but also for the charity inmates."47 ttiLnt Witb that hope in mind, hospital boards expanded the nuinber of po- f3aw, sitions for doctors who could serve as "feeders" to fill their beds. In ntd

Appx.443 reign Profession The Reconstitution of the Hospital 167 iiuice the services of Brooklyn, New York, according to a study of physician directories by iy to regulate their David Rosner, the big cltange came between igoo and igro, when thc :c attention. "Medi- proportion of hospital-affiliated practitioners rose from 15.6 to 42.3 per- mverted into a free cent. Many of Brooklyn's hospitals were in financial trouble because of a doctor's diploma," rising costs and opened their doors to new physicians to increase their -ther restricting the revenues. In New York City, other studies indicate, the proportion of acilities. They must hospital-affiliated physicians climbed from 36.8 to gz percent between nainly for the indis- 1921 and 1927. Moreover, no hospitals, except for research institutions, ^ here, first, for the were totally "closed," since they all generally had a courtesy staff with ommunity. Restric- the privilege of attending patients in private rooms. On ihe other hand, tals is the condition no hospitals were totally "open" either, since even hospitals with large courtesy staffs limited their access to the charity wards. Nationally, al- g as a way to rrrain- most two thirds of pltysicians in 1928 held staff appointments--90,903 led from city hospi- out of about rgo,ooo doctors. By 1933 the number of affiliated physicians `he "unjust and ttn- clintbed to 126,961, leaving one doctor in six without any privileges.48 of nronopolists; in While doctors' access to hospitals expanded, professional associations vsicians' economic sought ways to tighten the rnedical organization of hospitals. In tgrg, standards for hospital care, only too well, the as part of a campaign to assure minimum d a meeting of one the recently established American College of Surgeons adopted a re- ^ of a hospital staff quirement that hospitals wishing to receive its approval organize their " The staff could be rts another coterie affiliated physicians into a°clefinite medical staff. would blush with "open" or "closed," with as many "active," "associate," and "courtesy" physicians did he members as desired, so long as they were restricted to competerrt and 3 get on a hospital reputable physicians, engaged in no fee splitting, abided by formal by- served to edtrcate laws, and held monthly meetings and reviews of clinical experiences. embers of the pro- Also in rgtg, the AMA's Council of Medical Education set minirnum ospitals could not standards for hospital internships, the next year changing its name to the Council on Medical Education and Hospitals. Though compliance Voluntary hospitals with ttrese norniative bodies was voluntary, they pushed hospitals to- illen seriously into ward a more formally structured, hierarchical organiz.ation.49 als would fail with- Even if more doctors gained errtry to a hospital in their comrntmity, ;posed toward the ttrey did not necessarily gain access on the same footing as other physi- end that a patient cians or to hospitals of equivalent status and qua1ity. In Cleveland, ac- = neeci of this trans- cording to a study published in tg2a, zg percent of the medical profes- ration notcd, "'I'he aion held control of 8o percent of the hospital beds. Blacks and foreign- the medical staff." born doctors, particularly Italians and Slavs, were almost completely "then a suflicient unrepresented on hospital staffs. These kinds of ineqtialities persisted. he entire running When doctors froni lower-status e,thnie backgrounds obtained positions, aly for the private thoy did so at the lower levels of the system. Studying the informal orga- nizntion of inedical practice in Providence, Rhode Islartd, about 1940, the number of po- flswald llall founcl that appointment decisions depended largely on fill their beds. In t; (ntttchnical considerations, such as personality and social background.

Appx.444 T A Sovereign Profession i68 pr "In the earlier days," a hospital administrator told Hall in regard to the PC selection of interns, "we had conipetitive examinations, but we had to fe discontinue those. The person who did best on an exarnination niight not show up well in the intern situation. He mighe lack tact; he rnight not show presence of mind in crises; or he inight not be able to take orders. And more than likely the persons who did best on the written exarninations would be Jewish."^ T The continued dependence of practitioners on hospitals throughout their careers made thern dependent on what Iiall identified as the "inner fraternity" of the profession. "The freelance practitioner," he wrote, "has gradually been supplanted by one whose career depends on his relationship with a network of institutions." Access to favored positions in that network came through "sponsorship" by a community's established physicians, who could advance or exclude aspirants at various stages of tlreir careers by influencing professional school adniissions, dispensing hospital appointments, ref'erring patients, and desig- nating proteges and successors. Because the hospital was essential to successful practice, its various grades could be used as delicately calibrated rewards to signal the progress of a eareer.51 Although opening up hospitals to more doctors weakened the elite's traditional monopoly over hospitals, it brought greater control over the profession- "Paradoxically," writes William Glaser, "the integration of private and hospital practices in America produces a more diffuse staff structure inside the hospital and a more orderly structure in the community of private practitioners. Since the majority of doctors in inost countries practice outside the public and voluntary hospitals, rank in these institutions cannot be used to arrange a hierarohy in the medical profession generally. Granting or withdrawing hospitalization privileges cannot be used to regulate professional and personal behavior; in fact, this use of hospitalization privileges makes America one of the few countries with any controls over the quality of private practice."12 ? It is unclear whether the use of this power in the early twentieth century did raise the quality of private practice in Arneriea. But there can be no doubt it was used to exclude doctors unacceptable to the organized profession. By the twenties, membership in the local medical society had becoine an informal prerequisite for inembership on the staff of most local hospitals. In 1934 the AMA tried to institutionalize its control over hospital appointinents by re.quiring all hospitals accredited for internship training to appoint no one to their staff except rnenibers of the local medical society. Black doctors, who were excluded from the local societies, could be kept out of hospital positions on those grounds 5' So could anyone else who threatened to rock the boat. The

Appx.445 The Reconstitution of the Hospital 169 private practitioners, who had first seen hospitals as a threat to their position, had succeeded in converting them into an instrument of professional power.

TFIE PATTEIiN OF THE AOSPITAL SYSTEM

Class, Politics, and Ethnicity The rapid rise in the reported number of hospitals from 17$ in 1872 to more than 4,00e in rgro stemmed only in part from the growth of hospitalization. After all, more hospital beds rnight have been acconi- rnodated in fewcr institutions by increasing their average size. Mental hospitals in Ainerica developed in this way, enlarging their capacity rather than feverishly rnultiplying in nurnber. By ry2o, when there were some 4,013 general liospitals with an average size, in beds, of 78, there were 521 mental hospitals with an average size of 567.51 The contrast between the two kinds of hospitals developed bccause they had quite different functions. General hospitals became a necessary local adjunct of medical practice, while mental institutions did not. Physi- cians who were excluded from the staff of existing general hospitals forrned new ones; doctors in small towns opened hospitals to prevent their big-city colleagues from drawing away their patients. No sirnilar incentives promoted the establislnnent of mental institutions. While communities wanted to have general hospitals readily accessible, they were quite prepared to have the inentally ill renioved to a distance. Small general hospitals also multiplied because many of theni were sponsored by competing religious groups, while the more burdensome and unremunerative long-term institutional care of the mentally ill fell ahnost entirely to the states, which centralized facilities to save mor ey. The hospital systern in America-leaving mental institutions aside- r*merged in a series of three more or less coherent phases. The first of t}iese, running roughly for a century after 1751, saw the formation of two kinds of institutions: voluntary hospitals, operated by charitable lay 17oards, ostensibly nondenominational but in fact Protestant; and public hospitals, descended from ali.nshouses and operated by municipalities, by counties, and, in the case of merchant marine hospitals, by the fed- %I xoverninent. Itt the second phase, beginning about 1850, a variety of more "par- ;ulin`isl-ic" hospitals were also formed. T'hese were primarily religious

Appx.446 The lleconstitution of the llc A Sovereign Profession 170 profit institutions. Because the Sotitl or ethnic institutions and specialized hospitals for certain diseases or tal available for philantlv'opy, the} categories of patients, such as children and wocuen. Hospitals were also sector in hospital care and on the opened by medical sects, nFainly homeopaths. Despite these regional variatic The third phase of development, running from about 18go to 192,0, across the country fell into a fairly e saw the advent and spread of profit-making hospitals, which were oper- the largest institutions, the elite vo ated by physicians, singly or in partnership, and by corporations. The ethnic, religious, and special h This pattern of development was not accidental. The fortnation of less central (botti functionally anc denominational hospitals after 1850 reflected the arrival of large num- etary and medical scctarian institu bers of Catholic imtnigrants; the growth of proprictary hospitals after furthest on the fringe of the syst( 1890 reflected the new potential for profit due to the progress of sur- characteristic functions, organizaL gery. An internal dialectic was also at work. Once general hospitals had ods of finance. been established, physicians interested in creating institutions appealed The elite voluntary hospitals cc for funds and patients on more partial axes--ethnic a$'iliations, special relatively closed medical staffs and categories of diseases, sectarian medical ideas. Like the proprietary hos- schools. Their patients were the v pitals, these institutions were established in response to thc chauging the very rich (for revenue and, on structure of opportunities. est endowments, enjoyed the niosi This sequence of developmerrt unfolded in major cities with varia- ing and treatment, and were gen tions and exceptions, depending on the time a eornmunity was formed, The municipal and county host its size, the ethnic makeup of its inhabitants, and its economic develop- tions in nuniber of beds, cared fo rnent. In cities emerging after 1850, the first and second phases were illness. The organization of their superimposed. While municipal and nonsectarian voluntary hospitals fvrther west the city, the more lik generally preceded denominational institutions in the older cities of the lio hospitals generally treated tttc East, they emerged simultaneously in the Midwest; in some Midwest- ations rather than fees, and were ein cities, Catholic hospitals were actually built first. In those areas of graft and neglect. Some were i the country that built their institutions last-the Far West and the The religious and ethnic hosp South, where the growth of hospitals had been stunted by the economic group. In size, they were on the aftereffects of the Civil War-the profit-making sector took on more im- tary or municipal hospitals, but 1: portance than elsewhere. By the early igoos, in comparison with na- ments. They rarely had large eni tional averages, the Eastern states showed more nondenominational fees frorn patients, who were E voluntary hospitals, the Mid(ile West a disproportionate numbei- of middle classes. Most treated sht church hospitals, and the South and West an excess of proprietary hospi- voluntary hospitals, their nre.dica tals.* These regional variations reflect their successive development less frequent and less close ties and associated economic differences. Because the Eastern cities grew 'Che profit-making hospitals w up first, they had an edge as centers of banking and comnierce. The ustrdly small and had no ties tc greater accumulation of capital there aided the creation of the early ekclusively, and their patients w voluntary hospitals, as well as private colleges, museums, and other non- 'Choir rate of institutional survi, vol. "The differences are striking. In r^rcent of hospitals in the Mid-Atlantic states,rc.om- wcre typical of small businesses; utitary ins[itutionx represented 49 F situdcs of personal fortune. pared with 25 percent in the East North Central states, and only 12 percent on the Pacificn rose, Coast. tIospitals with religious sponsorship from in the PaciGc states^M^ e than 't`he hospital system had no c to 23 percent in the Midwest, but fell to just 13 percent d with e7 per- it had a pattern because it relie, half of the Pacific states' hospitals were proprietary (52 pereent), compare cent in the Mid-Atlantic and 3o percent in the East North Central states. The pattern '1'hc• elitc voluntary trospitals bi in the South resernble.d the West 55

Appx.447 ion The Reconstitution of the Hospital z71 s or profit institutions. Because the South and the West had less private capi- also tal available for philanthropy, they relied more on the profit-nlaking sector in hospital care and on the state in higher education. 920, Despite these regional variations, metropolitan hospital systems per- across the country fell into a fairly standard pattern. At their core were the largest institutions, the elite voluntary and the municipal hospitals. n of '1'he ethnic, religious, and special hospitals were somewhat smaller and mni- less central (both functionally and geographically), while the propri- rfter etary and medical sectarian institutions were typically the srnallest and sur- furthest on the fringe of the system. Each group of hospitals had its had characteristic functions, organizational structures, patients, and meth- ;aled ods of finance. ecial The elite voluntary hospitals concentrated on acute care; they had Iros- relatively closed inedical staffs and the closest ties to university rnedical ging schools. Their patients were ttie very poor (for teaching purposes) and the very rich (for revenuc and, one hoped, bequests). They had the larg- -aria- est endowrnents, enjoyed the most prestige as centers for medical train- nied, ing and treatment, and were generally old and stable. elop- The rnunicipal and county hospitals, usually the largest local institu- were tions in number of beds, cared for the full range of acute and chronic pitals illness. The organization of their medical staffs varied by region-the )f the further west the city, the more likely its hospitals were to be open. Pub- we,St- lic hospitals generally treated the poor, relied on government appropri- ^as of ations rather than fees, and were plagued periodically by scandals over 3 the graft arrd neglect. Some were important teaching institutions. tomic The religious and ettrnic hospitals were a rnixed and internlediate eim- group. In size, they were on the average smaller than the elite volun- h rla- tary or municipal hospitals, but larger than the profrt-rnaking establish- tional rnents. They rarely had large endowments and consequently relied on ,er of fees from patients, who were predominantly from the working and lospi- middle classes. Most treated short-term illness. Compared with elite -ment voluntary hospitals, their medical staffs were niore open and they had grew less frequent and less close ties to medical schools, The I'he profit-making hospitals were mainly surgical centers; they were early usually small and had no ties to medical schools. They relied on feeys: r rloll- osively, and their patients were from the middle and upper classes.

ian vo1- l'hc-ir rate of institutioual survival was the lowest. In this regard they s, coin- tvrrt+ typical of srnall businesses; they opened and closed with the vicis- Pacific :nglaad oi' personal fortune. re than hospital system had no design since it was never planned, but i7 per- a pattern because it reflected a definite system of class relations. pattern plltt+ voluntary hospitals brought together the top and bottom of

Appx.448 Sovereign Profession The Reconstitutiol 172 A pattern of uneven deN the society under one roof becatise their physicians simultancously Columbia, the secreta wanted to have poor patients for teacliing and to save time by treating government subsidies their wealthy patients in the same location. The mix of social classes pitals for acute medica was also thought to have some educational value. Onc hospital director far, to provide the nt candidly explained that in their training doctors and nurses tended,. to cent, tubercular, inebi deai wrm.., waru trai.ents "so ir=uch as cases, and not as nersons, w i e hospital was under the "the personalities of the patients and the friends come in very largely tal is constantly overci in the care of patients in private rooms."^ When the superintendents desired and which wi of several major hospitals in New York were asked in a 1904 survey immediate control of whether hospitals ought to be divided 'uito two classes-private hospi- ture of American mc tals for people who could pay and public hospitals for people who could acute treatment and a not-they unanimously rejected the idea. If all poor patients were Private hospitals for ac cared for by municipal hospitals, charitable donations would dry up, re- while overcrowded pi quiring higher rates in private rooms s' of tuberculosis, alcot o Thus the split between public and private hospitals did not become disorganization. a straightforward class boundary. Both kinds of hospitals treated poor The public anci pri patients, but they treated them in different ways. "[Plublic hospitals," tems of patronage and wrote S. S. Goldwater in r9o6, "are eonducted at a low rate of expendi- already seen, wealthy ture, which implies a low grade of efficiency; hospitals supported by vol- free beds, and staff al untary contributions, on the other hand, aim at a higher grade of service families, while Cathol and are unashamed of expense acconnts relatively vast." New York City public officials used n was a prime example. "Here, on the one hand, are the public hospitals, and secure the timely Bellevue, City, Metropolitan and Kings County, conducted at an aver- tients. Such interver age expense of $r.oo per capita per ilay or less; and on the other hand upper-class reforiners a large number of private institutions of the highest grade, supported institutions be run on mainly by the gifts of the benevolent anci conducted at a daily per cap- have argued, the urb ita cost which approximates $z. Tln-onghout the country, in Philadelpia, were also more respc Cincinnati, St. Paul, Milwaukee, Chicago, St. Louis, San P'rancisco, New Boston, Brahmin fain Orleans, etc., contrasts of this sort are fonnd. ..."^ hospitals, but after Bc The relation between public and private hospitals had been foreshad- and Jewish doctors w owed by the complenzentary roles of the almslrouses and early volun- the intervention of tl tary hospitals. While voluntary hospitals adinitted poor patients, the Discrimination was public institutions receivcd the less desirable poor, the overflow of religious atrd ethnic h mostly clironic cases. Other state welfare institutions, such as mental was rare, though the hospitals and hoines for the deaf, the blind, and the retarded, likewise admit Irish paNents provided long-term care of ttie poor at low average daily expenditures other people frorn er per person. 'I'he government accepted responsibility for the residual hospitals gave religio problem cases other institutions would not take. afraid they might noi In addition to operating their own hospitals, most state and local gov- have to eat nonkoshe ernments gave subsidies to private hospitals for their charitable ser- rituals. Both religious vices. In 1904 one quarter of all public funds spent for hospital care sup- to convert some of th ported private institutions." Such assistance, howevcr, promoted a

Appx.449 rofession The Reconstitution of the Hospital pattern of uneven developrnent in medical services. In the District of ultaneously Coluntbia, the secretary of the Board of Charities noted in 19o6 that by treating government subsidies had created "too many comparatively small hos- >cial classes pitals for acute medical and surgical services, and ... utterly failed, thus ital director far, to provide the necessary accommodations for chronic, convales- s tended to cent, tubercular, inebriate, and generally undesirable cases." Only one ;ons," while hospital was under the city's direct control. "The result is that ttus hospi- very largely tal is constantly overcrowded with general chronic cases, which are not rintendents desired and which will not be received by institutions not under the 3904 surJey immediate control of the city."" This pattern became a standard fea- rivate hospi- ture of American medicine-a highly developed private sector for .e who could acute treatment and an underdeveloped public sector for chronic care. ktients were Private hospitals for acute illness would be running well below capacity, d dry up, re,- while overcrowded public institutions were teeming with the victirns of tuberculosis, alcoholism, mental disorder, and other diseases of social not become treated poor disorganization. The public and private hospitals also functioned as alternative sys- ic hospitals," tems of patronage and sponsorship. At elite private hospitals, as we have e of expendi already seen, wealthy patrons sponsored the admission of patierrts to orted by vol- free beds, and staff appointments went to physicians from establishe.d ade of service famiHes, while Catholics and Jews were passed over. Correspondingly, ew York City public officials used municipal hospitals to dispense jobs and contracts blic hospitals, and secure the timely admission of their friends and constituents as pa- ^d at an aver- tients. Such intervention was roundly criticized by physicians and ie other hand upper-class reformers, who demanded that these and other rnunicipal le, supported institutions be run on a strictly disinterested basis. But as many people daily per cap- have argued, the urban political rnachines, while frequently corrupt, n Philadelpia, were also more responsive to pressures from lower-status groups. In rancisco, New Boston, flrahmin families dominated the medical staffs of the private hospitals, but after Boston City Hospital was opened in 1864, Catholic een foreshad- and Jewish doctors were able to get staff appointments there through d early volun- the intervention of their representatives.61 r patients, the Discrimination was a principal reason for the forination of separate le overflow of roligious and ethnic hospitals. Except against blacks, outright prejudice ;nch as rnental was rare, though the Massachusetts General Hosital initially refused to irded, likewise ddrnit Irish patients on the grounds that their presence kvould deter y expenditures other people from entering the hospital. The early moralistic aims of or the residual hospitals gave religious minorities reasons for anxiety. Catholics were ttFrr+id they rnight not be given last rites, and Jews feared they would = and local gov- YNve to eat nonkosher food and face ridicule for their appearance and charitable ser- cititttls. Both religious communities worried that efforts might be rnade rspital care sup- t fz convert some of their members in moments of personal crisis. Enter- .r, promoted a

Appx.450 174 A Sovereign Profession The Reconstit ing a hospital necessarily involved encounters with strangcrs at tirnes tainly find those 1 of weakness and vulnerability, but the encounters might be less threat- other chains of in ening if the hospital authorities and staff were of the same faith or, even native route, and better, of the same ethnic background. For even witltin religious also shelter him groups, there were sharp differences, as a Russian Jew in New York in more) advantage 1894 found out when visiting Mr. Sinai Hospital and othcr "nptown" It might seem, institutions controlled by the then dominant German Jews: tlte denominatioi patients. But thi: In the philanthropic institutions of our aristocratic German Jews you see America first to beautiful offices, desks, all decorated, but strict and angry faees. Every poor man While specific gr is questioned like a criminal, is looked down upon; every unfortunate suffers self-degradation and shivers like a leaf, just as if lte were standing before a Rus- patients of all fail sian official. When the same Russian Jew is in an institution of Russian Jews, no entele of a Prote: matter how poor and small the building, it will seem to him big and comfort- any other grottp. able. He feels at home among his own brethren who speak his tongue, under- tiles only in cases stand his thouglits and feel his heart. to Mt. Sirtai to sip hospitals were ru From the other side of the encounter with immigrant Jewish patients places took respo comes a confession of the gentile doctor's prejudice by Richard Cabot, nesota, the Mayo a medical professor at Harvard and physician at the Massachusetts Gen- tat, St. Mary's, eN eral Hospital: tients were Cath

IT]he chances are ten to one that I shall took out of nty eyes and see, aot Denomination: Abraham Cohen, but a]ew ... I do not see this man at all. I merge hirn in societ.y. In some the hazy backgrotrnd of the average Jew. But if I am a little less blind than usual than in the Unite today ... I may notice something in the way his hand lies on his knee, something to meet a broad r that is queer, unexpected. That hand ... it's a muscttlar hand, it's a prehensile oerzttiling, or "p hand; and whoever saw a Salem Street Jew with a muscular hand before ... supporting a con I saw him. Yet he was no more real than the thousands of others whom I had seen and forgotten, forgotten-because I never saw thertz, but only their ghostly (>oudsblorn abou outline, their generic type, the racial background out of which they emer- zations encompa, ged." (etnphases in original) universifies, radii welfare agencies Besides providing a haven from prejudice for the sick, the ethnic and system."" "I'his p, religious hospitals also offered material advantages to the sponsoring partially in Amer communities and their physicians. They furnished opportunities for in- erally felt little n ternships and residencies that Jewish, Catholic, and black doctors were deuominations ti denied elsewhere and staff appointnrents so that they could attend pa- those that see th tients of theirs needing hospitalization. As Oswald Hall discovered, the Among the tnajc most important dividing lines among hospitals were ethnic and reli- elaborate netwot gious, not technical. The ethnic and religious hospitals were part of a coturntmity assoc chain of ins6tutions that served doctors in each group at successive at least in theSou stages of their careers. While the upper-class Yankee would go to an have been tnore expensive undergraduate college, elite medical school, and prestigious than to build thei hospital for his internship, the young Italian doctor would almost cer- prt•ferred to rem

Appx. 451 fession The Reconstitution of the Hospital

al times tainly find those gateways blocked. "However," Hall noted, "there are s thrcat- other chains of institutions (in this case Catholic) which provide an alter- or, even native route, and not only open a road to a niedical career for him, but religious also shelter him in sorne degree from the conipetition of those [with York in more] advantages . . . ." 6' rptown" It might seem, frorn the role played in relievirrg discriniination, that the denominational hospitals would have attracted discrete groups of patients. But this was not so. The hospitals illustrate the tendency in s you see America first to assert and then to submerge religious differences. poor n an te suffers While specific groups sponsored hospitals, they took pride in serving re a Rtis- patients of all faiths-though not all races-without prejudice. The cli- i no entele of a Protestant hospital might well include more Catholics than comfort- any other group. Jews' Hospital in New York originally accepted gen- e, under- tiles only in cases of accident or emergency, but soon changed its name to Mt. Sinai to signify that it served the community at large. Catholic patients hospitals were not only open to the general community, but irt some d Cabot, places took responsibility for public hospital service. In Rochester, Min- >tts Gen- nesota, the Mayo brothers came to rely exclusively on a Catholic hospital, St. Mary's, even ttiough neither they nor the majority of their patients were Catholic. I see, ttot Denominational hospitals exemplified a broader pattern in American e him in society. In some countries, where eultural divisions run much deeper han usual than in the IJnited States, the various groups create separate institutions omething to meet a broad range of social needs. The Dutch call this phenomenon rehensile oerzuiling, or "pillarization," evoking the image of independent pillars efore . . . iom I lrad supporting a common roof. "Each denominational bloc," writes Johan ,ir ghostly Goudsblorn about the Netherlands, "has set up a whole array of organi- ey emer- zations encompassing practically every sphere of social life. Schools and universities, radio and television corporations, trade unions, health and wclfare agencies, sports associations, and so on, all fit into the zuilen hnic and system."'u This pattern of "segmented integration" has developed only onsoring partially in America. Protestants, as by far the largest group, have gen- es for in- orally felt little need to define their institutions on religious lines; the ors were denominations that do build their own schools and hospitals tend to be ttend pa- those that see themselves as deeply at odds with the dorninant cialture. ercd,the Among the rnajor religious groups, only Catholies have organized an and reli- Frl rborate network of separate instltufions-schools, colleges, hospitals, part of a ?Onununity associations. Blacks, too, have created separate institutions, xccessive st in the South, but perhaps more out of necessity than desire. Jews go to an avc been morc eager to join the common institutions of the society estigious tban to build their own. In education, for exanrple, Jews have generally nost cer- naliorre.d to remain within the established system at all levels (the first

Appx.452 A Sovereign Profession

Jewish university, Brandeis, was formed only after the Second World 1937, War).^ Jews made an exception of hospitals-every Jewish community capac of any size built its own hospital, often much larger than ttie community some required-possibly because of the special place that medicine occupied 8o pe in Jewish aspirations. Medicine was thought the ideal career for Jews or pa because of the professional autononiy of private practice, which rnade geon it possrble to e,cape n.ost institutional •ant:se;n:t:sm. But because of the discriniination in hospitals, special Jewistr institutions had to be estab- Th lished to supply positions as house, attending, and eonsulting physicians. Nevertheless, in the long run, ttre assimilationist pattern prevailed. WI Many of the Jewish hospitals later became major teaching and research multi institutions and fell into the orbit of inedical schools. In a sense, the as- trial similation and upward mobility of Jewish hospitals parallcled the larger thern experience of the Jewish cominunity in America. was : Cultural heterogeneity Iras been one ofthe chief factors inhibiting Ainei consolidation of hospitals in a state-run system. Ethnic and religious impo groups have wanted to protect their own separate interests. For the perfc upper-class Protestants, voluntarism offered a way to exercise direct zatio control without the mediation of state and local governrnents, which ernpl inimigrant groups began to influence in the later nineteenth century. one For the ethnic communities of lower status, private sponsorship offered been a defense against discriniination. In culturally hoinogeneous societies, need the administration of hospitals seems to gravitate sooner or later to the can t state. In a cross-national study of hospitals, Williarn Glaser found that natic in all countries with one prevalent religion, hospitals were run by the upor government. Even where hospitals originated as religious organiza- than tions, the church had found the expense of running them too irksome [mirt and had chosen to use its resources for activities that more directly af- owu fected religious observance and belief. But where competition existed ing, among religious groups, they retained control of hospitals lo protect Cpnd and extend their sphere of influence. As a general proposition, Glaser t[ton suggested that the greater the nun7ber of religions in a society, the more phys diffused the ownership and management of hospitals and the smaller ni4d thto^ their average size.6" V That there were too many small hospitals in Amerioa was a conrplaint hc+rs already being heard soon after rgoo, and it became a steady part of criti- tlolo cism of the hospital system. "If many hospitals in each city could pool ttitik their interests," wrote a hospital superintendent in rgrr, "the result n(µti would be greater efliciency and greater economy-and yet nothing is more unlikely than that independent, privately controlled hospitals will pool interests," Especially after the Depression began in 1929, private hospitals faced serious underutilization. A medical school professor in

Appx. 4 5 3 The Reconstitution of the Hospital

1987, noting the large rmrnber of hospitals in debt running at 5o percent Id capacity, suggested that their financial troubles could be alleviated if ty some hospitals closed, raising the occupancy rates of the rest to 75 or ty 8o percent. "The trouble, of course, is that the hospitals are sectariarr, -d or partially endowed, or are run for the individual benefit of some sur- Ns de geon or staff."e' he ib- The Peeuliar Bureaucracy ns. While eorporations at the end of the nineteenth century became A. multi-unit operations, hospitals remained at au earlier stage of indus- clr trial development because of the parochial interests that sustained them. Despite the possible advantages of integrated organization, none was achieved. 'I"he early efforts to reform hospitals rnounted by the American College of Surgeons had the goal of °standardizatioti": the ing irnposition of rninimurn requirements for medical record keeping, the Dus performance of autopsies, and various other aspects of hospital organi- the zation. Hospitals participated in such voluntary efforts partly to pre- ect empt demarrds for more thorough government regulation. Emulating ich one another, hospitals became more standardized than might have iry. been desirable, offering the same services regardless of the overall red needs of their communities. They came to present the familiar Ameri- :ies, can paradox of a systern of very great uniformity and very little coordi- the nation. The absence of integrated management made it incumbent liat upon individual hospitals to develop a more elaborate administration the than hospitals in other countries where administrative functions are dza- more centralized. In America each voluntary hospital had to raise its 3me own funds for capital expenditures, set its own fees, do its own purchas- p af- ing, recrnit staff, determine patients' ability to pay, collect bills, and sted conduct public relations efforts. All these activities required staff, .tect money, and space. At the same time, the American system of attending aser plrysicians also created demands for more administration. 'Phe stable rore medical staff typical of foreign hospitals can resolve many problems aller through face-to-face discussions. But in the United States, large numbers of practitioners circulate through the hospital at different times, laint delegating tasks to its employees and requiring niore coordination tta, criti- ru:ike thines run smoothly. Various internal responsibilities that in for- pool fga hospitals are controlled by powerful chiefs of service tall to aamrn- esult trtdors in American hospitals. Abroad, because of greater centraliza- ng is tion of functions in the society and greater decentralization within the s will soital, administrators have been weak in authority and low in status. ivate America, however, hospital administration became more rmpor au or in

Appx.454 The Reconstitution of the 11 A Sovereign Profe.ssion 178 hospitals by paying patients; the ri and prestigious because there was little centralization of fiinctions in tors depended in part on the resista the society and much within the hospital.' of tt e hospital system and full-tima So, paradoxically, as a result of the independence of both hospitals ticing in hospitals. These were the and doctors from higher bureaucratic authority, hospital administration but of a particular configuration c became professionalized more rapidly in America than it did else- While tlre general trend in the where. in i;urope hospital administrators generally had no professional more administrative eontrol and c degrees and were clearly subordinate in status and authority to the hospitals, they remain looscly ec leading clinicians. But in A*nerica physicians themsclves were attracted wbolc. Within the hospital, there i to hospital administration, and university degree programs in hospital of authority-trustees, physicians admiiiistration began in the 192os. in 1899 the adrninistrators had puzzle to students of formal orgat founded an Association of Hospital Superintendents, which in r9o8 know why the hospital departs fr changed its namc to the American Hospital Association; in 1933 the cracy in lacking a single, clear line Arnerican College of Hospital Administrators was formed. have wanted to know what the h Medical domination of hospitals began to wcaken in ttie thirties and miz.e profit. From the viewpoint c forties, as challenges from adrninistrators to the authority of physicians pital has been an anomaly. It see' became more common. Much of the mid-twentieth century American began as caretaking charities und sociological literature on hospitals reflects this development, emphasiz- Their reconstitution as centers o ing the split between "two lines of authority; " the clinical and adminis- vate prac:titioners anxious to gain trative, a much more salient issue in American hospitals because of the tioners were able to gain access somewhat stronger position of the administration. The two groups held needs of voluntary hospitals thai two different conceptions of ttie hospital. The private physicians contin- as a source of revenue. The inte ued to regard hospitals as "doctors' workshops," that is, as auxiliaries with those of different ethnic and to their office practices, while the administrators tended to see them tion of relatively small hospitals as "medical centers," serving tlie cominunity as the main coordinators the state. In turn, the absence o of health services. 'Phey frequently divided over administrators' efforts competition arnong hospitals, nic to expand outpatient care, increase rnedical researvh and education, more adniinistration. All of wh hire full-time physicians in specialized services, and add adrninistrative power, three centers of authorW. personnel to run those various activities.`" t<

Appx.455 The Reeonstitution of the Hospital ess•ion hospitals by paying patients; the rising influence of hospital administra- tions in tors depended in part on the resistance to both centralized coordination of the hospital system and full-time responsibilities for physicians prac- kospitals ticing in hospitals. These were the results, not of fuuctional necessities, istration but of a particular eonfiguration of interests. lid else- While the general trend in the twentieth century has been toward fessional more administrative control and more structure in the organization of y to the hospitals, they remain loosely coordinated, as does the system as a ,ttracted whole. Within the hospital, there continue to be three separate centers . hospital of authori'cy-rruscees, physicrans, a¢id admi:,istra 3rs-pcsu.g a g-eat tors had puzzle to students of fornial organizations. Sociologists have wanted to in 1908 know why the hospital departs froni the standard model of a bureau- 1933 the cracy in lacking a single, clear line of hierarchical authority. Economists have wanted to know what the hospital maximizes if it does not maxi- rties and niize profit. From the viewpoint of each discipline's paradigm, the hos- hysicians pital has been an anomaly. It seems much less so historically. Hospitals onerican began as caretaking charities under the sponsorship of wealthy patrons. niphasiz- Their reconstitution as centers of active medical treatment made pri- adminis- vate practitioners anxious to gain access to their precincts. The practi- rse of the tioners were able to gain access in America because of the financial ups held needs of voluntary hospitals that could not adequately draw on taxes ns contin- as a source of revenue. The interests of private practitioners, together iuxiliaries with those of different ethnic and religious groups, led to the multiplica- see them tion of relatively small hospitals and blocked their integration under )rdinators the state. In turn, the absence of integrated management led to more ns' efforts competition arnong hospitals, more emphasis on business functions, and ,ducation, more administration. All of whicli left, instead of a single governing inistrative power, three centers of authority held together in loose alliance. Hospi- tals retnained incompletely integrated, both as organizations and as a ias passed system of organizations-a case of blocked institutional development, he admin- a precapitalist inslitution radically changed in its functions and inoral changing identity but only partially transformed in its organizational st-ructure. ustees was This same pattern of blocked development was evident throughout ;ceptance. the medical system. h7tegrated organization was limited in public )lexity and Itcalth and ahnost cntirely absent froin what we now call "ambulatory" ird admin- eare. The rise of bureaucracy has been taken as an inexorable necessily ganization in modern life, but in America the medical profession escaped, or At ts virtually least postponed its capitulation. ig entirely g structure te growing -go part on ising use of

Appx.456