Nonprofit Regulation and Earnings Distribution

The good thing about hospitals, even more than colleges and universities or churches,  is that they provide the perfect laboratory to study all sorts of issues effecting tax exemption.  They are every purpose, typically, wrapped into one.  Scientific research, charity in the classic sense when they actually give away health care, education, and health care responsive to community needs supposedly without regard to profitability, the whole nine.  They are large and ubiquitous in big cities, but sometimes small and rare out in the country, they dispense something indispensable to life, they attract huge amounts of financial capital, they attract profit-takers and altruists simultaneously.  And they engage in political activity.  Its the collision of good works and show me the money.  So its not that I have a bone in my throat about nonprofit hospitals that makes me blog on them too much.  I try not to, lest people think nonprofit hospitals are representative of the entire civil sector.  Its just that if you want to know the tax [and more, antitrust and even bankruptcy] issues pertaining to civil society in general, study the issues pertaining to nonprofit hospitals in particular. 

Brian and Elena, out in Utah, finished collecting and analyzing some good data regarding (1) how nonprofits use profits they cannot distribute, and (2) how nonprofits use wages to effectuate profit distribution workarounds of the nondistribution constraint.  They use nonprofit hospitals for their context but I think their conclusions are useful throughout civil society:  

Abstract

Organizing as a nonprofit amplifies agency problems through limited ownership and restricted earnings distribution. We examine how these agency problems influence the distribution of economic profits by nonprofit hospitals, which dominate the population of tax-exempt organizations and account for a large fraction of the US economy. Using detailed hospital-level financial data, we find that nonprofit hospitals earn large economic profit. We also show that these hospitals hold five times more cash and 85% more retained earnings than for-profit hospitals. In addition, we document that general and administrative labor expenses are 60% larger, physician labor expenses are 32% larger, and expenses for drugs provided to patients are 31% larger for nonprofit hospitals. Finally, we find that nonprofit hospitals invest more in land improvements and buildings. The evidence suggests that nonprofit hospitals distribute economic profits through wages and capital expenditures.

None of us have time to stop, pause and download every new paper, but this one I think will provide some really good data analysis for most of the economic issues impacting nonprofits.  Here are the first two engaging paragraph.  

Nonprofit organizations must comply with federal and state regulations to enjoy relief from income taxation and gain access to tax-exempt bond financing and tax-subsidized revenue from charitable donations. Among these regulations is the stipulation that nonprofits cannot have shareholders or concentrated ownership with a financial interest in the firm. Instead nonprofits are typically monitored by a board of trustees with an obligation to the nonprofit’s mission, rather than to shareholders’ enrichment, and the constituents of a nonprofit organization are generally thought to be members of the community the nonprofit serves. The dispersed nature of the community and the lack of clear, direct oversight weakens typical governance controls. Moreover, to the extent that nonprofits earn economic profit, they are prevented from distributed earnings to controlling members of the organization, which heightens the typical agency problems of an organization. We consider whether these heightened agency problems and restricted earnings distribution result in earnings distribution to stakeholders through greater expenses and capital expenditures.

We explore the consequences of nonprofit organization within the context of hospitals. Nonprofit hospitals dominate the population of tax-exempt organizations, and nonprofit organization dominates the hospital industry: nonprofit hospitals hold 25% of aggregate retained earnings and earn 44% of aggregate net income within the tax-exempt sector. The industry is also highly profitable, which directly brings the earnings distribution restriction to bear: nonprofit and for-profit hospitals had, on average, $186 million and $50 million in retained earnings, respectively, in 2018. Finally, a natural comparison group exists with regard to governance and agency issues faced by nonprofit hospitals: for-profit hospitals. Despite differences in ownership and organizational structure, empirical evidence suggests that nonprofit hospitals behave like their for-profit counterparts, including in their pricing, efficiency, quality of care, and responses to competition (Duggan, 2000; Sloan, 2000; Dranove and Satterthwaite, 2000; Sloan et al., 2001; Duggan, 2002; Gaynor and Town, 2011).

darryll jones