Saturday, December 20, 2008
One of the perennial arguments regarding tax-exemption for nonprofit health care providers has centered on whether nonprofits provide "better" services in some way than for-profit providers. This question has been the subject of countless empirical studies which have provided largely mixed results depending on what exactly is being studied, by whom, and how. I have discussed some of the conflicting evidence in an article published in the Journal of Health Poliitics, Policy and Law (JHPPL, as it is widely known) in 2006 (Vol. 31, pages 623-642, available here, subscription required).
Now a new government rating of nursing homes is sure to add fuel to the fire. On Thursday, the Centers for Medicare and Medicaid Services released their first "star" ratings (from one to five stars) of nursing homes based on health inspection surveys, staffing information and quality-of-care measures. Individuals can view these ratings and the measures used in the rating system via the Medicare web site here.
As this report in today's Buffalo News indicates, the is no systematic difference in these ratings among nonprofit, for-profit and public facilities. The Buffalo News article notes that among the 81 nursing homes in western New York, the one-star (lowest-ranked) facilities included seven for-profit, four nonprofit and three public institutions, while the five-star (highest-ranked) facilities included seven for-profit, four nonprofit and one public operation.
As with all ranking systems, one can argue over the methodology, and some of those arguments are detailed in the Buffalo News story. Nevertheless, the fact that this first comprehensive rating of nursing homes found little to distinguish nonprofit facilities from for-profit ones is another data point in the debate over tax-exemption for nonprofit health care providers (although admittedly nursing homes provide many other services than just health care). If we're not getting better services from exempt nonprofits or more help for the poor (an issue of much debate with respect to hospitals, as the prior blog entry on Grassley's proposed legislation indicates), then just what ARE we getting?
Friday, December 19, 2008
What is the legal deal with the news regarding foreign donors to the Clinton Foundation? I am, of course, fully aware of the political hash being made by the media. The insinuation is that the donors, foreign and domestic, but foreign especially, are buying influence not making charitable contributions.
The potential for foreign donors to the Clinton foundation to create the appearance of conflicts of interest for Mrs. Clinton as she handles foreign policy matters was illustrated by Amar Singh, listed as giving between $1 million and $5 million. Mr. Singh is apparently a prominent Indian politician of that same name. In September, Mr. Singh visited Washington to lobby Congress to support a deal allowing India to obtain civilian nuclear fuel and technology from the United States. The deal was controversial because India has developed nuclear weapons but is not a party to the Nuclear Non-Proliferation Treaty. Mr. Singh met and posed for photographs with Mrs. Clinton, afterwards telling Indian reporters that Mrs. Clinton had assured him that Democrats would not block the deal. Congress approved the nuclear cooperation deal with India a few days later. Several other donors have connections to India — a potential foreign policy flashpoint because of tensions with Pakistan.Among them was Lakshmi Mittal, an Indian businessman — the fourth richest person in the world, according to Forbes — who made billions in the steel industry. Although he has long lived in London, Mr. Mittal, who donated from $1 million to $5 million, is also a board member of India’s second largest bank. In 2002, Mr. Mittal was involved in a British scandal when, shortly after making a large donation to the Labour Party, he gained the help of Prime Minister Tony Blair in his bid to convince Romania to sell him its state steel company.
All well and good for a couple of news cycles, I supposse. But most large donors to charities do it for some kind of quid pro quo anyway, even if we chose to think otherwise. In a few weeks, if not sooner, we will all sit down to watch "nonprofit" football bowl games sponsored by "nonadvertisers" who expect nothing in return (wink, wink!) The obvious speculative answer to the title question is that the foundation may be selling influence or access, not accepting donations. I suppose, then, that the foundation would be operating for a noncharitable purpose (selling lobbying services, for example) or conveying an improper private benefit. That is, if it could be proven that Bill and Hillary somehow do the bidding of the Saudi government, for example, in return for the huge donations that the Clinton Foundation is so adept at reeling in. Ah, so there is the rub. What, pray tell, does private benefit really mean. And when does a successful charity cross the line from charity to commercialism. Our intrepid co-editor, John C. has penned more than a few articles delving into these questions and why, if at all, we should be concerned. Alas, the deep structure of tax exempt law is still greek to most of us (except the people of Greece, to them it is American). It would be a shame, though, if all the good work the Clinton Foundation does (like making AIDS drugs affordable in third world countries) were to be somehow besmirched over a fake media generated controversy.
Seems pretty clear, at least by one case, that the Bernie Madoff (pictured below) ponzi scheme ought to generate some excise tax scrutiny. According to Bloomberg.com, Yeshiva University lost about $110 million in investments:
Most of the lost money was invested through hedge funds controlled by J. Ezra Merkin (pictured at top, second from left), who was a Yeshiva trustee and chairman of the investment committee, the spokesman, Bill Anderson, said today in a telephone interview. The losses left Yeshiva, a 122-year-old private school that combines academic and religious education, with an endowment of about $1.2 billion.
So let's see here. An influential member of the board of directors -- who serves as a member of the 501(c)(3)'s investment committee -- causes the charity to invest more than $100 million in that member's own investment firm. Let's just assume that the obviously lucrative fees paid by Yeshiva to its own board member's firms were reasonable. Still, I have argued elsewhere that tax law ought to recognize something called "joint venture private inurement."
One might legitimately conclude that the universe of private inurement violations is divided solely between strict accounting and incorporated pocketbook private inurement. Strict accounting private inurement, representing the literal form, is closest to the statutory language, and even incorporated pocketbook private inurement can be made to fit within the literal prohibition if one thinks of unrelated transactions benefiting insiders as distributions of earnings in kind, rather than of cash. Those two forms of private inurement seem to exhaust the means by which an insider might violate the prohibition. The universe, though, includes a third form of private inurement not contingent upon an unfair or unnecessary transaction. This final category, which I call "joint venture private inurement," can occur even though the entity pays or charges an appropriate amount and even though the transactions are entirely appropriate and necessary to the accomplishment of the tax-exempt purpose. Instead, the violation occurs because the operations of the tax-exempt entity and an insider-controlled taxable entity are so closely related that the insider, by virtue of his interest in the taxable entity, financially benefits from the exempt entity's invariable consumer power. The taxable and tax-exempt entities are engaged in an implicit joint venture. As such, the exempt entity purchases all of its necessary commodities solely from the insider's for-profit entities or otherwise conducts its affairs through an insider's profit-making apparatus. Although serving an exempt purpose, the entity necessarily subsidizes individual profit making. Through the use of his taxable entity as an intermediary, the insider manifests himself as a parasite draining a portion of the entity's tax-exempt lifeblood whenever the entity receives a tax-free infusion. There occurs a synonymity of wealth such that private inurement is justifiably found even in the absence of a bad quantitative transaction or a systematic looting of the entity's assets.
The Scintilla of Individual Profit: In Search of Private Inurement and Excess Benefit, 19 Va. Tax Rev. 620 - 622 2000). Here we have not just a member of a public charity's board, but the dadgum chair of the investment committee, investing a large portion of the tax exempt monies in his own investment firm! I am aware, of course, that traditional analysis prevents the occurrence of a private inurement or excess benefit transaction unless an insider is "skimming profits" and that the reasonableness of a payment logically precludes that conclusion. I am also aware of the argument that the private benefit doctrine might be the better rationale to apply in this case. The problem, of course, is that nobody knows what "private benefit" means. The historical articulation requires that the benefit to a noncharitable person be so large relative to the organization's benefit to charitable beneficiaries that we can conclude that the charity is not really achieving a charitable purpose at all. But that understanding is sufficient only when we are dealing with a contract between the organization and a stranger. When we are dealing with an organization and one of its fiduciaries, the doctrine is insufficient. When the organization deals with a stranger, the natural order of things means that there is little chance that some of the organization's funds will be skimmed off -- there is an opposing force (the charity itself) that limits the possibility. When the organization is engaged with its own fiduciary, the idea that a little private benefit is ok morphs into an almost inevitability. The insider who deals with himself on behalf of the organization ought to take a cut for himself (even if it is in the form of preferential award of an otherwise reasonable vendor or service contract) because the private benefit doctrine (as articulated above) allows it. What is to stop the insider from investing in his own investment firm at fair market rates?
The private inurement doctrine -- joint venture private inurement -- is better because it recognizes the inevitability of the conflict and eliminates the idea that we should balance the relatively insignificant harm to charitable beneficiaries (in this case $110 million) with the greater benefit to the charitable beneficiaries (however many billions Yeshiva spends on education and research). It also recognizes that the insider has ultimately skimmed just like any other vendor who might have more blatantly overcharged the organization. In this case, for example, an investment firm unrelated to the chairperson of the organization's investment comittee might very well have divested a long time ago when people started asking questions about the Madoff firm. We need a legal doctrine that prevents (or at least imposes certain process on) even fair market value transactions between a public charity and its own insider. I don't think the Exces Benefit Excise tax presently applies, but as we get out of the financial mess we are in, no doubt a whole host of regulaltions (or de-regulations) will be reconsidered. We ought to more precisely define private inurement and excess benefit to take into account this sort of self dealing in the public charity sector.
According to a report in the Wall Street Journal yesterday, Senator Charles Grassley is considering proposing legislation that would impose excise taxes on nonprofit hospitals that fail to provide a minimum level of charity care:
The legislation would require nonprofit hospitals to spend a minimum amount on free care for the poor, also known as charity care, and set curbs on executive compensation and conflicts of interest, according to staff members for Mr. Grassley, ranking Republican on the Senate Finance Committee. Under the new legislation, penalties would be imposed on nonprofit hospitals that fail to meet the new requirements, Sen. Grassley's aides said. The penalties could escalate from taxes and fines to stripping a hospital of its federal-tax exemption if it continues to misbehave, they say. Sen. Grassley is working on the proposed legislation with several Senate colleagues, including New Mexico Democrat Jeff Bingaman, and is hoping to capitalize on the momentum for health-care change in Washington. But he is likely to run into stiff resistance from the hospital industry's powerful lobby, making the chances that such a bill would pass difficult to handicap.
Needless to say, the voices of "big healthcare are none too thrilled with the idea:
Alicia Mitchell, a spokeswoman for the American Hospital Association, said such legislation would be premature given that nonprofit hospitals haven't had a chance to demonstrate their goodwill under new Internal Revenue Service reporting requirements. "Hospitals do more to assist the poor, the sick and the elderly than any other part of the health-care system," she said.
As I noted just a few days ago in "The Rich and Poor of Nonprofit Hospitals", it is not a good idea to impose a sort of "one size fits all" legislative mandate on any part of the nonprofit sector. On the other hand, tax laws must necessarily deal in generalities. Another point, of course, is that the poor nonprofit hospitals are poor precisely because they provide so much uncompensated care that any such legislation is probably no threat to them. And then finally, my cynical mind tells me that even the rich nonprofit hospitals will easily avoid any penalties under the tax by, ironically, paying more fees to their lawyers who are able to articulate even the most uncharitable expenditure as "charity care." Perhaps the only real solution is to better define and enforce the commerciaality doctrine so that nonprofit hospitals that evolve into for-profit empires eventually lose tax exempt status regardless of how good they are at dressing up profit centers as charity care.
Tuesday, December 16, 2008
Yesterday, we made reference to Bernard Madoff and his giant Ponzi scheme. Referring to the effects the scheme's collapse will most likely have on charities, we noted:
Many of [Madoff's] clients are also a main funding source for charities, acting as the key donors who provide large checks necessary to keep them running. Officials in the charity world said the effects would be felt for years, as donors curtail both current contributions and future commitments. "In the Jewish world, we've just taken a major, central player, and introduced fear and uncertainty all over the system. It's like finding out your brother is a murderer" said Gary Tobin, president of the Institute for Jewish and Community Research, which studies Jewish philanthropy. Dr. Tobin estimated the total amount of such giving in the U.S. to be as much as $5 billion annually. . . Two philanthropic trends over recent years made the fund-raising world -- both Jewish and non-Jewish -- particularly vulnerable to an investment scam. One is the rise in charitable endowments, as institutions moved away from the practice of distributing all the money they raised each year to beneficiaries and began to invest a portion of it. The second is the huge rise in family foundations, which typically have smaller advisory boards than larger charities and therefore may not get the same level of investing advice, philanthropic experts say.
The outlook for charities took a turn for the worse today as we discoverd that while some charities are bracing for reduced support from individuals and foundations that have seen their wealth wiped out or greatly reduced by Madoff's fraudulent acts, others -- like Yeshiva University and MorseLife Foundation, a nonprofit center for the elderly in West Palm Beach, Florida -- are actually counting their losses because they were themselves direct investors in Madoff's funds. In an open letter released on Monday, MorseLife acknowledged that it had invested with Madoff. According to a report in yesterday's Chronicle of Philantrophy, the MorseLife Foundation’s tax form for the year ending in May 2007 shows $59.1-million in assets, three-quarters of which were invested in “managed equity funds.” According to The Chronicle, a MorseLife spokesman has declined to say what percentage of the foundation’s assets were invested with Madoff. The Chronicle further reveals that nationwide, at least four foundations, including the JEHT Foundation and Arthur I. and Sydelle F. Meyer Charitable Foundation, in West Palm Beach, Florida, are closing as a result of being almost entirely invested in Madoff funds.
Only time will tell the true effects of the collapse of Madoff's Ponzi scheme.
The Doris Duke Charitable Foundation on Sunday announced that it has selected six mid-career physician-scientists to receive its 2008 Distinguished Clinical Scientist Awards. The awards provide recipients with $1.5 million each over five to seven years.
According to a press release from the Foundation, "The Distinguished Clinical Scientist Award recognizes outstanding leadership in clinical research and enables leading physician-scientists to continue bridging the crucial gap between biomedical research and clinical applications that improve human health." The release went on to state that the research aims proposed by the 2008 awardees "reflect the breadth of the work supported by the program, ranging from therapies for macular degeneration to recurrent gene fusions and translocations in a variety of tumors."
This year's awardees are: Sunil K. Ahuja, MD, University of Texas Health Science Center at San Antonio; Marcus Altfeld, MD, Ph.D., Massachusetts General Hospital/Harvard Medical School; Jayakrishna Ambati, MD, University of Kentucky College of Medicine; Arul M. Chinnaiyan, MD, Ph.D., University of Michigan; Terrie Inder, MD, Ph.D., Washington University in St. Louis/St. Louis Children’s Hospital; and Eric Vilian, MD, Ph.D., University of California, Los Angeles.
When I was a young ROTC "cadidiot" somebody was always yelling at me or my fellow cadets to "get your head out your ass!" In hindsight, it was a crude but effective admonition. Many foundation managers probably should have been subjected to the same advice. The advice is implicit, in more detail and legalese, in some of the private foundation excise taxes (such as IRC 4944, regarding jeopardizing investments). Somehow, I find it hard to feel sorry for the large wealthy foundations and other investors who appear to have lost billions in the "ponzi" scheme allegedly perpetrated by Bernard Madoff. As more and more information becomes available, it appears that the returns the Madoff firm was paying were always "too good to be true" and yet the uber rich foundations, university endowment funds, and individuals continued to pour money into what they "might shoulda known" was fishy! The harm, unfortunately, will no doubt be felt by the ordinary charities struggling on a daily basis to achieve extraordinary returns on a different level. So now is definitely not the time for righteous indignation. Funding for bone marrow transplant research, the innoccence project, death penalty appeals and a whole host of other important causes is apparently hanging in the balance.
As the press and government investigators begin to unravel it all, I can't help but wonder whether the case will serve as a teaching tool for the jeopardizing investment tax imposed under IRC 4944. The Wall Street Journal has published several articles, all of which suggest that the warning signs were all over the place but ignored because the "too good to be true" returns caused a bad case of "head in the sand (or other parts) amongst foundation managers. According to one such article:
Mr. Madoff was a central player in Manhattan's close-knit world of Jewish charities, serving both as a direct contributor and portfolio manager for individual foundations. Many of his clients are also a main funding source for charities, acting as the key donors who provide large checks necessary to keep them running. Officials in the charity world said the effects would be felt for years, as donors curtail both current contributions and future commitments. "In the Jewish world, we've just taken a major, central player, and introduced fear and uncertainty all over the system. It's like finding out your brother is a murderer" said Gary Tobin, president of the Institute for Jewish and Community Research, which studies Jewish philanthropy. Dr. Tobin estimated the total amount of such giving in the U.S. to be as much as $5 billion annually. . . Two philanthropic trends over recent years made the fund-raising world -- both Jewish and non-Jewish -- particularly vulnerable to an investment scam. One is the rise in charitable endowments, as institutions moved away from the practice of distributing all the money they raised each year to beneficiaries and began to invest a portion of it. The second is the huge rise in family foundations, which typically have smaller advisory boards than larger charities and therefore may not get the same level of investing advice, philanthropic experts say.
To see all of the Wall Street articles to date on the topic, go here. One article states that investment managers were simply dumb: "Here we have the biggest dirty secret of the "sophisticated investor": Due diligence often goes undone." I used to rail in my tax exempt organizations class against the "over legislation" I thought was so thoroughly exemplified by the private foundation excise tax statutes and regulations but this and other cases in both the profit and nonprofit worlds has pulled the rug out from under my righteous indignation. Now, unfortunately, I will have a pretty good case, setting aside the tragic consequences that will follow, to explain to my suffering students why the seemingly ridiculous detail of the excise taxes exist.
Monday, December 15, 2008
Many of the intellectuall fights in the nonprofit sector arise at the intersection of charity avenue and profit street -- aka, nonprofit hospitals and big university, respectively. Sometimes, the fights are resolved on the basis of an unfortunate or inaccurate caricature. The phrase, "nonprofit hospital," for example, conjures up images of pristine, well-lighted, luxurious waiting rooms, sorrounding the offices of very well-paid hospital executives, who direct the provision of services by equally well paid physicians who, in turn, are backed by a pack of collection agency hounds who will pick the bones of any poor patient who dares present herself without health insurance. But a Wall Street Journal article last week effectively depicts both the rich and poor amongst nonprofit hospitals:
While a number of nonprofit hospitals have grown into profit machines in recent years, some, like Mount Sinai, have stuck to their charitable mission but struggled financially. These institutions are usually located in inner cities and not anchored to big nonprofit systems, nor can they rely on government support the way county or state hospitals can. In return for exemption from local, state and federal taxes, nonprofit hospitals are expected to provide benefits to their community, including charity care for the poor. Surplus revenues are supposed to be channeled back into operations. Mount Sinai has teetered between a small net income and annual losses as high as $15 million over the past five years. While some large nonprofit hospitals have amassed billions of dollars in reserves, Mount Sinai's days of cash on hand -- a common gauge of a hospital's solvency -- is sometimes measured in hours. Mount Sinai's struggles reflect in part a paucity of government incentives for nonprofit hospitals to operate in inner cities. Earlier this decade, Illinois introduced a subsidy program to offset losses hospitals incur from accepting Medicaid, the government health-insurance plan for the poor, which often doesn't cover costs. Because of the way it is designed, the program makes higher payments to one of Chicago's richest nonprofit hospitals, University of Chicago Hospitals, than it does to Mount Sinai.
The article points out an interesting irony, perhaps present in other parts of the tax code, and no doubt documented in tax exemption scholarship. More than a few articles criticize tax exemption as both an inefficient and inequitable means of acquiring public goods (I am too lazy to find them now and, besides, I have exams that I should be grading instead). The irony is that the wealthiest charities receive the biggest tax subsidies under the present system. As anecdotal evidence, the article notes that Mount Sinai received lower payments than the University of Chicago Hospitals. No doubt, much important research happens at UC Hospitals, but that research is no more important than present day care for the poor amongst us right now.
My overall point, though, is that it is difficult to articulate a one size fits all rule of tax exemption, particularly with respect to a sector (such as the nonprofit world) that is comprised of both the rich and the poor.