Bad idea, some say: Should hospitals lose tax break?

State legislators are considering taking away a privilege that hospitals have zealously guarded: their tax-exempt status.

A proposal by Democrats in the N.C. Senate would force large nonprofit organizations to start paying some sales tax on purchases they make. Hospitals say that would cost them millions of dollars at a time when their budgets are already stretched thin by the economic recession and the rising number of uninsured patients.

"This will compromise our ability to take care of the most vulnerable," said Dr. John McConnell, the chief executive of Wake Forest University Baptist Medical Center.

Legislators, meanwhile, are grappling with their own financial crisis -- a projected $3.4 billion shortfall in the state budget. They say they are trying to overhaul the state's tax system to make it more stable and more fair.

"We're not trying to gore anybody's ox here in particular. But we're just saying we have got to have some help from all segments of our economy," said state Sen. David Hoyle, D-Gaston.

Hoyle is one of the primary architects of a large package of proposed tax changes that Democrats unveiled last week. In general, they are hoping to lower most tax rates while eliminating many tax deductions and expanding the range of goods and services that are taxed. The changes would generate $1.2 billion in new revenue over the next two years.

Different elements of the plan have already riled up various interest groups. The provision affecting hospitals promises to be one of the most controversial.

"You're going to have a lot of calls about it," Hoyle warned fellow legislators Wednesday.

Currently, hospitals are charged the regular sales tax -- 6.75 percent in most counties -- on all of their purchases, from office supplies to x-ray machines. But at the end of the year, the state gives each nonprofit hospital a refund for virtually all of the sales tax the hospital paid.

North Carolina has a few for-profit hospitals, most are nonprofit. They get their tax-exempt status because they provide "charity care" -- free care to patients who have no insurance and can't afford to pay their medical bills.

The Senate's proposal would, for the first time, limit the sales-tax exemption. It would put a $5 million cap on the annual sales-tax refund that a nonprofit organization can receive. Any sales tax that a nonprofit organization pays in excess of $5 million would have to come out of its own pocket.

The proposal applies to all nonprofit organizations, but in practice it would affect only the largest ones: mainly hospitals and possibly a few universities.

In Winston-Salem, the economy is largely dependent on the county's two major hospitals. Both would be affected by the cap on sales-tax refunds.

Baptist Hospital said that it received $8.3 million in sales-tax refunds last year. The Wake Forest University School of Medicine received an additional $5.3 million in sales-tax refunds.

Novant Health, which owns Forsyth Medical Center and eight other hospitals in North Carolina and South Carolina, said that it got $22 million in sales-tax refunds last year.

The Senate's tax plan calls for lowering the overall sales-tax rate -- so the hospitals' sales-tax bills would be expected to go down slightly. But they would still exceed the $5 million refund cap.

"The challenge that the Senate and state government has overall is how do you fill this big gap that they have?" said Jim Tobalski, a senior vice president at Novant. "I just think they miscalculated and they erred by looking at not-for-profit hospitals. We are already shouldering a large burden of the current economic crisis."

Tobalski said that Novant lost $187 million last year. A big reason for the loss is the growing number of uninsured and under-insured patients. Over the past two years, North Carolina had a 22.5 percent jump in the number of people without health insurance -- the biggest increase in the nation, according to the North Carolina Institute of Medicine.

Senate leaders said that it could be weeks before the Senate votes on the tax plan, and Hoyle said that the tax-refund proposal is not set in stone. But he said the state cannot afford to keep its current policy.

"We are asking everybody to put a little skin in the game," he said. "We can't continue to grant refunds in total to a lot of nonprofits."

The N.C. Hospital Association began lobbying against the proposal the moment that it learned of it last week.

The association estimates that capping sales-tax refunds would cost North Carolina hospitals $100 million a year. The association also worries that the proposal could set a dangerous precedent.

"The larger picture is that this begins to threaten not-for-profit tax-exempt status," said Don Dalton, a spokesman for the hospital association. "If you have a conditional tax exemption, then you don't have a tax exemption."

In Forsyth County, local officials have frequently expressed frustration that the major hospitals, which own so much property in the county, do not have to pay taxes like other businesses.

"Charity should be earned -- it shouldn't just be the nature of who you are, it should be what you do," said Pete Rodda, the county's tax assessor and collector. "I've always said that the property-tax exemptions, and in this case sales-tax exemptions, should be earned through their charity care."

Rodda said he is not sure if the two local hospitals fully "earn" their tax exemptions.

Baptist said it spent $41 million on charity care last year. Novant said it spent $116 million on charity care.

"If you try to chip away at tax exemptions, while the number of uninsured and the amount of charity care is almost doubling, those two factors create a crisis that I don't think anyone wants to imagine," Tobalski said.

■ James Romoser can be reached at 919-210-6794 or at jromoser@wsjournal.com.