Most of the public anger over the cost of American health care in recent years has been directed toward Congress, the insurance companies, and the pharmaceutical companies - but the latest national health expenditure data shows hospitals are by far the biggest driver of increased health care costs. As a result of government payment, regulatory, and tax policies, hospitals have evolved into enormous integrated "health systems." Most of these systems are operated as tax-exempt non-profits despite vast commercial activities, eroding federal, state, and local tax bases. Bringing market discipline to bear on these systems is a long overdue frontier for federal tax and health care policy.
Hospital prices have been by far the fastest rising component of inflation over the last two decades, outpacing even university tuition, which is number two. What these sectors have in common is that they are dominated by non-profit, tax-exempt organizations that are not accountable to shareholders and susceptible to market pressures. They have high barriers to entry, and they are heavily subsidized with taxpayer dollars.
A recent report from the Paragon Institute debunks the myth that hospitals are in financial distress. They find that 2024 hospital operating profits averaged 6.4 percent and that many hospitals also had substantial investment income. Marginal profit on Medicare patients in particular was consistently positive, in the range of 5 to 8 percent, in recent years, and because Medicare pays hospitals much more for the same procedures than it pays independent doctors and surgical centers, there has been a massive government-induced provider consolidation in recent years. In 2024, 55 percent of all physicians in the country were employed by hospitals, compared to just 26 percent in 2012.
The consolidation of health systems creates a serious public choice problem, because they are now the largest employers in many if not most congressional and state legislative districts and they have substantially increased their lobbying spending. Last year's One Big Beautiful Bill Act was almost derailed over their opposition to even minor reductions in the rate of increase of Medicaid spending until a new hospital subsidy program was added to the bill. They spend heavily on sports sponsorships and other brand advertising to burnish their public image, all of which raises the question of what policy purpose is served by the tax-exempt status most of them enjoy.
An analysis by Scott Hodge, Roger Meiners, and Andrew Morriss in the ABA Tax Lawyer quantified the exemption. They found that a significant majority of the $2.5 trillion earned by 501(c)(3) organizations in 2019 was concentrated within a small number of large institutions. Specifically, nonprofit healthcare providers and insurers accounted for 55 percent of these revenues, while higher education institutions contributed another 12 percent. They found that non-profit hospitals do no more charity care than for-profit hospitals.
Integrated health systems often use tax-exempt status to acquire competitors in ways that would trigger massive taxes or antitrust scrutiny for taxable companies. Assets flow into these integrated systems and are shielded from the tax code forever, while independent, tax-paying competitors are slowly choked out because they can't match the subsidized cost of capital.
The Congressional Research Service reviewed the literature on the hospital tax exemption and found annual federal tax benefits of about $17 billion per year, on top of another $20 billion in state and local benefits. These are revenues that could be recaptured in tax reform. Perhaps even more significantly, ending these exemptions - along with reforms to reverse the policy causes of overconsolidation - could create real competition, choice, and market discipline. Poorly run hospitals could be forced to answer to shareholders and improve their operations or lose market share, rather than just appealing to politicians for more subsidies.
The idea that some sectors are so important that they should be non-profit is exactly backwards: the profit-motive is the single best mechanism for allocating resources yet discovered. Congress has already taken baby steps on the other giant tax-exempt sectors with a university endowment tax. The next frontier for federal tax reform should be to reconsider hospital tax exemption, and the rest of the federal policies that have contributed to growth of integrated health systems and attendant sharp rise in prices.
Phil Kerpen is president of American Commitment and principal of Unleash Prosperity.
Tomas J. Philipson is the Daniel Levin Professor of Public Policy Emeritus at the University of Chicago, a former member and acting chairman of the White House’s Council of Economic Advisers, 2017–20, and a senior fellow at Unleash Prosperity.
They are co-chairmen of the Most Favored Patient health care reform initiative.
