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The Coming Battle Between Nonprofits and Government

Dan Caplinger
September 6, 2012

In an economy where local governments are stretched to the financial breaking point, officials are looking for ways to boost tax revenue. Increasingly, one set of institutions that has largely gone unnoticed in the tax debate has become a high-profile target for tax hikes: nonprofit charitable institutions.

An August 2012 publication from the Urban Institute Center on Nonprofits and Philanthropy, which examined in detail the huge impact that large nonprofit institutions like universities and hospitals can have on the local community, makes the specter of taxation loom even larger.

Are nonprofits not paying their fair share?
As the Urban Institute paper notes, large nonprofits that are exempt from taxation present a huge challenge to municipalities. On one hand, they often represent a huge economic opportunity for a city or town, especially in small towns that rely almost exclusively on a college or hospital for their citizens' employment and income.

Yet those benefits don't come free. Having thousands of students can put a huge burden on traditional city services like police and utilities, yet when universities aren't subject to property taxes on the buildings and land they own, other town taxpayers can get left footing the bill.

The issue isn't limited to small towns. Philadelphia has more than 10% of its total property value owned by nonprofits, while a host of other cities, including Boston, New York City, and Denver, weigh in at more than 5%. With so much of their tax bases exempt from property tax, these cities face challenges to stay in healthy financial condition.

Moreover, some argue that nonprofits have an unfair advantage over for-profit businesses providing similar services. For instance, Apollo Group (Nasdaq: APOL  ) , DeVry (NYSE: DV  ) , and other for-profit colleges don't automatically get the same tax exemption that most nonprofit institutions of higher learning enjoy. Similarly, many hospitals are nonprofit, putting for-profit health facility companies HCA (NYSE: HCA  ) and Tenet Healthcare (NYSE: THC  ) at a competitive disadvantage.

Making a preemptive strike
One solution that is gaining popularity involves getting big nonprofits to pay local taxes voluntarily. With "payments in lieu of tax" or PILOTs, a nonprofit institution negotiates with a municipality to come up with reasonable compensation for the services the local government provides.

One problem with PILOTs is that they tend to involve one-off solutions to a particular problem rather than a comprehensive policy intended to cover nonprofits broadly. But in Massachusetts, where these arrangements are much more common, the city of Boston has had a PILOT program in place for more than 85 years that currently generates about $15 million a year in extra property tax revenue. Although that amount is less than 1% of the city budget, smaller towns like Bristol, R.I., and Lebanon, N.H., get a much larger share of their budgets covered by PILOTs.