James Repetti (Boston College) presents “”Private Equity, Health Calamity: How Our Tax Laws Aid Private Equity Investment in Hospitals and Nursing Homes” Today at Boston College Tax Policy Workshop

The social welfare impact of investments by Private Equity funds (PEs) in various sectors of our economy is mixed due to the significant debt imposed on PE target companies and the short investment horizon of PE funds.  The picture is much clearer with respect to PE investment in hospitals and nursing homes. Most empirical studies suggest that PE investments in hospitals and nursing homes significantly harm welfare. The debt incurred by the targets of PE acquisitions increases the risk of default. Excessive cost cutting measures in the health field threaten patient safety and increase patient mortality.

    Our tax system contains two features that aid PEs in purchasing hospitals and nursing homes. First, our tax system subsidizes the acquisition of hospitals and nursing homes by PEs from tax-exempt entities. Since tax-exempt entities are not taxed on gain from that sale, theory predicts, and empirical evidence suggests, that tax-exempt sellers are willing to sell hospitals for less than a taxable seller would. In effect, tax-exempt sellers are sharing the benefit of their exemptions with for-profit purchasers. Second, our tax system encourages large tax-exempt institutions, such as university endowments and private pension funds, to invest heavily in PE funds. PEs structure their funds and investments in target companies such that tax-exempts investing in PEs avoid recognizing taxable gain under the debt-financed rules that normally would tax such investors on their investments financed with debt. The current debt-financed rules do not look through to the debt incurred by targets in PE acquisitions Moreover, if the PE fund itself is incurring debt, the tax-exempt investor can avoid the debt-financed rules by investing in a corporation (the blocker) which in turn invests in the PE fund. Our current rules also do not look through the blocker. As a result, tax exempts are incentivized to invest in PEs because the PEs present a convenient way to leverage their investments and to incur additional risk without incurring tax liability.  These incentives might be appropriate if there were clear benefits from PEs. However, the harmful effects of PE in the health industry and the ambiguous results elsewhere do not justify these incentives. Thus, the article concludes that this tax incentive should be eliminated.

To prevent a tax-exempt seller of a hospital or nursing home from sharing its exemption with a for-profit buyer this article suggests that tax exempts selling their hospitals or nursing homes to for-profit purchasers, including to PE funds, should become taxable on the gain from the sale. This would enable the government to “recapture” a portion of the benefit previously provided to the tax-exempt sellers and would provide an incentive to seek out a charitable purchaser.

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