The tax New Yorkers pay to train other states' doctors:

A fresh look at the $2.7 billion in subsidies given to New York's medical institutions

New York must soon decide the fate of the huge, one-of-a-kind taxes it imposes to subsidize hospital costs—including surcharges that extract almost three-quarters of a billion dollars every year from New Yorkers in order to train doctors for practice in other states.

This pending decision is already being portrayed in apocalyptic terms. Hospital unions and other interests have launched an expensive advertising campaign suggesting that any change in the taxes could almost These taxes were intended all along to provide a transitional subsidy — not a permanent one. mean the end of hospitals as we know them. The truth, of course, is more complicated. What's the background?

In 1996, after decades of government dominance that had helped make its health-care costs among the highest in the nation, New York State deregulated hospital rates. As a temporary measure to help hospitals cope with this change, the state adopted a total of $2.7 billion in health "surcharges"—taxes, and taxes on taxes—supporting costs that had previously been hidden in the state-set rates.

Whether these surcharges were fully necessary is still a subject of debate. But it is clear that hospitals have in fact made a reasonably successful transition to the deregulated environment. Reported hospital profits in the state jumped by more than $150 million in the very first year of deregulation, and hospital employment has grown, too. Meantime new funding sources have emerged for hospitals—including substantial federal aid that was not anticipated when New York's temporary surcharge taxes were adopted. Under existing law, New York's transitional health-care taxes are due to expire on December 31, 1999.

Hospital interests are insisting that these taxes must be renewed—or even increased. But a closer examination of the experience with the 1996 law suggests that instead, the surcharges need a very careful rethinking.

What the taxes are paying for

The surcharges adopted in 1996 help keep New York's cost of health care among the nation's highest; and by driving up the cost of health insurance they add to the ranks of those unable to afford insurance. Over $1.3 billion a year is added to the cost of the health insurance employers buy for their workers. Astonishingly, this is now, in effect, the second-largest business tax in New York State, exceeded only by the corporate franchise tax .

HCRA Surcharges Compared to Key Business Taxes
The rest of the $2.7 billion in costs comes from surcharges on health care financed by government (and hence it comes from the taxpayers; it is a tax on taxes). Most of this $2.7 billion total goes to fund two programs:

  • The largest share, $1.385 billion, subsidizes teaching hospitals—hospitals at which doctors who have earned their M.D.'s from medical school go through internship and residency programs in order to complete their training.

  • Most of the rest ($738 million) pays for "bad debt and charity care" in hospitals—that is, for the care of people who either could not or did not pay their bills.

The surcharges also finance the state's Child Health Plus insurance program for uninsured minors (currently $207 million), plus various other "public goods." This year these include $100 million for retraining hospital workers who supposedly faced layoff because of hospital deregulation (although in actuality there were minimal layoffs, and overall hospital employment is up by more than 5,000 in New York since deregulation took effect); $30 million for consultants and other services to help hospitals plan for deregulation; various grants to clinics and hospitals; and $82 million simply raided for the state budget.

And where the money comes from

The total of $2.7 billion is raised through a variety of different devices, with one feature in common: each device raises the cost of health care in New York State.

  • First, there is a statewide surcharge of 8.18 percent imposed on the costs of patient services delivered by hospitals, diagnostic and treatment centers and clinical laboratories, for all non-Medicaid and non-Medicare payers of health-care services—in other words, on all those who have health insurance (or who pay their own hospital bills). This raises about $666 million, which is mostly passed through via higher costs for health insurance.

  • Second, there is a surcharge on health insurance premiums, a so-called "covered lives" assessment. This is a surcharge on health insurance premiums, per employee or dependent, at a rate that varies depending upon the number and size of teaching hospitals in your region. This raises about $665 million a year—again, passed through in the form of higher health-insurance premiums.

  • Third, workers' comp and no-fault automobile insurance are surcharged by a total of $50 million.

  • The remaining $1.3 billion comes from surcharges on Medicaid—in other words, from the taxpayers.

How we got here

Peculiar as this system of surcharges may be, the system that went before it was even more so.

For 13 years New York State used an administrative process, under legislative guidelines, to set the price of every service at every hospital in the state. This process, known as NYPHRM (for "New York Prospective Hospital Reimbursement Methodology") was ostensibly intended to limit hospital costs. But the political log-rolling that inevitably goes along with a government-run system focused on meeting every hospital demand, not on reducing costs to patients, insurers and taxpayers.

Thus NYPHRM helped produce a bloated health-care system for New York in which overall costs are 22 percent above the national average, the cost of health insurance is about 25 percent above the national average, and only about 65 percent of hospital bed capacity is being used. And tucked away in the hospitals' rates, hidden from public view, was money to subsidize doctor training, bad debt and charity care, and other items.

Governor Pataki took office in 1995 and formed a task force to look into the possibility of a deregulated system, in which insurers and other payers would negotiate rates for hospital services—as was (and is) being done successfully in almost every other state.

The Governor won adoption of the deregulated system under the Health Care Reform Act (HCRA) in 1996, but only after a horrific fight over the dire consequences the hospitals said would flow from the loss of the formerly hidden subsidies.

In the end these hidden subsidies were cut by about $300 million, and brought out into the open through the use of the $2.7 billion in what are now called "HCRA surcharges." The act took effect on January 1, 1997, with the surcharges due to expire on December 31, 1999.

So what's the problem?

Health care is such an important concern—and New York's hospitals are such vital parts of their communities—that at first glance many people look at this system and say, in effect, "it's a bit goofy, but what's wrong with finding some way to subsidize medical education and charity care?"

It's a good question, but there's also a good answer. There should be a way to pay for these things—but this way costs too much, harms our state's economic competitiveness, and undermines efforts to improve the quality of health care.

The GME program

Let's look first at the subsidies for Graduate Medical Education—almost $1.385 billion extracted every year from employers ($594 million) and taxpayers (through Medicaid), and turned over to teaching hospitals.

Ostensibly this money helps pay the cost of the training provided to interns and residents in these hospitals. Many medical experts believe the presence of relatively low-paid interns and residents actually works to cut hospital costs, of course, so it's a matter of some debate whether a subsidy for the training per se is actually needed. In effect the GME program simply acts as a general subsidy for these hospitals.

No other state has a subsidy of this kind for its teaching hospitals, yet teaching hospitals thrive in those other states; Massachusetts General in Boston and Children's Hospital in Pittsburgh are among those that come to mind. Those programs survive because even in a deregulated environment, employers and insurers have agreed to pay higher rates at those institutions in return for the more advanced levels of care they offer. There is nothing unique about New York that would prevent such arrangements from developing here, once the forced subsidies end.

What is unique about New York, however, is the sheer volume of our graduate medical education business, which far exceeds the state's real needs for new physicians. With 6.8 percent of the nation's population, New York trains over 15 percent of its physicians, and half of these doctors leave the state after their training.

New York has more than twice as many resident physicians-in-training per capita as the national average (82 per 100,000, compared to 37 nationally, in 1997 figures). According to the American Medical Association, in 1997 New York had 14,841 residents in training; the next highest state was California, with 8,431. According to AMA data, New York trains 45 percent of New Jersey's doctors, 34 percent of Connecticut's, and 21 percent of Florida's—among others.

Table 1
Where The Doctors-in-Training Are
Number of Resident
Resident Physicians per
100,000 Population
NEW YORK 14,841 82
Massachusetts 4,264 70
Connecticut 1,801 55
Pennsylvania 6,484 54
Ohio 4,725 42
Vermont 226 39
New Jersey 2,507 32
U.S. overall 98,143 37
Source: Journal of the American Medical Association, Vol. 280 No. 9 (1998), p. 838

It bears repeating: New Yorkers are paying hefty sums to train doctors for other states. Given the $1.385 billion annual cost of the GME program, half of whose beneficiaries practice in other states, this little gift to New Jersey, Connecticut, Florida and the like is costing us about $700 million a year.

The hospital lobby argues that New York's GME spending is needed to attract research dollars from the National Institutes of Health. But more NIH dollars go to California ($1.66 billion) and Massachusetts ($1.17 billion) than to New York ($1.13 billion), without any GME surcharges at all in those two competing states.

It is particularly ironic that even with the lower numbers of physicians being trained in other states, the U.S. is considered to have a doctor surplus—one that is driving up health-care costs overall. To stem this problem Washington offered $400 million to 41 New York hospitals to reward them for training fewer doctors—at the very time that New York taxpayers are paying to train more.

Bad debt and charity

On its face, the subsidy provided for so-called bad debt and charity care seems less problematical than the flood of money being directed at doctor training. But upon examination there are reasons to question this program, as well.

Undoubtedly, as long as health-care costs remain so high that many New Yorkers cannot afford health insurance, some method of financing charity care will be necessary.

But the program now on the books is operated virtually as an unaudited slush fund, with no checks and balances to ensure that it is used only when necessary and appropriate.

Only about one-third of the $738 million allocated to this program is spent on health-care cases that hospitals classified as charity care at the outset; the rest is spent on "bad debt," cases where the patient's bill was not paid (or was not fully paid). No doubt some "bad debt" is owed by patients who could not pay if they wanted to—but surely not all of it. How hard do hospitals try to collect these bills before they turn to the tax fund? No statewide answer is available, because the use of these funds has not been audited in more than 10 years. But anecdotally, many hospital managers admit that the easy availability of the state money has made them lax in their collection efforts.

Times have changed

An additional consideration is that since these "transitional" subsidies for hospitals were adopted in 1996, the hospital industry has received repeated infusions of new cash from sources that were not anticipated at the time.

Governor Pataki announced in August that New York hospitals had been allocated $200 million in federal funds to assist them in the transition to managed-care coverage of Medicaid recipients. (This federal program will provide New York hospitals with a total of $1.25 billion over five years.) In October, Washington agreed to let New York hospitals keep $1 billion in disputed Medicare payments that the federal government had been trying to get back.

The state's Child Health Plus program, which previously covered only doctor bills, was extended in 1997 to pay hospital bills (removing a burden from the bad-debt and charity pool). In addition, the state has repealed its 0.7 percent tax on hospital gross receipts, saving the hospitals $154 million a year.

Costs have consequences

Finally, the $2.7 billion in subsidies is not some kind of "found money" that can be sent to hospitals without any impact on anybody else.

For employers and others who pay for health insurance, these surcharges account for as much as 11 percent of the cost of insurance—in effect requiring a "13th monthly premium payment" every year. The highest burden is in New York City, which has the heaviest density of teaching hospitals; but statewide the cost adds an average of $360 a year on the health insurance bill for a four-person family.

Higher health-insurance costs inevitably lead to fewer people having health insurance. New York has a higher proportion of its population uninsured than the national average, and that portion is growing.

For the whole health-care sector, it's a vicious cycle; subsidies to pay for things like bad debt drive up the cost of insurance, which means fewer people have insurance, which means more people can't pay their hospital bills.

Higher costs in New York also slow the state's economic growth, by making it more expensive for employers to add jobs here. And the heavy taxpayer cost of the HCRA subsidies is a significant factor in the state's excess state and local tax burden, another problem for our economy.

Table 2
Are New York's Hospitals Really About to Collapse?
Year Reported hospital profits* Hospital employment**
1991 (122,011,338) 317,500
1992 (150,605,509) 324,500
1993 (198,882,953) 329,000
1994 97,030,721 329,500
1995 380,597,985 331,800
1996 699,018,024 328,400
1997 $851,014,192 322,770
1998 (not available) 324,500
1999 (not available) 325,150
Sources: * State Health Department news release, Jan. 25, 1999.
** NYSDOL establishment data; annual average for 1991-98; average through
August for 1999.

What the hospital lobby says

In their advocacy for renewal or expansion of these HCRA surcharges, the hospital interests have rejected even a gradual phase-out or reform of the program. Their arguments are one part scorched earth, one part Chicken Little. Hospitals are vital, important and respected institutions in New York, but you would never know it from the cacophony.

Hospital unions have mounted overtly political campaigns vowing electoral vengeance against Governor Pataki or any other elected official who shows any willingness to rethink even part of these "temporary" taxes. They make not-so-veiled threats of consumer boycotts or other actions against any employer who wishes out loud for lower health-care costs.

The hospital lobbies, meanwhile, issue one round after another of proclamations that the sky is falling and New York hospitals are doomed. Their most flamboyant rhetorician, Kenneth Raske of the Greater New York Hospital Association, has an unbroken 10-year-record of predicting disaster at every turn, on HCRA and every other hospital finance issue. "We're facing the financial dismantling in one or two years of institutions that took 120 years to build," he declared in 1989. In 1991: "We will try to stave off the death blows." In 1993: "If these cuts were to be made, it would deal a devastating blow to many New York hospitals, especially those caring for the poor and the elderly." In 1995: "A nightmare for hospitals." Earlier this year: "You're going to see massive service cutbacks."

The news media dutifully cover these dire pronouncements, but they have been somewhat less dutiful in checking back to see whether any of them came true. As it happens, hospital employment in New York in August 1999 (the most recent month for which figures are available) was up 5,200, or 1.6 percent, from January 1997, when HCRA took effect.

The way out of this problem

The decision New York faces with the expiration of the HCRA surcharges in December is not the first tough decision the state has confronted in hospital financing, and it will not be the last. Political threats and Chicken Little posturing to one side, a reasonable solution is within sight.

New York's hospitals can make a successful transition to a system in which doctor training costs are negotiated with payers, rather than mandated by the state—just as they have already made a successful transition to a system in which the rest of their rates are negotiated.

And if taxpayer support is needed for charity care, New York can afford it—provided we know that this, and only this, is really what we're paying for.