CHICAGO — Still recovering from Gov. Pat Quinn’s recent call for $2.7 billion in Medicaid cuts, not-for-profit hospitals in Illinois took a second blow last week when he lifted a six-month moratorium on stripping hospitals of their property tax-exemptions for failing to provide sufficient charity care.

A long debate over whether nonprofits provide enough charity care escalated last August when the Illinois Department of Revenue moved to deny exemption applications for three hospitals for providing charity care equal to just 1% to 2% of their operating revenues.

Hospitals — already strained by the demands of federal healthcare reform, dwindling state Medicaid reimbursements, and possible future federal Medicaid and Medicare cuts — said they couldn’t afford the potential loss of their property tax exemption.

Supporters of the crackdown counter that nonprofit hospitals are well paid for their services, like a private enterprise, and should do more to help those who cannot afford health care services to warrant their public perks.

Rating agency analysts warned that the action poses added credit risks for the Illinois hospital sector, and investors have said hospitals, especially lower-rated ones, face added interest costs. The state’s crackdown does not affect a hospital’s federal status that allows it to tap the tax-exempt bond market.

The three hospitals denied last year were Northwestern Memorial’s Prentice Women’s Hospital, Edward Health Services Corp.’s Naperville hospital and Decatur Memorial Hospital.

With another 20 hospital applications pending, the Democratic governor in September ordered the Revenue Department to hold off on any further actions until March 1 to allow for state and local officials and hospital representatives to engage in talks aimed at legislation setting charity care standards.

Discussions led by Quinn’s office began in January, but the deadline arrived with no solution in hand and Quinn late last week ordered the department to resume its reviews while talks on legislation continue.

“Today, Gov. Quinn instructed revenue director Brian Hamer to resume his decision-making process in regard to hospitals seeking property tax exemptions based on charity care. The director will continue to review and rule on applications in accordance with the Illinois Constitution,” according to a statement.

Quinn said he planned to convene a meeting of stakeholders this week to work on a legislative resolution.

The Illinois Hospital Association expressed concern that further Revenue Department rulings — which could come as soon as this month — would distract from the effort to reach an agreement.

“It is critical that we work together to craft a legislative solution this spring that establishes clear and reasonable standards for tax exemption and supports sound health-care policy,” IHA president Maryjane Wurth said in a statement. “Requiring nonprofit hospitals across the state to pay property taxes would undermine patients’ access to care, increase health care costs and damage an already fragile health care system.”

Cook County Board President Toni Preckwinkle said she was pleased with Quinn’s decision.

“This is an important public health issue that impacts many of our most vulnerable citizens,” her statement said, noting that the county directly provides millions of dollars every year for charity care at its county hospital.

The state crackdown heated up in 2006 when Illinois Attorney General Lisa Madigan sponsored legislation that would have required hospitals to provide charity care equal to 8% of their operating costs. The measure has stalled.

The issue drew renewed attention in 2010 when the Illinois Supreme Court upheld a 2006 Revenue Department ruling that the former Provena Health hospital [the system later merged with Resurrection Health Care and is now known as Presence Health] had not provided enough charity care to earn a property tax exemption.

The state had sided with the local county tax review board’s 2002 decision.

The fundamental argument is about what constitutes charity care. The state argued that community benefits such as free health screenings and wellness classes don’t count toward charity care, and the court’s justices agreed.

The court also rejected hospitals’ position that the difference between the cost of providing care to Medicaid and Medicare recipients and the amount reimbursed by the state and federal government should be counted.

The Illinois Hospital Association is calling for legislation that would broaden the definition of “charity care” services that are counted to keep their properties exempt from taxes.

The group also warns that as federal health care mandates on insurance take hold, hospitals could face a tougher road meeting higher charitable thresholds.

The IHA, in its annual charity care and community benefits report released in January, said Illinois’ 109 nonprofit hospitals provided $4.6 billion in charity care and community benefits in 2010, up 26% in five years.

The figure includes $561 million in free and discounted care, another $2.2 billion in under-compensated care through the Medicaid and Medicare programs, $445 million for physician education, $266 million to subsidize money-losing services such as trauma, emergency care, neonatal intensive care units and burn units, and $906 million for patients unable to pay their bills.

The information comes from annual reports that the hospitals submit to the state under the Illinois Community Benefits Act.

Moody’s Investors’ Service late last year warned that the government crackdown could pose a credit threat to the sector here by further eroding hospital balance sheets.

“It places additional financial constraints on not-for-profit hospitals requiring more expense reductions and process redesign,” said Moody’s analyst Carrie Sheffield, who authored the special report wrote.

Bank of America Merrill Lynch municipal analysts wrote in a commentary late last year that the muni market perceives weakness in the Illinois sector with a trading differential between health care credits in Illinois and health care bonds as a whole.

In a review of trades of $1 million and up in the third quarter, analysts said general market health care bonds traded at an average spread of 170 basis points while Illinois health care bonds saw a 210 basis point spread.

Morgan Keegan & Co. municipal analyst and managing director Mike Ross blames the interest rate and trading penalties on a combination of the charity care debate and Illinois’ reputation for slow reimbursement, which hurts hospital liquidity.

Ross’ colleague Andy Foust, vice president, said the differential is seen less with the larger health care systems or higher-rated credits that can better absorb the burden.

“I think where it really is impacting  institutional sellers is name-specific on the lower end of the credit spectrum,” Foust said

The review of property tax exemptions comes after Quinn during his fiscal 2013 budget address in February said lawmakers must shave $2.7 billion off Medicaid spending to keep the system solvent. The state anticipates closing fiscal 2012 in June with $1.9 billion in unpaid Medicaid vouchers.

The Chicago Civic Federation, a local group that analyzes local and state government spending and tax issues, issued a position statement last week urging legislation that sets “clear, definable standards” on the level and type of care that must be provided to be eligible for the exemption.

The federation recommends the state estimate a hospital’s tax bill and require that it provide charity care and certain community benefits in an amount equal to or greater than the tax break. The group believes the legislation should count some bad debt towards charity care.

Illinois currently doesn’t count bad debt as charity care if the patient doesn’t disclose his or her inability to pay at the time of treatment.

The federation also believes any legislation should take into account the affects of federal health care reform that will increase Medicaid eligibility and the number of insured, making it more difficult for hospitals to reach higher charity care levels.

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