Social Impact Bonds: Rethinking Government Spending

Nels Johnson

Editor's note: We're thrilled to welcome Nels Johnson to our cast of contributors. Nels is a legislative advocate, a writer, and an activist who has worked on several recent campaigns in the region. More about Nels here.

It’s no secret that local government budgets have been shrinking since the Great Recession, much more so than states or the federal governments. As a city, Portland has struggled to pay the bills over the past few years and been forced to cut back positions and services, just like cities all across America. There’s a need to make long-term investments in things like infrastructure and education, but no money to do it. And even if there was money, it could be a tough sell to convince people that not only is a major project worthwhile, but that the government has the skills and capacity to deliver on time and on budget. We need to seriously rethink the way we raise and spend money on city government projects. There’s no more money for new projects and the old model of bonding and the current approach to funding creates barriers to innovation. Its time for a new approach, enter: social impact bonds.

As described in a recent article in The Economist, a social impact bond (SIB) is “an experimental financing method which connects financially-stressed municipalities with private investors to fund public projects at no initial cost to taxpayers.” Basically, private investors pay the costs of a new government program in the early years and then the government repays the investors if the program meets its goals, typically out of the budgetary savings that occur as a result of the program. Often, if the government program exceeds its goals, the private investors can earn bonuses. The payout typically comes from the government long-term budgetary savings resulting from the project. Not only does a SIB provide new revenue for the government, but it also provides an opportunity for private investment, thus creating jobs and more tax revenue for local governments.

The idea of social impact bonds is starting to catch on. Recently in New York City, Goldman Sachs invested $9.6 million over four years in a program designed to reduce re-incarceration rates among youth. The way it works is that if the re-incarceration rate among the youths involved in the program drops 10% at the end of four years, Goldman Sachs gets their money back. But if the re-incarceration rate drops even further, Goldman will make an even bigger profit. However, if the re-incarceration rate does not drop to 10%, then Goldman loses money. Make no mistake, Goldman Sachs isn’t investing in the program out of the goodness of their hearts, they’re investing because they believe in the quality of the program and believe they can make a profit off it. Imagine if Portland could create a model with reliable metrics for the structural long-term problems that ail us. We could not only solve a pressing problem, but we could make a serious investment into our future.

The Center for American Progress (CAP) argues that SIBs could revolutionize the way a local government spends money. CAP believes that SIBs will encourage innovation and provide greater accountability and creative flexibility for government projects. The thought being, if the government can’t demonstrate competent management and execution of a project, no private investor will be willing to plunk down money into a bond. Additionally, SIBs will also provide the desperately needed new revenue to tackle big, transformative projects like education or infrastructure that can take years to yield results.

SIBs aren’t without their critics. Some argue that a lot of what city governments do is basic maintenance and isn’t always easily reducible into metrics or definitive benchmarks. Governments provide a fundamentally different function from business and therefore can’t be measured against the same standards and metrics as businesses.

But lets just think for a moment about how this could play out in Portland. For instance, education advocates will say that one of the greatest indicators for whether or not a child succeeds in school is whether the child was exposed to early, pre-K childhood learning. According to the Children’s Institute, investment in early childhood education yields some of the greatest fiscal returns in public investment. For every dollar invested in early childhood education, there is nearly a $13 benefit through savings on future public expenditures related to social service and criminal justice costs. The problem is that it can take years to actually measure the positive results. In an age of chronic budget deficits and reductions, it’s hard to convince elected officials to look up from the current proverbial fire they’re fighting, to focus on long-term, preventative solutions like investing in early childhood education. SIBs would provide the necessary new revenue to make the long term investments in our children’s future that are needed to get back to stronger economic growth.

But most importantly, SIBs underscores a fundamental issue in local governance. Namely, how and why should the City spend money? What’s the right philosophy? What exactly is the role of local government? Is the City’s responsibility merely to focus on basic services and that doing so is the best way to encourage economic growth? Or should the City take more of an activist role, investing in projects or ideas that tackle our biggest structural problems like fixing education and long-term infrastructure projects. A candidate’s answer this question will shed light on how he will govern in City Hall. The next mayor is will have to find a creative way to tackle not just the short-term budgetary problems, but the long-term ones too. Social impact bonds may just be the way to do it.

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    If there were SIBs implemented, there likely would be some sort of return on investment back to those private investors.

    What would be a fair tax rate on those investment returns, if any?

    Tom, as to 70% for a top rate (or pick any other tax rate), any data to support whether that is fair or unfair? At what income levels would the tax rates kick in?

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      Look to history. From 1936 through 1981, the top bracket was 70-94%. Kick in level varied. $1 million seems a good starting point for discussion.

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      It was during the post-WWII era (through the '60s) that the US had both the highest tax rates in its history and the broadest middle class.

      Now we have the lowest tax rates and the worst economy since the Depression.

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    Welcome to BlueOregon, Nels!

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    Glad to read about your brilliant mind and sincere passion as a contributor, Nels. This proposal reminds me of the B-Corporation format, creating new social and environmental standards for business performance. It's a great way to incentivize social uplift, while working with instituions that are often associated with the root of the issue. I hope to see SIB's beginning to tackle the boondoggle we still face in the Oregon healthcare industry, increase preventative care that will lead to a strong and healthy workforce.

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    I like the general idea and you rightly identify early childhood education as a priority for additional public investments but the reasons many of these problems are “structural” is that existing political special interests have blocked change or grabbed any additional public investment. These existing political special interests (in the educational context think teachers’ and faculty unions, higher ed students and alumni, and others) are likely to game the political process of creating SIB to their advantage. Hypothetically, SIBs might work. In real world politics, I doubt it. Politically, even with new funds SIBs might bring, it is going to be difficult to shift priorities from K-12 and higher ed to early childhood education.

    Right now Oregon could save money in its K-12 education system by offering more online courses for high school students. Structurally, the teachers’ unions do like the idea and would, predictable, say it could not be done in a cost-saving way. This would be ideal for an experimental SIB, but politics would kill it before it is even imagined.

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    SIB's are an interesting idea and I thank you for bringing them to people's attention. A couple thoughts though...

    • How do you get a metric that's broad enough to matter (re-incarceration rate) and that also ties back to a specific program and filters out other influences such as demographic shifts or changes in the economy? Academics spend careers fighting over this stuff, how likely is a partnership between government and wall street to get it right? (and note only one of the parties has incentive to get it right)

    • How do we properly allocate the cost of a social investment? Sticking with jail, who would pay off a bond that invested in reducing recidivism in Portland? The city of Portland? Multnomah County? State of Oregon?

    • On a fundamental level, I think SIB's are predicated on the idea that foreign investors are better suited to judge the efficacy of our public spending than we are. That notion ought to be accompanied by a pretty big grain of salt.

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      Great thoughts.

      With regards to your first two points, the trick is finding projects that allow you to quantify success. Look at the early childhood education as an example. You can measure success by looking at any number of metrics, from graduation rates to the reduction in need for social services and criminal justice services. You then need to build an equation that allows you exclude other variables in a reduction in need of the government services. Also, something like this could take yerars or even a decade or two to really determine whether it was a successful program or not. It has the potential of being a really long-term investment.

      With regards to who ought to judge the efficacy of our public spending, its true, that private investors are the ones the pony up the capital to achieve the product. But going back to the Goldman Sachs example mentioned above, not only to they get a great return on their investment, but they also get great PR. Plenty of the big things we need to tackle in Portland (e.g., public schools, housing, poverty, etc.) are goodwill projects that would bring any investor good PR for being involved. The trick for the government is finding a project that not only is needed, but one that has clear, identifiable goals that can be easily communicated to potential investors.

      SIBs are a potentially powerful tool, governments need to have a vision for the City when using them.

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        One of the big questions I'm trying to get at is that there's a shortage of government money, but our need for investment has never been greater. The fact that governments are strapped for cash is not an excuse to neglect critical spending for education, infrastructure and other needed investments.

        Because we need to make these key investments in our future, but don't have the moeny to do it, we need to think outside the box and think of new ways to make the critical investments that will keep our city and state great for generations to come.

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          Nels, thanks for your comments on social impact financing. I am a partner in Third Sector Capital out of Cambridge MA and we are now advising on 3 of the four mandated social impact proposed programs being assessed in the US . There is one juvenile justice proposed intervention and one homelessness proposed intervention in Massachusetts. Cuyahoga County in Ohio is evaluating what can be several viable Pay for Success Programs.

          Traditionally, philanthropic investors have contributed vast sums of money to social service programs, but measuring results for those investments has been challenging. Data integration for social programs has improved measurably and some social programs can be scaled and measured for their outcomes to attract the same philanthropic investors and other new investors. Some investors don't need a return, but will want to leverage more investment dollars if they can see results for what they contribute and can even get paid back in some deals via government savings from the outcomes achieved when programs are scaled in size.

          Our goal is to build sustainability on these projects so that investors actually want to reinvest their capital to enable scaling of the chosen social services program. Lets' help Portland and Oregon consider best options.

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          Thanks for the response. If you're looking for projects to try this on consider the proposed med-mal reform. If that flies, I expect it will require substantial up front investment by whatever providers participate.

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    Hey Kids, what time is it? It is time to review what has happened since Ronald Reagan began the process which we can refer to as the financialization of the economy. Called trickle down or supply side the consequence has been to destroy a progressive income tax which gave an incentive for capital to be invested.

    Today, ninety thousand entities have off-shored thirty trillion dollars in cash equal to the combined GDP of Japan and the US combined.

    The level of fraud in banking is estimated at more than two trillion dollars per year. Recently, when Wachovia laundered four hundred billion dollars in drug money between 2004 and 2007 no one went to jail. They cut a deferred prosecution deal and paid a fine.

    So now the clever financial folks want to make some of their trillions legit. Since they have bought the political process why not own all the schools, roads libraries, bridges and social security and all public land.

    So please, oh wizzards of financial modernization tell me what is a performance goal? Clearly, there is none that would ssatisfy we who have worked and saved and had forty percent of our net worth stolen by the banksters. It is pointless to ask, "Get real." It is not going to happen. So instead why not ask your congress critters to demand that they have a vote on the International Bank of Settlements which President Obama has quietly approved. And no one is talking about it. This is the next step to a loss of the dollar as a currency and the US losing its standing as a free country. But there is no hope. Not under the current political climate that is thirlled to discuss Todd Aikin.

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    SIB's sound like a really innovative way to approach the problem of trying to raise money to support community schools in Washington County. SUN Schools are an example--they receive support from the Portland Children's Initiative.
    The Wash. Co. Children's Opportunity Fund Initiative has been looking SIB's and have found that: 1. SIB's simply postpone government payment for a prevention or intervention activity -- and at a higher cost since interest needs to be paid. 2. Objectives must be quantified and specific to the program. As was pointed out by an earlier comment, researchers constantly struggle to determine causality. Most outcomes involving people are complicated by multiple influences. Although community schools have been shown to be effective in promoting possitive youth development, other influences can also be important such as parents, schools, the neighborhood, nutrition, exercise, health, etc. Separating out the causes can be difficult and evaluation is expensive. 3. Outcomes must be relatively short-term to satisfy investors. When we talk about prevention involving kids, the outcomes can be 5-20 years off!

    The successful SIB programs that we have heard about have involved returning former prisoners to society or juvenile justice interventions. These programs are for a limited time and a specific intervention.

    Our group has asked Ted Wheeler, State Treasurer, to look into SIB's as a possible mechanism for funding prevention programs. However, for the reasons stated above, we are not optimistic that they are a viable strategy.

    We need to have financing for programs that prevent entry into crime in the first place--after school, summer activities, mentoring, etc. Funding has been cut back on these programs even though they pay off in the long run in terms of improved graduation rates, employment, and community participation. Our group is currently seeking funds to mount a survey and educational program in Washington County to develop support. All tax deductible contributions can be made through Impact Northwest.

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    I also serve on the Children's Opportunity Fund Committee with Katie Riley. What I like most about SIB's is that large foundations can use them as a positive form of investment for their portfolios. When they are used to solve a systemic problem that will save a government entity money over the term of the bond, the investor(s) get their money back with interest because the change saved money.

    I really hope we can figure out a way to save over the long-term on supports for school success. Not there yet, but we'll take ideas and do our homework.

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