Pay for Success: Separating Fact From Fear

Social impact bonds can offer government more bang for its buck.

In an era of tight budgets, finding innovative ways to fund social programs and improve the lives of Americans has become more important than ever. One strategy that has gained prominence in recent years is “pay for success.”

Also known as social impact bonds, pay for success aims to align government spending with targeted outcomes, such as lower recidivism rates or decreased homelessness, by raising capital from private or philanthropic sources to pay for a social program. If an independent evaluation shows that the program achieves those agreed-upon outcomes, the government repays the investor. If it falls short, investors take the loss.

Testing and implementation of the pay for success model are still in their infancy. Twelve pay for success projects are now active across the country—with dozens of jurisdictions exploring possible future initiatives—and results are just starting to come in.

Criticisms of the model are emerging as more and more projects launch. It is important to distinguish between legitimate concerns and less justified critiques.

Criticism #1: Pay for success projects ‘privatize’ public services

Pay for success finances programs delivered by a service provider—usually a nonprofit—using funding from a private or philanthropic investor. Some critics argue that this effectively outsources the government’s duty to provide public services.

In reality, government agencies at all levels contract with nonprofits all the time; a recent study estimates that they paid nonprofits $137 billion for services in 2012. Pay for success taps into this existing provider network but offers longer-term, upfront funding—then rigorously tracks whether providers’ services are really working. This focus on measuring the “bang” and not just the “buck” is a critical element of the model; right now, nonprofits raise funds for programming every year but are rarely on the hook for demonstrating the positive impact of their work. 

Criticism #2: Government should just pay for the social program outright

Some critics have asked why government would pursue pay for success instead of funding new programs directly. The reality is that tight fiscal environments in many areas have left little room to initiate or expand programs. When a traditional funding path is not possible, the model offers a funding source for  innovative preventive programs. It also transfers the risk of trying something new away from agencies, only requiring them to pay if a rigorous evaluation shows the program is successful. Government can then decide whether to fund the program in future budgets.

Also worth noting: pay for success is designed to complement existing public services. It should not be considered an alternative way to fund core government functions, such as policing and public education.

Criticism #3: Only investors benefit from the model

Other critics have argued that the real proponents of pay for success are the investors in the projects. This criticism is far off base. When a program has a positive impact, everyone benefits—especially the people it serves.

Both political parties recognize this fact. Pay for success has achieved remarkable bipartisan support in Congress—it is included in several recent bipartisan bills on education and workforce development—and has the backing of the Obama administration. This is no small feat given the partisan deadlock that afflicts Washington. Further, pay for success projects have been launched in states and cities with support from Democratic and Republican leadership. From geographies such as South Carolina to Santa Clara to Salt Lake City, the breadth of political will to launch PFS projects has been notable.

Criticism #4: Pay for success projects have high transaction costs

A final criticism is that pay for success projects can be lengthy and expensive to design, negotiate and evaluate. This concern is legitimate. At this time, these costs are generally covered by the investor, philanthropic grants, and/or the waiving of fees by some parties involved in the deal. But there is no guarantee that such support will continue.

With that said, these costs are a function of the model’s newness. The coordination and rigor required in pay for success deals pose unfamiliar legal and financial challenges that take time and thoughtfulness to untangle. These investments will likely decrease as the projects become more standardized.

In the end, time—and rigorous research—will tell whether the pay for success model delivers on its promise to better align government spending with the outcomes we would like to see for society. Already, pay for success is seeding critical conversations about measuring and improving the impact of social services. As part of this discussion, we should continue to carefully weigh where scrutiny of the model is most warranted.

Justin Milner is co-director of Urban Institute’s Pay for Success Initiative. Twitter: @jhmilner