By Forrest Hill

With Republicans signing pledges not to raise taxes and the likelihood that increased government austerity is going to make matters worse for struggling Americans, the only way out of the current debacle may be to entice the wealthier member’s of our society to put their money to work for the good of the country.According to a report by JPMorgan, the need for social investing by the wealthy is acute because the scope of our social problems vastly overwhelms the ability of government and nonprofit organizations to finance solutions.

Wealthy American’s on average donate about 3.1% of their income to charitable causes, but much more is needed. To increase their level of financial commitment to forwarding the interests of our citizenry will take monetary incentives. Fortunately, there is a new investment vehicle being tested out called a Social Impact Bond, which could provide the incentives necessary to attract enough private capital to solve some our countries most egregious social problems.

What is a Social Impact Bond?

The UK investment firm, Social Finance, came up with the concept of Social Impact Bonds in 2009 as a scheme to fund large scale social innovation.

Social Impact Bonds enable governments to contract with private investors to provide funding for nonprofits working on long-term preventative programs that if successful would save taxpayers serious money. For example, if capital raised from the sale of a Social Impact Bond were used to funded ex-offender reentry programs that nationally reduced recidivism rates by 10%, state and federal governments could potentially save $3 to $5 billion per year.

Thus the taxpayers are happy because taxpayers save money and progressives are happy because reducing recidivism may would help reduce our overcrowded prison system brought on by the drug war and mass incarceration policies of the past 40 years.

Unfortunately, government is not particularly good at funding preventive programs that improve the welfare of society. That’s because the time frame for success of such programs are long while the time frame between elections is short. From a lawmaker’s perspective, supporting programs that promote health, reduce homelessness, incentive alternative energy production or help ex-offenders find jobs can be politically costly if they don’t pay off quickly (especially in today’s Fox hyper driven news cycle).

Social Impact Bonds can help overcome this problem by shifting the risk of funding long-term preventative and social benefit programs from government to private investors.

Here’s how they work. First the government contracts with a mission-driven financial organization (MDFO), such as Social finance, to fund solutions to some social problem (e.g. reducing high school dropout rates). On the basis of this contract, the MDFO issues Social Impact Bonds to raises capital from investors. The MDFO uses this capital to hire qualified social service providers (i.e. non-profits) that can deliver the services necessary to meet performance targets set by the government. If the social targets are met (e.g. high school dropout rates decline by 10%) the government repays investors their principal plus a financial return. The size of the return is dependent to the degree to which outcomes improve.

This is really a Win, Win, Win scenario. The government takes on no financial risk, mission driven financial organizations have the financial freedom to experiment with potential solutions to serious social/environmental issues, and the investor receives a return if the outcome successfully saves the government money.

Seven Advantages of Social Impact Bonds

In addition to encouraging the wealthy to invest in social solutions, there are a number of other benefits that make Social Impact Bonds a good idea. These include:

  1. Prioritizing Outcomes Over Ideology: Forces governments and social service providers to focus on funding projects with measurable results as opposed to ideologically driven programs.
  2. Scaling Back Bureaucracy: Eliminates the risk of funding unsuccessful programs for decades because measurements of program success are a fundamental component of the payment mechanism.
  3. Targeting Success: Ensures that government pays only for programs and services that deliver on its promised impact.
  4. Encouraging Greater Experimentation: Allows government funders to commit more resources to programs that are promising but are not yet proven.
  5. Accelerating innovation: Greatly speeds up the expansion of successful models since scaling up and evaluating a programs impact occur simultaneously.
  6. Helping End Gridlock: Potentially breaks down the budget stalemates in government that currently hinder investing in prevention.
  7. Reducing Taxpayer Risk: Transfers the risk of funding social programs from taxpayers to the private sector.

Are Liberal Critics Missing the Boat?

Not everyone is elated about the potential of Social Impact Bonds to solve social problems. Critics of this approach believe that its government’s responsibility to fund the public good and that commercializing this process will eventually jeopardize services that don’t actualize a monetary gain for taxpayers.

This argument, however, seems spurious as Social Impact Bonds don’t cut out government services. Instead, they target preventative solutions to reduce spending on programs that are often the result of massive bureaucratic inefficiencies. Such inefficiencies, such as programs that increase spending on prisons while decreasing spending on the rehabilitation of prisoners, arise from short-term political thinking, special interest lobbies and the fear of making a mistake with taxpayer’s money.

Many of us may feel that government has a moral duty to alleviate social injustice – especially those resulting from the institutional failures of our economic system. In reality, however, this approach has rarely worked because those in power have little incentive to pursue long-term creative policies. Social Impact Bonds offer a mechanism by which those with wealth (as well as those of us with more moderate means) can become part of the solution. Monetizing the social good may sound distasteful to some, but in the economic system we live in today, where most of the wealth is concentrated within a small percentage of the population, it may be the only chance we have for solving some of our most entrenched social and environmental problems.