Social Impact Bonds: Private Capital for Public Services?

In times of financial belt-tightening, social programs are often the first to find their budgets significantly reduced. These budget reductions are often justified by the belief that social welfare programs are just not a good value for governments—in some cases, these programs can receive funding for years before an evaluation reveals an unsuccessful program model. However, in the wake of the Great Recession, policymakers have been paying more attention to an idea which funds social programs, traditionally paid for by taxpayers, through private investors. If the program fails, the investors lose their investment; but if the program succeeds, the investors get their money back, and possibly more, from the government who has just bought a social program which has been proven effective.

This idea is known as Social Impact Bonds (SIB), or Pay for Success Bonds, which is a funding model which allows for private investment to fund social programs without risking taxpayer dollars. Although called “bonds,” these really operate more as venture capital operations.

Put simply, the process works by having private investors buy bonds from a bond issuing agency, which raises enough funds for the proposed social program. The program is then given certain agreed upon goals, and if the program meets or exceeds these goals then the government (through the bond-issuing agency) repays the investors—sometimes with a return on the investment, depending on the success of the program. However, if the program fails to meet these goals, the government does not have to pay the investors back, and taxpayers are spared picking up the bill of an inefficient social program.

Social Impact Bonds are currently being used in the United Kingdom, where a pilot SIB program has been set up to reduce the recidivism rates of inmates at the Peterborough Prison. To accomplish this goal, the Ministry of Justice sold £5 million in bonds to private investors, and if recidivism is reduced by 7.5% for six to eight years, the investors will see modest returns on their investment; if the recidivism rate is reduced even more, investors will see an even greater return. Overall, investors can earn a profit anywhere from 2.5% to 13% in their initial investments—or nothing if the program fails. So far about a year old, a report shows that researchers following the Peterborough program seem uncertain but optomistic about the eventual outcome. 

Domestically, SIBs have been generating interest at the federal, state, and local levels. The White House has already shown a strong interest, proposing an upcoming 2012 budget that allows up to $100 million in SIB pilots. Likewise, Massachusetts has been edging towards the implementation of SIB pilot programs, and at the local level, the mayors of New York and Baltimore have reportedly shown interest in SIB pilot projects.

For a more in-depth explanation on SIBs, see Jeffrey Liebman’s white paper (released by the Center for American Progress), which can be accessed here.

State Government Privatization Reform: Examining the States

The Reason Foundation is a California based public policy think tank that, among other policy issues, conducts research on state government privatization and examines the public-private partnership models of various state governments.  Recently they have released their Annual Privatization Report 2010: State Government Privatization.   The report is a great resource for exploring state initiatives aimed at reforming state government and privatizing state government functions as a way to decrease government spending.  The following are examples of the content within the Reason Foundation’s annual report.

New Jersey’s Privatization Task Force

The Report highlights New Jersey’s efforts to reform government privatization policies by creating the New Jersey Privatization Task Force, which was established by Executive Order 17 under Governor Christie.  The Task Force reported to the Governor in 2010 outlining  various recommendations and identifying privatization opportunities available to New Jersey’s state government.  One recommendation is that the Governor should make it an administration priority to make private sector competition the standard for all state agencies and the creation of a centralized privatization entity.  Other recommendations and privatization opportunities identified by the task force include state parks management, state psychiatric hospitals, vehicle fleet maintenance and management, performance based highway maintenance, state parking facilities, water, printing services, workers compensation claim processing, toll collection, vehicle emissions inspections, higher education facility maintenance, correctional food services, hospital debt collection, golf corse management and housing and construction code enforcement.  The report also highlights that some of these recommendations have already been implemented by Governor Christie and the New Jersey State Legislature.

The Privatization Task Force report is available here

Louisiana’s Commission on Streamlining Government

Louisiana has implemented broad government reform efforts to increase public private partnerships by establishing the Commission on Streamlining Government (CSG).  The objective of the Commission is to recommend reform efforts that will reduce the cost of government through privatization, downsizing, and creating a more efficient government.  Recommendations include creating a state spending limit, shifting state retirement plans to 401K style and to reform state education financing to student based budgeting.  The full report includes over 200 recommendations for privatizing, streamlining, and downsizing state government.

The report is available here.

Puerto Rico’s Privatization Program

The Reason Foundation notes that in 2009 Puerto Rico enacted a law that allows state government agencies to enter into public-private partnerships with firms for the design, construction, finance, and maintenance of public facilities.  Furthermore, the law created the Public Private Partnership Authority (PPPA) which is a separate entity responsible for identifying and monitoring public private contracts as well as the enforcement of their terms.

Arizona and the Privatization of State Parks

In Arizona there is a proposal that would allow the state to privatize state parks by leasing them to Recreation Resource Management, which is one of the largest private park oversight companies in the United States.  By leasing the state parks through public-private partnership contracts the state would be able to reduce the cost of managing parks during a time when they are threatened by budget cuts.  Other states considering this model  include New Jersey, Utah, California, Georgia, and Kentucky.

The Arizona State Park Foundation has released a report “Arizona State Park privatization and Efficiency Plan” which lays out how such a privatization scheme would work and addresses the policy and financial details of the plan.

Reason’s Notable Privatization Highlights

The Reason report goes on to discuss the privatization of alcohol regulation, the Illinois program for the private management of the state lottery, California’s (and the United State’s) first privately financed courthouse, the privatization of worker compensation programs, and the privatization of Economic Development Agencies.