The Hidden Reality Behind Social Impact Bonds

Hidden within President Obama’s proposed budget is a line item that attempts to start a new model for financing government controlled projects: Social Impact Bonds. So, what exactly are Social Impact Bonds? How much of the budget is allocated to this?  Will it actually work, or is it too good to be true?

First off, the Social Impact Bond is truly hidden within the budget proposal. The term “Social Impact Bond” does not even show up in the 200+ page budget proposal. The closet line item to have the word ‘social’ in it (besides Social Security) is the Social Innovation Fund. But, this is a program created in prior budgets of the Obama administration.

Social Impact Bonds are an idea copied from the United Kingdom.  The term used for Social Impact Bonds in the Obama proposed budget is “pay for success” bonds.  This phrasing hints at how Social Impact Bond attempts to work.

According to social investment firm Social Finance, “through a Social Impact Bond, private investment is used to pay for interventions, which are delivered by service providers with a proven track record. Financial returns to investors are made by the public sector on the basis of improved social outcomes. If outcomes do not improve, then investors do not recover their investment.”

In other words, private money is invested in a given social project.  If the project fails, the investor gets no money back.  If the project succeeds (by the predefined measures of social outcomes) the government pays the private investor a return. Companies similar to UK based Social Finance, such as US-based Nonprofit Finance Fund, would act as the middlemen offering such bonds.

Out of the $3.7 trillion budget, Obama’s proposed budget is calling for $100 milliion to be used for Social Impact Bonds.  That’s only 0.003% of the entire budget.  Sounds like a good deal?  Not quite.

What is the hidden realty behind the Social Impact Bond?

Let’s take a systems approach to understanding the biggest flaw of the Social Impact Bond program. We have to ask the question, where does the money funding the Social Impact Bond come from?  Obviously, it comes from the budget of the federal government.  Now, where does the federal government get the money for its budget?  It comes from taxpayer dollars.

This is where a Social Impact Bond starts to make no sense at all.  Here is a more concrete example.  Assume that a given program is successful in meeting its predefined measures.  The program was funded by a private investor.  The government now has to pay the private investor its profit, using taxpayer dollars.  Taxpayer dollars are explicitly going into private hands through the use of the Social Impact Bond.

On a side note, assume that a given program is bound for failure.  What investor would invest in something with no return?  One might as well donate money instead.

Don’t get me wrong.  The core idea of funding a program from a voluntary private individual is fine. In fact, all things being equal, that is the best way to go through the trial and error process of an enterprise.

The problem is when you or I are forced to pay a profit to that private individual via a tax. It is no longer a voluntary exchange.  Private profit provided by taxpayer dollars, is in itself not sustainable.

While the intentions of the Social Impact Bond may be for the benefit of the social side of sustainability, ironically, in the long run, it may not provide financial or economic sustainability.

Jonathan Mariano is an MBA candidate with the Presidio Graduate School in San Francisco, CA. His interests include the convergence between lean & green and pursuing free-market based sustainable solutions.