Bay State Takes Lead in Innovation Finance

Massachusetts Aims to Be First State with “Pay for Success” Bonds

SOURCE: AP/Steven Senne

Massachusetts Gov. Deval Patrick announced last week that his state intends to be the first in the nation to implement so-called “pay for success” bonds.

By Kristina Costa | May 11, 2011

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Gov. Deval Patrick of Massachusetts announced last week that the Bay State intends to be the first in the nation to implement so-called “pay for success” bonds. These innovative financing tools enable governments to fund programs that produce results rather than simply promising them.

A pay-for-success bond (also known as a social impact bond) works like this. A government agency decides what outcomes it wants to accomplish (such as keeping people drug-free or out of jail), and then it does a deal with a nongovernmental intermediary to pay only if the outcome is achieved. The intermediary raises money from private investors such as foundations and uses it to hire service providers who work to achieve the desired outcome. The intermediary will work hard to manage the performance of its service providers to ensure the outcome is achieved. But if the approach fails to accomplish the outcomes agreed on with the government, then the intermediary receives nothing, its investors lose their money, and taxpayers are off the hook.

The Center for American Progress earlier this year published a report, “Social Impact Bonds: A Promising New Financing Model to Accelerate Social Innovation and Improve Government Performance,” by Harvard University public policy professor Jeffery Liebman, which detailed how social impact bonds work and their potential applications. The concept is also included in President Barack Obama’s 2012 budget proposal, which calls for $100 million to support “pay for success” pilot programs such as that being developed in Massachusetts.

In the grand scheme of the federal budget, this is not a deficit-busting proposal. But a small amount of federal money could catalyze a revolution in public finance.

Massachusetts has only taken the very first step toward implementing pay-for-success bonds. Last Friday’s announcement did not detail the areas in which Bay State social impact bonds would be used, but identified homelessness and public safety as targets.

The Massachusetts experiment could resemble the first pay-for-success trial currently under way in Peterborough, England (highlighted by CAP’s Doing What Works project last November). In Massachusetts’s announcement last week, the state pointed to the Peterborough pilot, where government funding is contingent on reducing the rate of recidivism by at least 10 percent. If the approach works, the British government will release up to $20 million. If the approach does not work, government keeps its money.

Admittedly, there are a lot of unknown elements at play here. Pay-for-success programs remain unproven, and it’s unclear whether Congress will fund the president’s $100 million request. Still, the Massachusetts pilot is important because it could encourage other states and American cities to experiment with pay-for-success bonds.

“If this model is proven to work, such experimental philanthropy might be viewed as the venture capital of an era of social innovation,” wrote social entrepreneur Jonathan Greenblatt in the Huffington Post this week. “Buckle up—it should be quite a ride.”

Kristina Costa is a Special Assistant at the Center for American Progress.