Why “Pay for Success” Financing Could Cost Taxpayers More Than They Bargained For

Cash-strapped governments are increasingly turning to Wall Street to fund social services. Will the model be a Trojan horse for privatization?

Rachel M. Cohen May 30, 2017

Chicago Mayor Rahm Emanuel visits kindergarten students at the start of the 2013 school year. In 2013, the city reached a $17 million agreement with several investment banks to expand preschool using “Pay for Success” financing. (Scott Olson/ Getty Images)

With loom­ing pen­sion pay­ments and a bud­get deficit of $129 mil­l­lion, the Chica­go Pub­lic Schools (CPS) is in finan­cial tur­moil. Ear­li­er this spring, May­or Rahm Emanuel even hint­ed that CPS might be forced to end the school year three weeks ear­ly to save money.

Undergirded by narratives of wasteful government spending and market-driven accountability, a small group of philanthropists, financiers, and policy leaders have helped elevate the Pay for Success model quickly over the past few years.

Yet despite these finan­cial woes, Chicago’s school dis­trict recent­ly agreed to pay more than a mil­lion dol­lars to Gold­man Sachs and oth­er investors that front­ed funds for an ear­ly child­hood edu­ca­tion pro­gram, part of a social exper­i­ment known as Pay for Success.”

Under Pay for Suc­cess, described as an inno­v­a­tive financ­ing struc­ture,” pri­vate investors such as banks and foun­da­tions put up mon­ey for social pro­grams with mea­sur­able out­comes — for exam­ple, reduc­ing chron­ic home­less­ness by 200 indi­vid­u­als per year. If the pre­de­ter­mined goals are met, the gov­ern­ment will pay the investors back with interest.

Chicago’s Pay for Suc­cess project launched in 2014, and aims to improve stu­dents’ kinder­garten readi­ness, boost third grade lit­er­a­cy and reduce spe­cial edu­ca­tion ser­vices. Gold­man Sachs, North­ern Trust and the Pritzk­er Fam­i­ly Foun­da­tion invest­ed $16.9 mil­lion into the pro­gram, with the poten­tial to rough­ly dou­ble their invest­ment over the next 18 years. The bulk of those returns would come from reduc­ing spe­cial edu­ca­tion ser­vices for the 2,600 pro­gram par­tic­i­pants — about $9,100 per child.

Under­gird­ed by nar­ra­tives of waste­ful gov­ern­ment spend­ing and mar­ket-dri­ven account­abil­i­ty, a small group of phil­an­thropists, financiers, and pol­i­cy lead­ers have helped ele­vate the Pay for Suc­cess mod­el quick­ly over the past few years. State and local gov­ern­ments have launched 16 such projects across the U.S since 2012, tack­ling a range of issues from fos­ter care and edu­ca­tion, to crim­i­nal jus­tice and pub­lic health. Dozens more wait in the pipeline.

At its best, advo­cates say that Pay for Suc­cess could fos­ter greater gov­ern­ment account­abil­i­ty, fund need­ed pro­grams in cash-strapped polit­i­cal cli­mates and poten­tial­ly save the pub­lic mon­ey down the line. Inno­v­a­tive mod­els like Pay for Suc­cess … shift the risk of achiev­ing tar­get­ed out­comes away from the tax­pay­er and enabl[e] gov­ern­ments to pay only for what works,” said Andrea Phillips, the Vice Pres­i­dent of Gold­man Sachs’ Urban Invest­ment Group.

But at its worst, Pay for Suc­cess can leave tax­pay­ers pay­ing sub­stan­tial­ly more than if their gov­ern­ments had just fund­ed pro­grams direct­ly, cement nar­ra­tives of fis­cal aus­ter­i­ty and incen­tivize mis­guid­ed social outcomes.

The Trump admin­is­tra­tion has yet to embrace Pay for Suc­cess by name, and cut fund­ing for a sig­nif­i­cant Oba­ma-era pro­gram that pro­mot­ed the mod­el. Yet the under­ly­ing goals of Pay for Suc­cess — expand­ing pub­lic-pri­vate part­ner­ships to tack­le soci­etal ills — fit com­fort­ably with the new administration’s stat­ed pri­or­i­ties. Though some sup­port­ers have expressed con­cerns about Pay for Success’s future under Don­ald Trump, there’s strong evi­dence to sug­gest it will con­tin­ue to grow over the next four years, espe­cial­ly in the realm of education.

The roots of a new model

In 2010, the first Pay for Suc­cess project launched in the Unit­ed King­dom, a six-year pilot aimed to reduce recidi­vism from a prison in Peter­bor­ough. It was fund­ed by social impact bonds” and pro­mot­ed by Social Finance UK, a group that had formed three years pri­or by Ronald Cohen, a man dubbed the father of British ven­ture cap­i­tal.” Social Finance UK helped raise the upfront £5 mil­lion, most­ly from the phil­an­thropic sec­tor. (The Rock­e­feller Foun­da­tion was the only U.S. insti­tu­tion to invest.)

Enthu­si­asm for and deep faith in Pay for Success’s inno­v­a­tive poten­tial spread quick­ly across the Atlantic Ocean, long before the results of the Peter­bor­ough pilot were in.

Some U.S. groups were already orga­niz­ing. New Prof­it — a ven­ture phil­an­thropy fund” with a board that boasts Bain Cap­i­tal exec­u­tives and oth­er invest­ment lead­ers — launched an advo­ca­cy arm in 2007, innocu­ous­ly named Amer­i­ca For­ward. When Barack Oba­ma was elect­ed pres­i­dent in 2008, the group rec­om­mend­ed that his tran­si­tion team estab­lish a social inno­va­tion fund.”

The Oba­ma admin­is­tra­tion ran with the idea, and in ear­ly 2009 estab­lished the first-ever Social Inno­va­tion Fund, admin­is­tered by the Cor­po­ra­tion for Nation­al and Com­mu­ni­ty Ser­vice, and the first-ever White House Office of Social Inno­va­tion—both of which mobi­lize pri­vate-sec­tor part­ner­ships and Pay for Suc­cess projects. Son­al Shah, an alum of both Gold­man Sachs and Google, came on board to lead the new exec­u­tive office.

We’re very lucky that this [Pay for Suc­cess] con­cept real­ly res­onat­ed with the White House, and Son­al Shah, she quick­ly saw that this tool com­bined many things that the Office of Social Inno­va­tion was try­ing to do,” says Tra­cy Paland­jian, the CEO and founder of Social Finance, the U.S. sis­ter orga­ni­za­tion to Social Finance UK. Shah, who left Obama’s admin­is­tra­tion in 2011, is now an emer­i­tus board mem­ber of Social Finance.

In its short exis­tence, Pay for Suc­cess has been cham­pi­oned by a small, inter­lock­ing group of actors with­in the Oba­ma admin­is­tra­tion, finan­cial insti­tu­tions, advo­ca­cy groups and research insti­tutes. Mean­while, three foun­da­tions have played par­tic­u­lar­ly sig­nif­i­cant roles: the Rock­e­feller Foun­da­tion, Bloomberg Phil­an­thropies, and the Lau­ra and John Arnold Foun­da­tion. In 2015, the Lau­ra and John Arnold Foun­da­tion gave $8.4 mil­lion to the Urban Insti­tute to launch an effort ded­i­cat­ed to advanc­ing Pay for Suc­cess projects across the coun­try. By 2014, the Rock­e­feller Foun­da­tion had spent near­ly $10 mil­lion get­ting Pay For Suc­cess off the ground, from facil­i­tat­ing meet­ings with PFS sup­port­ers and the White House, to fund­ing Cen­ter for Amer­i­can Progress pro­mo­tion­al mate­ri­als. And all three foun­da­tions have fund­ed the Gov­ern­ment Per­for­mance Lab at Har­vard, estab­lished in 2011, that helps imple­ment and expand Pay for Suc­cess ini­tia­tives. Jef­frey Lieb­man, who served in the Oba­ma admin­is­tra­tion as the deputy direc­tor for pol­i­cy at the OMB, runs the Har­vard center.

Fed­er­al sup­port for Pay for Suc­cess con­tin­ued to mount steadi­ly under the Oba­ma admin­is­tra­tion. In 2015, Con­gress passed the Every Stu­dents Suc­ceeds Act (ESSA) — the suc­ces­sor to No Child Left Behind — and changed the law to allow states and school dis­tricts to use fed­er­al dol­lars to fund Pay for Suc­cess projects. The move was applaud­ed by groups excit­ed about lever­ag­ing pub­lic mon­ey with pri­vate part­ners, and crit­i­cized by oth­ers for the same rea­son. Sen­a­tor Orrin Hatch, (R‑UT), large­ly respon­si­ble for the inclu­sion of Pay for Suc­cess in ESSA, said rather than being lim­it­ed by what fed­er­al bureau­crats at the Depart­ment of Edu­ca­tion think best, fund­ing should be more con­nect­ed to local inno­va­tion and suc­cess­ful outcomes.”

Lexi Bar­rett, a for­mer pol­i­cy advi­sor in Obama’s DOE who also served on his Domes­tic Pol­i­cy Coun­cil, left the exec­u­tive branch in 2014 to work as the pol­i­cy direc­tor for Amer­i­ca For­ward, where she pushed for Pay for Success’s inclu­sion in ESSA. Now she works as the direc­tor of Nation­al Edu­ca­tion Pol­i­cy at Jobs for the Future, which was recent­ly award­ed $2 mil­lion in Depart­ment of Edu­ca­tion grants to spear­head Pay for Suc­cess projects in career and tech­ni­cal education.

The fact is you have very senior lev­el offi­cials leave the fed­er­al gov­ern­ment and then turn around to lob­by and influ­ence their for­mer agen­cies,” says Craig Hol­man, the gov­ern­ment affairs lob­by­ist at Pub­lic Cit­i­zen, which advo­cates for tougher restric­tions on for­mer fed­er­al employees.

The Oba­ma admin­is­tra­tion laid the ground­work for Pay for Suc­cess, paving the way for its poten­tial expan­sion under Trump — who has declared his intent to expand pub­lic-pri­vate part­ner­ships across all sec­tors of government.

A bipar­ti­san com­mis­sion estab­lished last March by Speak­er Paul Ryan (R‑WI) and Sen­a­tor Pat­ty Mur­ray (D‑WA) will be issu­ing for­mal rec­om­men­da­tions lat­er this fall on how to grow the evi­dence-based pol­i­cy move­ment. Amer­i­ca For­ward lob­bied for this fed­er­al com­mis­sion, and Jef­frey Lieb­man serves on it. And a bipar­ti­san bill — the Social Impact Part­ner­ship to Pay for Results Act — was rein­tro­duced this past Jan­u­ary, which would direct at least $100 mil­lion to states and local com­mu­ni­ties to expand Pay for Suc­cess projects.

Mean­while, in March, Trump announced the cre­ation of the White House Office of Amer­i­can Inno­va­tion, charged with improv­ing gov­ern­ment and soci­ety in col­lab­o­ra­tion with the pri­vate sec­tor and oth­er thought lead­ers.” With its stat­ed plans to tack­le areas like work­force devel­op­ment and the opi­oid cri­sis, PFS sup­port­ers have been eye­ing the Office of Amer­i­can Inno­va­tion as a poten­tial new base of fed­er­al sup­port. Senior White House advis­ers, includ­ing Gold­man Sachs alum­ni Gary Cohn and Dina Pow­ell, were even tapped to help guide the new agency. Before join­ing the Trump admin­is­tra­tion Pow­ell her­self had led Goldman’s impact invest­ing” ini­tia­tives, a port­fo­lio that includes Pay for Success.

Dif­fer­ing def­i­n­i­tions of suc­cess”

With its inclu­sion in ESSA and its rel­a­tive­ly strong DOE sup­port, investors, non­prof­its, and pol­i­cy­mak­ers have iden­ti­fied real poten­tial for using Pay for Suc­cess in education.

Last Sep­tem­ber, Sen­a­tors Hatch and Michael Ben­net (D‑CO) intro­duced leg­is­la­tion that would encour­age schools to use Pay for Suc­cess to expand career and tech­ni­cal edu­ca­tion. The two leg­is­la­tors intro­duced anoth­er bill this month to include Pay for Suc­cess ini­tia­tives with­in the High­er Edu­ca­tion Act, so that PFS could fund inter­ven­tions around things like increas­ing col­lege com­ple­tion for low-income students.

More­over, this past Decem­ber, the fed­er­al edu­ca­tion depart­ment award­ed more than $3 mil­lion to eight gov­ern­ment orga­ni­za­tions to launch Pay for Suc­cess fea­si­bil­i­ty stud­ies in ear­ly child­hood edu­ca­tion. The win­ners include the state of Min­neso­ta, a char­ter school in South Car­oli­na, a school dis­trict in Cal­i­for­nia, and five local gov­ern­ment agen­cies. The goal, the DOE said, will be to assess each program’s design with a cost-ben­e­fit analy­sis show­ing the return on invest­ment to the community.”

Yet despite the enthu­si­asm, there are rea­sons for wary. So far, just two Pay for Suc­cess preschool pro­grams have launched, nei­ther of which could yet cred­i­bly be called successful.

One was an ear­ly child­hood edu­ca­tion pro­gram in Utah, which was ini­tial­ly report­ed to help 99 per­cent of stu­dents in its first cohort avoid spe­cial edu­ca­tion ser­vices. Gold­man Sachs front­ed $4.6 mil­lion for the project, and took home its first pay­ment of $267,000 in 2015 for sup­pos­ed­ly reduc­ing the num­ber of chil­dren who would have oth­er­wise need­ed spe­cial edu­ca­tion. But experts lat­er ques­tioned the program’s high suc­cess rate, and crit­i­cized its eval­u­a­tion met­rics for being designed in a way that could dra­mat­i­cal­ly over­state the program’s impacts.

Specif­i­cal­ly, a num­ber of ear­ly edu­ca­tion experts not­ed in The New York Times that the Utah pro­gram had far less fund­ing than that of oth­er high-qual­i­ty pro­grams, and those bet­ter-fund­ed mod­els gen­er­al­ly see suc­cess rates of around 10 to 20 per­cent — not 99. Utah’s high rate was premised on an unfound­ed assump­tion that every child would need spe­cial edu­ca­tion with­out the preschool inter­ven­tion, yet there was lit­tle evi­dence to sug­gest that was true. Nev­er­the­less, Pay for Suc­cess advo­cates — includ­ing Oba­ma White House offi­cials and DOE lead­ers — con­tin­ued to point to Utah as evi­dence that the PFS mod­el works” and should be replicated.

The oth­er ongo­ing PFS edu­ca­tion project is Chicago’s, which has sparked oppo­si­tion for using such an expen­sive financ­ing tool — par­tic­u­lar­ly amidst a local fis­cal cri­sis — for such a non-risky invest­ment. Crit­ics note that Chicago’s PFS preschool mod­el, Child Par­ent Cen­ters, has boast­ed pos­i­tive results for decades, and is well known to deliv­er improve­ments in stu­dent per­for­mance. The mayor’s office jus­ti­fied the Pay for Suc­cess invest­ment by say­ing today’s stu­dents are His­pan­ic, where­as much of the ear­li­er research was done with black students.

It’s not a high-risk pro­gram for the investors because they have all these met­rics and stud­ies that show these pro­grams have a pos­i­tive impact on the mea­sures they’re going to use to mea­sure suc­cess,” Pavlyn Jankov, a researcher with the Chica­go Teach­ers Union, told The Chica­go Reporter in 2016. They want­ed to declare suc­cess a year from now and pro­pel [social impact bonds] across oth­er edu­ca­tion endeav­ors. It’s very pre­scient, as investors know pub­lic edu­ca­tion is strug­gling for funding.”

In 2016, Chicago’s pro­gram yield­ed an ini­tial kinder­garten readi­ness suc­cess pay­ment” of $500,000, and last month eval­u­a­tors report­ed anoth­er $500,000 pay­ment for the sec­ond cohort. Eval­u­a­tors also recent­ly report­ed an ini­tial $17,597 pay­out for reduced spe­cial edu­ca­tion ser­vices — a fig­ure low­er than investors anticipated.

But is reduc­ing spe­cial edu­ca­tion ser­vices a success?

I’ve spent my entire career work­ing on improv­ing spe­cial edu­ca­tion ser­vices, and school dis­tricts con­tin­u­al­ly look for ways to not have to pro­vide them because it’s expen­sive,” says Bev Johns, pres­i­dent of the Learn­ing Dis­abil­i­ties Asso­ci­a­tion of Illi­nois, who has been a vocal Pay for Suc­cess critic.

Denise Mar­shall, exec­u­tive direc­tor of the Coun­cil of Par­ent Attor­neys and Advo­cates, which fights to pro­tect stu­dents with dis­abil­i­ties, says their mem­bers first start­ed rais­ing alarm when they heard Pay for Suc­cess was to be includ­ed in ESSA. They wor­ry such projects can run afoul, or com­pete with fed­er­al spe­cial edu­ca­tion law and civ­il rights law — specif­i­cal­ly the Child Find” under the Indi­vid­u­als with Dis­abil­i­ties Edu­ca­tion Act, which oblig­ates schools to iden­ti­fy and eval­u­ate stu­dents who lag behind, and pro­vide them with need­ed services.

Incen­tiviz­ing reduced refer­rals flies in the face of that [fed­er­al] oblig­a­tion,” says Mar­shall. Being placed in, or becom­ing eli­gi­ble for spe­cial edu­ca­tion ser­vices is not some­thing that should be frowned upon, or looked at as a social problem.”

Their con­cerns were exac­er­bat­ed by Don­ald Trump’s appoint­ment of Bet­sy DeVos as edu­ca­tion sec­re­tary, who demon­strat­ed shock­ing unfa­mil­iar­i­ty with the Indi­vid­u­als with Dis­abil­i­ties Edu­ca­tion Act dur­ing her Sen­ate con­fir­ma­tion hearing.

Nicole Truhe of Amer­i­ca For­ward defends using Pay for Suc­cess in edu­ca­tion, and says they’re work­ing on estab­lish­ing appro­pri­ate guardrails” to pro­tect stu­dents with dis­abil­i­ties. The Depart­ment of Edu­ca­tion also says they will require prop­er safe­guards” for the projects. Of the eight ear­ly child­hood edu­ca­tion pilots recent­ly award­ed fed­er­al grants, three includ­ed reduc­tions in spe­cial edu­ca­tion ser­vices as a reward­able out­come measure. 

Some in the Pay for Suc­cess orbit are opti­mistic that the field will con­tin­u­al­ly improve with more evi­dence and rig­or­ous eval­u­a­tion — ide­al­ly exper­i­men­tal mod­els known as ran­dom­ized con­trol tri­als’ — but oth­ers, like those at Social Finance, put less stock on research eval­u­a­tions, and urge lead­ers to focus pri­mar­i­ly on results.

While Obama’s admin­is­tra­tion cat­a­pult­ed Pay for Suc­cess onto the nation­al stage, the pub­lic-pri­vate mod­el is like­ly to grow under Repub­li­can con­trol. Sup­port­ers are quick to say that PFS is just one tool in the tool­box” to advance social pro­grams — yet there’s good rea­son to think it could become an awful­ly pop­u­lar tool in the com­ing years. After all, with con­ser­v­a­tive themes of using the pri­vate sec­tor to hold gov­ern­ments account­able, and with its invi­ta­tion to enrich the rich fur­ther if they can advance some sort of social good — well, banks are like­ly to deem that deal quite a success. 

This report­ing was sup­port­ed by the Leonard C. Good­man Insti­tute for Inves­tiga­tive Reporting. 

Rachel M. Cohen is a jour­nal­ist based in Wash­ing­ton D.C. Fol­low her on Twit­ter @rmc031
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