Pay for Success — How Market Forces Can Improve the Social Safety Net (Inside Sources)

It is generally believed that government does a good job lessening the material hardship of poverty through programs such as the Earned Income Tax Credit and food assistance, but it does less well helping people escape poverty without government aid. Pay for Success is an innovative way to finance social welfare programs that could substantially improve the social safety net so that people can finally lift themselves up.

At the core of Pay for Success are free-market principles. Under contractual arrangements, the government seeks private investors to finance a new social program. If the program meets the outcomes specified in the contract, the investors gets their money back plus a profit. If the program is not successful, the government doesn’t pay and the investor absorbs the costs. It allows government to be innovative, without the financial risk of failure. And it ensures that only those programs with proven success continue to receive government funding.

One can see how this might dramatically improve the quality of safety net programs. Government often pays for services without much evidence of effectiveness. As Jon Baron, founding president of the Coalition for Evidence-Based Policy, wrote in 2012, “Scientifically rigorous studies — particularly, the 'gold standard' of randomized controlled trials — are a mainstay of medicine, providing conclusive evidence of effectiveness for most major medical advances in recent history. In social spending, by contrast, such studies have only a toehold.”

One reason for this is that a program’s success (like that documented by a rigorous evaluation) is not necessary to obtain federal funding. The Temporary Assistance for Needy Families program, for example, spends $11 billion on job preparation services for poor Americans each year, but states are not required to use programs that have proved to be effective. State and local agencies too often rely on anecdotal or outcome data to justify programs, without rigorously testing whether programs are effective when compared to something else.

Pay for Success has the potential to fundamentally change how this works in a few ways. The first is by increasing the quantity and quality of research so that we can learn what actually works. Pay for Success uses evidence-based programs, typically proven through random-assignment experiments, because investors want to fund things that have already proven to work in other settings. With more demand for proven programs, the research (and funding) community will have to respond with more rigorous scientific studies.

Pay for Success also allows government to try evidence-based programs without the financial risk of failure. Too often government agencies are reluctant to try new programs because of the upfront investment and risk of failure. Existing programs, even if mediocre, may be viewed as safer. Pay for Success allows them to try new things, without the financial risk of failure.

And perhaps most important, Pay for Success has the potential to improve the social safety net in ways that the government alone cannot. Under Pay for Success, programs that do not work are immediately discontinued or forced to improve, a dynamic that is too often missing from government programs today. Only those programs that work will continue and the overall quality of programs will improve.

Pay for Success has already worked in the United States. In 2012, using a Pay for Success model, private investors funded an evidence-based behavioral therapy for youth exiting jail in New York City. The city hoped to reduce recidivism, but after the first year, the outcomes specified in the Pay for Success contracts were not met. The city did not pay, the investors absorbed the cost (although, in this case the investors were underwritten by philanthropy), and the program ended.

Had it not been for Pay for Success, New York City could have spent millions of dollars on a failed program.

The federal government invests billions of dollars each year in programs for low-income families. Yet too many poor Americans remain in poverty and must rely on government assistance to get by. By engaging the private sector and instilling market forces into the process, Pay for Success may finally offer a path toward achieving real gains for America’s low-income families.

Rachidi is a research fellow in poverty studies at the American Enterprise Institute. She wrote this for