Second, if social impact bonds catch on in any significant degree, they are going to end up creating all sorts of new groups who have a big interest in creating bonds and only a secondary interest in long-term social outcomes. The folks promoting these should be reading Josh Pacewicz’s excellent work on tax increment financing.
Tax increment financing is a now-common way of financing municipal economic development projects. It allows cities to sell bonds secured by the future increases in tax revenue that are expected to result from a development project. So the city borrows money for, say, waterfront development, and promises to pay it back with the tax revenues that it projects will come from the newly developed waterfront. But if the revenues don’t materialize, the city isn’t on the hook. Like social impact bonds, part of the appeal is that the risk is shifted away from the taxpayer.
The problem, though, is that cities have gone overboard with TIF. This means high debt levels and committing most of the tax revenues resulting from development to paying back the debt that made it possible.
According to Pacewicz, TIF didn’t take off because of huge investor demand for the debt. Its expansion was driven by a new group of economic development professionals who worked for cities. TIF gave these professionals influence because it made municipal finances more complex—to the point where they gained control over city budgets because no one else understood them.
These professionals are very aware that TIF is overused—that projections of tax revenue increases are too optimistic, that cities are taking on too much debt, and that many development projects are basically corporate welfare. And they regret it. But they advance in their careers by putting together big TIF projects. So they put together TIF projects, even when they think it’s bad for the city.
How does this apply to social impact bonds? Well, if SIBs take off, we can expect to see a new group of government professionals emerge whose job it is to create social impact bonds. And they, too, will most likely want to advance their careers by creating big, splashy SIBs. This could lead to the replacement of plain-vanilla government-provided social services with privately financed services, even if the latter cost more or involve more layers of bureaucracy than the original ones.