09/17/2013 01:12 pm ET Updated Nov 17, 2013

Paying for Success, Getting Results

Over the next year, the federal government intends to expand the use of a promising tool for funding social programs that could deliver better results. This tool, called "Pay for Success," has the potential to deliver better outcomes at lower cost for taxpayers through government partnerships with philanthropic and private sector investors.

Pay for Success is one of a number of innovative, outcome-focused efforts that the federal government's Office of Management and Budget (OMB) encouraged agencies to consider in recent guidance. Calling on agencies to deliver a smarter, more innovative and more accountable government and to draw upon existing credible evidence in formulating budget requests, agencies were told that "requests are more likely to be fully funded if they show a widespread commitment to evidence and innovation," signaling that, in no uncertain terms, the days of blindly funding programs are numbered.

So how does Pay for Success work? Instead of spending money in advance on a program with uncertain results, the government identifies an outcome or a goal -- such as reducing prison recidivism among young people or reducing homelessness -- and investors along with private funders provide the initial capital support to implement an evidence-based program with potential for better results and savings to the government. Only after the predetermined outcome has been achieved does the government spend any money. Through this funding tool, governments at the local, state and federal levels can begin to deliver better results, while also limiting the risk of wasted taxpayer dollars.

Why is this especially important now? With resources increasingly scarce, governments need tools to help them make better choices about how limited funds should be spent. At a time when Congress and many states across the country continue to implement blind, across-the-board spending cuts, funding tools like Pay for Success can ensure that taxpayer dollars go to programs that are demonstrating results. Even more importantly, the Pay for Success approach creates a default mechanism so that programs that are not producing the intended results are automatically ended. A simple concept, but as anyone who has worked in government knows, it isn't easy to end a failing program because of politics, bureaucracy or just plain inertia.

Despite these headwinds, paying for success is catching on. President Obama has proposed a results-oriented approach to higher education called Pay for Performance, creating a ratings system for schools that is tied to their performance on everything from graduation rates to post-graduate employment and student debt. The goal is to push schools to perform better and provide those that do with more federal support for their financial aid programs.

The president's fiscal year 2014 budget also sets aside $195 million for Pay for Success programs across the Departments of Education, Justice and Labor and proposes $300 million for the Treasury Department to establish a Pay for Success incentive fund which will help local and state governments implement Pay for Success projects that achieve savings across local, state and federal levels.

Yielding savings across government can be a challenge, and for local governments, finding experienced investors with whom to partner is often very difficult. The Treasury Department incentive fund will provide relief from the inherent accounting challenges associated with the Pay for Success model at the local level by managing the payment process. The fund will also provide the incentive for local governments to attempt these money-saving ventures by guaranteeing the funding they require.

While Congress still needs to approve the president's funding requests, select Pay for Success initiatives are already being implemented: New York City recently awarded its first Social Impact Bond contract to reduce recidivism rates. Goldman Sachs, which provided the upfront financing, Bloomberg Philanthropies, which provided grant support, and MDRC, a nonprofit overseeing the project, are using an evidence-based program that provides education and other services to young prisoners in an effort to reduce re-incarceration. The program will cost the city nothing if it doesn't meet predetermined goals for reducing recidivism rates; and if the program exceeds those goals, it doesn't cost extra. On the national level, the Department of Justice is also using the Pay for Success model to try to reduce recidivism and the Labor Department is building an effort focused on boosting employment and improving job retention.

While Pay for Success is still a new tool and there are real implementation challenges ahead, it has the potential to improve communities and save taxpayer dollars, while also providing a new way for governments to help make better spending decisions and end programs that aren't working. With tight budgets nationwide and increasingly frequent Washington spending battles, innovative funding models like Pay for Success represent a chance to improve outcomes without breaking the bank.