08/14/2012 05:11 pm ET Updated Oct 14, 2012

Nonprofits and the Government: A Relationship Strained by Bureaucracy

Providing a safety net for our most vulnerable citizens is a core function of government. And whatever one thinks of the appropriate scope of that function, we would all agree that whatever services government provides should be efficient and effective. A foster care system should provide a permanent home for children as quickly as possible. A workforce development program should help its participants find jobs. All of this work should be done at a reasonable cost. Yet governments often act in ways that undermine these common sense principles.

Governments often partner with nonprofit organizations to deliver services. New York City, for example, contracts with nonprofits to provide temporary shelter for homeless families, educational programs for pre-school and school-age children, re-entry programs for teens who have been released from juvenile detention facilities, and community centers for senior citizens.

These partnerships can offer significant potential benefits to those receiving services and to the taxpayers who pay for them. Nonprofit social service organizations are uniquely positioned to deliver the services that are necessary to effect positive change in under-resourced communities. They are often closer to families and can identify emergent problems and solutions long before government can intervene. And oftentimes, they can do so more cost-effectively than government. In addition, having multiple nonprofits delivering services instead of a single government agency allows for innovation and competition in how services are delivered.

Yet, government regularly acts to diminish this potential.

First, and most fundamentally, governments often hold nonprofits accountable for how programs are delivered instead of whether they produce results. Generally, nonprofits are paid through line-item reimbursements based on a pre-approved budget. They are accountable for whether they have delivered the service in the approved fashion and at the agreed-upon cost, not necessarily for whether the service has accomplished its intended result.

At second, governments tend to dictate how those nonprofits should deliver their services. A government-funded after-school program might prescribe detailed rules about how programs should be staffed and operated. Of course, common standards are necessary, especially when health and safety are involved. But when the rules are too constrained, they can stifle innovation. Instead of 100 nonprofits trying to build a better mouse trap, you have 100 nonprofits following a government-designed schematic for how to build a mouse trap. Even when the government's design is strong, we lose a central benefit: the ability to try new things and respond to local conditions.

Third, these funding structures lead to perverse financial incentives. Often, the costs of delivering services are greater than what the government is willing to pay. Faced with unrealistic expectations for the costs of delivering services, nonprofits underinvest in infrastructure and under-report their true costs, leading to weaker organizations and a poor understanding of what it takes to do this work. To have any chance of surviving, nonprofits have to supplement public funds through private fundraising. This isn't necessarily a bad thing, but it does mean that the most successful nonprofits are often those who can do the best job of raising money, which is not the same as doing the best job of delivering services.

It gets worse. As I previously stated, a contract typically calls on a nonprofit to deliver a service at a specified cost. If a nonprofit figures out a way to get people employed or prepare children for kindergarten at a lower cost, then the money needs to be returned; it can't be reinvested in the organization. This leads to the common phenomenon of a nonprofit rushing to spend money against its contracts at the end of the fiscal year, when those resources might be better invested in the long-term needs of the organization. The results: wasted public money and weaker nonprofit organizations.

Fourth, most government contracts put hard limits on "administrative," "indirect" or "overhead" costs (such as operations, program design and human resources). Capping these costs means squeezing out quality supervision, research and development and financial management -- in other words, the very things that drive the quality of services that children, the elderly or others will receive. If an organization delivers a quality result at a reasonable price, why should we care what percentage of its costs are "overhead?"

Imagine if government contracted with the private sector in this way. What if a city buying computers provided the company with the schematics for building the computer, refused to pay for anything but the direct costs of manufacturing, understated those costs, and continued to buy computers whether or not they worked. Absurd? Yet, that's standard operating procedure for working with the nonprofit sector.

Once an organization has received funding, it develops a constituency of elected officials, employees and others invested in the status quo. Without a discipline that limits funding to those programs that can demonstrate effectiveness, there is no way to divert funds to promising practices that have a better chance of addressing the serious challenges our nation faces. This is a serious concern in the best fiscal times, and is certainly much more so in today's challenging economic climate.

Around the country, governments are working to break this paradigm. New York City has been at the forefront. For example, Improved Outcomes for Children, launched in 2007 by New York City Children's Services, introduced a new funding model for nonprofit foster care agencies that aligned programmatic results with fiscal incentives. Organizations were given the flexibility to make decisions to meet the needs of each child, rather than follow a cookie-cutter approach that worked in some cases, but didn't work in most.

At my organization, The Children's Aid Society, Improved Outcomes for Children allowed us to invest in practice improvements such as reduced caseload size, extra supports for foster parents, and our Expedited Permanency program, which offers a continuum of services for birth parents to help us get children back to safe and stable home environments more quickly. The results? We improved outcomes for children and saved money.

Charter schools are another example. The idea is straightforward: community groups and educators apply for a charter directly from the state, and receive a "per pupil" fee for each child who enrolls. Free to spend those dollars as they see fit, charters can stay in business only if they drive better results for the children they serve. A school receives a charter for a limited time - and that charter is revoked if the school can't do the job. We are launching the Children's Aid College Prep Charter School this fall, and taking advantage of the opportunity to drive transformative change for children.

One of the most innovative new approaches is the Social Impact Bond, or Pay for Success. This model brings together government, private investors and nonprofits to create and deliver innovative social programs. All three parties agree on the desired program outcomes and an independent evaluator monitors performance. Private investors fund the initial capital needs for a social program, and nonprofits implement the program. Government reimburses investors only if the outcomes are achieved. This is a win-win scenario: nonprofits gain the freedom to develop innovative solutions to social problems, private investors can receive a return on their investment and government pays only for proven results. Original models of SIBs have thus far been implemented in Britain and Australia; however, New York City will be the first to test the model in the United States. Mayor Michael Bloomberg recently announced that Goldman Sachs will invest in a recidivism reduction SIB initiative coordinated by social service provider MDRC.

Our country faces existential challenges, such as rising income inequality, declining social mobility, poor educational outcomes and long-term health costs. We need real solutions, and we do not have money to waste. By rethinking how governments fund the agencies doing vital work, and refocusing on results, we can finally put the welfare of our citizens first.