December 12, 2013

Why Let Financial Institutions Profit From Financing Services for the Needy?

By Mark Rosenman

Not long ago, New York City and Goldman Sachs began to experiment with a new financial instrument—social-impact bonds—to provide private capital to finance a nonprofit program that might otherwise have been passed over for municipal aid. 

Now Goldman Sachs has started a $250-million fund to expand on the idea of social-impact investments, and Morgan Stanley hopes to attract $10-billion to a similar effort.

Such serious money flowing into programs that provide essential services has attracted much excitement as deficit-strapped governments, overstretched charities, and foundations that are worried about cash flow see a potential new source of program dollars.

But shouldn’t we be concerned about the implications of this idea—especially one so untested? Do we want to see services funded only when they can make money or also when they can save people and serve communities but not generate surplus dollars? Do we want to see private profit replace public and philanthropic responsibility?

In recent years, ideas for steering private capital to nonprofits have been growing in number and creativity.

Among the ideas gaining traction are social-impact bonds, which allow foundations or private investors to put up money for a government program. If the program succeeds in saving government money in the future—in the New York case, by reducing the number of repeat offenders who end up in prison—the foundations or other investors get their money back, possibly with extra earnings, depending on how strong a success the program they finance becomes.

Another social-impact bond that Goldman Sachs is backing finances early-childhood education in Utah. But that effort palls when you think about the over 57,000 children nationwide who have lost Head Start services because of tax cuts and the automatic-spending reductions imposed when Congress and the White House failed to come to a deficit-reduction agreement.

We know that Head Start saves government at least seven dollars for very one spent on it. If Goldman and Morgan Stanley have their way, we’ll now have to pay them and their clients a significant portion of those savings for having replaced tax revenues with investment dollars. 

How did we get to a world in which the rich profit from providing a social good?

Conservatives have long been trying to reduce taxes to benefit the wealthy. This has necessitated major reductions in services that benefit people in the middle and lower classes. As the  right-wing activist Grover Norquist famously said, “I don’t want to abolish government. I simply want to reduce it to the size where I can drag it into the bathroom and drown it in the bathtub.”

That’s why he long pushed politicians to sign a no-new-taxes pledge.

Even though compassionate conservatism has worked to get government out of the business of human welfare and put it in the hands of charities, it should be clear that private philanthropy will never be of a scale to replace tax revenue.

Yet while he was running for president, Mitt Romney argued that charitable contributions were the equivalent of taxes, suggesting that one could essentially choose between the two—and forgetting that government needs to serve everyone, while charities simply do the best they can with the money they have available.

That was troubling enough, but where conservatives formerly might have seen charity, Goldman Sachs and Morgan Stanley now see new profit centers.

Goldman promised when it announced its prison effort that the program it financed would reduce recidivism, therefore producing savings for society and government.

To be clear, that program and a host of others that might be financed through the new Goldman and Morgan Stanley funds quite likely will produce salutary outcomes, but the question our society must face is how we wish to pay for them and who should benefit from their success. It seems unwise to develop new investment opportunities that will further enrich the wealthy and financial institutions while costing government much more than if programs were paid for with tax dollars or even through interest-bearing government bonds.

Don’t citizens have a reason to be suspicious when those who will profit from these new social-investment schemes are the ones creating the financing imperative by working mightily to reduce the tax revenues that could otherwise be available to pay for government and its funding of nonprofit programs? 

Although Goldman’s CEO Lloyd Blankfein says he is in favor of increased taxes, he arranged for the early distribution of $65-million in stock for him and his top colleagues so they could avoid a new higher tax rate. If Goldman, Morgan Stanley, and other financial institutions are truly concerned with financing much-needed public services, they could give up on their efforts to avoid taxes and to finesse new schemes to profit at the margins and instead support a Wall Street sales tax that could yield hundreds of billions of dollars each year for public purposes.

They could also support changes in the IRS code that could stop Nike, Apple, Microsoft, and other corporations from stashing profits in tax havens to avoid paying more than the $92-billion that would otherwise flow to the U.S. Treasury. This practice is so prevalent that when Max Baucus, chairman of the Senate Finance Committee, recently proposed to address it as a tradeoff for reducing the corporate tax rate, business representatives became terribly alarmed.

Many individuals follow similar patterns of tax avoidance as the financial industry, including 35,000 of America’s wealthy families who managed to pay zero in federal taxes. If they and superwealthy investors truly favored doing the public good and followed the “Buffett Rule” to pay 30 percent on income over their first million dollars in earning each year, they could provide close to an additional $40-billion in tax revenue over the next 10 years, more than four times the amount to which Goldman and Morgan Stanley together hope to attract through this new industry.

There is some good associated with efforts to bring private investors into the social arena. They expand a focus on outcomes, which, when appropriately defined and assessed over time, can be helpful to organizations, the people they serve, and those who fund them. They bring human, community, and environmental needs and nonprofit programs to the attention of more people. And if they can be helped to transition away from pursuing private profit to becoming more engaged citizens and generous philanthropists, so much the better. 

Yet it’s not just the financing issues that are worrisome. It is very difficult to assess social outcomes over time and figure out whether it was a specific program—like providing job training to prison inmates—that made the difference or whether other factors mattered even more. It could be a combination of work by government, nonprofits, and business, even changes in the economy or in a person’s family, that made the critical difference in keeping people from returning to jail.

What’s more, the emphasis of many social-impact financing schemes seems to be on avoiding future costs for government and society rather that looking at the causes of today’s problems. For instance, will financial institutions see rewards in paying for long-term programs that seek to keep people from getting involved in crimes in the first place? Or is their work simply draining money and attention away from nonprofits that are working for fundamental social change.

Still, the basic question with which these schemes confront us is who we are as Americans. The market ought not rule in every area of society and the environment. Do we accept our shared obligation to take care of one another and the planet with government revenue and charitable dollars or do we fund programs only when we can benefit financially from them?

There’s still time for us to rise above private profit to serve public purpose. Nonprofits need to remember that their role is to work for the common good.

Mark Rosenman is emeritus professor at Union Institute & University.