Social Impact Bonds: A Tax-Favored Investment?

Abstract

Salt Lake County, Utah, like many other counties throughout the nation, has struggled with finding a meaningful and effective way to address persistent homelessness and high rates of recidivism within the county. Current government funding for programs to address these issues is limited and their effectiveness is often unknown. The result is costly: 43% of persistently homeless individuals in Salt Lake County become chronically homeless within two years; 74% of high-risk offenders return to county jail within four years of their release; and the Salt Lake County jail is currently operating at full capacity. These issues also result in numerous other social and financial costs to society. In an attempt to address these issues, in December 2016, Salt Lake County launched a million dollar initiative to provide more than 500 of the county’s most vulnerable and at-risk population with innovative, evidence-based, preventative services never before available to these residents. Unlike other social programs, the government (and taxpayers) will not have to pay anything initially. Instead, investors will provide the upfront capital to finance the program and assume the risk of an unsuccessful program. If the program is successful in achieving pre-determined results, only then will the government repay the investors their initial capital, as well as a small return on their investment. The structure of the Salt Lake County program is just one example of a new type of financing mechanism that has recently emerged: social impact bonds (“SIBs”). Although still in their infancy, SIBs have generated a lot of excitement. They have received support from the Obama administration, major financial institutions, policy experts, philanthropic organizations, and universities. As a result, numerous SIBs have already been launched in communities across the country and world to address issues ranging from unemployment and child welfare to education and mental illness. Despite this initial excitement, SIBs have not yet generated sufficient private capital to truly make an impact in the United States. This Article is the first to argue that U.S. tax law is one factor that significantly contributes to the lack of private SIB investments in the United States. To demonstrate the chilling effect that the tax law has on these potentially powerful investments, I first describe the concept of a SIB, its benefits and limitations, and the likely tax implications to private SIB investors. Against this backdrop, I then consider from a normative perspective whether Congress should modify federal income tax laws to make SIBs a more tax-favored investment for private investors. My conclusion is that a tax policy change is needed.