Social Impact Bonds: A Tax-Favored Investment?

Abstract

Social impact bonds (SIBs) have recently generated a lot of excitement nationwide as an innovative way to finance social projects. A SIB is a financing mechanism that uses private capital to fund social services, with the government only repaying investors their capital plus a potential return on investment if improved social outcomes are achieved. As such, it brings together the private, public, and non-profit sectors in a manner that unlocks an additional source of capital to fund social service providers, promotes innovation, encourages interagency cooperation, and creates more accountability. Despite these benefits, tax law likely hinders the development of SIB-funded programs in the United States by discouraging private investment in SIBs. This Article is the first to consider the role of U.S. tax law in promoting SIB investments by examining the tax implications of a SIB investment from both a doctrinal and policy perspective. It concludes that the current tax system creates unnecessary compliance risks for private SIB investors and unjustifiably treats SIB investments less favorably than comparable investments, thereby increasing administrative complexity, distorting investment decisions, and creating inequities among similarly situated investors. Given the unintended discriminatory tax treatment towards SIBs, this Article argues that Congress should consider enacting legislation to make a SIB investment a tax-favored investment. This change could best be achieved by extending preferential tax rates to SIB earnings, exempting SIB earnings from taxation, or by allowing an upfront deduction for contributions to SIB investments. By modifying the tax law to treat SIB investments more in parity with comparable investments, SIB-funded programs will likely attract additional private capital and allow SIBs to potentially make a meaningful impact on some of our nation’s most challenging social problem