Chicago to Expand Pre-K through Social Impact Bond Funding: Is it Worth it?

 /  Dec. 6, 2014, 6:24 p.m.


PreK

Earlier this month, the Chicago City Council approved Mayor Rahm Emanuel’s plan to expand early childhood education in the city by a 41–5 vote. Under the program, Chicago Public Schools’ (CPS) Child-Parent Center half-day preschool program will grow by 2,618 children over the next four years. While universal preschool education currently enjoys bipartisan support in the United States, Mayor Emanuel’s plan has drawn criticism for the method of funding it will use. Chicago’s expansion will be financed through a $17 million “social impact bond” from the Goldman Sachs Social Impact Fund, Northern Trust, and the J.B. and M.K. Pritzker Family Foundation.

Social impact bonds (SIBs) have become popular in recent years, lauded as a market-based way of solving societal problems. While typical bonds are loans that are paid back over time at a fixed interest rate, social impact bonds are different. Sometimes referred to as “results-based” or “pay-for-performance” financing, social impact bonds consist of a loan from a private lender to a government to fund a specific program, and only give investors a return on their principal if that program meets certain performance targets. Essentially, SIBs are designed to reallocate risk from the government actor to the private lender: the government only pays if the program is successful, and in theory will still save money on top of the returned principal and interest payments.

What’s more, Chicago’s SIB issue will simply expand an already low-risk program: CPS’s Child-Parent Center (CPC), which has a well-documented track record of success. The CPC program, founded in 1967, provides a stable educational environment and family support services to economically disadvantaged children and their parents. Parental involvement is highly emphasized: in order to enroll their children in the program, parents are required to volunteer at a CPC on a weekly basis. The program has been evaluated by multiple academic studies, with positive results. Compared to students who did not attend preschool, CPC students were less likely to need special education services, scored higher on reading and math tests by a statistically significant amount, and had a cognitive readiness advantage of 3 months’ learning performance at the point of kindergarten entry. In the long term, all of these gains translate into savings on remedial services for Chicago Public Schools.

Mayor Emanuel’s plan hinges on this benefit. Under the new SIB program, payments to lenders would be calculated based on the reduction in the number of children needing special education services after participating in the expanded pre-K program. CPS will pay $9,100 per child annually, increasing by 1 percent per year over the lifetime of the bond. Children would be assessed for kindergarten readiness using tests already employed in CPS preschools, and the city would repay lenders $2,900 for every child who scores at or above the national average on five or more of that assessment’s six sections. Third grade literacy will also serve as a performance metric, earning lenders $750 for every child who reads at grade level in the third grade.

The city of Chicago will contract with several third party nonprofit groups—IFF, the Finnegan Family Foundation, and Metropolitan Family Services—to hire teachers and administrators, coordinate SIB funding, and evaluate whether the program has met its performance goals. Ten percent of the $17 million bond will go towards these intermediaries.

The complexity of this financing scheme has sparked comparisons to Chicago’s infamous parking meter deal, which will ultimately cost the city far more in charges and lost revenue than it gained from the sale. This comparison is not an entirely fair one, simply because the city of Chicago is not privatizing its CPC program. Yet the 2011 parking meter deal left a lingering distrust of public-private partnerships among Chicago politicians. Several aldermen who voted against the pre-k expansion deal cited the potential for profit on the part of the banking industry: in the best-case scenario, investors will reap $34.5 million, more than double the original investment.

This is not CPS’ first time utilizing an unconventional method of financing. From 2003 to 2007, CPS issued $1 billion worth of bonds paired with a complex form of derivative contract called an interest rate swap; this move will ultimately cost around $100 million more than it would have with traditional fixed-rate bonds, according to an investigation by the Chicago Tribune. Risky decisions such as this one have augmented, rather than mitigated, the district’s financial troubles, and some may question whether SIB’s constitute another risky bond deal.

However, the current SIB program differs from previous CPS investments in important ways. On a technical level, SIBs contain risk-deflection mechanisms that interest rate swaps lack. In addition, borrowing to finance a pre-kindergarten program with a strong track record of success is likely to save CPS more money than it spends. In contrast, the money from the interest rate swaps went primarily to finance school construction and renovation—pure expansion, as opposed to substantive curriculum changes.

The CPC program’s demonstrated strength is a key element of this initiative. Professor Paula R. Worthington, a senior lecturer at the Harris School specializing in state and local public finance and cost-benefit analysis, spoke to the Gate about what Chicago stands to gain from Emanuel’s pre-k program and SIB funding. “This is a promising approach to funding expansion of a program that has solid evidence of its overall effectiveness,” she explained, “and I hope the initiative goes forward.” Noting Chicago’s budget limitations and the need to allocate scarce dollars effectively, Professor Worthington argued that the Child-Parent Center program was a good choice for funding:  “Child-Parent Centers have been evaluated and found, on average, to generate significant social returns on the program’s investment (costs), as participants have higher labor market earnings and commit fewer crimes than comparison groups…[SIB funding] will work only for programs with a solid track record of effectiveness, like the CPCs, which deliver fiscal savings to government. In this case, the ‘savings’ would come from having young children better prepared to enter school and therefore less likely to require special educational services. Down the road, we also expect those children will earn higher incomes, pay more taxes, and be less likely to commit crimes—all of which are positive things for the city.”

However, given the Child-Parent Center program’s well-documented successes, the question still stands as to why the government does not simply fund the expansion with public money, or by using low-risk private funding on less tried-and-true programs. Even with the SIB funds, the state will kick in $4.5 million, along with $10 million in capital improvement money from next year’s budget. When these costs are calculated together with the interest payments to investors, assuming that the program is successful, the city will spend more than it would have if it paid for the program expansion up front.

An examination of political considerations helps explain the decision to use SIB funds. Given Chicago’s well-documented budget woes, it would be difficult to reallocate funds to the CPC program without cutting other programs or raising taxes, both of which would be politically untenable to Mayor Emanuel as he prepares to seek reelection next year. Furthermore, a market-based approach, such as SIBs, appeals to a fiscally conservative constituency, which could prove useful if Emanuel decides to seek higher office in Illinois––although the city of Chicago is liberal, the rest of the state is more conservative. At the same time, expanding preschool education would appeal to progressives in Chicago, especially after Emanuel’s recent decisions to close many CPS schools angered the city’s liberal constituencies.

Political benefits aside, it’s worth noting that SIBs have already strengthened early childhood education. In 2013, Goldman Sachs’s Urban Investment Group partnered with the United Way of Salt Lake and J.B. Pritzker to commit up to $7 million to finance the Utah High Quality Preschool Program, which focused on increasing school readiness and academic performance for at-risk children in Utah. The Gate spoke with Brenda Van Gorder, Director of Preschool Services for the Granite School District, which implemented the High Quality Preschool Program. Echoing the broad consensus regarding the effectiveness of preschool programs, Van Gorder first noted that her district has “had a very positive experience working with our Social Impact partners…the pay-for-success model is providing an opportunity for 3- and 4-year-olds who live in at-risk conditions to enter school ready to progress in the general curriculum on pace with their age mate peers.” Van Gorder also explained the district’s decision to use SIB funding: “We had worked with Voices for Utah Children and United Way of Salt Lake in the recent past to get state legislative support and funding for a model similar to the pay-for-success model, which would have provided state funding for preschool. Utah currently does not have state funds dedicated to preschool services, necessitating a different and effective approach.”

Van Gorder’s explanation sheds light on Chicago’s choice to use SIB funding. Put simply, securing public funding, even for worthwhile programs is extremely difficult. . By borrowing money now, Chicago will help disadvantaged children catch up with their peers. As Van Gorder notes, “without the funding and support of the Social Impact funds, these children were destined to start school behind, and history and research tell us that those children who start school behind most likely will stay behind,” perpetuating a cycle of poverty and low scholastic achievement, and diminishing Chicago’s chances to bring more residents into the folds of a productive city economy.

While it is unsettling to see CPS take on further debt—the deficit for the 2014 fiscal year stood at $1 billion—the expansion of pre-kindergarten access is worth it. In the absence of state or federal funding, the imperative of educating Chicago’s most disadvantaged children remains. Ultimately, Chicago’s decision to use SIB funding is a good one, and will likely bring gains (both economic and in terms of equalizing educational opportunity) that far outweigh the funding method’s costs.

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Ava Henriksen


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