Not A Silver Bullet: Setting Rates by Cost of Care Is Not Enough to Fix the Child Care Market
Cost modeling has become a central tool in state child care subsidy policy. ACF has approved a growing number of alternative methodologies for setting subsidy rates, states are commissioning cost studies, and the proposed Child Care Modernization Act directs states to set rates that reflect the true cost of service delivery, including the staff salaries and benefits needed to recruit, train, and retain a qualified workforce.
But cost-based rate-setting has limits, and as more states move in this direction, it’s important to be clear about what reimbursement rates can and can’t do. Setting better rates is part of the answer. It isn’t the whole answer — and treating cost-based rates as a silver bullet risks unintended consequences for families and providers.
How we got here
Historically, states have used Market Rate Surveys (MRS) to set subsidy rates, measuring what providers charge non-subsidized parents for tuition. The problem with this approach is that market prices reflect what families can afford, not what high-quality care actually costs. Where families have less ability to pay, prices are lower, and providers balance their budgets by suppressing wages or scrimping on other quality features. Subsidy rates anchored to those prices reproduce the underlying inequity rather than correcting it.
Cost modeling is championed as a way to address this market flaw. It estimates the cost (different than price) of providing care under specified program parameters — staff qualifications, ratios, wages, and benefits — letting administrators identify the cost of the system the state wants, not the cost of the system family budgets currently sustain. As a foundation for rate-setting, cost data is an important addition to market data.
The limited power of cost-based rate setting to improve the child care system results comes from the structural role of subsidy itself. In the absence of a universal child care system, subsidies substitute for private tuition for families who cannot afford it. Programs serve a mix of subsidy and private-pay children, and the voucher essentially stands in for what a family would otherwise pay. Subsidy does that job relatively well, but it is poorly suited to driving system-wide change like higher wages, expanded supply, or improved quality. Three dynamics drive this.
1. Subsidy children are typically a small share of any classroom.
Teacher salaries are a classroom-level cost, but subsidized children make up a small and ever-shifting share of enrollment in most programs. Nationally, only 47% of centers enroll any children with subsidies, and only 10% use subsidies for more than half their children. Similarly, in home-based care, subsidies support fewer than 10% of enrolled children.* A voucher rate set at an aspirational cost of care — with target wages built in — doesn’t generate enough classroom revenue to actually raise wages, because the rate only applies to some of the children in each room. To close the gap, a program would need to either fill the classroom entirely with subsidized children or raise tuition for private-pay families up to the new subsidy rate. Neither is realistic at scale: subsidy access is limited in most states, and many private-pay families can't absorb cost-based tuition.
2. The child care market doesn’t set its prices by the cost of care.
In most markets, both private prices and subsidy rates for infants and toddlers fall well below the actual cost of providing that care. Currently, programs treat infants and toddlers as loss leaders, smoothing costs across age groups so preschool revenue offsets infant-toddler losses. In many markets where parents have the ability to pay high prices for care, a cost-based preschool rate would be lower than the current market-based rate. In higher-income communities, this would reduce subsidy purchasing power and push providers to fill seats with private-pay preschoolers instead.
3. Rate increases tend to push private prices up.
Increases in subsidy rates are often followed by increases in tuition for private-pay families – hitting middle-income families hard. Access to subsidy is already limited, with over 400,000 children across the nation on waitlists, and many working families who earn above the eligibility threshold cannot afford higher costs for child care. A policy change intended to strengthen the system can end up making care less affordable for the majority of families.
Matching the tool to the goal
These dynamics define what reimbursement rates can do, and what they can’t. Subsidy helps low- and moderate-income families buy into the child care market, so increasing subsidy rates is important to provide families with more purchasing power in the market. Rates are not particularly well-suited to raise wages, expand supply, or improve quality. Foundational funding — grants and contracts — can do that work: it funds classrooms rather than individual children, can come with conditions like wage floors and ratio standards, and can be targeted to places where the market consistently underdelivers.
Before committing to a specific funding strategy, state leaders can sharpen their decision-making by working through a few questions:
- What outcomes are we trying to achieve? Access for subsidy-eligible families? Higher wages for staff? More infant-toddler supply? Stronger quality? Each (potentially) calls for a different funding response.
- Is rate-setting the right tool for that goal, or does it require something else? If the goal goes beyond access to the market as it exists today, is there a foundational funding strategy to accompany the rate change, and what conditions should attach to it?
- Where is subsidy being stretched to do work it wasn’t designed for, and where could a grant or contract do that work more directly?
Cost and market-based approaches are complementary tools in the state’s funding toolkit, not competing strategies. The strongest state systems will be those that use each for what it's best suited to achieve.
*A.R. Datta, I. Ventura, 2023. Enrollment size and subsidy density of child care centers receiving child care subsidies in 2019. OPRE Report No. 2023-008, Washington DC: U.S. Dept. of HHS.