Federal funding for child care assistance is set to increase by $5.8 billion over the next two years under the terms of the bipartisan budget agreement passed earlier this month. But how will state agencies spend these new funds?

One pressing priority is to expand the number of children served. Currently, 1.4 million children from low-income families are in child care arrangements subsidized by federal and state governments.  This represents 15 percent of children eligible under federal law. More families are on waiting lists or are too discouraged by the scarcity of subsidies to even apply for assistance. 

Yet federal child care assistance has dual purposes. It supports parents who are working or in training and education programs, and it promotes children’s healthy development and school success. To meet the second goal, states should consider putting some of the new funding into raising the level of maximum reimbursements to providers.

How would raising reimbursement rates help children and families?

This recommendation is based on our recent research, which finds that the quality of child care centers participating in the subsidy program is higher in states with higher payment rates, after controlling for differences in licensing standards and other factors that affect quality.

This fits with how child care markets work. Many quality improvements increase operating costs (e.g., hiring additional staff to lower the child-to-staff ratio, paying for staff training, acquiring and implementing curricula). But providers with higher costs sometimes hesitate to serve children with subsidies because so many states set their maximum reimbursement well below the market rate for high-quality care. 

Increasing reimbursement rates could attract more qualified providers to participate in the subsidy system or allow participating providers to afford quality improvements. Analysis of data from the 2012 National Survey of Early Care and Education suggests that a $100 increase in monthly reimbursement rates is associated with a 30 percent increase in the likelihood that participating child care centers meet a summary measure of quality.  State-established maximum reimbursement rates in that year ranged from $325 to $882 per month  for center-based care for a preschool child, after adjusting for state cost of living differences.

Moreover, the quality of participating providers is higher in states that have a larger gap between their highest and lowest tiers of reimbursement rates. Many states have tiered reimbursement systems and provide higher payments to providers that meet certain quality standards. Such systems vary in structure. We found one state paying more than twice as much to a three-star provider as a one-star provider, whereas others paid a differential of less than $30 a month.

Increasing the financial incentives associated with meeting quality standards could be a cost-effective way to improve the quality of participating centers: 

• Among centers, a $100 increase in the difference between the lowest and highest tiers in a tiered reimbursement rate is associated with a 40 percent increase in the likelihood that participating centers meet our summary measure of quality. 
• Among home-based providers, the association is even stronger (though these findings are more tentative because of smaller sample sizes). In particular, as shown in our new report, a $100 increase in the gap between the lowest and highest payment tiers is associated with a 135 percent increase in the likelihood that participating homes meet our summary measure of quality.

These statistical analyses do not demonstrate a causal connection, but they offer strong suggestive evidence that higher subsidy payments—in general and for programs meeting the highest standards of quality—can improve the quality of providers participating in the subsidy system and promote the healthy development of children in low-income families.