The 2025-26 Budget: Child Care and State Preschool

2025-26 BUDGET The 2025-26 Budget: Child Care and State Preschool GABRIEL PETEK | LEGISLATIVE ANALYST | MARCH 2025 SUMMARY In this brief, we analyze the Governor’s child care and State Preschool budget proposals and provide associated recommendations. Also, in light of the significant changes to the programs that have been made in recent years, we recommend the Legislature revisit three policies related to child care and State Preschool that might no longer align with its key priorities. Consider Developing a Child Care Budget Plan in Case Legislature Does Not Receive Key Information Prior to Budget Deadline. The administration is currently developing a new reimbursement rate structure for subsidized child care providers. Statute requires the state to set reimbursement rates using the new rate structure by July 1, 2025. It is possible the Legislature will have little or no time to review the details of the new rate structure prior to the June 15 deadline to pass a budget. The Legislature could consider planning for costs associated with the new rates in 2025-26. The Legislature could also consider developing its own specific transition plan for non-represented child care centers if the timeline for implementing the alternative methodology by July 1 is not feasible. Recommend Reducing State Preschool Funding to Align With Contracted Costs. Under the Governor’s proposal, State Preschool funding would exceed projected costs in 2025-26—consistent with a trend over the last few years where the budgeted amount has exceeded actual costs. We recommend reducing ongoing State Preschool funding by $355 million Proposition 98 General Fund and $71 million non-Proposition 98 General Fund to better align funding with anticipated costs. Recommend Revisiting Three Other Policies. We recommend the Legislature revisit three policies that may no longer align with the Legislature’s key priorities given recent changes in child care and State Preschool funding. • We recommend repealing a statutory cost-of-living adjustment (COLA) that only applies to certain providers who are funded on the Standard Reimbursement Rate (SRR). The current policy effectively prioritizes additional funding for providers already receiving rates that are relatively high compared to the private market in their county. • We recommend the Legislature consider modifying the statutory COLA for voucher-based child care programs to better align funding with program costs. The state’s current approach applies a COLA to total program costs, including the portion of funding that covers child care provider payments. However, funding for provider payments is typically adjusted through other mechanisms in the state budget. The Legislature could continue providing an annual COLA only for operational costs, in recognition of some of the inflationary cost pressures that these agencies likely face, but no longer apply the COLA to the portion of funding related to provider payments. • During the pandemic, the state began allowing direct contract providers to receive their pre-pandemic contract amount, regardless of child attendance. We recommend allowing this reimbursement flexibility to expire June 30, 2025. Although this flexibility provided a great degree of fiscal stability for providers during the pandemic, maintaining the policy disconnects program funding from the number of children providers currently serve. www.lao.ca.gov 1 2025-26 BUDGET BACKGROUND State Subsidizes Child Care, Primarily for CalWORKs child care programs focus on families Low-Income Families. As shown in Figure 1, enrolled in or transitioning out of CalWORKs the state administers various child care and welfare-to-work activities. The remaining programs development programs. Most of the state’s are primarily designed for low-income, working subsidized child care is administered by the families that have not participated in CalWORKs. Department of Social Services (DSS) through Families are generally eligible for subsidized three programs: (1) California Work Opportunity child care if they have a family income of less and Responsibility to Kids (CalWORKs) child care, than 85 percent of the state median income (2) the California Alternative Payment Program ($89,659 annual income for a family of three). (CAPP), and (3) the General Child Care program. State Also Provides State Preschool for Certain Children. Figure 1 State Preschool is administered Overview of Child Care Programs by the California Department of Education (CDE) and provided Program Descriptiona by a variety of local agencies and CalWORKs Child Care Provides subsidized child care services to current and community-based organizations. former CalWORKs families. Slots are available for all eligible families. Three- and four-year old children are generally eligible for State California Alternative Provides subsidized child care vouchers to eligible Payment Program working families. Slots are limited by budget Preschool if their family earns appropriation. at or below the state median General Child Care and Directly contracts with center-based and licensed income ($105,482 for a family Development family child care providers to serve working families of three). State law includes eligible for subsidized care. Slots are limited by budget appropriation. various enrollment flexibilities Family Child Care Directly contracts with consortia of licensed family that allow providers to serve child care providers to serve working families eligible families with higher incomes, for subsidized care. Slots are limited by budget and some providers may choose appropriation. to serve eligible two-year olds. Migrant Child Care Provides subsidized child care services to migrant families working in agriculturally related industries.b Services are Based on preliminary numbers provided throughout the Central Valley. Slots are limited from October 2024, the state by budget appropriation. serves 101,000 children in Care for Children With Provides additional access to child care services for State Preschool. Severe Disabilities children under the age of 21 and with exceptional needs.c Program is located in the San Francisco Bay Child Care and State Area. Slots are limited by budget appropriation. Preschool Programs Supported Emergency Child Care Provides temporary child care services to children in With Multiple Funding Sources. Bridge foster care system and under age 13. Child care services are temporary until family finds longer-term The 2024-25 budget package child care solution.d provided $7 billion in funding a Unless otherwise specified, child must be under age 13 and families must earn at or below for the state’s subsidized child 85 percent of the state median income to be eligible for subsidized child care programs. For example, a family of three must earn less than $89,659 annually in 2024-25 to be eligible for care programs. The majority programs. of funding ($4 billion) was from b Family earned at least 50 percent of their total gross income from employment in fishing, agriculture, non-Proposition 98 General or agriculturally related work during the 12 months immediately preceding the date of application for services. Fund. The state also uses a total c Child must have an individualized education program or an individualized family service plan issued of roughly $2 billion in federal through a special education program. funding to partially cover program d Child care services provided up to 12 months, but may be extended for a compelling reason. costs. In addition, the state partially covers program costs with 2 LEGISLATIVE ANALYST’S OFFICE 2025-26 BUDGET funding from the Proposition 64 Youth Account, (CCPU). Under Chapter 385, the scope of collective which is funded by the cannabis retail excise tax bargaining includes 14 different topics, including established in 2016. State Preschool programs reimbursement rates, payment procedures, are funded entirely with General Fund. State and professional development and training for Preschool programs offered by local education providers. The details of a collective bargaining agencies (LEAs)—school districts, county offices of agreement, as well as the associated funding, education, community college districts, and certain must be approved by the Legislature via statute. charter schools—are funded with Proposition 98 The current memorandum of understanding (MOU) General Fund. Those programs offered by non-LEA between the state and these child care providers providers (community-based organizations, county expires June 30, 2025. welfare departments, and cities) are funded with Rates for Other Providers Are Determined non-Proposition 98 General Fund. by the Legislature. In contrast to licensed family 2021-22 Budget Agreement Included homes and license-exempt providers, licensed Multiyear Child Care Slot Expansion Plan. child care centers do not collectively bargain. The 2021-22 budget agreement intended to add Instead, rates and policies are determined by the 206,800 child care slots over a multiyear period. Legislature through the annual budget process. This expansion built upon the approximately The Legislature typically has provided “parity” for 100,000 non-CalWORKs slots the state already centers by applying funding rates and policies funded. The bulk of the expansion was planned similar to those that were included in the MOU for through two programs—CAPP (143,000 slots) represented providers. and General Child Care (62,000 slots). A smaller Child Care Providers Reimbursed Using portion of the expansion was set aside for Migrant Two Different Rate Structures. The state has Alternative Payment (1,300 slots) and Emergency historically used two different reimbursement rates Child Care Bridge (500 slots). The 2023-24 and for child care providers—the SRR and the Regional 2024-25 budgets subsequently made various Market Rate (RMR). The SRR is a statewide rate changes to delay implementation of the of the slot (currently set at $54.93 per child, per day) that expansion. Figure 2 shows the current multiyear historically was used for direct contract providers. expansion plan, as outlined in the 2024-25 Most of these direct contract providers are budget agreement. funded through either General Child Care or State Some Child Care Providers Collectively Preschool. Other providers are reimbursed using Bargain With the State. Chapter 385 of the RMR. The RMR is based on surveys of the 2019 (AB 379, Limón) established collective cost of child care and varies by county. The RMR bargaining for licensed family child care homes is currently set at the 75th percentile of market and license-exempt family, friend, and neighbor rates for child care that were identified in the 2018 providers. These providers are represented in regional market survey. (The state last conducted collective bargaining by Child Care Providers United a market rate survey in 2021, but has not updated Figure 2 State’s Multiyear Child Care Expansion Plan Number of New Child Care Slots by Year 2021-22 Through Program 2024-25 2025-26 2026-27 2027-28 Totals General Child Care 33,000 — 12,000 17,000 62,000 Alternative Payment 95,000 — 32,000 16,000 143,000 Migrant Alternative Payment 1,300 — — — 1,300 Emergency Child Care Bridge 500 — — — 500 Totals 129,800 — 44,000 33,000 206,800 www.lao.ca.gov 3 2025-26 BUDGET the RMR to reflect this data. The RMR is adjusted 2023-24 Budget Funded Temporary at the Legislature’s discretion.) In 2021-22, the state Rate Increases as Transition to Alternative shifted direct contract providers from the SRR to Methodology. The 2023-24 budget package the RMR to the extent the RMR was higher. adopted a two-year collectively bargained early State Developing Alternative Reimbursement education and parity agreement estimated to Rate Structure. In 2021, the state began cost $2 billion across 2023-24 and 2024-25. the process of developing a single child care The agreement was funded with a variety of reimbursement rate structure, in partnership with one-time funds, as well as foregone statutory the CCPU. This new alternative methodology is COLAs for child care programs. The largest to be based on estimates of child care provider component of the agreement was monthly cost costs, not market rates. DSS is in the process of care plus payments scheduled to be made of developing this alternative methodology, January 1, 2024 through June 30, 2025. These in collaboration with CDE. Components of temporary monthly per-child payments were the alternative methodology that relate to intended to increase rates above the current SRR reimbursement rates for licensed family child care and RMR levels while the alternative methodology homes and license-exempt providers must be was being developed. The cost of care plus collectively bargained. Chapter 73 of 2024 (SB 163, payments range from $140 to $211 per month, Committee on Budget and Fiscal Review) requires per child for licensed providers, depending on the reimbursement rates to be set using the alternative county in which the provider is located. methodology by July 1 2025. If the rates based on 2024-25 Budget Set “Floor” for 2025-26 the alternative methodology do not take effect by Funding Levels. Chapter 73 requires 2025-26 rates this date, DSS must provide the Legislature with to be no less than the rates that were in effect on a time line for transitioning to the new rates. As June 30, 2024. This includes the rates providers a condition of receiving federal funding for child receive under either the SRR or RMR, as well as the care, the state must obtain federal approval for monthly cost of care plus payments providers are its alternative methodology. The state received currently receiving. federal approval for the structure of the alternative methodology on November 8, 2024. CHILD CARE AND STATE PRESCHOOL PROPOSALS Governor’s Budget Largest Spending Increase Associated With Monthly Cost of Care Plus Payments for Child Governor Proposes $7.1 Billion for Child Care Care Providers. Figure 4 shows the Governor’s Programs in 2025-26. As shown in Figure 3, proposed changes in child care spending. The the Governor’s budget includes $7.1 billion for largest year-over-year increase in spending is child care programs in 2025-26—a decrease of $698 million non-Proposition 98 General Fund $207 million relative to the revised 2024-25 levels. that is effectively a placeholder funding amount This change includes a $420 million increase intended to meet the statutory requirement that in non-Proposition 98 General fund, which is 2025-26 rates be no less than the reimbursement more than offset by a $440 million decrease in rates that were in effect on June 30, 2024. This Proposition 64 funds and a $186 million decrease placeholder amount is equivalent to the value of in federal funding. The latter reductions are the monthly cost of care plus payments for child primarily due to the use of one-time carryover funds care providers. The specific methodology for in 2024-25. allocating these funds would be established as part of the budget process, and would be subject 4 LEGISLATIVE ANALYST’S OFFICE 2025-26 BUDGET Figure 3 Child Care Budget (Dollars in Millions) Change From 2024-25 2023-24 2024-25 2025-26 Reviseda Revisedb Proposedb Amount Percent Expenditures CalWORKs Child Care Stage 1 $550 $588 $602 $14 2% Stage 2c 420 546 599 53 10 Stage 3 559 541 524 -17 -3 Subtotals ($1,530) ($1,675) ($1,725) ($51) (3%) Non-CalWORKs Child Care Alternative Payment Program $2,028 $1,990 $2,052 $61 3% General Child Cared 1,255 1,495 1,594 99 7 Bridge program for foster children 94 107 94 -14 -13 Migrant Child Care 70 79 80 2 2 Care for Children With Severe Disabilities 2 2 2 — 6 Subtotals ($3,449) ($3,673) ($3,822) ($149) (4%) Support Programs $1,578e $1,929f $1,523g -$407 -21% Totals $6,557 $7,276 $7,070 -$207 -3% Funding Proposition 98 General Fundh $3 $2 $1 -$1 -37% Non-Proposition 98 General Fund 3,173 4189 4,609 420 10 Proposition 64 Special Fund 270 642 202 -440 -69 Federal 3,111 2,443 2,257 -186 -8 a Reflects 2024-25 May Revision estimates with LAO adjustments. b Reflects 2025-26 Governor’s budget. c Does not include $11.2 million provided to community colleges for certain child care services. d Includes funding for family child care home education networks. e Includes cost estimates for quality programs, child care infrastructure, Child and Adult Care Food Program, Child Care Providers United Retirement Benefit Trust, accounts payable, Whole Child Community Equity, court cases, and costs associated with 2023-24 memorandum of understanding (MOU) and parity agreement. f Includes cost estimates for quality programs, Child and Adult Care Food Program, accounts payable, Whole Child Community Equity, and costs associated with 2023-24 MOU and parity agreement. g Includes cost estimates for quality programs, Child and Adult Care Food Program, accounts payable, and Whole Child Community Equity. h Reflects Proposition 98 funds for Child and Adult Care Food Program. Figure 4 Changes in Child Care Spending (In Millions) General Fund Prop. 98 Non-Prop. 98 Prop. 64 Federal Total Monthly cost of care plus payments — $698 — — $698 Annualization of General Child Care slot increases — 76 — — 76 COLA for child care programs — 59 — — 59 CalWORKs caseload and cost of care — 108 — -$57 51 Child and Adult Care Food Program caseload and COLA -$0.7 0.2 — 16 16 COLA (2.43 percent) for Resource and Referral and LPCs — 1 — — 1 Technical adjustments — 48 -$32 -109 -86 One-time adjustmentsa — -572 -409 -35 -1,016 Totals -$0.7 $420 -$440 -$186 -$207 a Includes prior-year, one-time costs associated with quality carryover, SB 140 carryover, child care infrastructure program, court cases, temporary family fee waiver, and initial CCPU retirement fund deposit. COLA = cost-of-living adjustment; LPCs = Local Planning Councils; and CCPU = Child Care Providers United. www.lao.ca.gov 5 2025-26 BUDGET to collective bargaining for family child care Legislature May Not Have Time to Review homes and license-exempt providers. The largest Alternative Methodology Details Before year-over-year decrease reflects $1 billion of several Passing Budget. Although DSS is required to set one-time and carryover funds that are expected to rates based on the alternative methodology by be spent in 2024-25. July 1, 2025, the department’s time line for sharing Provides $2.9 Billion for State Preschool. the details with the Legislature is unclear at this Of this amount, $1.9 billion is Proposition 98 time. It is possible that the Legislature will not have General Fund for programs offered by LEAs and any information regarding the overall costs or key $1 billion is for programs offered by non-LEAs. details of the alternative reimbursement rates prior Overall, as Figure 5 shows, the Governor’s budget to the constitutional deadline to pass a budget by increases State Preschool funding by $684 million June 15. Furthermore, even if the information is compared to 2024-25. The largest year-over-year released around the time of the May Revision or change comes from restoring a $673 million later, the Legislature would have only limited time reduction made in 2024-25 to reflect the amount to review the details of the alternative methodology of funds that would otherwise have gone unused. and consider whether it would like to make The budget also includes $29 million to provide changes to the structure for non-represented child a 2.43 percent COLA to certain providers (those care centers. funded on the SRR). These increases are partially Funding for State Preschool Exceeds Amount offset by an $18 million decrease related to Necessary to Cover Costs. In 2021-22, the one-time spending provided 2024-25. state increased State Preschool rates by shifting providers from the SRR to the RMR, if the RMR Assessment was higher. The cost of these rate increases came Governor’s Child Care Budget Complies in lower than budgeted, but the state has not With Funding Requirement Adopted in 2024-25 made ongoing downward adjustments to align the Budget. As mentioned above, the Governor’s budgeted amount with the anticipated ongoing budget creates a placeholder ensuring sufficient costs. As such, according to CDE estimates, the funding to comply with the statutory requirement overall amount budgeted for State Preschool that 2025-26 rates be no less than the rates as exceeds the estimated costs by $426 million, of June 30, 2024. The specific rates providers including $355 million Proposition 98 General Fund receive in 2025-26—as well as the overall amount and $71 million non-Proposition 98 General Fund. of funding needed to support these rates—will Recommendations depend on the collective bargaining process, decisions regarding the alternative reimbursement Consider Developing a Child Care Budget rate structure, and actions by the Legislature. As Plan in Case Legislature Does Not Receive a result, it is possible that the amount set aside Key Information Prior to June 15. Given the would not be sufficient to cover all additional costs alternative methodology and a new collective in 2025-26. bargaining agreement may not be finalized prior to the June 15 deadline to pass a budget, the Legislature may want to Figure 5 plan for costs associated with the 2025-26 Changes in State Preschool Funding new rates in 2025-26. Budgeting (In Millions) for some costs would provide the Legislature with a cushion to the General Fund extent that the new agreements Change Prop. 98 Non-Prop. 98 Total have notable costs. The Legislature Restoration of one-time reduction $519 $153 $673 could also consider developing Cost-of-living adjustment (2.43 percent) 19 10 29 its own specific transition plan for Removal of one-time 2024-25 spending — -18 -18 2025-26 rates if the time line for Totals $539 $145 $684 6 LEGISLATIVE ANALYST’S OFFICE 2025-26 BUDGET implementing the alternative methodology by July 1 anticipated costs, we recommend reducing is not feasible. A transition plan for represented ongoing State Preschool funding by $355 million family child care homes and license-exempt Proposition 98 General Fund and $71 million providers would need to be collectively bargained. non-Proposition 98 General Fund. Under our However, the Legislature could establish transition recommendation, the budget would still provide rates for child care centers. This could help provide a total of $1.6 billion Proposition 98 General Fund centers clarity regarding what their reimbursement and $939 million non-Proposition 98 General Fund rates would be for 2025-26. for State Preschool—enough to cover estimated Reduce State Preschool Funding to Align contracted costs and provide funding equivalent to With Contracted Costs. To align funding with the monthly cost of care plus payments. REVISITING VARIOUS CHILD CARE AND STATE PRESCHOOL FUNDING POLICIES As we discuss in our recent post, The 2025-26 child care and preschool programs through either Budget: Undertaking Fiscal Oversight, we vouchers or direct contracts. The majority of direct advise the Legislature to use the 2025-26 budget contract providers are licensed centers funded process to conduct robust fiscal oversight of through General Child Care and State Preschool. state programs. Oversight of programs allows the Prior to 2021-22, direct contract providers were state to determine whether existing programs are funded based on the SRR. The SRR is a fixed well-designed to address their key goals, as well as statewide rate (currently $54.93 per day for child help inform legislative actions that might be needed care programs and $55.27 for State Preschool) that to help balance the state budget over the next is adjusted by length of care and age of child. few years. In 2021-22, Most Direct Contract Providers Consistent with this guidance, in this section, Shifted to RMR. In 2021-22, the state began we describe three policies related to child care and funding most direct contract providers based on the State Preschool that we recommend the Legislature RMR—the rate used for voucher-based providers— revisit. These policies may no longer align with the which reflects the 75th percentile of a county’s Legislature’s key priorities given recent changes market rates for child care identified in the 2018 in child care and State Preschool funding. Our survey. One goal of the change was to address review focuses on aspects of child care and State concerns that—because the SRR is not adjusted by Preschool funding that are not within the scope of region—direct contract providers in many high-cost collective bargaining because the Legislature has counties received lower rates than voucher-based more flexibility to make changes in these areas. providers funded through the RMR. The 2021-22 The Legislature could consider these changes budget also included a hold harmless provision as part of the 2025-26 budget process, but also that funded direct contract providers based on the could take action next year, when the Legislature SRR if it was higher than the RMR in their county. has more details related to the alternative In 2024-25, providers in 42 counties (representing reimbursement rate structure. about one-third of the state’s population) continue to be funded based on the SRR. These counties to STANDARD tend to be located outside of the most expensive REIMBURSEMENT RATE COLA regions of the state. In these areas, the SRR reimbursement rate is higher than the RMR rate. Background Current Law Requires Annual COLA for State Historically Used SRR for Direct SRR. The state provides a statutorily required Contract Providers. The state funds subsidized annual COLA—the same rate provided to K-12 www.lao.ca.gov 7 2025-26 BUDGET education programs—to the SRR. (The RMR does could be directed to other legislative priorities. not have a statutory COLA and is adjusted at the Moving forward, the rates for these providers would Legislature’s discretion.) After the COLA is applied, be set at the discretion of the Legislature, similar to the state determines whether direct contract all other direct contract providers. providers will be funded based on the SRR or the RMR. As part of the 2023 collectively bargained COLA FOR early education and parity agreement, the state VOUCHER-BASED PROGRAMS did not apply the COLAs for 2023-24 and 2024-25. Instead, the amount that would have been required Background to fund the 2023-24 COLA over the next two years Alternative Payment (AP) Agencies was used to fund the agreement. Administer Most Voucher-Based Programs. Governor’s Budget Includes $37.9 Million The state tasks AP agencies with administering for 2.43 Percent COLA to SRR. Of this amount, most voucher-based child care programs, including $19.3 million is Proposition 98 General Fund CalWORKs Stage 2 and Stage 3, CAPP, and and $18.6 million is non-Proposition 98 General California Migrant Alternative Payment (CMAP). Fund. After applying the COLA, the administration (County welfare departments are responsible projects that providers in three additional counties for administering CalWORKs Stage 1, although would be funded based on the SRR, resulting in a most counties contract with an AP agency to total of 45 counties funded based on the SRR. administer the program.) Most AP agencies are community-based organizations, but in some LAO Comments regions the AP agency is a local governmental COLA Policy Effectively Prioritizes agency, such as a county office of education, Rate Increases for Lower-Cost Counties. county welfare department, or school district. Prior to 2021-22, when the SRR was the only AP Agencies’ Operational Funding Based reimbursement structure for direct contract on Proportion of Budget Appropriation. AP providers, providing a COLA was a reasonable way agencies’ primary voucher-related responsibilities to adjust rates to ensure the state was adequately are to determine a family’s eligibility for child care, covering provider costs. However, under the state’s make payments to the child care provider of a current approach—where direct contractors get family’s choice, and ensure families and providers the higher of SRR or RMR rates—the only providers are complying with state rules and regulations. that receive an annual COLA are those with rates Funding to cover these activities is based on a that are higher than the 75th percentile of what proportion of total program funding. AP agencies private child care providers in their county charge generally are authorized to spend up to 17.5 percent based on the 2018 market survey. For example, in of total program funding on operational costs. 30 of the 42 counties where direct contractors are (The remaining funding is to cover payments to currently funded on the SRR and receive an annual child care providers.) For CAPP and CMAP, annual COLA, the SRR is higher than the 90th percentile funding is limited by the amount appropriated in of the regional market rate for four-year olds in the annual budget. If the AP agency does not have full-time care. sufficient funding to serve all eligible families, it may Recommend Repealing COLA. In our view, place families on a waiting list. For CalWORKs child there is no compelling policy reason for prioritizing care, the administration has authority to increase funding for providers that already receive rates funding midyear if the amount of funding is not that are relatively high compared to the private sufficient to cover all eligible families. market in their county. As a result, we recommend State Applies a Statutory COLA to Total CAPP the Legislature repeal the required COLA for the and CMAP Funding. Typically, the total amount SRR. This would free up $37.9 million ($19.3 million of state funding provided to AP agencies is based Proposition 98 General Fund and $18.6 million on the amount they received in the previous year, non-Proposition 98 General Fund) in 2025-26 that adjusted for any changes in reimbursement rates 8 LEGISLATIVE ANALYST’S OFFICE 2025-26 BUDGET or slots specified in the most recent state budget. agencies likely face. More broadly, the Legislature For CAPP and CMAP, the state then increases total might also want to consider changes to how AP funding based on the statutory COLA. (AP agencies agencies are funded. In a previous analysis of AP do not receive a similar COLA for CalWORKs child agency funding, we make several recommendations care.) As part of the 2023 collectively bargained that would better align funding for AP agencies with early education and parity agreement, the state the costs to administer voucher-based programs. did not apply the COLAs for 2023-24 and 2024-25. Instead, the amount that would have been required REIMBURSEMENT to fund the 2023-24 COLA over the next two years FLEXIBILITY FOR DIRECT was used to fund the agreement. CONTRACT PROVIDERS Governor’s Budget Provides $49.6 Million for COLA. The Governor’s 2025-26 budget provides Background $49.6 million non-Proposition 98 General Fund Prior to Pandemic, Funding for Direct to fund a 2.43 percent statutory COLA. Of this Contract Providers Based Partly on Attendance. amount, $48.7 million is for CAPP and $904,000 is The state directly contracts with some providers for CMAP. for subsidized child care and preschool, primarily LAO Comments through State Preschool and General Child Care. The state sets an annual maximum reimbursable COLA Approach for Voucher-Based amount that each contractor can receive. Prior to Programs Not Well-Targeted to Program Cost the pandemic, the specific amount that a contractor Pressures. In our view, providing a statutory COLA would be reimbursed was based on the lesser to AP agencies’ operational costs is reasonable, as of (1) the maximum reimbursable amount; (2) the these agencies face inflationary cost pressures in contractor’s reimbursable program costs; or (3) the administering voucher-based child care programs. contract rate per child day of enrollment, multiplied However, there is no clear rationale for applying a by the attendance rate of its children. Under this COLA to the portion of funding that covers child approach, providers had to have a specified care provider payments as these payment amounts amount of attendance to fully earn their contract. are typically adjusted through other mechanisms Any unearned funds would be returned to the state in the state budget. For example, rates are set in and could be redistributed to other providers that statute and, when the Legislature has increased had capacity to serve more children. rates in the past, it has provided associated Since the Pandemic, the State Has Provided increases in funding to address the higher costs. Direct Contractors With Reimbursement Also, payments are adjusted when the state Flexibility. Since 2020-21, the state has provided provides additional funding for new child care slots reimbursement flexibility for child care and State as part of the annual budget. As a result, under the Preschool direct contractors. This flexibility was current COLA structure—where it is applied to the initially intended to minimize the fiscal effects entire AP agency allocation, rather than only the of pandemic-related attendance declines and portion related to operational costs—the amount temporary requirements for smaller group sizes. of COLA funding likely exceeds the amount that is Under this policy, providers receive the lesser of needed to cover inflationary cost increases. their reimbursable program costs or the maximum Consider Modifying COLA. Given the COLA reimbursable amount. This allows providers to is not targeted to AP agency operational costs receive their full contract amount regardless of child (the component of these programs that faces attendance in the program. inflationary costs), the Legislature may want to Reimbursement Flexibility Set to Expire consider modifying the statutory COLA to better June 30, 2025. Although the state initially enacted align funding with costs. The Legislature could this reimbursement flexibility during the pandemic, choose to continue providing an annual COLA only the policy was later extended. Most recently, the for AP agency operational costs, in recognition of 2023-24 budget extended the flexibilities until some of the inflationary cost pressures that these June 30, 2025. www.lao.ca.gov 9 2025-26 BUDGET LAO Comments Recommend Allowing Direct Contract Flexibility to Expire. We recommend allowing Direct Contractor Reimbursement Flexibility the reimbursement flexibility provisions for direct Disconnects Funding From Current Program contract providers to expire. This would ensure Attendance. During the pandemic, reimbursement that funding levels for direct contractors are flexibility provided a great degree of fiscal stability more closely aligned with the number of children for providers, particularly given the uncertainty they serve. If a contractor’s attendance remains regarding enrollment and attendance rates in below pre-pandemic levels, they likely would see child care and preschool programs. However, by reductions in the amount of funding they receive. maintaining this policy for several years, the amount Over time, CDE and DSS could determine whether of funding direct contractors receive is not closely some contracts should be reduced and funds connected to their current program attendance. should be allocated to other providers that could The disconnect between funding and program serve additional children. The state would see attendance is likely larger in State Preschool. General Fund savings to the extent that overall Although annual statewide attendance is not attendance does not return to pre-pandemic levels. publicly reported, statewide enrollment for State Preschool is currently 30 percent below pre-pandemic levels. 10 LEGISLATIVE ANALYST’S OFFICE 2025-26 BUDGET www.lao.ca.gov 11 2025-26 BUDGET LAO PUBLICATIONS This report was prepared by Dylan Hawksworth-Lutzow and Sara Cortez, and reviewed by Edgar Cabral and Ross Brown. The Legislative Analyst’s Office (LAO) is a nonpartisan office that provides fiscal and policy information and advice to the Legislature. To request publications call (916) 445-4656. This report and others, as well as an e-mail subscription service, are available on the LAO’s website at www.lao.ca.gov. The LAO is located at 925 L Street, Suite 1000, Sacramento, California 95814. 12 LEGISLATIVE ANALYST’S OFFICE