The ongoing policy debate surrounding funding models for Australia’s early childhood education and care (ECEC) sector has sparked widespread interest and analysis. Recent proposals suggest transitioning from the current demand-side funding model, where subsidies are provided to families, to a supply-side funding model, where funds flow directly to service providers. To assess the potential implications, the Australian Childcare Alliance commissioned a report by dandolopartners, examining Australia’s residential aged care funding model as a comparator (dandolopartners, 2024). This blog "Navigating ECEC Funding Reform" unpacks the report’s key findings, exploring the opportunities and risks of supply-side funding, and identifying critical lessons from aged care for policymakers and sector leaders.

Context: Why Compare Aged Care and ECEC Funding Models?

Both the ECEC and aged care sectors share structural and functional similarities (dandolopartners, 2024):
  • They receive significant government funding supplemented by user payments.
  • They serve large and vulnerable populations.
  • They are highly regulated to ensure safety, quality, and accessibility.
  • Both are undergoing substantial reforms to address affordability, quality, and sustainability challenges.
Given these parallels, aged care provides a useful case study for understanding how supply-side funding models operate—and the potential pitfalls of poorly designed systems.

The ECEC Demand-Side Model: Current Strengths and Challenges

Under the current ECEC funding model, the Child Care Subsidy (CCS) is paid to families based on their income, work activity, and the provider’s hourly fees. This demand-side approach has delivered key benefits:
  • Targeted support: Families most in need receive higher subsidies.
  • Choice and competition: Families can select services that align with their preferences.
  • Flexible operations: Providers retain the autonomy to set prices and adapt to local demand (ACCC, 2024).
However, the report highlights notable challenges:
  • Rising costs: Subsidy increases have not consistently kept pace with operational costs, leading to fee growth (dandolopartners, 2024).
  • Inadequate price control: The hourly rate cap (HRC) has been ineffective in constraining fees or signalling reasonable costs to families (ACCC, 2024).
  • Underserved areas: Some regions, particularly rural and low socioeconomic areas, face accessibility issues due to insufficient provider incentives (dandolopartners, 2024).
These challenges have led to calls for a supply-side funding model to cap fees and deliver greater price control for families.

Understanding the Supply-Side Funding Model: Aged Care Insights

The residential aged care sector operates under a supply-side funding model, where the government directly funds providers through activity-based subsidies. The system includes capped user contributions and pricing advice from the Independent Health and Aged Care Pricing Authority (IHACPA) (Royal Commission, 2021). While this model gives the government greater control over expenditure and pricing, the aged care experience underscores significant risks:

1. Financial Viability and Underfunding Risks

The Aged Care Royal Commission revealed that underfunding severely compromised the system. Funding levels did not keep pace with increasing costs, demand, or quality expectations, resulting in:
  • Widespread financial strain: 42% of providers reported losses in 2018-19, increasing to 64% in 2021-22 (Royal Commission, 2021).
  • Reduced supply: Inadequate funding discouraged new investment, particularly in rural and underserved areas (KPMG, 2023).
  • Degraded quality: 1 in 3 residents experienced substandard care due to staffing shortages and underinvestment (Royal Commission, 2021).

2. Complexity and Administrative Burden

Supply-side funding requires significant administrative infrastructure to ensure funds are allocated appropriately. In aged care, this includes:
  • An independent pricing authority (IHACPA) with a multimillion-dollar annual budget.
  • Extensive financial reporting obligations for providers, including monthly claims and quarterly statements.
  • Ongoing investment in IT infrastructure for data collection and payment systems (dandolopartners, 2024).

3. Incentives and Market Dynamics

Supply-side funding models must carefully balance financial incentives to avoid unintended consequences. In aged care, poorly designed incentives led to:
  • Minimalist staffing: Providers were incentivised to meet, but not exceed, minimum standards (Royal Commission, 2021).
  • Market consolidation: Smaller providers exited the market, reducing diversity and increasing risks tied to large providers.
  • Underinvestment in facilities: Limited capital returns resulted in outdated infrastructure and insufficient supply growth (dandolopartners, 2024).

Implications for ECEC: Key Lessons from Aged Care

If Australia’s ECEC sector were to adopt a supply-side funding model, the aged care experience offers several cautionary lessons:

1. The Risk of Inadequate Funding

One of the most critical takeaways is the danger of setting funding levels too low. The ECEC sector, like aged care, serves vulnerable populations and operates with high fixed costs, including labour and property expenses. If funding fails to match delivery costs, the consequences could include:
  • Compromised quality: Providers may struggle to invest in staff, training, and infrastructure.
  • Financial instability: Smaller providers, particularly in underserved areas, could exit the market, exacerbating accessibility issues (KPMG, 2023).
  • Reduced supply: Insufficient funding would deter investment in new services, particularly in high-cost or low-demand areas (dandolopartners, 2024).

2. The Need for Sector Knowledge and Infrastructure

Transitioning to a supply-side model requires robust administrative systems and sector-specific expertise. Unlike aged care, which benefited from pre-existing pricing frameworks and data infrastructure, ECEC would need to build these systems from scratch. This transition would be costly, time-consuming, and disruptive (dandolopartners, 2024).

3. Balancing Simplicity, Equity, and Efficiency

While supply-side models aim to simplify funding for families by capping fees, the aged care example shows that these systems can still be highly complex to administer. Moreover, universal funding risks over- or under-supplying services, creating inefficiencies and inequities (Royal Commission, 2021).

A Sensible Path Forward: ACCC Recommendations

The Australian Competition and Consumer Commission (ACCC) has proposed a balanced approach to ECEC funding reform, recommending:
  • Targeted supply-side funding for underserved markets, such as rural or low-income areas.
  • Retaining demand-side funding with critical improvements, including:
    • Strengthening price signals through a reformed hourly rate cap.
    • Introducing stronger government monitoring of fees, profits, and quality outcomes.
    • Implementing a “credible threat of intervention” to curb excessive fee increases (ACCC, 2024).
This approach aligns with the lessons from aged care, offering a measured alternative to wholesale funding model changes. By improving the existing demand-side model and targeting supply-side funding where needed, policymakers can address affordability, accessibility, and quality without risking widespread disruption.

Conclusion: Learning from Aged Care to Inform ECEC Policy

The aged care sector’s experience with supply-side funding highlights both opportunities and risks for Australia’s ECEC sector. While direct provider funding can enhance price control and accountability, it also carries significant challenges related to financial viability, administrative complexity, and system sustainability. The ACCC’s recommendations strike a sensible balance: targeted supply-side funding for underserved areas, combined with critical improvements to the current demand-side model. By learning from aged care’s cautionary tale, policymakers can design funding reforms that support ECEC providers, improve affordability for families, and ensure high-quality outcomes for children across Australia. As the ECEC sector navigates this wave of reform, collaboration between government, providers, and sector experts will be essential to delivering funding settings that meet the needs of families today and into the future.

References

  1. Australian Childcare Alliance & dandolopartners (2024). Comparing ECEC and Aged Care Funding Models.
  2. Royal Commission into Aged Care Quality and Safety (2021). Final Report: Care, Dignity and Respect.
  3. Australian Competition and Consumer Commission (2024). Interim Findings on ECEC Pricing and Affordability.
  4. KPMG (2023). Aged Care Sector Analysis 2023.