IV. Costs: Analysis and Comparisons

Table 3

Economic principles tell us nothing is produced for free, including government programs. What it costs to deliver a bottle of milk, for example, and what it costs to deliver a government program have one thing in common: they both absorb scarce economic resources. A dairy company which fails to fully account for a) labor costs, including all fringe benefits and b) capital costs, including the value of foregone interest income when funds are sunk in machines, tools, and equipment, will eventually face bankruptcy. Similarly, failure to account for the same type of costs absorbed by one government agency will, in the face of public resistance to tax hikes, eventually result in either denial of scarce resources to other equally important government services, or a reduction in the quality of services.

If private agencies didn't know all their costs at every moment in time, they would be operating in the dark and, sooner or later, they would be forced to close.

In the production of foster care services, what costs must be measured by private and government child care agencies?


    These include salaries, supplies, transportation expenditures (if the caseworker uses his or her own vehicle and is paid a mileage rate), telephone and fax charges, postage, printing and other charges for which specific invoices exist and can be clearly noted and assigned to particular activities.


    These include so-called "overhead costs" – especially costs such as fringe benefits and accrued pension liabilities and insurance – which are not immediately identifiable and assignable for specific services. Private firms use accounting systems that discover, count and assign such charges to specific activities. Failure to discover and assign overhead costs would leave a private firm in the dark, making it impossible for the firm to know if it should do certain things directly and "in-house" or hire someone else to do it for them. Firms "outsource" when they discover that a job can be done better or for less by paying someone else to do it for them.

    Table 4

    Governments should do the same thing. One problem with the accounting procedures used by governments, i.e., "fund accounting," is that overhead costs are often not precisely assigned to specific agencies and activities. Government overhead costs are usually kept in separate budget accounts and are therefore difficult to count and assign. To determine whether or not it is appropriate to contract out a government program or have it done in-house, overhead costs should be discovered and assigned to every government agency which performs a public service task.


    Virtually no government agency fully accounts for the value of physical capital used in performing the agency's services. Private firms, since they must over the long run receive revenues in excess of all their costs, do account for the depreciation of their capital.

    Property and equipment used in providing a service or producing a good should be depreciated, and the full opportunity cost of capital should be measured. Explicitly or implicitly, private firms determine the return that capital could earn in its next best alternative use, along with the expected useful "economic" life of the project. The application of this concept to capital equipment generates information which tells firms whether or not funds should be invested in machines and equipment and if they should be rented rather than purchased.

    Governments act as if they have no use for this concept.[26] Under usual government accounting procedures, capital costs are normally charged as a capital outlay expense in the year of purchase. The total purchase cost is assigned as an asset to a General Fixed Asset Group, and the depreciation costs of these assets (even if some effort is made to charge depreciation costs) are not included as a cost for performing a specific project. Therefore, the full value of capital absorbed by a specific agency or project will never be fully discovered and assigned, and the actual capital costs of providing a yearly service will never be fully known.

Government, including the State of Michigan and DSS, does not track function-specific costs the same way a private agency does. This is not to say that government operates dishonestly, but rather to say that the usual accounting procedures used by all levels of government are not specifically designed to allocate costs by agencies and by specific activities within agencies.

Somewhat ironically, all private, nonprofit child and family services agencies that provide social services under contract with DSS must account for and assign all costs. Unlike government, private agencies do not have the power to levy taxes. Nor do they have access to credit markets in the same manner as do governments. Therefore, their revenues must cover all their costs. If private agencies didn't know all their costs at every moment in time, they would be operating in the dark and, sooner or later, they would be forced to close. In that respect, private, nonprofit agencies have something in common with private, for-profit firms which neither has in common with government: they can go bankrupt.

Because accounting systems for private agency placement services and for DSS placement services are different, one cannot answer the first question posed earlier – what does it cost the state to do the job compared to what it costs to have the private sector deliver the same services? The best way to do this is to attempt to hold con-stant the level of service being provided and account fully for all costs – then comparing apples to apples and oranges to oranges.

As is the case with many government services, there is no clear measure of output for foster care supervision services. The quality of the caseworker's advice, his or her ability to interact with the children and their foster families, and other types of activities are very difficult to measure. The best we can do is to presume that, on average, caseworkers employed by the private sector will be as successful in providing these services as case-workers employed by DSS. We know of no claims to the contrary. Indeed, because private agencies must compete for contracts with one another and with in-house DSS supervision, failure to provide adequate service can result in elimination of contracts. There is direct market feedback to the private service provider as opposed to indirect feedback for government provision of services. Thus, we accept equal service levels for equal inputs as a reasonable assumption.

Table 3 provides aggregate budget data on current DSS-supervised child foster care for Fiscal Year (FY) 1992-93:

The estimated average salary DSS foster care workers will receive in FY 1992-93 is slightly more than $30,600. Retirement costs are anticipated to be an additional 22.8%, or approximately $6,985, with longevity and insurance an additional $9,950 per worker. Thus, total compensation per worker is approximately $47,535. This presumes that retirement benefits are fully funded out of current revenues allocated to the DSS. If they are not fully funded each fiscal year, then at some point in the future, as DSS employees retire, the State will have to divert funds from other programs to meet pension obligations.

In Table 1 above, we said there were 3,874 children in DSS-supervised foster care placements in FY 1990-91. Although this number fluctuates from year to year, it provides a useful starting point for economic analysis. Multiplying 3,874 children by 365 days yields 1,414,010 days of care per year. Dividing the current DSS foster care budget of $30.8 million by days of care yields a DSS administrative rate of $21.82 per day. That is, DSS has an in-house cost of at least $21.82.

Private child care agencies know exactly what it costs them to produce foster care services. DSS also knows what it costs the private sector to do the job. In the DSS Cost Schedule Instruction Manual Bulletin, we find the following:

"Each child-caring agency which provides service to youth under agreement with DSS and/or provides services to court wards is required to provide cost information annually to DSS using Cost Schedule Forms DSS-573 and DSS-573A." Furthermore, "The agency's Financial Audit Report is to include a statement of functional expenses as required by industry audit guide on 'Audits of Voluntary Health and Welfare Organizations.' The Report is also to include an expressed opinion on paid days of care and adoption contact hours/or placements if applicable." The agency is required to maintain records of equipment purchase, daily attendance reports, staff payroll records and time sheets, and other information as outlined in the manual.[27] In addition, DSS retains the responsibility to monitor and process fiscal reports in this purchase of services system, and after the cost schedules have been returned to the department, only then will a per diem rate be established for any foster care agency, regardless of the department's intent to purchase from the agency.

Strict controls – as indeed should be the case – are exercised by DSS on rates paid to private agency services. Indeed, one could argue that DSS has a tighter hold on what it costs to contract for foster care services from a private agency than on what it costs to have the work done "in-house."

When DSS examines the costs incurred by private agencies to supply foster care services, a daily "administrative rate" is determined. This is the payment received by the private agency. The DSS Services Manual Bulletin of March 1, 1993, provides administrative rates paid to private agencies for various programs in the current fiscal year. Fifty-one of the private agency programs are paid an. administrative rate of less than the $21.82 calculated for DSS-supervised care for FY 1992-93. Of those paid a rate above $21.82, nearly all are supervising specialized foster care or providing intensive institutional services.

Only four agencies that receive more than $21.82 are not also providing institutional care, managing semi-independent living or supervising difficult children. These are Area Youth for Christ in Battle Creek at $31.29; Child and Family Services, St. Joseph at $33.38; Camp Highfields in Onondaga at $37.45; and Sault Ste. Marie Tribe Binoji Place-ment Agency at $30.70. These agencies may also be supervising difficult youths, but this is not indicated by the DSS Services Manual.

In our effort to compare apples to apples, we have discovered that the administrative rate paid by DSS to private agencies is lower than what DSS spends for in-house care. In fact, since we presumed equal inputs result in equal outputs, private agency placement is even less costly to taxpayers than our estimates show. This is because private agencies have a lower child-to-staff ratio than DSS.

Because most of the children under DSS supervision are placed in regular foster care, it is appropriate to compare the daily administrative rate paid for regular foster care supervision to the DSS in-house estimate. As we have noted, the administrative rate paid to private agencies is clearly less than even our lower estimate for DSS in-house costs. There are at least two obvious explanations for this. One is that at least some private agencies receive donations or have endowments that allow them to subsidize care. The second has to do with labor costs.

Table 4 indicates that salaries for many highly-trained people in private foster care agencies are below what the state pays its own employees.

What is the fringe benefit rate for child care staff in the private sector? In the cost schedule supplied to DSS – under rules of the DSS Cost Schedule Instruction Manual mentioned above – by one of the larger private agencies in Michigan, employee benefits represented

9.2% of salaries, and payroll taxes represented 7.2% of salaries. By contrast, as noted in Table 3 above, DSS employee retirement benefits alone represented 22.8% of payroll, and Longevity &; Insurance were charged at $6,950 per FTE. Thus, private agency labor costs are much lower than the $47,535 per DSS worker we estimated above.

If we are to compare the costs of providing a given amount of foster care supervision, then it is clear that for the same child-to-foster-care-worker ratio the private sector has lower costs – answering the first of the questions posed at the end of Section III above.