Government Pay Packages Have Room for Big Savings

Published February 14, 2010

State and local governments face large budget deficits as revenues have stagnated and spending has remained high. To reduce deficits, large savings can be found in the generous compensation packages of the nation’s 20 million state and local workers.

In 2008, wages and benefits of $1.1 trillion accounted for half of total state and local government spending.
Public sector pay averaged $39.66 per hour in 2009, 45 percent higher than the private sector average. The public sector advantage was 34 percent in wages and 70 percent in benefits.
Pricey Public Sector Perks
Public sector workers have the largest advantages in health insurance, defined benefit pension plans, and paid leave. Government workers also enjoy high job security. During good times and bad, “layoffs and discharges” in the public sector occur at just one-third the rate of the private sector.
One way to assess whether overall public sector compensation is too high is to look at voluntary job quit rates. U.S. Bureau of Labor Statistics data show the average quit rate in the state and local workforce is just one-third the rate in the private sector. That suggests state and local pay is higher than needed to attract qualified workers.
Regional Variations in Compensation
Average compensation per hour for government workers varies from $49.02 in the Pacific region to $30.73 in the West South Central region. Part of this variation results from general differences in pay levels, as reflected in private sector pay differences between the regions.
However, the data also show the ratio of public to private sector pay is generally higher in the high-pay regions. For example, the Pacific region has the highest public pay and a public pay advantage of 59 percent, while the West South Central region has the lowest public pay and a public pay advantage of 26 percent.

One factor driving these regional differences is the degree of unionization of the workforce. The four states with the highest public pay have a high share of union members in their public sector workforces. Also, regions with the highest public pay advantage generally have the highest union shares.
Excessive Retirement Benefits
State and local workers have very generous defined-benefit (DB) pension plans compared to private sector workers. These plans have been overpromised and underfunded, creating huge long-term gaps in government budgets.

According to official estimates, state and local pension plans are underfunded (or overpromised) by about $1 trillion. And these estimates greatly understate the poor shape of pension plans because they rely on optimistic assumptions to value future liabilities.
A recent study by Robert Novy-Marx and Joshua Rauh found governments are “severely underestimating” their pension liabilities by using high discount rates. Using more realistic assumptions the authors found state and local pensions were underfunded by $3.2 trillion, three times the officially reported amount.

In 2009, DB plans were available to 84 percent of state and local workers but just 21 percent of private workers. And public sector DB plans are generally much more generous than the remaining private plans. One study found the median public sector DB plan paid benefits more than twice as high as the median private plan.

Outlandish Pensions
A flood of news articles has highlighted the excesses in public sector pension plans, with some cities and states providing truly outlandish benefits. Some of the factors driving up costs in public DB plans include:
• Early Retirement. Public sector workers generally retire earlier than private sector workers and enjoy generous pension benefits for life, indexed for inflation. They can typically retire at age 55 after 30 years of work, as in California’s CalPERs system. Public safety workers in CalPERs can retire at age 50 after 30 years of work with benefits equal to 90 percent of their final salary.
• Pension Formulas. Virtually all public sector plans calculate benefits based on pay in the last one to three years of work. Private plans are more likely to use a lower-cost approach such as the last five years of pay or career-average pay. Also, public plans typically have a more generous factor to adjust pension benefits for number of years worked.
• Double Dipping. In California, New Jersey, Utah, and other states, public workers can “retire” early and then either resume their existing job or take a new one, thus receiving a salary and pension at the same time.
• Disability Claims. Governing magazine notes, “hundreds of local governments and several states are wrestling with what some view as out-of-control disability pension and health insurance systems hard-wired to allow police and fire personnel to retire early and with very generous benefits. At the same time, they may pursue other full-time careers.”

State and local governments across the nation face huge fiscal challenges. With employee compensation representing half of total state and local spending, large savings could be found by freezing wages and overhauling excessive benefit packages.

Chris Edwards ([email protected]) is director of tax policy studies at the Cato Institute. A version of this article first appeared in Tax & Budget Bulletin No. 59. Used with permission.

Internet Info

Cato Institute’s Tax & Budget Bulletin No. 59: