State and Local Pensions: What Now?

Are Public Emplyees Overpaid or Underpaid?

139 6 Are Public Employees Overpaid or Underpaid? The previous chapters focused on one component of compensation for state and local workers—namely, pensions. They explored the extent to which government employers had put aside money for future benefits and the extent to which shortfalls will require future contributions that squeeze out other priorities . The discussion showed that funded levels have declined sharply in the wake of the financial crisis and that the recession decimated state and local revenues , making it impossible for governments to compensate for the shortfall. As a result, politicians everywhere are looking for ways to reduce pension costs. Proposals to cut pensions are usually based on the presumption that pensions are “too generous.” But pensions are just one part of total compensation. The relevant question is not whether one component of compensation is excessive but whether the total compensation package—including both wages and fringe benefits—is appropriate for attracting and retaining state and local employees. The most obvious metric against which to assess the appropriateness of public sector compensation is pay in the private sector. As a result, the comparability of state and local versus private sector compensation has re-emerged as a major issue in the wake of the financial crisis. This chapter explores what is known about public versus private sector compensation . The first section reports on some basic facts about the nature of public employees and their compensation. The second section reports on the existing literature—a luxury not available for the topics of earlier chapters—regarding the comparability of public and private compensation. The third section describes a rash of recent studies arguing that state and local workers are paid less or more than their private sector counterparts. Most agree that wages of state and local 140 Are Public Employees Overpaid or Underpaid? employees are lower than for private sector workers with similar education and experience, but researchers differ on the extent to which pensions and other benefits compensate for the shortfall.1 The next two sections explore the relative outcomes for short-term versus long-term state and local employees compared to private sector workers. The fourth section, using household data from the Health and Retirement Study (HRS), asks whether, at the end of the day, state and local employees end up richer or poorer than their private sector counterparts and how that outcome varies by duration of employment. The fifth section narrows the issue back to pensions and uses the HRS to explore replacement rates for shortterm versus long-term state and local employees relative to private sector workers. A number of conclusions emerge. First, wages for workers with similar characteristics , education, and experience are lower for state and local workers than for those in the private sector. Virtually all researchers agree on this point. Second , pension and retiree health benefits for state and local workers roughly offset the wage penalty, so that, taken as a whole, compensation in the two sectors is roughly comparable. Most researchers agree on this point. The remaining issue is job security. Should it be viewed as a compensating differential, which perhaps offsets poor working conditions or a compressed wage structure, or should it be assigned a value and added to the compensation calculation? Third, the parity of compensation between the public and private sectors hides enormous variation by wage levels. State and local workers in the lowest third of the wage distribution are paid somewhat more than their private sector counterparts, those in the middle roughly comparable amounts, and those in the top third significantly less. Fourth, exercises using the Health and Retirement Study that relate lifetime employment patterns to outcomes at retirement show that those who spend most of their career in the state and local sector end up with more wealth and higher replacement rates than those who spend their entire career in the private sector. Short-term state and local workers actually appear to lose from the experience, ending up with less wealth and lower replacement rates than their private sector counterparts. Moreover, for households where the male is the public employee, the higher wealth appears to be attributable to the discipline imposed by being forced to save through a defined benefit plan. In short, for the nation as a whole, the difference between public and private sector compensation appears modest. The relatively modest differential should make policymakers cautious about massive changes without carefully studying the specifics of their particular situation. This caution is particularly relevant in the case of...