Are public-sector employees “overpaid”?

February 7

This is the fifth post in a series. In the first four posts, I discussed the “California rule” for constitutional protection of public-employee pensions: click here for Monday’s, Tuesday’s, Wednesday’s, and Thursday’s posts. The posts were based on my Federalist Society White Paper, Overprotecting Public Employee Pensions: The Contract Clause and the California Rule, and discussed both constitutional and policy issues. On Thursday, I closed with a discussion of a proposed California voter initiative, the Pension Reform Act of 2014, which would repeal the California rule. I haven’t been following the news on this — I was entirely unaware of the initiative until my second day of blogging about the California — but a quick search of news articles turns up that there are disputes over the Attorney General’s description of the initiative, so we’ll see if they get these problems ironed out in time to get it on the ballot soon.

Readers of the last posts will know that I think eliminating the California rule is sound, but a voter initiative amending the California Constitution may itself count as a “law impairing the obligation of contracts” and therefore be unconstitutional except as to future employees. (Legislature v. Eu (Cal. 1991) is a good example of a California amendment passed by initiative that was partially invalidated by the California Supreme Court for exactly this reason.) The result might be different with the Pension Reform Act because, rather than eliminating pension benefits, it changes the rules of how to interpret statutes to create contracts, so one could think of this as being analogous to a California Supreme Court decision reversing course on the ground rules of contract law. But I’m not sure.

This is all I have to say so far on the “California rule”. But I thought I’d close with a short discussion of a separate question that people are interested in when it comes to discussing public-sector employees: are public-sector employees “overpaid”, in the sense of being paid more than private-sector counterparts for comparable work? This hasn’t been relevant to my work — I don’t think it’s necessarily relevant to a policy analysis of whether the California rule is a good idea, and I expressed no opinion on the subject and didn’t rely on any view of the matter in my previous discussion. But it’s still an interesting question.

It turns out that it’s a hard question, much like other public-private cost comparison questions. For instance, does Medicare have higher or lower administrative costs than private insurance? Many advocates of public health financing say Medicare has (much) lower administrative costs, but Robert Book makes cogent arguments to the contrary, which I recommend.

Or: do private prisons cost more or less than public prisons? Most analysts seem to agree that private prisons cost less; pro-private-prison people cite this as an advantage, while anti-private-prison people argue that private prisons can save money by skimping on quality, so overall it’s a bad deal. But some recent meta-analyses purport to find the contrary: that private prisons are actually more expensive. Who’s right? In a forthcoming Emory Law Journal article which I’ll blog here soon, I argue that private prisons really do cost less, but whether the cost savings are on the order of 15% or on the order of 3% depends heavily on one’s assumptions. (While you’re waiting for my blog posts, I’ll direct you to an excellent survey article on private-prison research by Gerald Gaes.)

But back to public-sector employees. Here are three interesting sources to read for more information on the subject: (1) Out of Balance? Comparing Public and Private Sector Compensation Over 20 Years, a study from the Center for State and Local Government Excellence by Keith A. Bender and John S. Heywood; (2) Are State and Local Government Employees Paid Too Much? by Ford Fessenden in the New York Times; and (3) Comparing Private Sector and Government Worker Salaries by Adam Summers from the Reason Foundation.

First, note that public-sector jobs and private-sector jobs are different — for instance, public-sector jobs are more likely to require a college degree — so just looking at overall averages isn’t likely to tell you much. You have to find comparable jobs to compare. The Bender and Heywood study says that for workers with “comparable earnings determinants (e.g., education)”, public-sector workers make less in wages and salaries: state employees make 11% less than private-sector employees, and local workers make 12% less.

But these are wages and salaries, and there’s a lot of compensation that isn’t wages and salaries. One component is pensions, which are a greater share of compensation for public-sector workers. Why is that? I suggest an answer in my own paper: “governments, free from the ERISA regulations that govern private employers, find it easier to promise generous pensions and then underfund them, leaving future generations to pick up the bill. Underfunded public employee pensions are thus a form of deficit spending.” The Bender and Heywood study says the differences between public and private sectors are fairly slight, and considering it all together, public-sector workers still make less than the private-sector workers, by about 7%.

But the Fessenden piece in the New York Times raises a number of extra issues. For instance, public-sector workers typically work fewer hours, so comparing per-hour compensation makes public-sector wages look higher. (More accurately, one should count the extra leisure as a component of public-sector compensation, which isn’t the same as dividing by the number of hours.) Another confounding factor is that public-sector employees are more likely to be unionized, and one might want to disentangle any possible public-sector premium from a unionization premium (not that unionization necessarily increases wages). The piece continues with a discussion of the value of job security and the difficulties of correctly valuing pensions and health benefits:

Public workers quit less often and are fired less often.But there are other issues. The rate at which state and local workers voluntarily quit is very low. Some economists argue that this confirms that they are overpaid and that private workers leave for better pay.

Public workers are also fired at much lower rates. By estimating the income loss before fired workers find new jobs, some economists argue that this is a benefit worth as much as 15 percent of their pay.

Finally, much of the debate relies on elusive accounting.Ultimately, the argument turns on things that are difficult to value, especially retirement benefits. Most public employees are guaranteed a pension and have access to retirement health insurance – benefits that are disappearing from the private sector. What is this worth?

A lot more than federal surveys show, said Andrew G. Biggs of the American Enterprise Institute, because state and local governments are putting away far less than they should to finance their obligations, especially in some heavily unionized states. But Jeffrey H. Keefe, a Rutgers professor who studies the issue for the liberal Economic Policy Institute, disputes this and argues that the cost of defined benefit pensions is overestimated in federal surveys.

Mr. Biggs argues that public retiree health care is also underestimated. He says that the value of that is huge and pushes public workers’ compensation well above private workers’. Mr. Keefe cites California, where less than 1 percent of state employee retirement spending goes for this purpose. The debate goes on.

The Summers article from the Reason Foundation discusses these issues and some more. I’m inclined to think that public-sector workers tend to be paid more once you consider the greater non-wage benefits, the value of job security, and the extra leisure, and that lower quit rates support this theory. But the most important point is that it’s a hard question without clear-cut answers. I recommend you read the sources for yourselves!

Sasha Volokh lives in Atlanta with his wife and three kids, and is an associate professor at Emory Law School. He has written numerous articles and commentaries on law and economics, privatization, antitrust, prisons, constitutional law, regulation, torts, and legal history.
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