The challenge of determining fair pay for government employees

This article was a part of a debate featuring three sets of statements on the question of government pay and benefits. The full debate is available as an Adobe Acrobat PDF below.

THE GREAT GOVERNMENT PAY DEBATE

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The public sector pay controversy has touched every level of government over the past few years, playing out in political campaigns, newspaper headlines and Internet blogs. But even as the political debate over reform continues, we believe that the purely empirical issue regarding the relative generosity of public sector compensation has been settled: On average, public employees receive higher combined wages and benefits than they would receive in the private sector.

The average, of course, does not apply to all workers or to all jobs. Wages and benefits differ at the federal, state and local levels, between different cities and states and between different types of jobs and employees. The challenge for policy makers is not to simply reduce total public sector compensation but to cut back in ways that ensure fair market compensation for all public employees rather than just for the average employee. 

Careful reform will not be easyand developing the perfect system is not realisticbut even minor steps toward a more rational compensation system can help balance government budgets.

When comparing wages among different types of workersfor example, testing for discrimination based on race or gender, or looking for a pay premium for union membersmost labor economists rely on what is called the "human capital model." This approach is based on evidence that the main drivers of pay differences among workers are differences in their human capitalthat is, their education, work experience and other traits related to productivity. Specific work tasks, unless associated with different levels of employee skill, are less important drivers of pay.

Using regression analysis, economists can analyze the effect on wages of being employed by the government while controlling for human capital differences between the public and private sector workforces. These analyses generally show that state and local government workers receive wages slightly below those of similar private sector workers, while federal employees receive slightly higher wages.

Other economists have approached the problem by analyzing how wages differ between public and private jobs that require the same levels of skill. In a recent academic study, two BLS economists compared salaries in state and local government to private sector positions demanding the same job skills. State government employees receive salaries 2.3% below those for similar private sector jobs, while local government employees were paid 9.2% more than private jobs demanding similar skills. The study did not attempt to analyze federal employee wages, as the BLS data set does not grade the skill requirements of federal jobs.

Whether the relevant comparison is worker-to-worker or job-to-job, the suggestion that public sector workers receive vastly lower salaries than they would receive in the private sector is not supported by the most rigorous research.

The clear difference maker in public-private comparisonsis fringe benefits, particularly retirement packages. Most government employees continue to participate intraditional "defined benefit" pensions, which can be several times more generous than the defined contribution 401(k) plans common in the private sector. For example, an Illinois school teacher who retired in 2010 after 30 to 34 years of service would collect a pension of $60,756 a year, a benefit that is guaranteed against market risk and also exceeds the income of 95% of retirees in Illinois. To match that, a private sector employee with the same salary would need to contribute roughly 45% of his or her earnings to his or her 401(k).

On top of pensions, most federal, state and local employees continue to be eligible for retiree health coverage, which can be worth thousands of dollars per year. In California, for instance, the cost of accruing retiree health benefits is equivalent to over 10% of wages. Public employees have protested recent reductions in the generosity of retiree health care, but most private sector workers receive no coverage at all.

Generous fringe benefits can push public sector compensation well ahead of private sector pay.

A common rejoinder to this empirical argument is that instead of reducing benefits for government workers, benefits in the private sector should be increased. Unfortunately, this is not a viable option for private sector employers.

In a competitive labor market, employers cannot pay workers significantly more than they produce without risking bankruptcy. Employers also cannot pay workers significantly less than they produce without losing employees to rival firms. Without changes in worker productivity, total employee compensation—meaning salaries, benefits, taxes paid on workers' behalf and so forth—is not very flexible.

While legislation could raise private sector benefits by fiat—for example, by mandating health or pension coverage—private employers would need to offset the added cost by lowering salaries, leaving the public sector compensation advantage unchanged. Mandating higher private sector benefits is no solution to public-private pay disparities.

In contrast to the private sector, governments are not limited to paying their workers according to their productivity. The public sector is restricted not by profit and loss but only by voter-imposed constraints on taxing and borrowing. Given the ability of the public sector workforce to influence policy—directly through collective bargaining and indirectly through political organizing—it should not be surprising when government workers receive a compensation premium.

Restricting collective bargaining and union influence will help change the political dynamics that lead to excessive average compensation and rigid salary structures.Union membership and dues should be made optional, not required. Direct reforms to benefits, such as raising retirement ages to match private sector norms and shifting public employees to 401(k)-style plans also would help restore pay parity. 

Andrew Biggs is a resident scholar at AEI and Jason Rishwine is a senior policy analyst at the Heritage Foundation. 

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