The effect of pension accounting rules on public–private pay comparisons

I. Introduction

Across the country, debates over the appropriate level of public-employee compensation are ongoing. Due to the recession, governments at every level are seeking to reduce budget deficits, and public employees often enter their crosshairs. At the federal level, President Obama asked Congress to cancel federal workers' annual wage increase, essentially leading to a two to three percent cut in real wages.1 Several states, most notably Wisconsin and Ohio, have passed controversial laws that reduce compensation for public workers and restrict the power of their unions.2

Central to the compensation debate is the question of whether public-sector employees are "overpaid" or "underpaid." If public employees are compensated more than similar private-sector workers, then pay reductions could save taxpayers money without a significant impact on workforce quality. If, on the other hand, public workers are already being shortchanged, further cuts would damage the public sector's ability to recruit and retain qualified workers.

Because of the well-known tendency for public employers to be more generous with benefits than with wages, any analysis that attempts to settle the "overpaid" or "underpaid" question must include all forms of compensation in the comparison. However, this article is not an all-inclusive analysis.3 Instead, our goal is to correct a significant error in many existing public-private comparisons.

Simply put, it is incorrect to assume that the amount that state and local governments set aside for pension financing is equivalent to the "pension compensation" that public employees receive. In fact, because of accounting differences between the public and private sectors, 4 public defined benefit pension plans contribute far less for each dollar of future pension benefits than private plans do, potentially skewing comparisons of overall compensation.

The assumption that current contributions are equivalent to future benefits has led some analysts to dramatically undervalue public employees' retirement benefits.5 Section II of this article explains the origin of incorrect pension valuation and why it leads to erroneous results. Section III analyzes how better estimates can be generated and provides empirical examples. The article concludes by noting that until pension values are calculated using the same assumptions, public-private pay comparisons will continue to be skewed.

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Endnotes

1. Peter Baker & Jackie Calmes, Obama Declares Two-Year Freeze on Federal Pay, N.Y. TIMES, Nov. 30, 2010, at A1, available at 2010 WLNR 23765163. After the two-year pay freeze, President Obama proposed a 0.5% pay increase for 2012. Ed O'Keefe, Federal Workers' Pay Could Bump Up by .5%, WASH. POST, Jan. 7, 2012, at A1, available at 2012 WLNR 418605.

2. S.B. 5, 129 Gen. Assemb. (Ohio 2011) (overturned by referendum); 2011 Wis. Act 10.

3. For an example of an all-inclusive analysis, see JASON RICHWINE & ANDREW G. BIGGS, HERITAGE CTR. FOR DATA ANALYSIS: ASSESSING THE COMPENSATION OF PUBLIC-SCHOOL TEACHERS (2011), http://www.aei.org/files/2011/11/02/-assessing-the-compensation-of-public-school-teachers_19282337242.pdf.

4. For the Governmental Accounting Standards Board's views on why it treats public employers differently, see GOV'T ACCT. STANDARDS BD., WHY GOVERNMENTAL ACCOUNTING AND FINANCIAL REPORTING IS-AND SHOULD BE-DIFFERENT (2006), http://www.gasb.org/
cs/ContentServer?c=GASBContent_C&pagename=GASB%2FGASBContent_C%2FGASBNewsPage&cid=1176156736250.

5. See, e.g., http://www.heritage.org/Research/Reports/2011/03/Are-California-Public-Employees-Overpaid-_ftnref2KEITH A. BENDER & JOHN S. HEYWOOD, CTR. FOR STATE & LOCAL GOV'T EXCELLENCE, OUT OF BALANCE?: COMPARING PUBLIC AND PRIVATE SECTOR COMPENSATION OVER 20 YEARS (2010); JOHN SCHMITT, CTR. FOR ECON. & POL'Y RESEARCH, THE BENEFITS OF STATE AND LOCAL GOVERNMENT EMPLOYEES (2010), http://www.cepr.net/index.php/publications/reports/benefits-of-state-local-gov-employees/; Sylvia A. Allegretto & Jeffrey Keefe, The Truth About Public Employees in California: They Are Neither Overpaid Nor Overcompensated, CENTER ON WAGE & EMP. DYNAMICS Oct. 2010, http://www.irle.berkeley.edu/cwed/wp/2010-03.pdf; Jeffrey Keefe, Debunking the Myth of the Overcompensated Public Employee, 276 ECON. POL'Y INST. 1 (Sept. 15, 2010), http://www.epi.org/page/-/pdf/bp276.pdf. Keefe and the Economic Policy Institute have also published several state-specific analyses that make the same error in pension valuation. See, e.g., Jeffrey H. Keefe, Are New Jersey Public Employees Overpaid?, 270 ECON. POL'Y INST. 1 (July 30, 2010).

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