Public sector unions and the rising costs of employee compensation.

• Author: Edwards, Chris
• Position: Report

Public sector compensation is becoming a high-profile policy issue. While private sector wages and benefits have stagnated during the recession, many governments continue to increase compensation for public sector workers. At the same time, there are growing concerns about huge underfunding in public sector retirement plans across the nation.

This article examines the compensation of state and local workers, who account for 20 million of the 23 million civilian government workers in the United States. (1) State and local workers include teachers, college instructors, police officers, health care administrators, and many other occupational groups.

Examining state and local compensation is important because it represents a major portion of the overall U.S. economy. In 2008, the total cost of wages and benefits for state and local workers was $1.1 trillion, which was half of the $2.2 trillion in total spending by state and local governments. (2) Compensation costs are expected to rise rapidly in coming years due to growing pension and health care costs.

This study begins with a look at trends in state and local government compensation since 1950. Then it compares compensation levels in the public and private sectors using data for 2008, Note that I will use the phrase "public sector" to refer to state and local governments and not the federal government, which is not examined here.

Next, the growth of labor unions in the public sector workforce is discussed. In 2008, 39 percent of state and local workers were members of unions, but that percentage varies widely by state as a result of differences in state legislation on collective bargaining and other aspects of union organization.

Does the presence of labor unions in the public sector increase the costs of public sector compensation? I use state-level data on public sector compensation and union shares in an OLS regression to explore this question. I find that public sector unions push up the costs of the public sector workforce in the United States by about 8 percent, on average, but the increase would be more in states with highly unionized public sectors such as California.

The final section discusses the coming fiscal crisis in state and local budgets. Many state and local governments have huge unfunded obligations in worker retirement plans, and they will need to make major reforms to their budgets in the years ahead. However, enacting reforms will be a significant challenge given the resistance to change in the politically active and unionized workforces of state and local governments.

Growth in Public Sector Compensation

The U.S. Bureau of Economic Analysis publishes time series data on employment and compensation by industry. (3) Based on these data, Figure 1 shows average compensation levels in the public and private sectors since 1950. Compensation includes wages and benefits, such as the costs of health care and pensions. The data are in constant 2008 dollars, deflated by the consumer price index.

Between 1950 and about 1980, average compensation in the public and private sectors moved in lockstep. But 'after 1980, public sector compensation growth began to outpace private sector compensation growth, and by the mid-1990s public sector workers had a substantial pay advantage. In the boom years of the late-1990s, private sector workers closed the gap a bit, but public sector pay moved ahead again in the 2000s.

[FIGURE 1 OMITTED]

The public sector pay advantage is most pronounced in benefits. Bureau of Economic Analysis data show that average compensation in the private sector was $59,909 in 2008, including $50,028 in wages and $9,881 in benefits. Average compensation in the public sector was $67,812, including $52,051 in wages and $15,761 in benefits.

The BEA data break down the public sector workforce into three groups: education, public enterprises (such as government liquor stores), and all other government functions. The long-term compensation trends in the three groups have been similar.

Finally, note that the BEA data on benefits include employer contributions to defined-benefit pension and health care plans. But state and local pension and retiree health plans are, in aggregate, hugely underfunded, as discussed below, Thus, these data understate the level of benefits that state and local workers are currently accruing.

Compensation Levels in the Public and Private Sectors

The U.S. Bureau of Labor Statistics (BLS 2009d) provides data allowing a detailed comparison of compensation in the public and private sectors. Table 1 shows employer costs per hour of work for each component of compensation in 2008. These data show a much larger gap between average public and average private sector compensation than the BEA data.

In June 2009, total compensation per hour was $39.66 in the public sector, which was 45 percent greater than the average $27.42 per hour in the private sector. The public sector advantage in average wages was 34 percent, while the advantage in benefits was a huge 70 percent.

These BLS data allow a public-private comparison for three broad occupational groups: "management and professional," "sales and office," and "service." For the first occupational group, average public and private compensation was similar, but public sector workers had a large compensation advantage in the latter two occupational groups.

Why is the public sector compensation advantage much larger in the BLS data than the BEA data discussed above? One important reason is that public sector employees work substantially fewer hours than do private sector employees. The BLS National Compensation Survey (BLS 2009c: Tables 4 and 5) shows that full-time private sector workers averaged 2,050 hours of work in 2008, or 12 percent more than the 1,825 hours worked by the average public sector worker.

Let's go back to the data in Table 1. They reveal that the largest public sector compensation advantages are in health insurance, defined benefit retirement plans, and paid leave. These advantages are due to the greater generosity of public sector benefit packages and the fact that more public employers offer those benefits.

The BLS (2009b) provides data on the share of employers who offer various types of benefit. The advantages of public sector employment include:

* Health care benefits are available to 71 percent of private sector employees but 88 percent of public sector employees.

* Retirement plans (defined-benefit or defined-contribution) are available to 67 percent of private sector employees but 90 percent of public sector employees. Among full-time employees, the shares rise to 76 percent and 99 percent, respectively.

* Life insurance benefits are available to 59 percent of private sector employees but 80 percent of public sector employees.

* Paid sick leave is available to 61 percent of private sector employees but 89 percent of public sector employees.

Many state and local governments have expanded their worker retirement benefits during the last couple of decades. Because most public sector workers receive defined-benefit pensions, policymakers have been able to expand promised benefits without incurring a large short-term budget impact. However, generous benefit packages have created large unfunded liabilities in employee retirement plans, as discussed below. As with the BEA compensation data, the BLS data understate the full cost of current employee benefits to the extent of underfunding in state and local pension and retiree health care plans.

Public sector retirement plans are usually more generous than those in the private sector, The annual benefit of the median public sector defined-benefit pension is more than twice the benefit in the median private plan (Pew 2007: 11). One factor driving that difference is that nearly all public sector defined-benefit plans calculate benefits based on earnings during the last one to three years of work (Braden and Hyland 1993: 19). By contrast, private sector defined benefit plans are more likely to use a lower-cost approach, such as basing benefits on career-average earnings.

Another difference between public and private compensation regards retiree health benefits. In the public sector, employees can retire early--usually at age 55--and then enjoy years of health care coverage at taxpayers' expense before Medicare kicks at age 65. Such retiree health care coverage is a very rare perk in the private sector.

Aside from all these monetary benefits of public sector employment, there is one very important nonmonetary benefit of working for the government: very high job security. During good times and bad, BLS data show that "layoffs and discharges" in the public sector occur at just one-third the rate as in the private sector (BLS 2009e). (4) Public sector workers rarely get fired for poor performance or laid off because of employer cost-cutting, but those events occur frequently in the private sector.

Finally, there is a very good market indicator of the generosity of compensation in the public sector: voluntary job-quit rates. If an industry has a low quit rate, it indicates that compensation is more than adequate to attract qualified workers. The BLS (2009e) has data on employee quit rates across industries, and over the years the quit rate among public sector workers has been just one-third the quit rate in the private sector. With the poor economy in 2009, quit rates fell in both the private and public sectors, but the public sector rate remained at just one-third the rate in the private sector.

Pension Scandals

So far I've focused on public sector compensation as reflected in national statistics, but those statistics tell only part of the story. In recent years, many news articles have highlighted examples of public sector pay packages--particularly pensions--that often seem grossly excessive. These excessive public pensions may not be reflected in official statistics on compensation because they reflect...