Economics

Wisconsin Public Employees: A Question of Justice or Rent-Seeking?

Over at the New Republic, Jon Cohn discusses the Economic Policy Institute’s (EPI’s) report on public-sector pay in Wisconsin, which has gotten some coverage in the media and around the Internet. Jason Richwine and I spent some time over the weekend looking at Wisconsin public employees in the context of our other work on public-sector pay. While we’ll have a longer piece out on Wisconsin pay soon, I figured that in response to Cohn’s post I’d raise a couple issues regarding EPI’s report.

First, we’ve found a lower salary penalty for Wisconsin public employees than EPI did (around -5 percent versus -11 percent in EPI’s study). It’s not clear what’s driving the difference, since we’re using the same data, but that’s something to track down. It’s also worth noting that both our calculations and EPI’s control for firm size; this means that essentially we’re comparing Wisconsin public employees not to all private workers, but to employees at the very largest Wisconsin firms, who tend to pay more generous salaries and benefits. Whether to control for firm size is an open question, since if a given public employee didn’t work for the government there’s a good chance he wouldn’t work at a large private firm. But readers at least should be aware of the issue.

Second, the benefits shown in the EPI report aren’t actually for Wisconsin alone. They’re an average for the “East North Central Census Division,” which comprises Illinois, Indiana, Michigan, Ohio, and Wisconsin. Because the Bureau of Labor Statistics doesn’t publish compensation data at the state level (due to small sample sizes) regional figures are the best we’ve got. The problem is, if Wisconsin government workers get relatively better benefits than public employees in other states—which seems to be part of the argument that Governor Walker is making—then these figures will understate true compensation. For instance, in practice Wisconsin public employees make essentially no contribution toward their pensions (formally they must contribute around 5 percent of pay, but their employers almost always cover it). Nationally, public employees contribute an average of around 5.7 percent of pay to their pensions.

Third, the benefit measures in the EPI study are based on what employers pay, not what employees actually receive. This matters for public-sector defined-benefit pensions, which use much more optimistic investment return assumptions than private pensions (a 7.8 percent assumed return in the Wisconsin Retirement System, versus around a 4 percent riskless return in U.S. Treasury securities) and fund their benefits accordingly. Most economists think public pensions are wrong to make these assumptions, but what matters is that employees effectively receive those higher returns whether the investments pan out or not. Adjusting for the differences in implicit returns to pensions would increase total Wisconsin compensation by around 4 percent.

Fourth, and related, is that the EPI study omits the value of retiree health benefits, which most public workers receive but most private employees don’t. (Some very large firms still offer retiree health benefits, but they’re increasingly rare and increasingly stingy.) The value of retiree healthcare can vary significantly. For instance, most run-of-the-mill Wisconsin state retirees are offered the right to buy into the employee plan. This provides an implicit subsidy, since they’re buying at rates calculated for the working-age population rather than their own health risk. The value of this is equal to a percent or so of extra pay every year. Other employees, such as Milwaukee teachers, have almost all their premiums paid for them. Actuarial reports list these protections as costing over 17 percent of salaries, meaning that for these workers EPI’s approach would miss a lot of benefit income. In addition, even these actuarial studies value retiree health coverage at employer cost, not the benefit to the employee. A retired 60-year-old purchasing coverage in the individual market would pay significantly more than the reported cost of his public-sector retiree health plan, because individual coverage costs more than group coverage. Some studies place the cost differential at around 25 percent; the Congressional Budget Office’s health insurance model appears to assume something larger: they say that “once differences in the characteristics of nongroup versus ESI [employer sponsored insurance] policyholders are considered and different loading costs are considered, a typical nongroup policy has roughly 60 percent of the relative plan value of an average ESI policy. That finding is supported by a recent survey of nongroup and ESI premiums and relative plan values in California.” So we know something is being missed and we have good reason to believe that even when we find actuarial reports calculating the cost of retiree health coverage, it’s still an underestimate. Unfortunately, there’s no central data source for retiree health benefits, meaning there’s a lot of digging to get a correct answer.

Fifth, the EPI report doesn’t calculate the value of public-sector job security. In a given year, a state/local worker has less than one-third the chance of being fired or laid off as a private worker. There’s a long history in economics (back to Adam Smith, actually) of thinking in terms of “compensating wage differentials,” although it’s only in the last 20 years or so that there’s been much progress in measuring them. We took a somewhat different approach, of using financial tools to calculate the price of an insurance policy that would protect against job loss and counting the value of that insurance toward public-sector pay. In theory each should produce the same answer, but as always things are messy. There may be a way of using CPS data to get on top of this, though.

At the end of the day, I just don’t think we can make any final conclusions on state/local pay because so much of the data, particularly on the benefits end, is still too loosey-goosey. There’s just more work to be done. (At the federal level, though, the measured overpayment is so large that I’m willing to say I’m convinced.)

Finally, Cohn argues, “Who’s to say that the problem is public workers making too much, rather than private sector workers making too little?” Daft as it sounds, in a sense I don’t know what this really means since he’s not providing a criterion for what the right pay should be. Are private workers paid too little relative to the past? Not really: the ratio of compensation to national income is about the same today as it was in 1970, it’s just the form of compensation (more healthcare, less wages) has changed. Second, in the market there’s a decent definition of the “right” pay: it equals the worker’s marginal product, or in English, what he produces for the firm. Pay him more than what he produces and the firm goes broke; pay him less and he’ll leave for a competitor. Obviously it’s not as clean as that, but by and large it works. I think Cohn is referring to a moral criterion of the right pay, which is fine but harder to define. Moreover, even if we have a social standard for pay that exceeds the market standard—that’s one reason we have a progressive income tax, the Earned Income Tax Credit, and so forth—it makes sense to do it openly and uniformly so everyone gets to share. Overpayment for public sector workers, if it exists, isn’t about equity to low earners but rent-seeking by a powerful interest group.

Image by TheShutterbugEye.

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