‘What a Piece of Junk’: Responding to the Economic Policy Institute on Public Employee Pay

Great post by Andrew Biggs of AEI

In the original”Star Wars” trilogy (not those crappy prequels), Luke Skywalker uttered these words when he first saw Han Solo’s ship, the Millennium Falcon: “What a piece of junk.” I had the same reaction to a new policy brief from the Economic Policy Institute (EPI), which attacks my work with Jason Richwine on public sector pay, in particular a recent study for the Ohio Business Roundtable. (I should note that these comments are my own and that Jason is far more polite than I am).

In previous work for EPI, Rutgers University’s Jeffrey Keefe concluded that Ohio state and local government workers receive slightly lower total pay and benefits than similar workers in the private sector. We find, by contrast, that the combined value of public sector salaries, benefits, and job security exceeds private sector levels by roughly 43 percent.

Keefe questions practically every part of our Ohio paper and, trust me, we have answers to almost all of his points. If you read EPI’s paper and are tempted to believe its claims, post a comment and I’ll address it.

But pensions are where the real action is. Once you accept our view of pensions, you could buy pretty much everything else EPI says and still conclude that public employees are overpaid. EPI thinks pay studies should focus on what employers contribute toward pensions while we look at the benefits employees actually receive.

Put simply, EPI believes that government pensions can generate a given dollar of future retirement benefits at roughly one-third the cost of a private sector employer. And it’s true that, for each dollar of guaranteed future benefits, governments actually do contribute about one-third as much as private pensions. These lower contributions are based on aggressive accounting rules that let public plans “discount” their future benefit liabilities using high interest rates of around 8 percent, versus about 5.5 percent for private defined benefit (DB) plans and, implicitly, around 4 percent for 401(k)-type pensions. Based on low employer contributions, EPI concludes that public sector pensions aren’t actually all that generous. We counter that if you look at the benefits employees actually receive, most public employees’ total compensation package is well above private sector levels.

In effect, EPI’s argument rests on you believing that “Public employees are overpaid, but we aren’t overpaying them.” That is, government possesses some magic by which it can pay far higher pensions at far lower costs than the private sector. This claim is doubly wrong.

1) The vast, vast majority of professional economists don’t believe that government possesses such magic. As Keefe himself admits, most economists argue that accounting rules that let public plans contribute so much less than private pensions are simply wrong. Don’t take my word for it, though: Nobel Prize-winning economists, the Federal Reserve, and the Congressional Budget Office all say the same thing. If public pensions followed economically-sound accounting rules, their contribution rates would rise and it would be obvious that public employees receive higher total compensation.

2) Moreover, even if government can magically generate pension benefits at one third the cost, that does not imply that employees should be the beneficiaries of that little miracle. According to the theory of “equalizing differences”—which the Handbook of Labor Economics calls “the fundamental (long-run) market equilibrium construct in labor economics”—government just as well could pay lower wages and use the savings to reduce taxes or increase other government programs.

For a public/private pay comparison, what we want to know is whether that offset has taken place. By measuring the pensions people will actually receive, along with their salaries and other benefits, we can accurately compare total compensation packages between the public and private sectors. And, based on these actual benefits, it is unequivocal that public employees in Ohio, and in most other states for that matter, receive higher total pay than private sector workers.

Other public sector pay studies—such as from the (hardly conservative-leaning) Center for State and Local Government Excellence, which EPI cited in its highly-misleading blog post on our paper—note that, “the public sector contribution under-states public sector compensation,” for exactly the reasons we describe. (We have other issues with the CSLGE study, but on this point they’re correct).

So to accept EPI’s arguments regarding pensions and overall public sector compensation, you have to reject the views of both the vast majority of financial economists and the vast majority of labor economists. Nice going, EPI

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