Weighing Public Pay Scales

Let's put "total compensation" to the test — and into the law — to debunk the myths on both sides.
by | April 7, 2011

Girard Miller

Girard Miller is the Public Money columnist for GOVERNING and a senior strategist at the PFM Group.

Defenders and opponents of public pensions live on two different planets. Nothing illustrates this more clearly than the ongoing debate about whether public employees are overpaid — especially when we take into account their pensions and retirement benefits. The pension debate would be far less vitriolic if both sides could agree on this one point.

Public-employee advocates and most public administrators cling to traditional wisdom that public servants are paid less in cash — and to compensate for this, they should get better benefits. They believe that when total compensation is calculated, public employees come up short when compared with their private sector counterparts. Many will point to profit-sharing, bonuses and corporate CEO compensation with an envious and often disdainful eye. They consider themselves scapegoats.

Pension reformers, tea-partiers, and anti-government cynics have a completely different view — shared by many upright labor attorneys and other professionals working on behalf of governments in the public-compensation space. They see costly retirement benefits pushing the total compensation of many public employees above what they would receive for comparable work in the private sector. Their thesis is that public compensation has gone overboard when the true cost of retirement benefits is included and we consider the benefits promised but not paid for. Others take a softer posture and simply say that today's financial constraints on state and local governments demand that public employees share part of the burden with many taxpayers who are also hurting from unemployment and devastated balance sheets from underwater home mortgages.

To counter that, the pension advocates point to research showing that public employees are paid less than private workers even when retirement costs are calculated, especially when education levels are considered. What they fail to admit is that these academic studies omit entirely the unfunded liabilities of public pension and retiree medical plans, which would cost most of these employers another 10 to 15 percent of payroll if included and amortized properly — as they will eventually be required to do under preliminary views of the governmental accounting standards board. There is not an academic study with credible results on this issue that has addressed this problem. And although there is a germ of truth in the analysis showing that public-employee compensation levels are comparable to the private sector when education levels are considered, this approach is skewed by over-emphasis on credentialed educational personnel and tells us little about the general governmental workforce.

Meanwhile, the pension abolitionists point to similarly flawed academic research that unnecessarily inflates the true cost of public pensions by insisting that we account for them like lottery prizes, and discount their value using government bond rates — even though most investment professionals would agree strongly that the reasonable rate to expect from investment returns on pension funds will be significantly more over a generation in time.

When I speak with seasoned public administrators, they are quite candid about this issue. They tell me that some entry-level and professionally lower-skilled public employees are compensated above private market standards. But they would argue that the higher on the educational and job-responsibility ladders one goes, the greater the gap behind the private sector. City administrators usually want to compare themselves with corporate CEOs, while finance directors point to CFOs, and IT directors cite the pay of CIOs in the business world. Some of them lust for the profit-sharing and bonuses of their private-sector counterparts. Few, however, have worked in the pressure-cooker of high-paced, risk-taking, competitive-market employers who actually have to win a sale or beat out a competitor in order to make payroll or satisfy investors. Most public administrators focus their pay-comparability on total budgets and numbers of employees supervised — which is how bureaucrats evaluate responsibility — rather than the results of their activities which is how the private sector tends to measure (as in profits, market share, operating margins or returns on investment).

The debate thus resembles the fabled "12 blind men with an elephant": Everybody sees one or two pieces of anecdotal evidence and draws conclusions without a methodological context. So, where is the middle ground? Is there a rational, unbiased way to resolve this debate? How can we end the pension-envy on one side and the bonus-envy on the other? Can we eliminate the obvious abuses in public compensation systems without demoralizing and scapegoating public servants?

Of course we can. Here's a sensible approach that can put an end to this theoretical debate and provide workable concepts and tools for legislatures, public administrators, elected officials, union officials and labor arbitrators to use as we all seek to achieve sustainable, competitive and sufficient levels of public employee compensation:

1. Total compensation of public employees should not exceed competitive market levels. Competitive-market data must include both public- and private-sector labor markets from which employees are routinely recruited.

Firefighters, maintenance workers and office clerical staff should be compensated initially at levels commensurate with the labor markets from which they are recruited, especially with respect to benefits. As they gain skills and undertake unique specialized activities, it is appropriate to include retention compensation in comparison with other public agencies to the extent that such employees have ever actually transferred elsewhere in significant numbers, but this should not be the dominant consideration. Otherwise, public-employee compensation abuses and labor arbitration awards resulting from incestuous comparisons are inherently circular.

If incumbent employees' total compensation exceeds competitive market standards, and retirement benefits are immutable, then the cash compensation should be adjusted downward and employee contributions to retirement benefits can be increased commensurately to achieve competitive levels overall. In extreme cases, employees receiving excessive total compensation could be disqualified from accruing additional retirement service credits in the future.

2. In this context, benefits for newly hired public employees should not exceed private-sector labor market standards.

If total compensation is insufficient to compete for talent in real-world labor markets, public employers would be far wiser to adjust their (modifiable) cash compensation than to take on perpetual and irrevocable commitments to retirement funding schemes.

3. Total compensation includes the full actuarial cost of retirement benefits amortized over the remaining average service lives of current employees.

This includes retiree medical benefits which are presently unfunded actuarially by most public employers, and the cost of amortizing pensions over 12-15 years and not 30 years as most pension funds presently practice. Failure to include this hidden cost of public employee compensation is where the debate typically breaks down. Let's put total costs on the table, not just the partial costs that many employers now pay. This will rectify the research deficiencies of the academic studies mentioned previously.

4. Public sector compensation systems must focus more on market compensation levels and less on "internal equity" which tends to reward bureaucrats rather than the achievers and competitors.

Supply and demand must ultimately determine what jobs pay. A high school math teacher may have two masters degrees and the city IT worker or civil engineer may have only an undergrad degree, but it's folly to compare them using only pedigrees and internal metrics. Compensation must be market-competitive first and internally consistent second.

5. Uniquely skilled individuals with private-sector career alternatives can be rewarded above a market average through incentive compensation systems, but not by salaries or retirement benefits.

Professionally qualified workers in competitive or scarce-talent industries, such as information-technology professionals, CPAs and public hospital doctors, may require higher compensation through variable pay than others on the public payroll. Unions must learn to live with variable pay for such workers instead of holding them back. Accomplishments that genuinely impact public-service delivery must trump internal and political popularity, seniority and efforts over results.

6. Workers exposed to hazardous duty should be fairly compensated for uninsured risks.

Certain public-sector occupations entail higher personal risks than trades workers in the private-sector labor markets. Public safety and even sanitation workers are often exposed to occupational hazards that should be fairly compensated. Life and disability insurance can and should be provided to such workers in fair proportion to the economic value (impairment and loss of earning capacity) that a civil court would typically award for personal injury.

Clearly, the families of such workers should be protected from insurable occupational risks. But most already are. What is often unknown to the general public is the long-standing federal program that now provides $300,000 or more in benefits to the survivors of fallen public safety employees, plus a disability benefit often complemented by similar state-level programs, plus employer-paid life insurance, workers compensation and disability pension benefits that are largely untaxed. If those policies are insufficient, let's beef them up before handing out supersized lifetime pensions and medical benefits to healthy 45- and 50-year-olds. Otherwise we are mismatching benefits and rewarding the wrong recipients.

Additional or uninsured stress-related risks that are less quantifiable should be compensated through higher pay than typical for the labor markets from which such workers are typically recruited — instead of bloated, underfunded retirement benefits. Some labor relations professionals suggest that the community would be better off if we paid firefighters salaries of perhaps 10 or 20 percent more than electricians, ironworkers and plumbers (for purposes of illustration). Similarly police officers deserve a risk- and skills-based premium over private security guards, military police and airport TSA officers. The labor market can then determine if that's enough to recruit first-responders. In many cases this will reduce total compensation to align with market levels. If there are abundant applicants for new position vacancies, one must conclude that the compensation is sufficient. Otherwise, the concept of public service is overshadowed by mercenary values that are anything but heroic.

These essential public-policy concepts can be refined in the design of a formal statutory structure to guide public-sector compensation. Professionals working in the labor relations field would welcome statutory standards along these lines. Pension reform legislation should also include a paragraph that addresses the competitive public-private labor market standard. Suggested language:

Total compensation of all public employees shall not exceed competitive market levels, except for performance-based compensation as provided below. In determining total compensation, competitive markets used for benchmarking and labor arbitration shall include both public- and private-sector labor markets from which employees are routinely recruited. Total compensation includes the full actuarial cost of retirement benefits amortized over the remaining average service lives of current employees. Retirement benefits for newly hired public employees may not exceed private-sector labor market standards unless they contribute at least one-half the total actuarial cost using a government-bond discount rate. Employers with more than 75 employees in a given occupation, bargaining unit or general job classification shall periodically obtain sufficient marketplace survey data to substantiate compliance with these requirements, and make such information available for use by other public employers.

Uniquely skilled individuals with private-sector career alternatives can be rewarded above a market average through performance-based incentive compensation systems authorized and disclosed in public, but not by salaries or retirement benefits. Public employees in hazardous occupations may receive supplemental salary compensation to assure sufficient recruitment and to compensate for uninsured risks associated with their public service which would not be comparable with private sector employees, based on empirical analysis of the economic costs and frequency of losses arising from such exposure.

A legal framework like this will undoubtedly spawn a new sub-industry for compensation consultants, and wage-and-benefits surveys. Some will scoff at the added cost of collecting and scrutinizing such data, especially for smaller employers. So it makes sense to apply these standards only to the larger public employers with 75 or more workers in a given job classification. Then the cost of data collection will be miniscule — a slim fraction of 1 percent of payroll every few years (and before any labor agreements are signed). Once the larger employers achieve true labor-market competitiveness, the smaller ones will find themselves comparing with the big guys and can thus enjoy the cost-control benefits of this system without bearing administrative expenses. They can even freeload from the surveys obtained by the larger employers, which would be public information.

This statutory system will assure that public compensation levels are curbed where they may now be excessive. Equally importantly, this bevy of information will insert facts and logic into the pension and retirement reform debate. The entire labor arbitration process would be improved with such standards, once the data become available and standards evolve. Taxpayers will benefit when excessive pay and benefits are curbed, and at the same time we can stop scapegoating those public employees who are truly underpaid.

Based on multi-state experience, I would expect to find that nationally, most public employees are not over-compensated when we take into account (1) their retirement benefits at current cost, (2) the skill sets required for their work, and (3) in some cases, the hazards they undertake. But when we properly measure and compare total compensation costs in competitive local labor markets outside of government, it will clearly be necessary to make adjustments in a number of occupational categories in many states, especially in highly unionized jurisdictions. We'll also have to re-think the concept of "pay for performance" in the public sector, which will present a host of challenges as well.

I would welcome commentary and suggestions from practicing governmental labor-relations professionals who could offer suggestions for superior language to operationalize these concepts in what eventually could become model legislation. The pension debates will never end until we resolve this comparable-pay issue.


More from Public Money