Why Public Employee Pay Probably Won’t Keep Up With Inflation
Inflation is pressuring state and local employers to grant big cost-of-living increases. But they’ll need to keep in mind the prospect of diminishing revenues in coming fiscal years.
First, it’s worth noting that even the federal government, with its unparalleled powers of deficit finance and money printing, has scheduled a pay increase for its civilian workers averaging just 4.6 percent for fiscal 2023, which is more in line with the national average in the private sector. It’s possible that the lame-duck Congress could boost that number by a fraction, but even federal workers’ unions expect COLAs of no more than about 5.1 percent, given political realities.
For states and local governments, neither of these benchmarks will mean much in their deliberations over budgets and pay plans, and very little in collective bargaining. Nor will the talk of recession in the national economy, as tax revenues continue to plow in at rates above last year’s (except for capital gains taxes, which are down with the stock market, and corporate taxes in several states). The rates of increase are dropping of late, but as of mid-2022 the reported revenue increases from the prior year were still running double-digit at the state and local level; heading into the second half of 2022, they were actually outpacing inflation overall.
Despite those swelling coffers at the tax collectors’ offices, however, the outlook for fiscal years beginning after this past September is less rosy. Highly cyclical California, for example, is already drawing down its reserves, and its budget for FY 2023 envisions both a notable decline in revenues and dramatically lower reserve balances, according to the state’s legislative analyst. Elsewhere, it’s likely that property tax assessments will level off from recent years’ overheated rates of increase, which will put a crimp on local government budgets in many regions.
Where the Bucks Stop
When state and local budget officers see belt-tightening ahead, it’s natural that their line items for salary increases will reflect top-line revenue limitations. Combine that with wage increases below the CPI in the private sector, which averaged about 5.2 percent over the past year, and the prospects for heftier inflation adjustments to state and local government employee paychecks look pretty thin. Even allowing for a modest catch-up for relatively lagging pay increases in recent years for public employees, 5 percent or maybe 5.5 percent is probably the level where the bucks stop for most public employers.
In the conceptual world of public-sector human resources management theory, government employees would be compensated at rates competitive with private markets, after taking into account their job security (if any, realistically) plus fringe benefits such as usually superior health insurance, pensions and their retirement medical benefits, which have become quite rare in the private sector. So it’s natural to look at local labor markets, unemployment rates and pay levels for similar positions — as difficult as that can be for some professional job titles. Clearly, the HR departments and civic leaders will be watching those salary survey reports for clues to local pay increases.
As for retirees on public pensions, CPI adjustments will be a mixed bag. Very few retirement systems provide an unlimited inflation increase; most of them cap their CPI adjustments, typically at 2 percent or 3 percent per year or thereabouts. In some cases, where no formulas are deployed, the board or the employer typically will approve an ad hoc COLA increase. That plays havoc with actuarial assumptions. Almost nobody is thinking that public pensioners will get anything like a Social Security-level 8.7 percent COLA increase this year. That would wreak fiscal mayhem in pension-land.
So it’s highly predictable that city halls and state capitols will see plenty of drama from their elder retirees packing the rooms at public meetings pleading their case for higher benefit levels. Local TV stations eat this stuff up on dull news days. Such awards, of course, will ultimately increase the employers’ pension contribution rates to cover what otherwise would be additional unfunded liabilities. But it’s often easier to kick that can than to face up to the paradox that the nasty stock market has not awarded the pension systems their own COLA increase, but rather the opposite in sinking asset valuations.
Don’t be surprised to see some public employers cope with this problem by granting a one-time, non-recurring COLA “stipend” to retirees in an effort to show compassion — or at least calm the waters — without breaking the bank.
The Guns and Hoses Wild Card
There’s one segment of local government payrolls — and some state governments’ — where the economics described above could play second fiddle to institutional forces that defy the gravity of revenue constraints. In the unique parallel universe of collective bargaining for police and firefighter pay, it’s common for compulsory arbitration to change the calculus for pay raises.
It goes like this: Many police and firefighter bargaining agreements have COLA clauses that tie the pay rates in their second and third years to the CPI. So contracts that were inked before inflation broke out in late 2021 may already have a sleeper cell in them, which will automatically push their formulaic salary increases closer to the nearly 9 percent level that Social Security recipients will enjoy.
You may think that’s going to be only an isolated case or two, that such anomalies will be exceptions rather than the rule. But here’s where there could be a wild card in store for municipalities whose public safety workers are prohibited from striking and subject to compulsory binding arbitration: In labor circles, it’s well known that a round robin of pay hikes can ripple through a geographic region if one labor contract becomes the forerunner “comparable” that a subsequent arbitrator fixates on, and pushes up the pay rates for a neighbor.
The whole process can snowball throughout a metropolitan area, as each department’s employees and their unions sequentially point fingers at the contracts in neighboring jurisdictions. In this case, a single city’s innocent inclusion (in 2019 through 2021) of an unlimited contractual CPI index obligation — now paying out an 8 percent COLA increase —could poison the well for all its neighbors. Call it a viral CPI=COLA pandemic.
My standing advice to municipal labor negotiators and pension officials: Avoid unlimited COLA clauses, which can become blank checks to fiscal misery.
To worsen the problem for budgeters, the police and firefighting world is keen on the notion of “parity,” whereby the benefits and pay raises awarded to cops should be shared with smoke-eaters, and vice versa. Elected officials often get caught in a trap — a budget and political vise — trying to placate these local unions, which can become quite vocal and visible at election time. There’s a potential domino effect.
It’s commonplace for public safety pay impasses to take many months and sometimes years to settle, with retroactive pay increases awarded when they conclude. Then the public employer has to deal with the disparity between its uniformed, unionized employees and everybody else who got peanuts, comparatively, just as the budget crunch of softening revenues hits.
It’s too early in these inflation and business cycles to know how this will all play out. But don’t be surprised if state and local workers and retirees ask for more than their private-sector counterparts — and for public employers to be prudently stingy while seeking some creative ways to address the problem without running their budgets into the ditch. Eventually, compensation must be competitive, but that could take years. Meanwhile, watch out for those wild cards and CPI viruses.
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