Sita Nataraj Slavov is a resident scholar at the American Enterprise Institute.
Public sector retirement benefits have come under fire in recent years as state and local governments struggle to deal with large funding shortfalls. While many public sector employers have cut pension benefits, serious challenges remain.
A number of recent studies have concluded that public sector workers are overpaid relative to their private sector counterparts. For example, my colleague at the American Enterprise Institute, Andrew Biggs, along with his co-author Jason Richwine of the Heritage Foundation, show that the compensation of public school teachers is 52 percent greater than that of private sector workers with similar characteristics. The Congressional Budget Office has shown that federal employees receive 16 percent more in compensation than private sector workers with similar characteristics. Finally, in a recent article in the Journal of Economic Perspectives, Maury Gittleman and Brooks Pierce, both economists at the Bureau of Labor Statistics, show that state and local government employees enjoy more generous compensation packages than private sector workers with similar characteristics.
To be more specific, these studies show that, while the salaries of public sector workers are roughly in line with those paid in the private sector, public sector workers receive substantially more generous fringe benefits, such as pensions, health benefits, vacation and job security.
These studies raise a number of questions. Why are public sector workers so highly compensated? And, why is their compensation so heavy on benefits? Workers certainly value benefits, such as access to group health insurance, and many benefits are tax advantaged. But do public sector workers really value these benefits more than private sector workers?
Edward Glaeser and Giacomo Ponzetto have attempted to address these questions in a recent National Bureau of Economic Research working paper entitled "Shrouded Costs of Government: The Political Economy of State and Local Public Pensions." The authors present a formal model in which public sector compensation is determined by a political process that pits politicians against each other in a competition for votes. They show that this political process results in a public sector compensation package with generous benefits.
The authors focus on pension benefits, but their argument is applicable to other hard-to-measure benefits like job security or retiree health insurance. They assume that there are two types of voters: public sector workers and other individuals. Public sector workers have an information advantage over other voters. In particular, they are better informed about their own compensation packages.
Moreover, this information advantage is more pronounced for benefits than salary. This is plausible because information about public sector salaries is available to the general public (for the small cost of doing an Internet search). In contrast, information about public sector pensions is less widely available, and because of complications involved in valuing future pension benefit promises, it is also more difficult to interpret.
As a result, politicians propose generous public sector compensation that is tilted towards benefits rather than salary. A politician who tries to scale back public sector benefits will lose support from public sector voters (who are hurt by the benefit cut) without gaining much support from other voters (who gain from lower taxes but are poorly informed). Even if the politician tries to raise public sector salaries to win back public sector votes, he or she will lose votes on net because other voters will be better informed about the proposed salary increase (and the associated tax increase) than the proposed benefit cut (and the associated tax cut).
Clearly this outcome is bad for individuals who don't work in the public sector, as they pay higher taxes to fund generous public sector compensation. But it's also bad for public sector workers, who would probably prefer to have more of their compensation package come in the form of salary than benefits.
In other words, if policy makers were to cut public sector pensions and raise salaries by the cash equivalent, public sector workers would be better off without increasing the cost to other individuals in society.
What can be done about this outcome? The authors suggest that increased transparency can help. If voters were more aware of the true costs of pensions and other public sector benefits, they would be less likely to tolerate generous public sector benefit packages.
More generally, recognizing the role that politics plays in economic outcomes is important. As public sector pension and retiree health benefits exert increasing pressure on state budgets, voters will be better empowered to push for sensible reforms if they have a solid understanding of the politics of public sector compensation.
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