Public-employee unions and left-leaning think tanks dismissed our analyses—"lies" and "scapegoating" were some of their choice descriptors. Their reaction came despite the fact that nearly all financial economists, including Nobel Prize winners and the Federal Reserve Board, shared our critique of public-pension accounting. Now several government agencies have weighed in with analyses that strongly support our original insight.
THE WALL STREET JOURNAL - April10, 2012
One year ago, Wisconsin Gov. Scott Walker signed legislation increasing the pension and health contributions of public-sector employees and restricting their collective-bargaining power. The governor set off a firestorm that continues today, with a recall effort being waged against him and his allies.
In Ohio, Gov. John Kasich signed similar legislation only to see it repealed in a statewide referendum last November. And nationwide, as governors and legislators seek to rein in labor costs, public-employee unions are protesting that their members are actually underpaid. But a growing body of evidence strongly suggests that their protests have no basis in fact.
When the public pay debate began to simmer two years ago, we were among the few analysts to show that many public employees—federal, state and local, including public school teachers—are paid more than what their skills would merit in the private economy. Our core insight was that public-sector pensions are several times more generous than typical private-sector plans, but this generosity is obscured by accounting assumptions that allow governments to contribute far less to pension plans than private employers must.
Public pensions calculate annual contributions based on assumed investment returns of around 8%. However, they must pay full benefits even if those returns don't pan out. In effect, public employees as a group are guaranteed an 8% return on both their own contributions and those made by their employers—at a time when private-sector workers with 401(k) plans receive a yield of only 2%-3% on comparatively riskless investments such as U.S. Treasurys. The difference in retirement benefits is stark.
Most prior analyses of public-sector compensation were severely understated because they looked only at how much governments contributed to pension funds—not how much governments were on the hook to pay out. This meant that state and local government finances were in much worse shape than people long believed.
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The Bureau of Economic Analysis has announced that, beginning in 2013, the National Income and Product Accounts of the United States will calculate defined-benefit pension liabilities—and the income flowing to employees in those plans—on an accrual basis that reflects the value of benefits promised, regardless of the contributions made by employers today.
The bureau's reasoning is a 2009 research paper stating that "if the assets of a defined benefit plan are insufficient to pay promised benefits, the plan sponsor must cover the shortfall. This obligation represents an additional source of pension wealth for participants in an underfunded plan." At current interest rates, this adjustment would roughly double reported compensation paid through public pensions.
The Congressional Budget Office endorsed a similar approach last month in a new report on federal employee compensation. The report—which congressional Democrats reportedly hoped would debunk our 2011 paper on federal pay—found that the federal retirement package of pensions plus retiree health care was 3.5 times more generous than private-sector plans, contributing to a 16% average federal compensation premium.
Even more recently, an analysis by two Bureau of Labor Statistics economists, published in the winter 2012 Journal of Economic Perspectives, concluded that the salary and current benefits of state and local government employees nationwide are 10% and 21% higher, respectively, than private-sector employees doing similar work. This study didn't even factor in the market value of public-pension benefits, nor did it include the value of retiree health coverage.
Basic fairness requires that public employees be paid for their skills at the same market rates as the taxpayers who fund their salaries and benefits. In some states accommodations have been struck, but in others further confrontation remains likely.
Reformers will have more help in those battles ahead. Academic economists, the Federal Reserve, the Bureau of Economic Analysis, and the Congressional Budget Office have all thrown their weight behind proper pension valuation. It will now be that much harder for public-employee unions and their advocates to deny the obvious.
Mr. Biggs is a resident scholar at the American Enterprise Institute. Mr. Richwine is a senior policy analyst at the Heritage Foundation.