Retirement Inequity in America: Taxpayers Provide the Public Sector (the Haves) with Benefits Lacking in the Private Sector (the Have Nots)

The Cost of Retirement Security in America

The average public sector worker spends about 30 years in the workforce and 30 years retired, and the average private sector worker spends about 40 years in the workforce and 20 years retired. California public sector retirees, on average, receive a retirement pension equal to 66% of their average base pay after working 30 years while private sector retirees receive retirement benefits equal to 33% of their base pay after working 40 years (in California the average base pay of public servants is $68,000 while the average base pay of private workers is $41,500). Extrapolated to the United States as a whole, it is clear that the California model would mean that public sector retirees would cost taxpayers $862 billion per year, which is only 6% less than the entire bill for social security for more than six times as many people.

In other words, local and state public sector workers (16% of the workforce in California) retire 10 years earlier with retirement benefits 33% greater than private sector workers (84% of the workforce) — all at the expense of the taxpayers.

January 1, 2011

Free Republic - One way to distill the debate over the sustainability of retirement security in the United States is to evaluate the absolute amount of money that will be paid out each year for public sector pensions vs. social security. Doing this removes the necessity to debate what rate at which public employee pension funds can earn investment returns in the market, which presumably diminishes the amount taxpayers have to contribute to fund these pensions. Instead of evaluating how much money has to go in to fund retirement benefits, this post evaluates how much will come out in actual retirement payments.

Making this analysis easier is the fact that the United States, almost uniquely among nations, enjoys an age distribution that is, for people under 60, almost evenly distributed. As the table below indicates, there are about 20 million people in each five year age group, starting with children under five years old, all the way through adults between the ages of 55 and 60. It is a fairly safe assumption that this trend will continue over the next 40 years, and in fact, if you review the United States — 2050 population pyramid projection from the U.S. Census Bureau, that is exactly what is expected. As will be seen, this even distribution of age groups in the U.S. makes projecting future aggregate retirement payouts for social security and public sector pensions somewhat easier.

Before reviewing the actual calculations, it is also important to note the significant differences between the formulas governing social security benefits vs. the formulas governing public sector pension benefits. One of the most important of these differences is the fact that the social security benefit is progressive, that is, the more you make when you are working, the lower the percentage of your earnings will be realized in social security benefits.

The table below presents graphically the information provided by the Social Security Administration in their “Estimated Retirement Payments Chart.” As can be seen, the retirement benefit provided by social security — as a percentage of career earnings — drops of significantly the more someone earns.

With public sector pensions, there is no ceiling on benefits, or formula in place to diminish the payouts for people who are highly compensated.

For the purposes of analysis, the assumption here is that the retirement formulas that apply to public sector employees in California are typical of public sector employees in the other 49 states. In reality, many of the larger industrial (or post-industrial) states in the U.S. match California’s public sector employee retirement benefit formulas, as does the federal government, but this isn’t necessarily true everywhere.

Nonetheless, since California’s public sector unions and public sector pension funds — echoing their counterparts in the other states who grant retirement benefits to their public employees at a level matching California’s — are generally proclaiming that these benefits are not inequitable and are not unsustainable, this analysis will estimate total retirement payouts per year for social security vs. public sector pensions as if every public agency in the U.S. had the same benefits structure as California’s.

In the next table, “What if the U.S. Had California’s Public Sector,” several assumptions are made that are fairly representative of the relative work histories and compensation profiles of public vs. private employees in California. The average public sector worker spends about 30 years in the workforce and 30 years retired, and the average private sector worker spends about 40 years in the workforce and 20 years retired. Because — returning to our population pyramid — the U.S. population is on track to have an even distribution of people in all age groups, this means the ratio of workers to retirees in the public sector is one-to-one, and the ratio of workers to retirees in the private sector is two-to-one. This is not true today, since the nation’s 20 million people per five year age group only begins with people under 60, but it is decidedly the long-term trend facing the U.S.

The other key set of assumptions are the average base pay of public servants in California, $68,000, vs. the average base pay of private workers in California, $41,500, along with the retirement benefit as a percent of base pay, which for the public sector is 66% (documented with sources in “Calculating Employee Benefit Overhead“), and for the private sector is 33% (as documented on table two above).

Melding these assumptions with the respective worker to retiree ratios for the public vs. the private sector yields dramatic results. A final assumption is the percentage of private sector workers vs. public sector workers — using data from California’s Employment Development Department, California Labor Force & Job Numbers, there are 2.5 million government workers in California, 16% of the workforce, and 13.5 million private sector workers in California, 84% of the workforce.

If you know that in the future there will be 20 million Americans in each five year age group, and you know that public sector workers, who comprise 16% of the workforce, are retired for 30 years, then you can reasonably infer that there will be 19 million public sector retirees in the population. Using similar logic, knowing that private sector workers will be retired on average for 20 years, and that they represent 84% of the workforce, you may infer that there will be 67 million of them in the population. Calculating the aggregate retirement payout for both sectors of retirees is now possible.

By assuming these 19 million public sector retirees, on average, received a retirement pension equal to 66% of their average base pay of $68,000 per year, you may estimate the total public employee pension bill per year at $862 billion. Similarly, by assuming these 67 million private sector retirees, on average, received a retirement pension equal to 33% of their average base pay of $41,500 per year, you may estimate the total private employee social security bill per year at $920 billion.

The implications of these calculations are difficult to overstate. Using assumptions which are well documented and representative of the actual wage and benefit realities in California, extrapolated to the United States as a whole, it is clear that the California model would mean that public sector retirees would cost taxpayers $862 billion per year, which is only 6% less than the entire bill for social security for more than six times as many people.

The idea that investment fund returns can mitigate this cost to taxpayers is absurd (ref. “National Debt and Rates of Return“). And even if it were not absurd, the idea that public sector pensions are invested in the market, while social security funds are not, is inexplicable. Either both public sector pension funds and the social security trust fund should be invested in the market, or, better yet, both of them should operate on a pay-as-you-go basis, where current worker withholdings fund current retiree benefits. This would spare our markets both the political agenda of pension bureaucrats controlled by leftist government unions, as well as the massive distortions that are inevitable when trillion dollar funds face the prospect of notifying taxpayers they’ll have to pony up more because their investments didn’t hit their projected returns.

On a pay-as-you-go basis, Social Security is reasonably solvent, requiring only a 17% total withholding (employer plus employee) to maintain current benefit formulas for the next several decades. On the other hand, on a pay-as-you-go basis, public sector pensions will require contributions of 66% of base salary to maintain current benefits into the foreseeable future.

Calls to cut social security’s percentage contribution are irresponsible, but correctable. Calls to maintain public sector pensions without massive increases to fund contributions, on the other hand, are ridiculous.

How Much Do Pensions Really Cost?

The average government worker’s retirement pension is equivalent to the average private sector worker’s base wages while still working! And government workers typically work from ages 25 to 55, then retire for 30 years, while private sector workers typically work from ages 25 to 65, then retire for 20 years.

March 11, 2011

CalWatchDog.com - Earlier this week the Sacramento Bee hosted a chat on the topic “Should States Rethink Collective Bargaining.” In addition to journalists from the Bee, participants included Steve Greenhut, editor of CalWatchdog.org, and Art Pulaski, the chief officer of the California Labor Federation, AFL-CIO.

During the hour-long discussion, the topic of public sector pensions came up a few times, and Pulaski stated that the average pension collected by retired state workers in California are not much more than social security. Referencing the chat log, he said:

ArtPulaskiCLF:
the average state worker gets a pension of $24,000 and often without social security. Not lavish by any means (Tuesday March 8, 2011 12:48 ArtPulaski CLF)

This is a profoundly misleading statement. When Pulaski, and others who share his perspective on these issues, use numbers this low, they are reporting an average that includes everyone on the CalPERS retirement rolls, even people who have barely vested their retirement benefit by only working five years for the state. Furthermore, this average includes part-time workers, and it includes long-time retirees who left the workforce before base pay and pension formulas had been increased significantly — and unsustainably — as they have in the last 10-15 years during the economic bubbles.

A more realistic way to gauge the fairness and financial sustainability of state worker pensions is to reference the average pension for currently retiring state workers who have logged 30 years of full-time work for the government. Using data from CalPERS annual report for the fiscal year ended June 30th, 2010, entitled “Shaping our Future,” (ref. page 151) the average pension for a state employee enrolled in CalPERS who retired last year after 30 years of service is $66,828 per year.

This amount, far in excess of the “$24,000″ claim by Pulaski, is based on data provided by CalPERS, and is further evidenced by evaluating the typical pension benefit formulas currently granted government workers in California. People employed by the University of California, for example, as can be seen on the “University Retirement Plan” (ref. page 13), will receive between 60 percent (30 years, age 55) and 75 percent (30 years, age 60) of the average of their final three years salary in retirement. Benefits for state and local public employees in California typically range between 2.0 percent and 2.5 percent times years worked, times their final salary.

For public safety employees, who comprise approximately 15 percent of the state and local public sector workforce in California, pension benefits typically are calculated based on 3.0 percent, times years worked, times their final salary. The labor agreement between Sacramento County and their firefighter union provides a representative example. (Ref. “Agreement between Sacramento Fire Fighters Union and City of Sacramento,” page 55.) For information on all bargaining units and their pensions in the City of Sacramento, refer to the links on their “City of Sacramento Labor Agreements” page. You will see that in the city of Sacramento, whose worker benefits are quite typical of the cities and counties in California, it is typical for workers currently retiring after 30 years to receive about two-thirds of their final salary in pension benefits.

To really understand what this means, it is necessary to come up with two additional estimates:

(1) the average base salary for a government worker in California — which allows one to estimate the average pension of a retired government worker — and

(2) the number of retired government workers.

This allows one to calculate how much money is disbursed each year to pay retirement pensions to retired government workers. This amount, in-turn, can be compared to how much is being disbursed each year to pay retired private sector workers who collect Social Security.

Using California as an example, and using conservative assumptions (because the CalPERS data already noted suggests the average career pension to be far higher than $46K per year), the following table illustrates how much the average government worker makes per year both while working and during retirement, and compares it to how much the average private sector worker makes both while working and during retirement. These figures dramatically illustrate the disparity between government worker compensation and private sector worker compensation.

On average, government workers collect a base salary that is nearly 50 percent more than private sector workers during their active careers, then collect over three times as much through their pensions in retirement than retired private sector workers collect from social security. In fact, the average government worker’s retirement pension is equivalent to the average private sector worker’s base wages while still working!

The amounts presented in the above table are fairly easily calculated using core data that any reader is invited to verify for themselves. The average California state and local government worker wage of $68,500 per year is derived from U.S. Census Bureau data which can be found on the following tables “U.S. Census Bureau 2008 Public Employment Data Local Governments California,” and “U.S. Census Bureau 2008 Public Employment Data State Government California.” The average California private sector worker wage of $46,500 per year can be found from the U.S. Bureau of Labor Statistics “May 2009 California Occupational Employment and Wage Estimates.” The average social security benefit for an average wage earner can be found on the “U.S. Social Security Estimated Retirement Payments Chart.”

The cost to Californians of paying government workers, on average, a pension that is literally triple what the average private sector worker collects from Social Security is compounded by the fact that the ratio of government workers to government retirees is on-track to be 1-1, i.e., one worker for each retiree, whereas the ratio of active private sector workers to retired social security recipients is unlikely to ever dip below 2-1. This is because government workers typically work from ages 25 to 55, then retire for 30 years, and private sector workers typically work from ages 25 to 65, then retire for 20 years.

An examination of projected age distributions in America for 2030, as documented on the U.S. Census Bureau’s International Database, indicates the United States is destined to have an even streamed age distribution, i.e., about 20 million citizens in each five year age group, which makes these calculations much easier. This disparity is illustrated in the table below:

What the above table demonstrates is the following: Notwithstanding investment returns, if there is only one active government worker — working 30 years — for every retired government worker — retired for 30 years, and if the average government pensioner receives a pension equivalent to two-thirds of what they made when they worked, then funding government worker pensions would require each government worker to contribute an amount equal to 66% of their salary towards supporting the retirees.

By contrast, if at least two private sector workers — who work for 40 years and are retired for half that time — are employed for each one who is retired, and if the average private sector retiree receives a social security benefit equal to one-third of what they made when they worked, then adequately funding social security would require each private sector worker to contribute an amount equal to only 16 percent of their salary towards supporting the retirees.

This reasoning holds enormous implications when assessing the relative long-term viability of government worker pensions vs. Social Security.

Perhaps the most dramatic illustration of the inequity of California’s government worker pensions averaging literally the same amount as what the average private sector worker earns while actively working is illustrated in the next table. The calculations are based on multiplying the average amount of the government worker pensions by the estimated number of retired government workers, and comparing that to the average amount of the social security benefit multiplied by the estimated number of retired private sector workers. To estimate California’s projected population of retired government workers, simply use the same number as their working population, 2.4 million, since on average they work 30 years and are retired 30 years. To estimate California’s projected population of retired private sector workers, similarly, just take the population of active private sector workers, 12.2, and divide by two, since on average they work 40 years and are retired 20 years. Data for these working populations can be found from the California Employment Development Dept., Labor Market Trends 2009.

On the above table, the green columns represent the projected number of retired social security recipients in California, 6.1 million, and the amount they will collect in aggregate in Social Security, $95 billion per year. The blue columns represent the projected number of retired government workers in California, 2.4 million, and the amount they will collect in aggregate in pensions, $110 billion per year. This is an astonishing projection. It indicates that the government will be spending more, in total dollars per year, to pay pensions to retired government workers, than it will be spending, in total dollars per year, to provide social security to retired private sector workers who are nearly three times as numerous.

To the extent these extravagant benefits have been approved by compliant politicians on behalf of government workers in other states, what these figures illuminate for California can be extrapolated to apply across the United States.

To suggest that Wall Street pension fund investments are going to be able to make up for this disparity, and therefore somehow mitigate the burden this disparity places on taxpayers, is not only extremely debatable — because the high returns that pension funds delivered over the past 30+ years were driven by an unsustainable expansion of debt — but also specious. Because if Wall Street investments are the panacea, set to rescue taxpayers from the burden of supporting retired government workers, why are spokespersons for government worker unions blaming Wall Street at the same time as they fail to recognize that their pension funds are Wall Street?

If government worker pensions, whose solvency is currently guaranteed by taxpayers, are to be gambled on Wall Street, why isn’t the Social Security fund also gambled on Wall Street? Why do taxpayers bear the downside of the Wall Street manipulated economic meltdown not only for themselves and their own individual investments, but also take the hit and make up the difference for the government workers and their pension funds?

Anyone representing government worker unions who claims Wall Street is both the problem and the answer should seriously examine their premises. And anyone who suggests government worker pensions are not extravagant, or do not place a crippling burden on taxpayers and government budgets, is not confronting the facts.

Defined-benefit Public Sector Pensions: A Bad Habit Continues

The public sector employees in a pension plan get a total benefit some 25% better than the private sector employee. That is a pretty good incentive to work in the public sector.

February 21, 2011

The Economist - Fresh from a duel with Free Exchange, I now find myself compelled to add some context to a Democracy in America post on the Wisconsin situation.

The problem with public sector/private sector pay comparisons is that pay comes in two forms; current and deferred (ie pensions). A pension promise from the government is a very valuable thing indeed; some states have made it constitutionally protected. So, unlike the typical private sector employee who is now in a DC scheme, the public sector employee has certainty about his or her pension entitlement. If the equity market falters, the DC plan member will suffer; the employer of the DB member will make up the shortfall.

In effect, the employer has written the employee a put option on the market. How valuable is this option? We can make a judgment by looking at the Bank of England scheme. It avoids all equity risk by buying index-linked bonds to cover its pension liability. This costs it 55% of payroll in the current year (the ratio varies with the level of real yields). The average contribution into a DC scheme (employer and employee) is 10%, in both Britain and America. In a room full of actuaries last week, I asked whether this was a fair basis of pay comparsion and the answer was yes.

Now the Bank of England scheme may be more generous than the Wisconsin version; employees can retire at 60, with full inflation-linking. But even if one were to knock 20 points off the contribution rate to 35%, that would still suggest that public sector employees in a pension plan get a total benefit some 25% better than the private sector employee. That is a pretty good incentive to work in the public sector.

UPDATE: I have had a look at the paper which compares Wisconsin public sector and private sector pay. With respect to pensions, it seems to base its calculations on the figure that:

Retirement benefits account for 8% of state and local compensation costs compared with 2.5% to 4.9% in the private sector.

But there is a big difference between how much employers are putting aside and the true cost, which is what they have promised. Wisconsin's scheme is fairly complicated but a quick perusal shows that employees can retire at 57, if they have 30 years of employment and that:

There are two methods of calculating retirement benefits, the formula and money purchase methods, and you are entitled to the higher of the two amounts. A formula benefit is based on your three highest years of earnings (your "final average earnings"), a formula multiplier based on your employment category, your years of creditable service (including any creditable military service) and any actuarial reduction for early retirement.

The formula appears to be one-sixtieth for years worked after 2000 for most employees but one-fiftieth for executives and protected employees (presumably fire and police). A higher ratio applies to pre-1999 years. No way can that payout be achieved at a cost of just 8% of payroll unless the pension fund has a strategy for beating the tables at Vegas.