Calculating Public Employee Total Compensation
December 19, 2010
A study released late last year, sponsored by U.C. Berkeley’s “Institute for Research on Labor and Employment” entitled “The Truth about Public Employees in California: They are Neither Overpaid nor Overcompensated,” contains its conclusion in its title, but whether or not this study is presenting the “truth” or not is worthy of further discussion.
According to this study, “the wages received by California public employees are about 7% lower, on average, than wages received by comparable private sector workers; however, public employees do receive more generous benefits. An apples to apples comparison, or one that controls for education, experience, and other factors that may influence pay, reveals no significant difference in the level of employee compensation costs…”
While the study goes on to explain the variables they evaluate in order to arrive at an “apples to apples” comparison, it never actually estimates the actual amount of wage disparity between the average compensation packages for California’s public employees compared to California’s private sector employees, so here goes:
Using California’s Employment Development Department’s 2010 report “Labor Market Trends,” (ref. figure 1) it is evident there are 2.4 million Federal, State and Local employees in California, 12.2 million full-time private sector employees who work for an employer, and another 1.4 million “self-employed” private sector workers. Worker compensation as reported by the Bureau of Labor Statistics don’t include estimates for California’s 1.4 million self-employed workers, nor does the U.C. Berkeley study. If these estimates were included, they would almost certainly skew average private sector compensation downwards, since according to California’s Employment Development Dept., self-employment does not include anyone working for a Corporation or LLC, even their own, meaning that more highly-compensated professionals fall within the BLS statistics for California’s 12.2 million private sector employees, whereas the remaining self-employed include part-time workers, independent contractors; in aggregate, a marginally compensated multitude who have to cover 100% of their benefits – a 2x payment for social security, and zero paid time off, or free insurance of any kind, or automatic pay for sick time and retirement.
Returning to the 14.6 million people in California who either work for the government or are employed by private sector firms, according to the Bureau of Labor Statistics report “May 2009 State Occupational Employment and Wage Estimates California,” their average annual compensation (not including employer funded benefits) in 2009 was $49,550. In order to extract from that average the compensation for the 2.4 million government workers in California, one may refer to Census Bureau data for 2009 as follows – for 394,000 state workers ref. State Government Employment Data, and for 1,451,619 local government workers ref. Local Government Employment Data. If you combine and average the compensation data for these two groups, you will arrive at an annual average pay – before any employer funded benefits – of $65,000 per year.
Making just one assumption, that California’s 500,000 federal workers not included in these statistics are earning the same average salary as the state and local workers, it is possible to subtract the figures for government workers from the pool of 14.6 million workers, who, according to the BLS earn an average of $49,500 per year, in order to calculate an average private sector (not including self-employed) compensation of $46,528 per year. This means that the Berkeley study has “normalized” for education, experience, and “other factors” to turn a 40% disparity between public and private sector compensation into a 7% disparity.
Before accepting the conclusion of this study, there are several assumptions it makes, both factual and subjective, that should be questioned; starting with this: “The average age of a typical worker in state and local government is 44 compared to 40 in the private sector.” The benefit of coming up with a “fact” like this, of course, is because by combining this fact with the assumption that compensation increases with seniority, the researchers are able to normalize downwards the average compensation of public employees significantly. For example, if one assumes an average career of 30 years, and that a worker’s inflation-adjusted salary will double between when their career begins and when they retire, than one might reasonably conclude a “normalized” compensation average for the public sector worker must be adjusted downwards by 13.3% in order to represent an “apples-to-apples” comparison with the younger private sector workers. Here again, it is serendipitous for the Berkeley study to exclude self-employed individuals, since according to California’s EDD, for workers over forty years of age, fully 50% of the civilian workforce is self-employed (ref. EDD’s California’s Self-Employed Workforce,” figure 6).
Another normalizing factor used by the researchers is gender, wherein they claim 55% of the state and local government workers are women, compared with 40% of the private sector. This is partially skewed, again, by the fact that 60% of self-employed people are men, but even adjusting for that, this fact, if accurate, represents another huge opportunity for the researchers to “normalize” compensation statistics in favor of reducing the disparity between private and public sector pay. Without having access to the work-papers used by the researchers, one can only speculate, but here’s the logic that could have been used: If women make 30% less than what men make for comparable work requiring comparable credentials, and if women represent 55% of the government workforce compared to 40% of the private sector workforce, this means an “apples-to-apples” comparison would require adjusting the public sector compensation upwards by 17% (55% x 30%) vs. an upwards adjustment of only 12% (40% x 30%) for the private sector workforce. Voila, another 5% of pay disparity is vaporized. The problem here is whether or not the “30%” pay differential rests on valid assumptions. When one normalizes for technical degrees vs. non-technical degrees, and the actual supply and demand parameters for jobs that might be deemed “comparable,” as well as for the significant percentage of women who opt out of full-time work in favor of being moms, much of this gender disparity may disappear. Whether or not there remains a gender bias in employee compensation is certainly open to debate, but the researchers should be transparent regarding how significant this factor was in their calculations.
The other major normalizing factor employed by the researchers is education, because the researchers have determined that 35% of the private sector workforce have earned at least a bachelors degree, compared with 55% of the public sector workforce. The researchers also claim the “return to education,” wherein people who have higher educational attainment should earn more, is skewed; that is, they claim private industry rewards education more than the public sector. What the study ignores here, however, is the fact that educational attainment yields qualitative dividends – what degrees are being compared? Is a sociology degree from Sonoma State the equivalent of a computer science degree from Stanford? Is it appropriate to pay more to employees with advanced degrees even if the job they do doesn’t require that level of education? The study doesn’t address this.
In any event, by excluding 1.4 million self-employed and part-time workers, and “normalizing” for seniority, gender and education, the Berkeley study has concluded that an average public sector salary in California is not 40% more than an average private sector salary – and without any normalizing adjustments, 40% higher wages for public sector vs. private sector workers appears to be a conservative estimate – but instead, that public sector wages are 7% less than private sector wages.
When turning to comparing benefits for public employees vs. private sector workers, it is important to understand that salary is the base on which the most significant benefits are calculated. In particular, the largest benefit category in the public sector is retirement pensions, which are calculated based on final salary earned. This means that even if public employee pension benefits were calculated in the same parsimonious manner as social security, they would apply to an average compensation base that is 40% larger for public employees. Moreover, public sector pensions are linear, meaning the benefit increases exactly proportionally to the amount of base salary without limit, whereas social security benefits increase at progressively lower rates, meaning that the more one makes, the lower percentage of their final salary will actually be realized in a social security benefit. These sound like nuances, but have enormous financial consequences.
Before independently estimating the disparity between public employee and private sector employee benefits, here is the Berkeley study’s specific conclusion: “public employers contribute on average 35.7% of employee compensation expenses to benefits, whereas private employers devote 30% of compensation to benefits.”
By far the biggest single cost for employee benefits in both the public and private sector is the cost of retirement security. The calculation in the private sector is relatively straightforward – the employer withholds 6.2% for social security and 1.45% for medicare from employee paychecks, and contributes an equivalent amount themselves as a benefit – 7.65%. Some private sector employers will match a 401K contribution up to 6.0%, but the percentage of private sector employers who do this, combined with the number of private sector employees who take full advantage of this, is probably under 25%, which means the average overall retirement benefit paid by private sector employers is probably 10% (or less) of total wages.
For the public sector in California, the cost of retirement security borne by the employer is something else entirely. The typical formula for non-safety employees (about 85% of the public sector workforce) is to multiply the number of years they work by 2.0%, and apply the resulting percentage to their earnings in their final year of active employment. For example, if a non-safety employee works for 30 years, then 60% of their final salary will be the amount of their retirement pension. For safety employees, the typical formula is the same, but based on a 3.0% per year accrual. In the public sector, unlike with social security, the money contributed each year to fund the future retirement benefit is invested by a pension fund, which means the value of this benefit – and the funding required each year to ensure the pension fund remains solvent – must be calculated based on the expected investment returns of the pension fund. This is a matter of great controversy.
In the California Public Policy Center study “What Payroll Contribution Will Keep Pensions Solvent?,” a best-case and realistic-case set of scenarios are offered:
(1) At a real rate of return of 4.75% per year, a worker would need to set aside an additional 20% of their salary each year for 30 years, in order to enjoy a pension benefit during a 30 year retirement equivalent to 60% of their paycheck.
(2) At a real rate of return of 4.75% per year, a worker would need to set aside an additional 30% of their salary each year for 30 years, in order to enjoy a pension benefit during a 30 year retirement equivalent to 90% of their paycheck.
(3) At a real rate of return of 2.75% per year, a worker would need to set aside an additional 36% of their salary each year for 30 years, in order to enjoy a pension benefit during a 30 year retirement equivalent to 60% of their paycheck.
(4) At a real rate of return of 2.75% per year, a worker would need to set aside an additional 54% of their salary each year for 30 years, in order to enjoy a pension benefit during a 30 year retirement equivalent to 90% of their paycheck.
For this independent estimate of the value of public sector employee pension benefits, using an assumption that 15% of public employees receive the enhanced “safety” pension, and assuming that the real rate of pension fund returns going forward will be 3.0% per year (still quite optimistic), it is necessary to contribute an amount equivalent to 38% of the average public employee’s pay in order to keep their pension solvent. Since, on average, public employees contribute about 5% of this amount in the form of withholding, an additional 33% has to be contributed by the employer. Many public employees receive supplemental retirement health insurance, for which few of them contribute anything at all in the form of withholding. It is certainly accurate to value this additional benefit as at least twice the amount of medicare, which adds another 3.0% per year.
Adding this all up, using conservative assumptions, the employer contribution to retirement security in the private sector is at most 10% of average salary, whereas in the public sector the employer contribution is at least 36% of average salary.
When assessing the value of current benefits granted public employees, most reviews of public sector benefit schedules suggest the standard package is a comprehensive set of benefits – for example, if one refers to the State of California’s Dept. of Personnel Administration, some of the current benefits include health insurance, dental benefits, a vision program, long-term care insurance, and long-term disability insurance. While these benefits are partially funded through employee withholding, the amounts withheld almost never exceed 50% of the premium, even for dependent coverage. To suggest that current benefits for public employees are, on average, less generous than the average current benefit for private sector employees strains credulity. What about the millions of part-time workers and self-employed people, who have to pay 100% of whatever health insurance they can afford – at premium rates that aren’t discounted and guaranteed by the insurance companies the way they are for the huge state employee bargaining units? What about all the small companies out there, employing at least 50% of full-time private sector workers, who can barely afford to offer basic health insurance, much less dental, vision, long-term care and long-term disability? It would be conservative indeed to simply assume the cost of current health insurance and other current benefits paid for by the employer is the same for both public and private sector workers, at approximately 5.0% of payroll.
The other significant factor to assess when estimating the value of public sector benefits is the amount of paid time off enjoyed by public sector employees vs. private sector employees. On this matter the Berkeley study makes a claim that they simply must substantiate; they state: “public employees receive considerably less supplemental pay and vacation time.”
Perhaps to rebut this preposterous claim one must revert to anecdotes, but here at least are some quantitative considerations: there are 723,000 teachers in California who work for the government either in primary and secondary school or in higher education. Every one of these instructors and administrators works about 180 days per year, which when one considers there are 260 weekdays in a year (52 weeks x five days per week), indicates that teachers in California get 16 weeks of paid days off each year. What about college professors who only teach one class per week, yet enjoy total compensation packages worth $138K per year (ref. The Real Reason for College Tuition Increases). If you review compensation studies for safety employees in the city of Costa Mesa (ref. The Price of Public Safety), or firefighters in Sacramento (ref. California Firefighter Compensation), you can see, for example, that before overtime, full-time service for a veteran firefighter in Sacramento requires them to work, on average, two 24 hour shifts per week. Does the Berkeley study normalize for any of this? Compare vacation time in any public entity in California against private sector norms – the average vacation days awarded in the public sector allocate employees after about 10-15 years of service 20 days of vacation per year, and by the end of their careers, up to 30 days of vacation per year (ref. CA Dept. of Personnel Administration, Leave Benefits). This amount of paid vacation is rarely offered to employees in the private sector – with many small companies offering virtually no vacation to their employees, a generous assumption might be 10 days, half as much as public sector vacation benefits. With respect to paid holidays, the typical public sector benefit is at least 12 days, while small private companies often only award six (Christmas, New Year, Memorial Day, July 4th, Labor Day and Thanksgiving), if that. In addition to vacation and holidays, many local governments and various state units also offer paid “personal days,” something nearly unheard of in the private sector. It is also common for sick time to be accrued without limit in the public sector, also something nearly unheard of in the private sector. And self-employed workers, of course, get nothing.
In order to continue to make conservative assumptions, however, one may estimate the average number of paid days off in the private sector to be 20 per year (probably high) and the average number of paid days off in the public sector to be 30 per year (probably low). How does this all add up?
The average public sector worker makes $65,000 per year, with the employer contributing an additional 21,450 for their retirement pension, $1,950 for their retirement health insurance, $3,250 for their current health insurance and other benefits, and they earn vacation worth an additional $10,575 – making their average total compensation $102,225 per year. It is interesting to note that the benefits as a percent of total compensation in this analysis agree with the Berkeley study – 36.4% vs. 35.7%, because the Berkeley study has almost certainly understated the value of the required pension fund contribution, which is another reason why the assumptions made here to estimate the value of all the other public employee non-pension benefits are probably conservative.
The average private sector worker makes $46,500 per year, with the employer contributing an additional $4,650 for their social security, medicare, and 401K, $2,325 for their current health insurance and other benefits, and they earn vacation worth an additional $4,113 – making their average total compensation $57,558 per year. The average private sector worker’s benefits as a percent of total compensation in this analysis is 19%, not 30% as claimed in the Berkeley study. And again, the Berkeley study failed to consider any of California’s 1.4 million self-employed and part-time workers in the pool they evaluated .
It is left to the reader to decide which numbers are more accurate, the numbers put forward here, or the numbers put forward by the Berkeley research team. Similarly, it is left to the reader – and the voter – to decide whether or not the services provided by California’s state and local governments, and the skills required to render them, entitle California’s public servants to earn, on average, $102K per year, compared to average annual earnings of $57K by those of us whose taxes sustain them.