Comparing Private Sector and Government Worker Salaries

Public sector offers ironclad job security and greater pension benefits

Adam Summers
Policy Analyst, Reason Foundation
May 10, 2010

[Editors note: Much has been said or written lately regarding compensation of public employees, often offering contradictory conclusions. Do they make more or less than their private sector counterparts? Are they overpaid or underpaid?  In this article, the author examines such a study that claims public employees should make more because they are better educated and have more skills. Those findings, says Summers, “are suspect at best.” His rebuttal takes into account all of the intangibles, and concludes the best deal for the taxpayer is delivered by the private sector. BG]

There has been much debate over whether public sector employees are overpaid or underpaid, relative to their private sector counterparts, and how to make an "apples-to-apples" comparison of the compensation received by each since job functions are oftentimes quite different.  The following seeks to address this issue in light of a new report that suggests that state and local government workers receive less total compensation than comparable private-sector workers, and to examine how issues not addressed in the study might affect those conclusions.

Are Public Sector Workers Overcompensated?

Several analyses of average wages and benefits in the public and private sectors reveal that state and local government workers earn more than private sector workers. According to the most recent Employer Costs for Employee Compensation survey from the U.S. Bureau of Labor Statistics, as of December 2009, state and local government employees earned total compensation of $39.60 an hour, compared to $27.42 an hour for private industry workers-a difference of over 44 percent. This includes 35 percent higher wages and nearly 69 percent greater benefits.

Data from the U.S. Census Bureau similarly show that in 2007 the average annual salary of a California state government employee was $53,958, nearly 32 percent greater than the average private sector worker ($40,991).  In addition, as noted by reporter and Calpensions.com blogger Ed Mendel, in 2006 the state conducted a comparison of state and private sector compensation for the first time in two decades.  While the Department of Personnel Administration survey did not include all job classifications, the analysis determined a number of benchmark job classifications and found that state compensation was greater than private sector compensation for clerical jobs, accountants, custodians, electricians, stationary engineers, and analysts, but lagged in medical occupations.

Moreover, data from the Bureau of Economic Analysis illustrate that average state and local government compensation has been increasing at a faster rate than average private sector compensation over the past 30 years (see the graph on page 89 of this Cato Journal article).

Are Public Sector Workers Undercompensated?

But according to a new study published by the Center for State & Local Government Excellence and the National Institute on Retirement Security, these aggregate compensation comparisons are misleading.  The authors, University of Wisconsin-Milwaukee economics professors Keith A. Bender and John S. Heywood, assert that state and local government workers are better educated and have more work experience, on average, than do private sector workers, so it is natural that their overall average compensation would be higher.  "Thus," they conclude, "the fact that public sector workers receive greater aver­age compensation than private sector workers should be no more surprising than the fact that those with more skills and education earn more."

Furthermore, after attempting to control for such variables, they find that state and local government workers actually earn less than their private sector counterparts.  According to the analysis, state government workers earn an average of 11.4 percent less than private-sector workers of similar education and work experience and local government workers earn 12.0 percent less.  Due to the greater benefits received by public sector workers, the gap narrows when these benefits are factored in, to 6.8 percent and 7.4 percent, respectively.  (Even this appears to underestimate the cost of the benefits provided government workers, as discussed below.)

The Difficulty of Compensation Comparisons

As the report notes, it is difficult to do a real "apples-to-apples" comparison of public  and private sector compensation because public sector job descriptions and duties may be very different from those in the private sector, and vice versa, so oftentimes there are no good positions to compare to in the other sector.

It would be interesting to take a closer look at the education statistics.  Knowing the percentage of workers with a college degree, for example, is helpful, but not all college degrees are equal.  Some fields of study are more rigorous than others, and some universities and colleges are more prestigious than others.  One who earns a degree in a more rigorous field, or who attends a more prestigious (and usually a more costly) university, would expect to earn a higher salary after college than one who did not.  While data with this level of detail do not seem to be available, it would be interesting to see if there are any differences in these more specific educational categories between public and private sector employees.

It is also worth asking whether higher education levels are actually required to perform many government jobs.  The Bender and Heywood study presumes that we should expect public employees to be paid more because they tend to be better educated than comparable private sector employees, but is this additional education necessary?

It may be that state and local governments hire more educated people not because job duties demand more education, but rather simply because they can, as they have access to the public's money and, as such, government budgets are not so constrained as private firms' budgets.  In the private sector, firms have strong incentives to keep costs down and pay no more for labor than they need to.  The public sector, by contrast, is infamous for its lack of efficiency, and budgets are determined by political means, resulting in budgets that are usually much different-and more wasteful-than those determined by economic means (see the discussion of public-sector versus private-sector productivity below).  This is why governments typically achieve significant cost savings by outsourcing the provision of services to the private sector.  Thus, it may be that governments are paying higher wages to better-educated employees not because those employees' educational skills are required to perform their job duties, but rather because they are overqualified for their jobs.

It is worth noting that private sector compensation might also be skewed higher by a relatively small number of very high income earners, such as large corporation CEOs and senior officers, entertainers, and professional athletes, for which there is no equal in the public sector.

Productivity Differences

Even taking the study's analysis as given, this does not mean that the value of an average government worker's labor is equal to that of an average private sector worker with similar education and work experience.  This is because private sector workers tend to be more productive.  As Cato Institute Director of Tax Policy Studies Chris Edwards notes in a recent paper, according to the U.S. Bureau of Labor Statistics (BLS) National Compensation Survey, private-sector employees worked an average of 2,050 hours in 2008, 12 percent more than the 1,825 hours worked by the average public-sector employee.

Even on an hour-for-hour basis, one would expect private sector workers to be more productive due to the lack of competitive forces in government.  Private sector businesses face constant pressures of competition to innovate and improve their goods and services, lest they lose business to their competitors.  Government agencies, by contrast, are typically monopolies protected by law, and thus are not subject to such competitive incentives and pressures.  (There is a reason for all those jokes and complaints about the efficiency of post office and DMV workers.)

Job Security Differences

The notion that public employees are significantly undercompensated begs the question: if they are so underpaid, why would they agree to take government jobs when they could earn more by performing similar jobs in the private sector?  Some might cling to the romantic idea of "public service," but public-sector employees are every bit as self-interested as private-sector workers, so this answer is wholly unsatisfying.

One major factor not discussed by the report's authors that could provide an explanation (setting aside the possibility that public-sector workers are actually overcompensated, relative to their private-sector counterparts) is the significant difference in job security.  Government job security is famously, and notoriously, ironclad, oftentimes making it practically impossible to fire or lay off public-sector workers for the same reasons employees are terminated in the private sector, even in cases of poor performance or unethical activity.  This job protection has tremendous value which is not captured in the Bender and Heywood report.

Whether for job security or other reasons, the attraction to government jobs is evidenced by job-quit rates.  Lower quit rates indicate a lack of better job opportunities elsewhere.  Indeed, as the Cato Institute's Chris Edwards points out (see pages 92-93), BLS data reveal that the quit rate is significantly lower in the public sector than in the private sector.  Between 2001 and 2009, the public sector layoff and discharge rate is only about one-third of the private-sector rate.  Surely, if government workers were so poorly compensated and were qualified to earn significantly more in the private sector, they would leave for those private sector opportunities and the quit rate would be much higher.

In California, the state's prison guards provide a good example of the lack of dissatisfaction with public-sector compensation.  According to a February 2008 Legislative Analyst's Office report, correctional peace officer costs make up the largest share of General Fund personnel expenses.  The approximately 30,000 state correctional peace officers make up nearly 10 percent of all state employees.  The report described correctional officers' overall compensation levels as "very attractive," particularly considering that the job requires only a high school or equivalent education, and noted that the California Department of Corrections and Rehabilitation (CDCR) boasts that the job "has been called 'the greatest entry level job in California'-and for good reason," and that "Along with the great salary, our peace officers earn a retirement package you just can't find in private industry."   Perhaps this, along with the CDCR's inability to control sick leave and overtime benefits, is why the state receives roughly 130,000 applications to become a prison guard each year.

Not surprisingly, there is very little turnover among California prison guards.  A May 2006 California Policy Research Center report found that

Only 1,000 of California's 36,000 sworn peace officers left the CDCR [California Department of Corrections and Rehabilitation], an annual turnover rate of 3.6%.  This is very low for public service generally and quite unusual for correctional settings, where burnout is typically a significant staff issue.  California may have the lowest turnover rate of any state corrections department.  In many states, by contrast, turnover rates among correctional officers hover around 20%. (see page 27)

Rising Numbers of Government Workers

Even if we were to assume that the productivity of public and private sector workers is equal, or that differences in job security were not a factor, this would not speak to the necessity or sheer number of government employees, and thus to the overall cost or necessity of government programs.  Unlike the private sector, where decisions on the number and compensation of employees are driven by supply and demand and economic realities, the size and cost of government employees is driven by the political process.  Thus, government employees' labor unions are constantly pressuring legislators (who are frequently indebted to the unions for campaign contributions and other help provided to get them elected) to increase workers' wages and benefits, and legislators are always creating or expanding government programs that may or may not be needed or effective.  These pressures are independent of economic constraints, and are limited only to the extent that taxpayers refuse to consent to additional borrowing or tax increases.

This has allowed governments at all levels to continue to add employees even during the severe recession that has forced a significant contraction in the private sector.  Between December 2007 and December 2009, the private sector lost more than 7.3 million jobs, yet the number of government jobs actually increased by about 100,000 (see figure below).

In California, even as the state struggled with the recession, plummeting revenues, and record budget deficits, and Gov. Schwarzenegger issued a supposed hiring freeze, the state continued to hire more workers. Incredibly, the state has added over 13,000 employees since the onset of the economic recession in 2008 and continued hiring even during the worst of the recession. According to a Sacramento Bee analysis of State Controller's Office data, between June 2008 and January 31, 2009, most state agencies either maintained or increased the number of full-time employees, resulting in a net increase of over 2,000 workers (not counting the Department of Forestry and Fire Protection, which always sees large drops in the number of its employees after fire season).

It should come as little surprise, then, that taxpayers are upset as they watch government union ranks swell as their governments face serious budget strains and private businesses and households have been forced to cut back to adjust to economic conditions and live within their means.

The implication behind the argument that public-sector workers are no better compensated than private sector workers is that taxpayers are getting their money's worth, but this is not necessarily the case.  Even if public employee compensation is on an even keel with comparable private employee compensation, the government may still be employing more people than necessary to do the job or hiring people to perform tasks in which the government should not be involved in the first place.  Such conclusions involve subjective determinations outside the scope of the Bender and Heywood report, but they should certainly not be overlooked in discussions of the cost of government services.

Public-Sector Pension and Retiree Health-Care Benefits Differences

As with job security, there is a value to the guaranteed nature of public sector benefits that is not captured in the Bender and Heywood report.  In most states, including California, government workers' benefits are protected by state constitutions, and the benefits of current employees cannot be reduced.  This is a protection that is not available in the private sector, where pension plans may be frozen, benefits may be reduced, and companies can go bankrupt, which could cause employees to receive fewer benefits than promised.

In addition, the value of public sector benefits seems to be understated.  Granting that the BLS's Employer Costs for Employee Compensation (ECEC) survey does not account for differences in worker education, job experience, or job duties, the survey can nonetheless prove instructive.  The survey estimated that public sector workers, in aggregate, earned an average 35 percent more than private sector workers, and the Bender and Heywood report found that, after controlling for the aforementioned variables, public sector workers actually earned 11-12 percent less than comparable private sector workers.  Yet, while the ECEC survey reported a much greater 69 percent advantage for public sector benefits, the Bender and Heywood total compensation gap narrowed only slightly, from 11-12 percent to roughly 7 percent (public employees received more benefits than comparable private-sector workers, but the difference was much smaller than that reflected in the ECEC survey).  The relatively small impact of the greater benefits of public employees also appears to fly in the face of the fact that in California and elsewhere, many state and local governments have increased government employees' benefits by as much as 50 percent in the past decade or so, allowing many workers to retire as young as 50 or 55 years old with pensions equal to as much as 90 percent of their final salaries.  These are benefits unheard of in the private sector.

In the Bender and Heywood report, the authors assumed that the determinants of benefit values-factors such as education, age, and other demographic characteristics-affect the results in the same way that the determinants affect the calculations of hourly earnings.  The authors acknowledge that this assumption is debatable.  If the determinants affect the comparability of benefits in a different way than they affect wages, then this could skew the results.  Perhaps this could account for at least some of the apparent discrepancy.

Moreover, the report cannot account for expected increases in benefits that would result in greater compensation for public employees, relative to comparable private-sector employees.  The report is necessarily a snapshot in time, as it would be impossible to predict all future changes to employees' wages and benefits.  Yet, we can safely assume that health care costs, and thus the costs of employees retiree health care benefits, which have risen on the order of 10 percent a year for most of the last decade, will continue to rise, particularly since demand for health-care services will increase as the Baby Boomer generation enters retirement (and, it could be argued, the supply of health care practitioners might be reduced by increased government involvement in the health care industry, thus exacerbating these cost increases).  Retiree health benefits are typically much more generous in the public sector than they are in the private sector, if they are provided at all in the private sector.  In California, the state pays 100 percent of health care costs for retired state workers and 90 percent of costs for retirees' families.  Barring any commensurate reductions to these benefits, which, unlike pension benefits, can, in fact, be reduced, we should expect to see the gap between public and private employee benefits widen and the differences in comparable public and private employees' total compensation to adjust accordingly.

Conclusions

While the recent study from the Center for State & Local Government Excellence and the National Institute on Retirement Security comparing public sector and private sector compensation levels correctly notes that aggregate comparisons of average public and private wages and benefits can be misleading, its conclusion that state and local government employees are undercompensated, compared to private-sector employees, is suspect at best.  The analysis ignores the value of virtually ironclad job security and certainty of pension benefits, features that are notably absent in the private sector.  It also overlooks the greater efficiency and productivity of private sector workers, which is a result of competitive pressures not experienced in government agencies.  The conclusion that public-sector workers are more highly educated than comparable private sector workers, upon which higher pay and benefit levels is justified, is called into question by the fact that not all college degrees are equal (and may vary between public and private sector employees) and the possibility that governments are hiring overqualified workers because they face looser budget constraints than private companies (i.e., governments are overpaying for their labor).

There are other considerations outside the scope of the report that affect discussions of the cost of government services.  Since retiree health care costs are expected to continue to rise rapidly, and public employees' retiree health care benefits are significantly greater than those of private sector employees, this will increase government workers' total compensation relative to comparable private sector employee compensation.  Furthermore, even if we assume that public employees are underpaid, or at least not overpaid, that does not mean that the number of government workers is necessary or desirable, or that the cost and scope of government is not excessive.

The fact is that state and local government labor costs are continuing to escalate drastically.  There is a reason why the City of Vallejo, California, cited skyrocketing pension costs as the chief cause of its fall into municipal bankruptcy, and why many other local governments in California and elsewhere are on the brink of bankruptcy.  There is a reason why California's pension costs have been described as unsustainable by everyone from the chief actuary of the California Public Employees' Retirement System to Republican Gov. Arnold Schwarzenegger, to Democratic State Treasurer Bill Lockyer.  There is a reason that governments at the federal, state, and local levels achieve significant cost savings by contracting with private sector businesses to provide a wide variety of services previously performed by government workers.  State and local governments in California and across the nation must address public employee compensation levels if they are to maintain any sense of fiscal responsibility, particularly in these difficult economic times.

Court of California’s Duty to Defend Decision

The California Court of Appeal, Sixth District, recently decided on an industry-defining case regarding the extent of duty to defend and duty to indemnify when a suit is brought against developers. The duty to defend is seen as a separate point of coverage, much broader than the duty to indemnify. The case, UDC vs. CH2M Hill, was contested after the homeowners brought suit against the developer, who in turn tendered defense to CH2M Hill, among other contractors involved.

CH2M Hill was found not negligent in its work in a trial by jury, which rendered the duty to indemnify null. However, due to the language of the contract, the court found that CH2M Hill still was required to fulfill the duty to defend. The court decided that the duty to defend must occur before the duty to indemnify. The legal support the court used was from Crawford vs. Weather Shield, where a subcontractor’s product was found defective and destructive, and the subcontractor was responsible for a major share in defense costs incurred by the contractor.

The Court of California has deemed "a duty to defend... is different from a duty expressed simply as an obligation to pay another, after the fact, for defense costs..." (Crawford v. Weather Shield). A contract with the language of "duty to defend and indemnify" is seen as two separate and actionable agreements. The duty to defend "the indemnitee upon tender of the defense thus extends to all such claims" (Crawford) regardless of determination of negligence.

With this decision, consultants will be on the hook for legal expenses as soon as the indemnitee issues a tender for defense. As the indemnitor, the consultant would be required to cover the costs even if the claim is found invalid or not negligent. California has also made it clear that it is not the Plaintiff who claims fault, but rather the indemnitee can "...name a particular subcontractor or consultant in order to obtain a promised defense by the one the indemnitee believes is responsible for the plaintiff's damages" (UDC v. CH2M Hill).

California set a legal precedent, which when used as the basis for other suits and claims across the country (apparently Florida already has), will require consultants to pay for more lawsuits and claims, warranted or not. Instead of engineering our future, consultants will be fighting and paying for legal actions that likely will have nothing to do with their work. In future contracts, consultants will need to advocate for a release of duty to defend outside of claims of negligence, a new clause that will be a lively discussion during contract negotiations.

SPECIAL SESSION ENDS – Tax increase a reality!

The Washington State Legislature finally went home this week at the conclusion of the “special” session. It certainly wasn’t special for engineering firms and other professional services who were hit with a devastating 20% increase in the gross-revenue based B&O tax, providing ironic symmetry to the 20% reduction in force the industry has suffered during the last year of this downturn. That symmetry will be temporary; however, as most firms claim the tax increase will cause additional loss of jobs. “We won’t pay this increase out of profits,” wrote one firm CEO to his legislator, “there aren’t any! We’ll pay this tax with the loss of one or two additional jobs.”

ACEC asked its members to mount an aggressive campaign against the increases, and many contacted their lawmakers, who seemed insensitive to our industry’s economic woes… or just didn’t get it at all.

Senator Jeanne Kohl-Welles (D-36) responded to those who wrote to her, “It’s important to note that, between the additional tax and the additional tax credit, businesses actually would pay less in B&O taxes until they make more than $72,000 in gross revenue annually.  The new surcharge in the Senate plan sunsets in three years but the increased tax credit is permanent.” Really! All the way up to $72,000! Not many constituents were comforted by Kohl-Welles‘ response.

The increase is scheduled to sunset in 2013, but most analysts agree that these solutions have done little to fix the budget problem, that we are running out of federal money and short-term accounting maneuvers so it’s hard to believe the taxes won’t be permanent.

During the 60-day regular legislative session, the legislature considered more than 1,600 bills introduced this year and passed about 260 bills to the governor. Here is a summary of the other issues we cared about.

LIABILITY

Residential Construction Liability (2SHB 1393, SSB 6701 – DIED) AELC Rating: H. These bills address residential construction liability through statutory warranties, alternative dispute resolution, increased consumer education, and licensing of contractors and tradesmen. Each bill would have created damaging liability and insurance issues for design professionals doing residential design. Neither chamber could garner enough votes for passage when it became clear that a construction industry-backed amendment would be successfully added to the bill in the Senate.

Wrongful Death (2ESSB 6508 – DIED) AELC Rating: -M. This bill would remove the age limit for recovering damages in the wrongful death of child at age 18, and also would allow for recovery of non-economic damages in these claims. The Liability Reform Coalition worked with state and local governments to amend the bill to eliminate joint and several liability for government entities for these new claims. The bill died when the House refused to accept the amendment and the Senate refused to approve the bill without this limit on government liability.

Limits on Indemnification Agreements for Design Professionals (HB 3208 – DIED). The bill limits the use of indemnification agreements by state and local governments in contracts with design consultants.  Under the bill, indemnification agreements would only be enforceable to the extent of a consultant’s fault.

GOVERNMENT CONTRACTING / A&E SELECTION

False Claims Act (SB 5144 – DIED) AELC Rating: -M. This bill allows private plaintiff attorneys to bring a civil action against any person who presents a false or fraudulent claim for payment to the government. If successful, the private party would be awarded between 25-30 percent of the recovered value plus attorney’s fees, creating an incentive to file lawsuits against government contractors whenever there is a disagreement with the contracting agency over the cost of a project.

Prevailing Wage Expansion (HB 1992 – DIED). The bill would have expanded the state’s prevailing wage requirements to private construction projects that involve tax incentives, public loans and grants, or public land that is sold or leased.

Commercial Activities by State Government (HB 2808 – DIED). This bill would prohibit a state agency from engaging in commercial activities, unless an exception is granted by the office of financial management.

LICENSING

Architecture Practice Act Update (ESSB 5529 – PASSED) (Governor Signed) AELC Rating: +L. The American Institute of Architects/Washington Council completed a six-year effort to update the architect licensing law. An agreement on the 4,000-square foot rule was reached with the Associated General Contractors that had held up the bill in previous years.

Continuing Education Requirements for Engineers (SHB 2602 – DIED). This bill would establish mandatory continuing education requirements for engineers. In the alternative, legislators have asked the Department of Licensing to study the issue and report back prior to the 2011 session.

Other. Proposals to license soil and wetland scientists (SSB 5698, HB 3075) and interior designers (HB 1608/SB 5514) were once again unsuccessful.

TAXES/FEES

Hazardous Substance Tax Increase (2SHB 3181/SSB 6851). This bill would increase the existing model toxics control act tax (MTCA), which receives roughly 85 percent of funding from petroleum, to help pay for storm water cleanup projects. As originally introduced, the tax would have been tripled with most of funds diverted to the general fund budget. The measure was amended to lower the increased tax to about 0.5 percent with no general fund diversion.  It continues to be deliberated during the special session. The Washington Construction Industry Council opposes the bill because it diverts petroleum product taxes from transportation purposes.

Two-thirds Majority Requirement for Tax Increases / I-960 (ESSB 6130 – PASSED)(Chapter 4, Laws of 2010). The legislature suspended voter-approved Initiative 960-- which requires a two-thirds majority vote of the legislature to raise taxes. The Washington Construction Industry Council opposed overturning I-960. The two-thirds vote requirement is reinstated after July 1, 2011.

2010 Legislative Special Session Update

Reports are the tax negotiators have agreed to the size of the tax increase: $800 million. They have agreement on about $300 million, but are not close to agreement on finding the additional $500 million.

We also are hearing that the House is going to agree to the Senate’s version of the B&O tax increase, which raises the rate by 17% for all services (which includes A/E firms).

This week, we issued a new action alert related to the special session and the tax increases being discussed. Many have responded already, but we need to continue to push for more ACEC members to take action. Lawmakers are not listening to lobbyists at this point. It is up to the constituents in the districts to make enough noise for the tax hike vote to be uncomfortable. Please continue to contact your lawmakers to oppose a tax increase on engineering firms.

News reports are that the House tax negotiators are Speaker Frank Chopp and Finance Committee Chair Ross Hunter. The Senate negotiators are Senate Ways and Means Chair Margarita Prentice, state Senator Ed Murray and state Senator Rodney Tom. If you reside in any of these lawmakers districts, it is especially important to let them know how the tax increase will affect you and your firm.

The latest data from the US Bureau of Labor Statistics show that Washington lost another 900 architecture & engineering jobs in January 2010. Washington has lost 6,300 A&E jobs since July of 2008. The state is reporting that statewide unemployment rates went up again (to 9.5%) and the state lost another 2,100 jobs in professional and business services. This tax increase will only make matters worse. Here's the Legislative Alert sent last week.