Public-Sector Pension Changes Create Residual Effects

A new Issue Brief publication from the Center for State and Local Government Excellence (SLGE) seeks to answer the broad and challenging question, “How Have Pension Cuts Affected Public Sector Competitiveness?”

The analysis explores the impacts of public pension reform from 2005 to 2014, finding some statistically significant evidence that cuts to pension benefits have reduced the ability of public-sector employers to compete with private-sector employers for workers. As the organization points out, there is a growing need for states and localities to consider in detail how pension benefit reductions may impact public-worker recruitment and retention, and whether more analytical work can/should be done to further examine the workforce impacts of pension cuts.

“Often lost in ongoing conversations about how to best improve the financial status of public pension systems is the important role these retirement programs fill as workforce management tools,” explains Joshua Franzel, president and CEO at SLGE. “Given the current, increased focus on wage and benefit compensation for teachers, public safety professionals, and many other public servants in a range of states, it is essential for reforms to be analyzed not only by their budgetary impacts, but also for their long-term public workforce development implications.”

The Issue Brief shows reductions to pension benefits were relatively uncommon before the stock market crash of 2008, but quickly became more prevalent as plan sponsors realized the extent of the deterioration in their funded ratio.

“Most, but not all, of the cuts applied only to new hires because many states consider future accruals of pension benefits for current workers to be contractual obligations that cannot be reduced,” researchers note. “In general, cuts for newly hired workers directly targeted benefits by increasing the normal retirement age and/or reducing the final-average-salary and benefit multiplier (the percentage of final-average-salary). Since it is often legally or politically challenging to reduce the benefits of current employees, cuts for this group target the COLA and/or require employees to contribute more of their salaries to help pre-fund the pension.”

At first blush, it seems clear that changes to reduce compensation, like those above, would hurt governments’ ability to recruit and retain employees. However, the evidence to date is mixed.

“For example, one study showed that federal workers who earned positive performance reviews and high rates of promotion valued employer retirement savings plans,” the Issue Brief states. “This finding suggests that pension reductions may hurt public employers’ competitiveness in the labor market. Other studies have suggested that workers value pensions very little compared to wages, in which case benefit cuts might not hurt recruitment or retention in a meaningful way. Hence, the effect of recent pension reductions on public-sector competitiveness remains an open question.”

To determine the effect of benefit cuts on overall public-sector competitiveness versus the private sector, the analysis examines how the average private-sector wage of new hires and separators changed after the cuts were enacted.

“For example, if a public-sector employer was recruiting workers earning $50,000 in the private sector prior to pension cuts, but recruited workers earning $45,000 after cuts, then the private-sector wage of new hires dropped by 10%,” the analysis explains. “If, prior to the cut, employees separating from the same public employer and moving to the private sector earned $60,000, but after the cut earned $66,000, then the private-sector wage of separators increased by 10%. Both effects would suggest some loss of competitiveness on the part of the public sector.”

Of course, states and localities that reduce pension benefits are often trying to ease broader budgetary pressures, researchers point out.

“So, they may implement other cost-saving personnel policies—such as wage freezes, reductions in hiring, and cuts to health insurance benefits—at the same time as pension cuts, making it difficult to pin down the effect of any pension reductions on competitiveness. Therefore, the brief uses a regression approach to isolate the impact of benefit cuts,” the brief continues. “The dependent variable is the private-sector wage of workers entering or leaving the sample of public-sector employers. The independent variables include an indicator for whether the employer made a pension cut in the recent past, with controls for personal characteristics of the worker; the type of job they performed for the government; and cost-saving personnel policies that the employers may have implemented in the year that the worker switched sectors.”

The analysis assumes that less observable aspects of public-sector employment—for example the motivation to do public service—did not change after benefit reductions.

“After cuts in pension benefits, the private-sector wage of new hires declined by a statistically significant 2.9%,” the researchers find. “The private-sector wage of separators increased, as expected, but the change was not statistically significant. Such a small change for separators is consistent with the fact that most benefit cuts affected only new hires. Taken together, the results imply that the public sector had trouble hiring and retaining the same type of workers it used to after a benefit cut.”

Interestingly, the organization candidly suggests these research results “should be interpreted with some caution.” As the research explains, fiscally stressed governments have cut wages, hiring, and health insurance at the same time as pensions. Thus, the analysis attempted to control for these factors, but the available data were limited, and it is possible that additional personnel policies changed during the period.

“Future research should continue to explore the effect of pension cuts, and the results of this brief indicate that states and localities should at least consider how benefit cuts might affect worker recruitment and retention,” the Issue Brief concludes.

A full copy of the Issue Brief is available for download here.