USA Today is reporting Pension gap divides public and private workers.

As the first wave of 79 million baby boomers heads to retirement, the nation is dividing into two classes of workers: those who have government benefits and those who don’t. The gap is accelerating in every way — pensions, medical benefits, retirement ages.

Retired government workers are twice as likely to get a pension as their counterparts in the private sector, and the typical benefit is far more generous. The nation’s 6 million retired civil servants — teachers, police, administrators, laborers — received a median benefit of $17,640 in 2005, according to the Congressional Research Service. Eleven million private-sector retirees covered by traditional pensions got $7,692.

Governments’ generosity could have serious consequences for taxpayers and pensioners. Some states — including Illinois, Indiana, Michigan, New Jersey, Ohio and West Virginia — have troubled retirement systems that may require huge tax increases, spending cuts or even defaulting on promised benefits. The U.S. government has a bigger unfunded liability for military and civil servant retirement benefits ($4.7 trillion) than it does for Social Security ($4.6 trillion).

A sharp contrast

State and local governments have sweetened retirement benefits during the past decade at a time when corporations have soured on them because of their cost. Only 18% of private workers now have traditional defined benefit pension plans, compared with more than 80% of government employees.

Contrary to a widely held notion, the extra government benefits aren’t compensation for lower pay. Most government workers are paid more than private employees in similar jobs, and the wage gap is growing.

A typical full-time state or local government worker made $78,853 in wages and benefits in the third quarter of 2006, $25,771 more than a typical private-sector worker, the Bureau of Labor Statistics reports. The difference was $7,604 in 2000. The compensation advantage holds true for all types of public workers, from teachers to laborers and managers. Better benefits for government workers is the biggest reason for the growing compensation gap.

“The government is in direct competition with us for employees. It’s hard to compete against these benefit packages,” says James Bellis, owner of Tree Tech, a 120-worker tree trimming company in Randolph, N.J. His company has a 401(k) plan that matches up to 2% of employee pay. By comparison, tree trimmers working for a government in New Jersey would get a pension benefit worth more than three times that.

Baby boomer retirements will force governments to confront the rising costs of civil servant benefits. The U.S. government’s unfunded retirement obligation grew $200 billion last year to $4.7 trillion.

Unlike private pensions, though, the federal system still encourages early retirement. “The sweet spot for me is about age 56. When I run the numbers, the system almost forces me to retire” early, Nichols says.

Another big incentive to retire early: Most governments offer health insurance to early retirees until they qualify for Medicare at 65. Massachusetts spent $377 million on retiree medical benefits last year. The state’s unfunded liability for such costs is $13.3 billion, nearly as much as its actual debt of $18.5 billion, which is counted separately.

Medical insurance may be the most vulnerable benefit because it has fewer legal protections than pensions, which often are guaranteed in state constitutions. Orange County, Calif., recently slashed promised retiree medical benefits, cutting its liability from $1.4 billion to $600 million. The county hasn’t done anything about its pension problem.

“Pension benefits are like a lobster trap. You can get in, but you can’t get out,” says John Moorlach, an Orange County supervisor who has tried to reduce retirement benefits for government workers.

Taxpayers on the hook

Government pensions are, on average, in a similar condition as private pensions — about 20% below the assets needed to be properly funded. But some states, especially in the industrial Midwest, have severely troubled pensions. “The taxes needed to pay for these promises would push many of these states’ economies into a death spiral,” Chicago bankruptcy lawyer James Spiotto says.

Pension Envy

  • 80% of government employees have defined benefit plans but only 18% of private workers do.
  • The “sweet spot” for some government workers is as early as age 56.
  • Some states, especially in the industrial Midwest, have severely troubled pensions. “The taxes needed to pay for these promises would push many of these states’ economies into a death spiral
  • Pension benefits are like a lobster trap [to state and local governments]. You can get in, but you can’t get out“.

Trouble Spots

The above chart shows results from the 5 worst states. For an interactive map of the US where you can see the results of your state, click on Cracked Nest Egg.

Note: those figures are as of June 30, 2004. A significant stock market rally may have reduced some of those deficits in some states. Then again, forward stock market assumptions are likely to be way off the mark and a mere 20% correction will put states way back in the hole.

More Public Pension Trouble Ahead?

Nationwide, pension monies currently promised to state and local workers and retirees total an estimated $2 trillion. But the shortfall in funds to pay this amount is estimated at $460-700 billion.

San Diego, dubbed “the Enron-by-the-Sea” in one New York Times headline, is the poster child for this problem. Now teetering near bankruptcy, San Diego has racked up $1.5 billion in pension debt, another $1 billion in retiree health care debt, and faces six conflict-of-interest indictments against members of its pension board, who cut deals to raise benefits while letting the city underfund its plans.

In addition, state and local governments don’t have a pension insurance system like the federal Pension Benefit Guarantee Corporation (PBGC) that guarantees private sector pensions. They must either raise taxes to cover their debts or float bonds, passing the interest on to another generation of taxpayers. And while distressed cities like San Diego can elect Chapter 9 bankruptcy to walk away from their pension promises, states have no such recourse.

Faced with these shortfalls, some states are following the private sector’s lead and shifting their employees into 401(k)-style retirement plans:

  • After estimating that its pension plan was short $5.7 billion, Alaska dropped lifetime pensions for new hires, offering instead a 401(k)-style plan. Alaska also reworked its health care benefits for state employees, shifting more of the cost onto workers and retirees.
  • Michigan has done away with lifetime pensions for new employees.
  • Oregon has taken the middle ground, capping some pension benefits for current employees and offering new hires cash-balance or “hybrid” plans instead.
  • And California is talking about dropping pensions. Governor Arnold Schwarzenegger has seized on San Diego’s plight to call for a statewide shift to 401(k)-style plans. If California, a bellwether state on social and economic issues, were to dump pensions, many other states could follow.

Good News for San Diego?

SignOn San Diego is reported January 13, 2007 that San Diego’s pension gap apparently decreases to $1 billion.

San Diego must pay $138 million this year to keep up with the city’s pension obligations, even as the overall deficit, after years of logging precipitous increases, fell to $1 billion.The fund had developed a systemwide deficit of at least $1.43 billion by 2005 – $1.4 billion of which was San Diego’s responsibility.

Investment success in 2006, along with a new method of determining the system’s fitness, led to the marked improvement, according to city and pension fund officials who reviewed the valuation report, which was released yesterday.

Yet Mayor Jerry Sanders, who warned this week that the city must endure significant budget cuts to meet its obligations was not celebrating. Sanders, said spokesman Fred Sainz, “wants to take a cautious approach to this” and will await an analysis from another expert hired by the city, before accepting the apparent improvement in the pension system’s prospects.

The yearly amount owed to the pension was set at just over $160 million the last two years, but last year the city pumped in an additional $108 million. Much of that money came from San Diego’s general fund, leading to substantial cuts in services for residents and job losses for city employees.

City Attorney Michael Aguirre, who is challenging the legality of some city benefits in an ongoing trial, dismissed the report immediately, and said retirement fund officials are “slicing and dicing, rather than showing what the actual shortfall is.”

David Wescoe, the pension system’s administrator, bristled at that accusation. “These numbers are solid and they’re transparent,” he said.

Several developments allowed some of its liabilities to be chipped away. The fund posted an 11 percent return on investments, leading to a $159 million gain. An additional $184 million boost was attributed to a change in the method of calculating system assets and liabilities.

Wescoe described the method as “widely accepted” in pension circles, but Aguirre called it “hocus-pocus.”

The estimate, however, also doesn’t reflect potential trouble. Individual pension checks are based on salaries, and earnings for about 6,000 city employees are set to rise July 1.

It’s hard to say how much “hocus-pocus” is going on but if San Diego is taking on excessive risk to achieve those 11% gains while and counting on such gains deep into the future, there is going to be another crisis as soon as the stock market makes a significant correction.

Non-Farm Payrolls

Let’s look at “Pension Envy & Lobster Traps” one last way.

A typical full-time state or local government worker made $78,853 in wages and benefits in the third quarter of 2006, $25,771 more than a typical private-sector worker, the Bureau of Labor Statistics reports. The difference was $7,604 in 2000. The compensation advantage holds true for all types of public workers, from teachers to laborers and managers. Better benefits for government workers is the biggest reason for the growing compensation gap.

If government was shrinking that might not be such a problem. So let’s take a look at what is happening in practice.

The above chart was created specifically for this article thanks to Bart at NowAndFutures.

BLS Jobs Data

Since 2001 the US has added 4,386,000 total jobs.
Since 2001 the US has added 3,185,000 private non-farm jobs.
Since 2001 the US has added 1,201,000 government jobs.
Since 2001 the government accounted for 27.38% of job growth.
Note: 2001 uses year end 2000 numbers as a starting point for the calculation.

In 2006 the US added 2,468,000 total jobs.
In 2006 the US added 2,282,000 total jobs.
In 2006 the US added 186,000 government jobs.
In 2006 the government accounted for 7.48% of job growth.
Note: The 2006 numbers above were created by subtracting 2005 from 2006.

What seems to be happening is that government hiring steps up in a recession and/or government layoffs are less than layoffs in the private sector. Interestingly enough the last recession was the mildest ever yet it took nearly 6 years for the job picture to recover.

Currently (as of year end 2006) government jobs account for 16.14% of total non-farm jobs. On a wage and a pension basis most of those jobs are making far more than private sector jobs and the discrepancy keeps widening. The discrepancy in pay was $7,604 in 2000 and as of 3rd quarter 2006 widened to $25,771.

So how does the lobster get out of the trap? State governments are going to have a tough time in the next recession. The choice will be to cut services (jobs), or raise taxes or both right as the housing economy (and housing related jobs) collapse. Longer term, the discrepancy in benefits needs to be addressed.

This post originally appeared in Whiskey & Gunpowder.

Mike Shedlock / Mish/