Private vs. Public Sector Pensions

by Veronique de Rugy

The millionaire’s tax on New York’s top wage earners is set to expire at the end of the year. The New York Post has a piece on where some of the proceeds of the tax would go:

The big irony here is that much of the money raised from any “millionaire” tax hikes would go to fund the growing phenomenon of public-sector millionaires.

How’s that? Well, most dictionaries define a millionaire as someone with wealth (i.e., assets) of $1 million. By that definition, many New York teachers and the vast majority of police and firefighters are millionaires, because the “net present value” of their retirement benefits is well in excess of $1 million.

That is, if they had to fund their retirements from their own savings, they’d have to set aside seven figures today.

Few who don’t work for the government sector have comparable assets. Over the last several decades, the private sector has moved increasingly to the 401(k)-style “defined contribution” model, which yields a retirement nest egg based on what both employers and employees have contributed to individual accounts.

Public-sector workers, on the other hand, still rely on “defined benefit” pensions, which provide a guaranteed stream of income based on career longevity and late-career peak salaries.

Writing for Bloomberg View yesterday, Peter Orszag explained how in the private sector, “defined contribution” pensions have become the rule:

The defined-contribution concept is already familiar to most American workers through their retirement benefits. Over the past two decades, company retirement programs have moved decisively away from defined-benefit plans, in which workers are paid a given amount of retirement income, and toward defined- contribution 401(k) plans, in which risks — from fluctuating financial markets, for example — are borne by workers.

In 1985, a total of 89 of the Fortune 100 companies offered their new hires a traditional defined-benefit pension plan, and just 10 of them offered only a defined-contribution plan. Today, only 13 of the Fortune 100 companies offer a traditional defined-benefit plan, and 70 offer only a defined-contribution plan.

Orszag predicts that the same trend should be expected in the health-care market too. In fact, he claims that the adoption of the president’s health-care bill will accelerate this transition.

The NCPA Digest has a summary of other differences between private- and public-sector pensions:

These millionaires on the city payroll have been made so by generous salaries, but more so by astoundingly large pension benefits that are included when calculating a person’s net wealth.

  • A New York City public school teacher earning $100,000 can retire at age 55 with a pension of $60,000.
  • A private-sector worker would need $1.2 million to buy an annuity with the same yield.
  • It would take an even larger nest egg to replicate the pension income of city police officers — they typically retire in their 40s and collect an average pension of $58,563 with a $12,000 annual supplement.

In the private sector, however, the Federal Reserve states that the average worker in his late 50s has a balance of $85,600 in his retirement account, and a net worth of $222,300 overall.

Many are quick to point out that many of these public workers labor in fields that are vital to America’s growth or that are disproportionately dangerous, and that these facts warrants larger compensation packages.  Yet, regardless of a comparison between private sector and public sector workers, it seems that public compensation at current levels is unsustainable.

  • New York City, specifically, offers a guaranteed 8-percent annual rate of return for its pension holders.
  • This benefit, in addition to the sheer volume of public workers, has led to increased city pension costs from about 4 percent of city tax revenues to 20 percent over the past decade, crowding out other vital public investments.

For more on this issue, look at my Mercatus Center’s colleague Eileen Norcross’ study “Accounting for the Cost of a Public Sector Worker in New Jersey.”

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