With both a government shutdown and a potential default looming this fall, Congress and the White House are gearing up for another round of budget negotiations. In searching for ways to save, both sides should take a close look at federal-employee benefits.
Federal employees receive greater compensation than comparably skilled private-sector workers. Reducing federal compensation to market levels should therefore have only a minimal effect on recruitment and retention of qualified workers. It would save money without a significant reduction in services.
But what is the best way to pursue reform? After James Sherk, Andrew Biggs, and I began calling attention to the federal-pay problem back in 2010, lawmakers responded by denying federal workers a cost-of-living increase for three straight years. I remain ambivalent about these so-called pay “freezes.” (“Freeze” is a misnomer, since federal employees still earned regular step increases and merit-based raises during that time.) While the “freeze” certainly saves money, it’s a blunt instrument that doesn’t reform the structure of the compensation system in a meaningful way.
The federal government needs a less costly pay system, but it also needs a more flexible one. Wages are compressed between the lowest and highest earners, and the health and retirement benefits are far more generous than what large private-sector firms offer. Cutting back on benefits and developing a more market-based wage system should be the goals of any reform.
To that end, I propose a first step for budget negotiators to consider: phase out the defined-benefit portion of the Federal Employees Retirement System (FERS). Employees hired under FERS currently receive both a 401(k)-style defined-contribution plan (with generous federal matching funds) and a traditional defined-benefit pension. The defined-benefit pension is dying out in the private sector, and its persistence in FERS is an unnecessary luxury. In fact, the CBO noted that much of the federal-benefits premium can be ascribed to the pension.
Stop new FERS pension accruals for all federal employees who are not near retirement, and gradually convert their already-accrued benefits into 401(k) contributions. (The pension plan for currently retired and nearly-retired workers would remain unchanged.) This could save around $150 billion over ten years, depending on implementation and accounting, and still leave federal employees with generous 401(k)-style benefits. It’s the type of substantial but not-too-painful cut that budget negotiators should be looking for.