One way to distill the debate over the sustainability of retirement security in the United States is to evaluate the absolute amount of money that will be paid out each year for public sector pensions vs. social security. Doing this removes the necessity to debate what rate at which public employee pension funds can earn investment returns in the market, which presumably diminishes the amount taxpayers have to contribute to fund these pensions. Instead of evaluating how much money has to go in to fund retirement benefits, this post evaluates how much will come out in actual retirement payments.
Making this analysis easier is the fact that the United States, almost uniquely among nations, enjoys an age distribution that is, for people under 60, almost evenly distributed. As the table below indicates, there are about 20 million people in each five year age group, starting with children under five years old, all the way through adults between the ages of 55 and 60. It is a fairly safe assumption that this trend will continue over the next 40 years, and in fact, if you review the United States – 2050 population pyramid projection from the U.S. Census Bureau, that is exactly what is expected. As will be seen, this even distribution of age groups in the U.S. makes projecting future aggregate retirement payouts for social security and public sector pensions somewhat easier.
Before reviewing the actual calculations, it is also important to note the significant differences between the formulas governing social security benefits vs. the formulas governing public sector pension benefits. One of the most important of these differences is the fact that the social security benefit is progressive, that is, the more you make when you are working, the lower the percentage of your earnings will be realized in social security benefits. The table below presents graphically the information provided by the Social Security Administration in their “Estimated Retirement Payments Chart.” As can be seen, the retirement benefit provided by social security – as a percentage of career earnings – drops of significantly the more someone earns.
With public sector pensions, there is no ceiling on benefits, or formula in place to diminish the payouts for people who are highly compensated. For the purposes of analysis, the assumption here is that the retirement formulas that apply to public sector employees in California are typical of public sector employees in the other 49 states. In reality, many of the larger industrial (or post-industrial) states in the U.S. match California’s public sector employee retirement benefit formulas, as does the federal government, but this isn’t necessarily true everywhere. Nonetheless, since California’s public sector unions and public sector pension funds – echoing their counterparts in the other states who grant retirement benefits to their public employees at a level matching California’s – are generally proclaiming that these benefits are not inequitable and are not unsustainable, this analysis will estimate total retirement payouts per year for social security vs. public sector pensions as if every public agency in the U.S. had the same benefits structure as California’s.
In the next table, “What if the U.S. Had California’s Public Sector,” several assumptions are made that are fairly representative of the relative work histories and compensation profiles of public vs. private employees in California. The average public sector worker spends about 30 years in the workforce and 30 years retired, and the average private sector worker spends about 40 years in the workforce and 20 years retired. Because – returning to our population pyramid – the U.S. population is on track to have an even distribution of people in all age groups, this means the ratio of workers to retirees in the public sector is one-to-one, and the ratio of workers to retirees in the private sector is two-to-one. This is not true today, since the nation’s 20 million people per five year age group only begins with people under 60, but it is decidedly the long-term trend facing the U.S.
The other key set of assumptions are the average base pay of public servants in California, $68,000, vs. the average base pay of private workers in California, $41,500, along with the retirement benefit as a percent of base pay, which for the public sector is 66% (documented with sources in “Calculating Employee Benefit Overhead“), and for the private sector is 33% (as documented on table two above). Melding these assumptions with the respective worker to retiree ratios for the public vs. the private sector yields dramatic results. A final assumption is the percentage of private sector workers vs. public sector workers – using data from California’s Employment Development Department, California Labor Force & Job Numbers, there are 2.5 million government workers in California, 16% of the workforce, and 13.5 million private sector workers in California, 84% of the workforce.
If you know that in the future there will be 20 million Americans in each five year age group, and you know that public sector workers, who comprise 16% of the workforce, are retired for 30 years, then you can reasonably infer that there will be 19 million public sector retirees in the population. Using similar logic, knowing that private sector workers will be retired on average for 20 years, and that they represent 84% of the workforce, you may infer that there will be 67 million of them in the population. Calculating the aggregate retirement payout for both sectors of retirees is now possible.
By assuming these 19 million public sector retirees, on average, received a retirement pension equal to 66% of their average base pay of $68,000 per year, you may estimate the total public employee pension bill per year at $862 billion. Similarly, by assuming these 67 million private sector retirees, on average, received a retirement pension equal to 33% of their average base pay of $41,500 per year, you may estimate the total private employee social security bill per year at $920 billion.
The implications of these calculations are difficult to overstate. Using assumptions which are well documented and representative of the actual wage and benefit realities in California, extrapolated to the United States as a whole, it is clear that the California model would mean that public sector retirees would cost taxpayers $862 billion per year, which is only 6% less than the entire bill for social security for more than six times as many people.
The idea that investment fund returns can mitigate this cost to taxpayers is absurd (ref. “National Debt and Rates of Return“). And even if it were not absurd, the idea that public sector pensions are invested in the market, while social security funds are not, is inexplicable. Either both public sector pension funds and the social security trust fund should be invested in the market, or, better yet, both of them should operate on a pay-as-you-go basis, where current worker withholdings fund current retiree benefits. This would spare our markets both the political agenda of pension bureaucrats controlled by leftist government unions, as well as the massive distortions that are inevitable when trillion dollar funds face the prospect of notifying taxpayers they’ll have to pony up more because their investments didn’t hit their projected returns.
On a pay-as-you-go basis, Social Security is reasonably solvent, requiring only a 17% total withholding (employer plus employee) to maintain current benefit formulas for the next several decades. On the other hand, on a pay-as-you-go basis, public sector pensions will require contributions of 66% of base salary to maintain current benefits into the foreseeable future. Calls to cut social security’s percentage contribution are irresponsible, but correctable. Calls to maintain public sector pensions without massive increases to fund contributions, on the other hand, are ridiculous.
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