The Impact of Tax Exempt Pensions

It is surprisingly difficult to gather data on just how many public safety employees claim disability in their retirements, but this should not prevent us from estimating what the benefits bestowed on disability claimants cost taxpayers.

A common program to compensate public safety workers for job-related disabilities is to grant them a tax exemption, whereby 50% of their retirement pension is exempt from state and federal taxes. While it is virtually impossible to collect data from pension fund administrators on exactly how many retired public safety workers have retired with this benefit, a 2004 investigative report by the Sacramento Bee found that among retired members of the California Highway Patrol, 66% of the rank and file officers, and 82% of the chiefs retired with service disabilities. Similarly, a 2006 investigative report by the San Jose Mercury found that two-thirds of San Jose Firefighters retired with service disabilities. Neither of these reports remain available online, although a Google search on the term “Chief’s Disease” (a term coined by the Sacramento Bee) will find dozens of secondary references to these studies; you can start here, and here.

The point of this analysis, other than to point out the shocking lack of comprehensive data on this issue, is to perform a what-if, based on assumptions that might be reasonably extrapolated from the available data.

The first section of the table below, “Impact per Worker,” shows what a person receiving a service disability tax exemption is really making annually, based on normalizing the take-home, after-tax earnings between the case with a 50% tax exemption vs. one with no tax exemption. Column one shows an average annual pension for a recently retired California public safety employee – probably low – of $75,000 per year. It then shows what their tax burden would be based on 50% of that income being exempt from taxes – leaving a taxable income of only $37,500, which invokes far lower withholding percentages. As can be seen, someone with a gross income of $75K per year who only pays taxes on $37.5K will have an after-tax income of $67,999 per year.

Still examining the “Impact per Worker” section of the table below, column two shows that in order to collect an after tax income of $67,999 per year, if one pays taxes on 100% of their income, would require an income of $90K per year, a 20% increase in gross income. This is the true value of the service disability 50% tax exemption. As retirement incomes increase, the disparity actually widens, because the tax brackets invoke higher withholding percentages. For example, a pension income of $100K – quite common among retired public safety workers – paying income taxes on only $50K, would deliver a take-home, after-tax income of $88,858. To earn this much while paying normal taxes without special exemptions would require an annual income of $128,363, a 28% increase. The reader is invited to verify these figures by referring to 2011 Federal Income Tax Brackets, and 2011 California Income Tax Brackets.

The second half of the above table, “Impact for California Taxpayers,” attempts to quantify what the prolific granting of service disability tax exemptions to retired public safety workers costs taxpayers. Based on updated 2010 data from the U.S. Census Bureau for California State Worker Payroll and California Local Government Worker Payroll, there were 222,898 full-time police, firefighters, and correctional officers working at the state and local level in California in March 2010. This amount does not include “full-time equivalents” who brought the total up to nearly 230,000 employees. On average, these full-time public safety workers earned $84,929 per year. Among firefighters, the average was $113,057 per year. Because public safety workers have life-expectancies that – according to CalPERS own actuarial data – meet or exceed national averages, and because they are eligible for retirement at age 50 (in some cases earlier), the calculations on the above table assume we are on track to have one retired public safety worker for every active public safety worker.

As can be seen, based on these assumptions – and the pension estimate of $75K per year is almost certainly quite a bit lower than the reality, since the average mid-career earnings of public safety workers is currently $85,000 per year, and pensions are calculated on end-of-career earnings – if 50% of public safety workers retire on service disability tax exemptions, the cost to California’s taxpayers is $1.7 billion per year.

Whether or not this is an accurate estimate, and available data suggests that this estimate is, if anything, on the low side, is almost beside the point. Where is this data? Why doesn’t CalPERS, and the other pension funds managing public safety employee retirement assets, release this data?

Nobody seriously questions that public safety workers deserve to make a premium for the work they do. The level of sophistication required to work in law enforcement and fire suppression today is far greater than it was 20 or 30 years ago. The value we place on life and personal security is also greater today than ever before. There is a price for this, and it is one taxpayers should pay without resentment. The question is how much of a premium is equitable, and how much of a premium is financially sustainable. A related question is how much of this premium paid to public safety workers, to the extent it is excessive, the result of powerful government worker unions who pool taxpayer’s money to control local elections with massive campaign contributions. How much is this pay premium elevated because public safety worker unions, and their PR firms, exploited their deserved hero status in inappropriate ways to manipulate the electorate to ignore fiscal reality?

When the question turns to pensions, however, the issue of whether or not a premium is appropriate for service in public safety may not be as justifiable. If public safety workers deserve a premium, it should be paid as part of their current compensation. This way they may share, along with all public employees, the same obligations to financially prepare for their retirement that face working private sector taxpayers. As for disability pensions, it strains credulity to think that over 80% of police chiefs and fire captains, and over 60% of other public safety workers are disabled in the course of their jobs. And even if they are, these disabilities can be remedied through far less expensive private disability insurance, not through the granting of service disability tax exemptions that increase the effective gross amount of their pensions by 20-30%.

Questioning whether or not we should offer pensions in excess of $75K per year to workers who retire in their early 50s, or then offer as many as half of these retirees with service disability tax exemptions, goes beyond questions of financial sustainability. It goes beyond questioning how much of a premium they deserve for the risks they take to protect the public. A deeper question is not how much we value the lives of those who protect us, but how much we value everyone’s life. Dozens of jobs are more dangerous than those in public safety. Logging, fishing, agriculture, and mining occupations claim thousands of lives every year, and maim thousands more. Few if any of these workers retire in their early 50s with pensions of $75K or more, and none of them receive service disability tax exemptions. Do we consume the products that these workers lose their lives and endure disabling injuries to provide for us? Can we live without those products? Are their lives any less significant than the lives of others who wear badges? For that matter, are the millions who toil in factories or in front of computers any less likely to wear out and become disabled through repetitive motions and eye strain? Are their injuries less debilitating? Is their life’s work undeserving of commensurate dignity?

Ultimately, we all share the fate of our mortality, the ultimate disability. We age, we wear out, we are progressively disabled, and then we die. Nobody escapes this verdict, whether our professions are public or private, intellectual or physical, noble or profane. This common denominator – tempered by considerations of what is financially realistic – should govern our common response to the challenges of disabilities, not privilege, nor political power, nor manipulative emotional appeals.

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3 comments to The Impact of Tax Exempt Pensions

  • Jessica

    Interesting post!
    You have a very good point here “Ultimately, we all share the fate of our mortality, the ultimate disability. We age, we wear out, we are progressively disabled, and then we die. Nobody escapes this verdict, whether our professions are public or private, intellectual or physical, noble or profane. This common denominator – tempered by considerations of what is financially realistic – should govern our common response to the challenges of disabilities, not privilege, nor political power, nor manipulative emotional appeals.” I totally agree with you.

  • SkippingDog

    One correction to your hypothesis. Retiring with a service-related disability doesn’t mean the individual receives a full, tax-exempt disability pension. Many officers have either presumptive or directly documented disabilities when they retire, such as hearing loss, heart disease, illness from exposure to hazardous materials, etc. Those are generally resolved as workers compensation claims, not full disability retirements.

  • BoxerRob

    The tests for ‘disability’ for cops/ff are much, much more inclusive than other disability plans. Tiny findings, knee pain without anatomic changes, headaches have been certified as ‘complete disability. Unlike any other disability plan, there is no ongoing exams or future re qualification tests. Also no sanctioning of employment while in ‘disability’ status. In many states, cops/ff sit on the decision making board for these findings. Medical science and evidence is a back seat to flag waving and rubberstamping. Also, the tax free deal is an IRS law, not state law. Anybody who funds their own disability insurance plan, then receives payments from that plan, has the same tax relief. I know what you’re thinking, do all cops/ff’s self enroll in the same plan and send in a premium check every month? Here’s the deal, union contracts, all cop/ff, stipulate that employer will pay the employee in taxable money the amount of premium, then automatically deduct it from the paycheck and send it to insurance underwriter. Pretty slick eh….Cal and Uncle Sam could use that cash