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MN2020 - The Conservative Spin on Public Compensation
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The Conservative Spin on Public Compensation

January 22, 2014 By Jeff Van Wychen, Fellow and Director of Tax Policy & Analysis

Conservatives frequently beat up on state and local governments—and by implication, public workers—for "lavish"compensation packages, including "excessive" healthcare and other benefits. Some on the right go so far as to claim that overly generous public employee compensation explains why inflation for state and local purchases is higher than inflation for ordinary consumer purchases.  However, a Minnesota 2020 examination of public versus private employee compensation show these accusations to be baseless.

Whether examining changes over time in family income or the state general fund, it is necessary to factor in inflation. However, the "basket of goods" purchased by state and local governments is distinctly different from that of the typical consumer.  While consumer purchases are heavily weighted toward food, clothing, and housing, state and local government purchases are more heavily weighted toward wages and benefits, including rapidly escalating healthcare costs.

For this reason, the index used to adjust state and local government purchases for the impact of inflation is different than the index used to adjust ordinary consumer purchases. Whereas inflation in consumer purchases is measured using the Consumer Price Index, inflation in state and local government purchases is measured using the Implicit Price Deflator for State and Local Government Purchases (S&L IPD).* The case for using the S&L IPD to adjust state and local government finances for the effects of inflation was laid out in detail in a 2008 Minnesota 2020 article.

In using the S&L IPD to adjust state finances for the impact of inflation, Minnesota 2020 is following the lead of respected research organizations. First and foremost among these is the State Council of Economic Advisors, which has flatly stated its preference for use of the S&L IPD over the CPI as a measure of inflation for state general fund expenditures. In addition, House Research Department, the Office of Senate Counsel, Research, and Fiscal Analysis, the Minnesota Department of Revenue, Department of Education, and the Office of the State Auditor typically use the S&L IPD when adjusting local government finances for the impact of inflation. Even conservative state policymakers have consistently used the S&L IPD instead of the CPI as a measure of inflation for state and local governments.†

In recent years, however, conservative advocacy groups have challenged the propriety of the S&L IPD as the inflation index of choice for state and local governments. Since 2003, the rate of inflation as measured by the S&L IPD has been 42.0 percent, compared to 26.4 percent as measured by the CPI.‡ The higher the rate of inflation, the lower the rate of growth—or the greater the rate of decline—in real (i.e., inflation-adjusted) revenues and expenditures.

While conservative groups acknowledge the role of escalating human service costs—including healthcare—as a significant driver of higher inflation for state and local governments, they also contend that lavish pension and “other post employment benefits” (e.g., healthcare, life insurance premiums, deferred compensation) are a major driver of higher costs among state and local governments and thus a major contributor to the higher inflation rate as measured by the S&L IPD. According to the conservative critique, it is inappropriate or misleading to use the S&L IPD as an inflation index for state and local governments because growth in this index is driven by extravagant state local and government spending decisions for pensions and other benefits.

However, upon closer scrutiny this critique falls apart. The following three part response to the conservative critique of the S&L IPD is based on the Employment Cost Index (ECI), an index prepared by the U.S. Bureau of Labor Statistics which measures growth in hourly labor costs, including both wages and benefits.

First, growth in the ECI from 2003 to 2013 for state and local governments is 31.9 percent, compared to 27.7 percent for the private sector—a difference of 4.2 percent. This 4.2 percent difference is hardly sufficient to explain the 15.6 percent difference between the S&L IPD and the CPI over the same time period, especially when we consider that only about 60 percent of state and local spending consists of employee compensation; inflation in the remaining 40 percent of state and local spending would be unaffected by employee benefits or other compensation costs.

Second, the higher rate of growth in the state and local ECI appears to be driven largely by the type of occupations that comprise state and local government employment relative to the private sector. The relatively low rate of ECI growth for the private sector is driven in part by the prevalence of “service” jobs (e.g., sales people, house cleaners); the ECI for these jobs increased by only 25.4 percent from 2003 to 2013. Such occupations comprise a relatively small share of public sector employment. State and local employment is more heavily weighted toward professional occupations, which have had a higher rate of ECI growth. Incidentally, the rate of ECI growth from 2003 to 2013 for state and local “professional and related” positions is 30.4 percent, slightly lower than the 30.7 percent growth rate for similar positions in the private sector.

Third, from 2009 to 2013** the total state and local government ECI grew by 6.2 percent, compared to 7.9 percent in the public sector. Despite the fact that state and local government employment costs grew less rapidly than private sector costs over this period, the S&L IPD continued to grow more rapidly than the CPI (10.3 percent versus 8.3 percent). The fact that the S&L IPD continues to grow more rapidly than CPI even during a period when state and local government employment costs are growing less rapidly undermines the premise that the more rapid rate of growth in the S&L IPD is due to growth in state and local employee wages and benefits.

Yet another reason for the lower rate of growth in the CPI relative to the S&L IPD has been the decline in housing prices since 2006. Housing comprises a large share of the consumption of the typical household and thus the decline in housing prices has had a significant effect in suppressing growth in the CPI. However, housing comprises a negligible share of total state and local government purchases and thus the decline in housing prices had very little impact on the S&L IPD.

The theory that discretionary state and local spending on employee compensation—including benefits—is driving the higher rate of growth in the S&L IPD relative to the CPI does not hold water. Trends in the ECI demonstrates that state and local compensation costs have grown at a pace that is roughly comparable to the private sector after taking into account the different mix of occupations between the public and private sectors. Differences in the composition of state and local government purchases versus ordinary consumer purchases—not lavish state and local spending decisions—are the principal reason for the difference between S&L IPD and CPI growth rates. The State and Local Implicit Price Deflator remains the most accurate and sensible way to adjust state and local government finances for the impact of inflation.

 

*Recent examples of material from Minnesota 2020 that use the S&L IPD to adjust for the impact of inflation on public finances include a January 13, 2014 article on state general fund revenue, an April 15, 2013 report on state general fund expenditures, a November 11, 2013 report on school district revenue, levies, and state aid, and a December 16, 2013 article on city revenues and levies, and a September 23, 2013 on city Local Government Aid.

†For example, conservative Governor Tim Pawlenty used the S&L IPD to adjust city revenue need for inflation in his proposed LGA formula and to adjust local government levies for inflation in his various levy limit proposals; Pawlenty’s LGA proposal and several of his levy limit proposals incorporating the S&L IPD inflation adjustment were enacted into state law. In 2005, the conservative dominated 2005 Minnesota House opted to require local governments to use the S&L IPD—not the CPI—when presenting inflation-adjusted budget information on their supplemental “truth-in-taxation” statements; this proposal was also enacted into law.

‡Unless otherwise needed, the S&L IPD, CPI, and Employment Cost Index (ECI) growth percentages cited in this article are based on a comparison between the index values for the third quarter of 2003 and the third quarter of 2013. (The third quarter of 2013 is the most recent quarter for which ECI data is available.)

**The S&L IPD, CPI, and Employment Cost Index (ECI) growth percentages cited in this paragraph are based on a comparison between the index values for the third quarter of 2009 and the third quarter of 2013. (The third quarter of 2013 is the most recent quarter for which ECI data is available.)
 

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4 Comments:

  • Kevin Terrell says:

    January 27, 2014 at 11:18 am

    Jeff:

    A couple of points regarding school spending, for which you have previously chosen to use S&L IPD, citing the same logic you use here.

    From the 2013 budget, Minneapolis Public Schools’ expenditures across the General Fund, Community Services and Food Services are 94% salaries, benefits or purchased services, with 80% being employee salaries and benefits. This contrasts with your assertion that “only about 60 percent of state and local spending consists of employee compensation.”

    If 80% of MPS expenditures are employee costs, and another 14% are purchased services that one would have to classify the same as “employment costs”, why not just use the ECI as the inflation index for public schools?

    Also, the 31.9% growth in the S&L ECI from 2000 to 2013 versus the private sector’s 27.7% is in fact 15% higher than the private sector. As i am sure you know, that type of compounding difference over time can lead to significant differences in costs to taxpayers, which is the flip side of benefits to staff.

    In light of that, why does it make sense to use S&L IPD for school spending?

    • Jeff Van Wychen says:

      January 27, 2014 at 1:42 pm

      Mr. Terrell:
      The 60% is an estimate of the percentage of the total budget spent on wages and salaries for state and local governments combined (“local” including not only school districts, but counties, cities, towns, and miscellaneous special taxing districts as well).  It is not just measuring school districts, which probably have a higher percentage of labor costs than other local governments.  In addition, the 94% and 80% figures you cite appear to be percentages based on operating expenditures; if my hunch is correct, the percentage of school district budgets comprised of compensation would decline if we were looking at operating and capital (e.g., new school construction, building repair & maintenance, etc.) budgets combined.  While state and local governments spent a lot on employee compensation, they still have expenses outside of compensation that need to be factored in when measuring inflation.  Hence the need for the S&L IPD.

      The disparity between the private sector and state & local governments compensation growth is greatly diminished if we control for differences in types of occupations that comprise each sector.  Please see paragraph nine in the article.

      • Kevin Terrell says:

        January 27, 2014 at 2:36 pm

        General Fund - $538M
        Comm Services - $23M
        Food Service - $18M

        All of which is the vast majority of MPS spending.

        I excluded capital costs because whenever I talk with MPS personnel, they advise me that we should not include those figures in total per pupil spending. (Which is a discussion for a different day.)

        I’ll even concede for the moment that using public sector ECI is more appropriate than the general ECI. Excluding labor costs, what is in the S&L IPD, and what is the detailed justification for using it on public schools? I’d be very interested in seeing the math on that for schools, because your use of S&L IPD is a critical part of your argument that schools are currently underfunded.

        • Jeff Van Wychen says:

          January 27, 2014 at 3:10 pm

          Mr. Terrell:
          I think we agree that school budgets are heavily weighted to compensation costs—probably more so than other levels of local government.  I think including capital costs is perhaps more appropriate for this exercise, since we are (or, at least, I was) discussing inflation in the entirety of the budget, not just the operating portion.  Also, I would think that in a district with more growth than MPS, the share of the budget that is compensation costs might be less than in MPS due to new facility construction.

          The source that I get the S&L IPD from does not give a breakdown of the components of the index.  However, I would note that the MN Dept. of Education also uses the S&L IPD in its 11-year revenue trend spreadsheet.