You give us too much credit…

The Congressional Budget Office’s finding this week that federal employees receive average compensation 16 percent above that of similar private sector workers builds on work that Jason Richwine and I did in an AEI paper last year. One of our key results was that federal retirement benefits are much more generous than private sector benefits—3.5 times more generous in CBO’s study, and even more so in ours.

One element in this conclusion is in how you “discount” future retirement benefits to calculate their value to workers today. We and CBO both assumed that if a future benefit was guaranteed, you should discount it using the market interest rate on guaranteed assets. You’d use that lower interest rate even if the government funds its benefits using risky assets with higher expected returns, because what you’re valuing is the benefit, not the government’s strategy for financing it.

Our friends at the Economic Policy Institute, however, think that somehow Jason and I duped CBO into using this method:

The experts consulted by CBO for this report include my EPI colleague, Heidi Shierholz, as well as two researchers on the other end of the political spectrum, Andrew Biggs of the American Enterprise Institute and Jason Richwine of the Heritage Foundation. Though it’s nice that CBO considered a range of opinions, it’s a shame that Biggs, Richwine and others have been successful in convincing CBO and others to use low Treasury yields to estimate the cost of future pension benefits.

I’d like to think that our prior work made clear how important it is to correctly value future retirement benefits. But it’s evidence of how out of step EPI is with the rest of the economics profession that we really didn’t have to convince CBO of anything.

If anything, I think CBO may not have gone far enough. The 20-year Treasury yield today is around 2.6 percent. CBO assumed a 4 percent Treasury rate, then added 100 basis points to account for the fact that federal pensions aren’t as guaranteed as Treasuries. I think a 100-basis point risk adjustment is too much for already-accrued federal pensions, which seem almost certain to be paid even if the terms by which future benefits are earned change. The value of benefits is very sensitive to the discount rate, so using plausible assumptions, the federal compensation premium today could be even larger than what CBO found.

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