Increase Federal Civilian Employees’ Contributions to the Federal Employees Retirement System

Background

The federal government provides most of its civilian employees with a defined benefit retirement plan through the Federal Employees Retirement System (FERS) or its predecessor, the Civil Service Retirement System. The plan provides retirees with a monthly benefit in the form of an annuity. Those annuities are jointly funded by the employees and the federal agencies that hire them. Employees contribute a portion of their salary to the plan, and those contributions are subject to income and payroll taxes. Whereas agencies' contributions to FERS do not have any effect on total federal spending or revenues because they are intragovernmental payments, employees' contributions are counted as federal revenues. Annuity payments made to FERS beneficiaries represent federal spending.

Over 90 percent of federal employees participate in FERS, and most of them contribute 0.8 percent of their salary toward their future annuity. The contribution rates for most employees hired since 2012, however, are higher. First, the Middle Class Tax Relief and Job Creation Act of 2012 increased the contribution rate to 3.1 percent for most employees hired after December 31, 2012. Then, the Bipartisan Budget Act of 2013 increased the contribution rate further, to 4.4 percent, for most employees hired after December 31, 2013.

Option

Under this option, most employees enrolled in FERS would contribute 4.4 percent of their salary toward their retirement annuity. The contribution rate would thus increase by 3.6 percentage points for employees who enrolled in FERS before 2013 and by 1.3 percentage points for employees who enrolled in FERS in 2013. The increased contribution rates would be phased in over the next four years. The dollar amount of future annuities would not change under the option, and the option would not affect employees hired in 2014 or later who already make or will make the larger contributions under the Bipartisan Budget Act. Agencies' contributions would remain the same under the option.

Effects on the Budget

If implemented, the option would increase federal revenues by $45 billion from 2019 through 2028, the Congressional Budget Office estimates.Annual revenues would increase gradually in the first four years as the increased contribution rate was phased in. For example, drawing on payroll data from the Office of Personnel Management, CBO estimates that in 2019, approximately 1.9 million FERS employees with an average annual salary of about $88,000 would see their contribution rate increase by 0.9 percentage points, on average. By 2022, all federal workers enrolled in FERS would be contributing 4.4 percent of their salary toward their retirement annuity. Because the option would affect only current workers hired in 2013 or earlier, the government's savings would gradually decline as those workers retired or left federal employment.

The estimate for this option is uncertain because both the underlying projection of federal workers' salaries and the projection of the number of workers who would be affected by the option are uncertain. The estimate is based on past rates of employee retention and on CBO's projections of growth in earnings. The amount of revenues raised by the option could diverge from the estimate if there are unanticipated changes in federal workers' salaries or in the rates at which those workers leave federal employment. If salary growth is higher or lower than projected, then revenues under the option would also be higher or lower than projected. If employee retention declines as a result of the option and workers who leave the federal workforce are replaced with workers who are paid less, then revenues under the option would probably be lower than projected. In its estimate of the effect on the budget, CBO did not consider potential changes in employee retention that might result from this option.

Other Effects

An argument in favor of this option is that it would bring federal workers' total compensation more in line with that of workers in the private sector. Federal employees receive, on average, more total compensation—the sum of wages and benefits—than private-sector workers in similar occupations and with similar education and experience. In fact, a substantial number of private-sector employers no longer provide health insurance for their retirees or defined benefit retirement annuities, instead offering only defined contribution retirement plans that are less costly. By contrast, the federal government provides a defined benefit retirement plan, a defined contribution retirement plan, and health insurance in retirement. Therefore, even if federal employees hired before 2014 had to contribute more toward their annuity, their total compensation would, on average, still be higher than that available in the private sector. In addition, because this option would not change the compensation of federal employees hired after 2014, who are already contributing 4.4 percent of their salary toward their retirement annuity, the option would probably not affect the quality of new recruits.

An argument against this option is that it would cause retention rates to decline, particularly among highly qualified federal employees. In fact, recent research suggests that federal employees are about twice as likely to leave their jobs following reductions in take-home pay compared with similar reductions in future retirement benefits. The effects on retention appear to be stronger among workers who are rated more highly in terms of performance. In addition, employees who have served long enough to be eligible for a FERS annuity immediately upon leaving the federal workforce are forgoing annuity payments by remaining in federal service. Some of those employees might choose to retire instead of making larger contributions to the annuity in addition to forgoing payments. Also, some highly qualified federal employees have more lucrative job opportunities in the private sector than in the federal government, in part because private-sector salaries have grown faster than federal salaries since 2010. More of those employees would leave for the private sector under this option.

The option would also further accentuate the difference in the timing of compensation provided by the federal government and the private sector. Because many private-sector employers no longer provide health insurance for their retirees or defined benefit retirement annuities, a significantly greater share of total compensation in the private sector is paid to workers immediately, whereas federal employees receive a larger portion of their compensation in retirement. If that shift by private firms indicates that workers prefer to receive more of their compensation right away, then shifting federal compensation in the opposite direction—which this option would do, by reducing current compensation while maintaining retirement benefits—would be detrimental to the retention of federal employees. If lawmakers wanted to reduce the total compensation of federal employees while maintaining or increasing the share of compensation that is provided immediately, they could consider modifying the formula used to calculate federal annuities (see "Reduce Pension Benefits for New Federal Retirees") or making other changes to salaries and benefits (see "Eliminate the Special Retirement Supplement for New Federal Retirees").