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Thursday, February 9, 2017

Budget Analysis 3: State Workforce Cost Cap

After yesterday's blog article about the basic difference between short- and long-term spending reforms, it is time to focus on actual reforms of the long-term kind. Thank you, readers who have reached out with questions about this issue - your feedback is encouraging!

For the reader who wants more in-depth insight into the need for long-term reforms in government spending, I have put up a separate page on this blog

Let me first make clear that there is no contradiction between short- and long-term spending reforms.
One does not necessarily exclude the other. The problem with short-term reforms is that they tend to require almost as much legislative time and effort, and political capital, as long-term reforms, that once legislators have sent a bill for short-term reforms to the governor, they do not have much time or interest left for long-term reforms. 

This is highly unfortunate, especially since the economic payoff from short-term reforms - if done alone - is small, even negligible, compared to what we need here in Wyoming. However, if short-term reforms are used as a launch pad for long-term reforms, they can suddenly become fiscally meaningful. If done right, they will buy the legislature time that they can use for long-term reforms, which require 2-5 years before their positive effects on state finances are fully visible. 

A good example of a short-term reform is an efficiency-enhancement program that weeds out waste and inefficient operational practices within government. It is unclear how much such a reform could reduce operational costs of government - both high and low numbers have been floating around the literature - but one thing is certain: you cannot go wrong with this one. Even if an efficiency enhancement program only reduces government operation costs by a few percent, it is still worth it, both to taxpayers and to legislators considering long-term reforms.

When it comes to Wyoming, though, I am convinced that we could see substantial reductions in the operational costs of government if we made it run more efficiently. We have the single costliest government sector in the country, measured as government employment vs. private employment. For example, by adjusting the size of our tax-funded workforce to Nebraska proportions, we could cut the cost of our government sector by as much as $1.5 billion.

The one thing about efficiency reforms to keep in mind is that they do not change the long-term trajectory of government costs. The factors that drive entitlement spending are not touched by efficiency improvement programs; if you cut the costs of the health care that a Medicaid enrollee can receive, you reduce the quality of his health care services. The gains from more efficiency are instead associated with how the Medicaid program is run - a small but not insignificant part of the program costs.

In other words, long-term reforms focus on the entitlement program itself. I have previously written about how to reform Medicaid for permanent cost reductions; I have also written about K-12 and University of Wyoming reforms for the same kind of purpose. These are program-specific reforms that, in and by themselves, would make a clearly noticeable difference to the state budget. If taken together, they would reduce the costs of our state government by more than the currently predicted budget deficit.

However, individual program reforms can prove to be a bit cumbersome to move forward. Ideally, they should all be wrapped in an overarching reform aiming squarely for the cost of operating government. This allows the legislature to move reforms forward under one banner of fiscal conservatism. 

The best overarching reform is one that applies equally to all kinds of government operations, be it transportation or school administration. The common denominator for all government programs is employee compensation (which also happens to be a key factor in putting government spending on expenditure autopilot). A reform that controls government employment costs can greatly facilitate the implementation of program-oriented long-term reforms, and it can help contain the costs of a downsized, post long-term reform government.

A reform to cap workforce costs could have the following design. 

1. It would have to cover every person working for government: full-time and part-time permanent employees as well as full-time and part-time temporary employees; but it would also have to extend to contractors of all kinds, as government otherwise would reduce its own staff and rely on staffing firms, consultants and other contractors. 
2. All forms of employee compensation would be included: wage, salary, benefits, paid-leave compensation and all sorts of fringe benefits; many forms of spending caps have proven to be ineffective because government agencies subjected to those caps have found ways around them - as have politicians opposed to them, whose job it is to pass appropriations for cash-limited government agencies.
3. Once the "employee" and "compensation" variables are defined, a workforce cost cap would impose a total cash limit on how much government can spend on its employees. For the sake of argument, suppose that cap is $10,000, that government has 100 employees and that each of them is compensated by $100, of which $90 is salary and $10 is benefits. Let us say that government wants to hire more people. Since it can only spend $10,000, this means it has to reduce compensation accordingly: a salary cut of $10 per current employee opens up $1,000 for which government can now hire eleven new workers. Correspondingly, in order to give its employees a raise, government would have to fire some employees to free up cash.
4. The cash limit is there to contain total costs, but it is perfectly reasonable to expect that those costs will change over time. Therefore, the workforce cost cap must include a mechanism to regulate cost increases. The only realistic option is to tie cost increases for the government workforce to increases in earnings in the private sector. For Wyoming, this would mean the cost increase in employee compensation in the private non-minerals sector of the Wyoming economy. (Both "employee compensation" and "private non-minerals sector" are easily defined by the classification systems used by the Bureau of Economic Analysis and the Bureau of Labor Statistics.) If the total employee compensation paid out to private, non-minerals workers increases by five percent in one year, then government can raise the cap on its workforce compensation by five percent. 

Obviously, the last point also means that if the private non-minerals sector cuts its employee compensation, then the government workforce cost cap must be reduced by the same percentage.

Why use the non-minerals sector? Why exclude minerals? There are two reasons for this. First, the minerals industry pays its employees disproportionately well (as they should); if government workforce compensation was even partly tied to their earnings, its costs would run amok in good times for the volatile minerals industry - and plunge unpredictably in bad economic times. Neither violent upswings nor rapid downswings are good for the long-term stability of government (regardless of its size). 

Secondly, for far too long our state government has been too focused on minerals as the bread and butter of our private sector. Yet most Wyomingites do not work in the minerals industry. Furthermore, if our state's economy had been blessed with a couple of strong secondary industries, the downturn in minerals would not have hit our state as badly as it did. 

One reason why our state is still relatively dependent on minerals is that our lawmakers have had no incentives to care about anything outside the severance-tax paying minerals industry. Therefore, by tying government workforce compensation to the non-minerals sector we might get policy reforms that make lives much better for small, non-minerals businesses.

With an efficiency-enhancement reform and a workforce cost cap, our legislature can turn their attention to long-term, program-specific reforms in education, health care and other sectors. (Oh, and don't forget tolling I-80!)

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