Tuesday, October 10, 2017

Government Pay: We Stand Out Again

One of the arguments we often hear for why it is good to raise taxes in Wyoming, is that our state has a relatively low cost of living anyway. After all, compare to California and New York and Wyoming is downright a bargain. 

There is just one problem with this argument: Wyomingites in general do not make that much money. In the private sector, with the exception of the approximately ten percent who work in minerals, an average employee pulls in some $37,000 per year. If that were the average personal income in our state as a whole, we would be one of the three worst-off states in the country.

In fact, even if we adjust for cost of living, that average non-minerals private-sector income would put us among the poorest states in the nation. 

Statistically, though, we do not rank among the poorest. On the contrary, as my good friend and fellow economist Byron Schlomach explains in a new research report, Wyoming actually ranks right at the top in personal income. 

Schlomach reports that when personal income per capita (not per employee, which I use) is adjusted for cost of living, Wyomingites have $58,359 in pre-tax income at their disposal. This is the highest number in the country; Connecticut is second ($55,574) and North Dakota third ($55,524).

How is this possible? How can Wyoming, a state where most private-sector employees average three grand a month before taxes, suddenly rank as the most affordable place to live and earn a paycheck?

The reason is not sloppy work on Schlomach's behalf. He is a solid economist who, in his report, takes careful measures to qualify his findings and caution against runaway conclusions. That said, like any other economist he is stuck in a methodology that someone once summarized with the words: you get the answers you ask for. In using traditional economics methods, Schlomach has to narrow down his focus and leave out some real-world factors that - if brought into the picture - would dramatically alter his conclusions. 

The good thing with Schlomach's study, aside the fact that it is a solid piece of research worth reading, is that he makes a meaningful contribution by defining cost of living in a realistic fashion. In doing so, he establishes that Wyoming's overall cost of living is somewhere in the lower third of all states, in a strictly relative comparison. Using a realistic definition of cost of living, he makes a good case for Wyoming as a relatively affordable state. 

There are, however, two points where his study somewhat skews the picture of cost of living here in Wyoming. First, there is the problem with the sharp division between minerals and non-minerals jobs. Even though our state is suffering from the decline in the coal industry, the difference in earnings between minerals and non-minerals jobs has remained. This, in turn, is due to the overall weakness of non-minerals industries; when minerals production and employment decline, there is no secondary industry there to step in. Incomes outside minerals remain depressed. 

The second point has to do with government - and I have to criticize Schlomach for overlooking this factor in his study. Not only does government artificially drive up compensation of its employees, but the government employment ratio varies substantially between states: in Wyoming, we have some 300 state and local government employees per 1,000 private employees, while in other states the ratio is less than half of ours. 

A high government employment ratio, combined with a big difference in earnings between government and the private sector, can together make a statistically identifiable difference.* The comparatively high per-capita personal income number for Wyoming is partly the result of a very large, well paid government workforce. 

Government employees make more than private employees in every state, thereby pulling up average income. However, the disparity varies quite a bit. Figure 1 shows compensation of employees, per state government employee, per dollar earned by a private employee. In other words, for every $1.00 of compensation of one private employee, a state government employee earns $1.90 in compensation:

Source: Bureau of Economic Analysis

Wyoming ranks fifth-highest in the country, more than 20 percent above the U.S. average, and 52 percent above Indiana, ranked 50th, where the state employee makes $1.25 in compensation per $1.00 of a private employee.

On the local-government side, things do not look much better for Wyoming:

With a compensation disparity of $1.77, we are now 19 percent above the U.S. average, and 51 percent above Kansas, which is dead last at a $1.17 compensation disparity. 

Already here, we have a reason to believe that government is skewing the personal-income numbers in Schlomach's report. But the most compelling numbers on artificial inflation of government employee compensation are reported in the so called government compensation ratio in Figure 3 below. Here, we compare total employee compensation in state and local governments to total employee compensation in the private sector. The percentage we get is, so to speak, a hypothetical tax rate that private-sector employees would have to pay, if state and local government workers got paid directly out of private-sector compensation. 

In other words, in Wyoming in 2016 all private workers made a total of $11.8 billion, and state and local government employees earned almost $4.4 billion in total compensation. This comes out to a ratio of 36.8 percent: if we privately employed paid for our state and local government employees directly out of our paychecks, we would lose almost 37 cents out of every dollar we made:

Figure 3

U.S. average is 17.7 percent. Once again, Indiana comes in dead last at 13.9 percent. This discrepancy makes me wonder what eminent, brilliant services we get from our government employees that Indiana residents have to give up. And no, it is not a matter of us being a rural state: in North Dakota, this government-to-private compensation ratio is 18.5 percent, or almost exactly half of ours. In South Dakota it is 19.4 percent. In Idaho, 20.4.

If we had the same compensation ratio as North Dakota, Wyoming taxpayers would get to keep more than $2.1 billion per year. Inject that back into the private sector, folks, and you would see substantial economic growth and persistently rising prosperity. 

The numbers reported in this article clearly demonstrate that Wyoming looks artificially prosperous, especially when adjusted for cost of living, and that over-inflated compensation of government employees is a major contributor to this artificial image. 

These numbers also demonstrate, beyond a shred of a doubt, that we have built a government sector in our state that is indefensibly expensive. Let us keep that in mind as we continue our arguments with those who want to raise our taxes by up to half a billion dollars. 
*) I purposely do not use the term "statistically significant". I do not want to make this a peeing contest between different regression models. For the purposes of public policy, a modest diet of statistical methodology is highly preferable. I will be happy to elaborate in case anyone is interested.

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