Shrouded Costs of Government: The Political Economy of State and Local Public Pensions

Why are public-sector workers so heavily compensated with pensions and other non-pecuniary benefits? In this paper, we present a political economy model of shrouded compensation in which politicians compete for taxpayers' and public employees' votes by promising compensation packages, but some voters cannot evaluate every aspect of compensation. If pension packages are "shrouded," meaning that public-sector workers better understand their value than ordinary taxpayers, then compensation will be inefficiently back-loaded. In equilibrium, the welfare of public-sector workers could be improved, holding total public sector costs constant, if they received higher wages and lower pensions. Central control over dispersed municipal pensions has two offsetting effects on pension generosity: more state-level media attention helps taxpayers better understand pension costs, which reduces pension generosity; but a larger share of public sector workers will live within the jurisdiction, which increases pension generosity. We discuss pension arrangements in two decentralized states (California and Pennsylvania) and two centralized states (Massachusetts and Ohio) and find that in these cases, centralization appears to have modestly reduced pension arrangements; but, as the model suggests, this finding is unlikely to be universal.