State and local governments employ some 20 million people nationwide. Employee compensation costs represent the largest set of expenditures in every state budget. Analyzing the fiscal dynamics of the civil service system reveals some of the most significant constraints and opportunities legislators confront in balancing state budgets.

Total state expenditures exceeded $2.2 trillion last year, of which wages and benefits amounted to $1.1 trillion.[1] Consequently, budgeting decisions related to at least 50 percent of all state budgets are driven by the wage provisions of civil service contracts and funding obligations for state workers' health care and pension plans.

Labor costs also constitute a sizable proportion of private-sector business costs. But the average wages and benefits provided to public sector employees far exceed the rates paid by private employers. For example, the average hourly wage of public employees last year-$39.66-was 45 percent more than the average hourly wage of $27.42 paid in the private sector.[2]

States fulfill health care and pension obligations through direct contributions as well as investment earnings on those contributions. At its most fundamental, the formula for sustainability of health care and pension funds is: Contributions + Investments = Benefits + Expenses.

Most states have consistently unfunded the actuary recommended level of pension funding resulting in large unfunded pension obligations. By underfunding the state not only has to make up the amount unfunded but in addition the lost interest that would have been earned.

But states' recent investment losses, which exceeded $800 billion in 2008, have added to the serious shortfalls in meeting pension obligations. For example, the state of Illinois was forced to borrow $3.5 billion to meet its pension obligations, thereby incurring tens of millions of dollars in additional debt service costs. Estimates peg the total unfunded liabilities of state and local pension plans between $1 trillion and $3 trillion.

Federal, state and local governments have largely adopted "defined benefit" plans, under which specific types of services are assured. (In 2009, for example, defined benefit plans were provided to 84 percent of state and local workers compared to 21 percent of private-sector employees.[3] The costs of defined benefit plans escalate annually. In contrast, "defined contribution" plans provide a fixed payment for pensions and thus in fully funding pensions.

Health care obligations likewise are sapping state budgets. In many states the public employees only pay 12% of the cost of their benefit package compared to 24% for the private sector.

Another largely unfunded liability is retiree health care coverage. In Washington state alone this amounts to $10 billion.

Demographics also are exacerbating the budgetary burden of the public-sector workforce.
Current retirees leave work at an earlier age and live longer, thus drawing substantially more retiree health care and pension benefits than their predecessors.

[1] U.S. Bureau of Economic Analysis.
[2] U.S. Bureau of Labor Statistics.
[3] U.S. Bureau of Labor Statistics.