Issue Briefs

Following is the portion of a recent CRS report examining provisions of language in several bills that were incorporated into the recently enacted DoD authorization measure regarding the phaseout of COLAs and the phase-in of locality pay for employees in non-foreign areas outside the contiguous states.

Both H.R. 1266 and S. 507 would affect the pay of a federal employee living in a nonforeign area who is on the GS or a GS-related pay scale. Employees may be affected differently, according to a variety of circumstances that include the employee’s tax filing status, age, location, grade, and step. Language is included in both H.R. 1266 and S. 507 that expresses a "sense of Congress" that "the application of this Act to any employee should not result in a decrease in the take home pay of that employee." The "decrease in the take home pay" could mean decrease from year to year after implementation, or decrease when compared to current law. Under the first interpretation, employee take-home pay would have to increase each year. The second interpretation would be difficult for new legislation to satisfy for all taxpayers, as each taxpayer has a unique tax situation. The taxability of locality pay reduces take-home pay.

The employee’s tax situation dictates the extent to which take-home pay would be reduced when compared to current law. As noted previously, the transition proposals provide a partial COLA adjustment in addition to the locality pay. The proposals gradually reduce the COLA by 65% of the locality pay percentage until the COLA is completely expired. This will happen when 65% of the locality pay percentage is greater than the generally fixed COLA percentage. For example, if the COLA is a fixed 25%, once the locality pay percentage reaches 38.5%, the COLA is no longer applicable. Nonforeign COLAs, therefore, will continue to be paid after the three-year phase in of locality pay, although at a decreasing percentage. The COLA offset, would "help protect employees’ take home pay as locality pay is extended to non-foreign areas." One outcome of the COLA offset is that federal workers in the contiguous United States at the same grade, tax situation, and locality pay percentage as those in non-foreign areas will earn less than the non-foreign area workers. 

Calculating the Phase-In

Methodology

In this section, CRS evaluates the possible effects of S. 507 using examples of how hypothetical federal employees would fare under S. 507 when compared to current law. CRS used two hypothetical unmarried federal workers—one that is mid-career, a GS-11, step 10—and a second nearing retirement, a GS-13, step 10. CRS uses grades 11 and 13 because they represented a large number of employees in the nonforeign areas. CRS chose to use step 10 within each grade because it represented employees at their grade’s maximum pay, and, therefore, those employees in those grades who would encounter the maximum tax effects if a transition bill were enacted. CRS places the hypothetical workers in each of three non-foreign areas—Anchorage, AK, Honolulu, HI, and Puerto Rico—and calculates (1) the take home pay for the mid-career worker and (2) the retirement annuity for a worker nearing retirement. These three non-foreign areas contain 94.4% of nonforeign federal employees. Puerto Rico was also selected because the tax situation in Puerto Rico is very different from the other non-foreign areas. Unlike the other nonforeign areas, Puerto Rico’s income tax is completely independent of the federal income tax structure that applies to workers in the rest of the United States. This analysis examines how the independent tax structure could be affected by the proposed transition to locality pay. As noted earlier, a change from an income-tax-free COLA to a taxable locality pay adjustment would increase both regular income taxes and payroll taxes for the workers. The additional tax liability, however, would be partially compensated for by the COLA offset as described earlier. Additionally, workers’ retirement annuities would increase significantly under S. 507 for almost every federal worker in a nonforeign area. 

Unique Pay Scales Some white-collar federal employees are not paid under the General Schedule. Employees in non- GS pay systems who receive a nonforeign COLA would be included in the transition to locality pay—including employees at the Transportation Security Administration (TSA), the Department of Defense (DOD), and the Federal Aviation Administration (FAA) who are currently in performance-based pay systems. Both legislative proposals include language prohibiting a reduction in locality pay if the employees receives a poor performance rating. In addition, some federal employees receive a "special rate," which is additional pay used to attract qualified employees to areas facing recruitment difficulties. According to OPM, employees in nonforeign areas who received a special rate would be able to keep that pay differential under the transition unless the locality pay rate was larger than their special rate. Employees automatically receive the pay differential that gives them the highest pay rate.

U.S. Postal Service Nearly 8,000 of the more than 34,000 nonforeign area federal employees are employees of the United States Postal Service (USPS). USPS employees living in the continental United States are not eligible to receive locality pay. Under S. 507, most USPS employees would not be permitted to transition to locality pay. Instead, USPS employees would continue to receive a COLA. The COLA, however, would be tied to the locality pay rate. If the locality pay percentage were to climb higher than the nonforeign COLA percentage, USPS employees would then receive the locality pay rate—although the pay supplement would still be considered a COLA for tax and other purposes. The USPS nonforeign area COLA would not be taxable on the federal level, and would not count when calculating retirement and other benefits—even if the rate were linked to the locality pay rate. Unlike current statutes that govern COLAs, however, S. 507 would allow the USPS nonforeign COLA rate to climb above 25% if BLS data warranted the increase.