Issue Briefs

Among the options affecting federal employees and retirees in the latest CBO “budget options” report, the two with the potential greatest impact in terms of cost involve the FEHB “voucher” idea and increasing required contributions toward retirement for most FERS employees. Following is the CBO’s analysis of those options

Adopt a Voucher Plan and Slow the Growth of Federal Contributions for the Federal Employees Health Benefits Program

Background

The Federal Employees Health Benefits (FEHB) pro­gram provides health insurance coverage to 4 million federal workers and annuitants, as well as to approxi­mately 4 million of their dependents and survivors. In 2018, those benefits are expected to cost the govern­ment (including the Postal Service) about $38 billion. Policyholders, whether they are active employees or annuitants, generally pay 25 percent of the premium for lower-cost plans and a larger share for higher-cost plans; the federal government pays the rest of the premium. That premium-sharing structure provides some incen­tive for federal employees to choose plans with lower premiums, although the incentive is smaller than it would be if they realized the full savings from choosing such plans. The premium-sharing structure also imposes some competitive pressure on insurers to hold down premiums—but again, less pressure than would exist if employees paid the full cost of choosing more expensive plans.

Option

This option consists of two alternatives. Each alternative would replace the current premium-sharing structure with a voucher, which would be excluded from income and payroll taxes, starting in January 2021. Under the first alternative, the voucher would be updated each year by the projected rate of inflation as measured by the consumer price index for all urban consumers (CPI-U). The second alternative would index the voucher to the chained CPI-U, rather than the CPI-U.

According to the Congressional Budget Office’s esti­mates, the voucher under the first alternative would cover roughly the first $6,500 of a self-only premium, the first $14,000 of a self-plus-one premium, or the first $15,000 of a family premium in 2021. CBO calculated those amounts by taking its estimates of the govern­ment’s average expected contributions to FEHB premi­ums in 2018 and then increasing them by the CPI-U from 2018 through 2021. Each year, the voucher would continue to grow at that rate of inflation, rather than at the average rate of growth for FEHB premiums.

Because the chained CPI-U grows more slowly than the CPI-U, the value of the voucher under the second alternative would cover less of the premium than the first alternative. Relative to current law, CBO estimates that average contributions to FEHB premiums would be 3 percent lower in 2021 and 22 percent lower in 2028 under the CPI-U alternative and 3 percent lower in 2021 and 23 percent lower in 2028 under the chained CPI-U alternative.

Effects on the Budget

Under current law, FEHB premiums grow significantly faster than either measure of inflation in CBO’s projec­tions. (The expected rate of growth for FEHB premiums is similar to that for private insurance premiums, which the agency estimates on the basis of its projections of increases in disposable income and other factors that have historically been associated with growth in premi­ums.) Indexing the voucher to either measure of inflation would produce budgetary savings. However, in general, linking the voucher amount to an index that grows faster (as under the first alternative) would result in lower savings, and linking the voucher amount to an index that grows more slowly (as under the second alternative) would produce greater savings.

Mandatory Spending and Revenues. Both alterna­tives would affect mandatory spending and revenues. They would reduce mandatory spending for the FEHB program because the Treasury and the Postal Service would make lower payments for FEHB premiums for annuitants and postal workers. (That reduced spending spending is classified as off-budget.)

In addition, both alternatives would have other effects on mandatory spending because some FEHB participants would leave the program. On the one hand, mandatory spending would increase if FEHB participants disen­rolled from FEHB and enrolled in federally subsidized insurance provided by Medicare or the health insurance marketplaces established under the Affordable Care Act. (People whose contributions to employment-based health insurance exceed a specified percentage of income are eligible for subsidies through the marketplaces if they meet other eligibility criteria; by increasing enroll­ees’ premium contributions, this option would boost the number who qualify on that basis.) On the other hand, mandatory spending would be further reduced if annuitants who are FEHB participants disenrolled from the program and either became uninsured or bought unsubsidized coverage in the marketplaces or from insurers outside the marketplaces. The net effect of those disenrolled FEHB participants on changes in mandatory spending would be small relative to the savings from the voucher, but the direction of the change is uncertain.

Revenues also would be affected because of changes in the number of people with employment-based insurance (obtained through a spouse, for example). Those changes would affect the share of total compensation that takes the form of taxable wages and salaries and the share that takes the form of nontaxable health benefits. Taxable compensation would increase for some people and decrease for others. Those effects on revenues, however, would be minimal.

Overall, estimated changes in mandatory spending and revenues would reduce the deficit between 2021 and 2028 by $35 billion under the first alternative and by $37 billion under the second alternative.

Discretionary Spending. By reducing federal agencies’ payments for FEHB premiums for current employees and their dependents, the first alternative would reduce discretionary spending by an estimated $29 billion from 2021 through 2028, provided that appropriations were reduced to reflect those lower costs. The second alterna­tive would reduce discretionary spending by an estimated $31 billion from 2021 through 2028.

Uncertainty. The largest source of uncertainty in the esti­mate of savings over the next 10 years is CBO’s estimate of how the growth of FEHB premiums under current law would compare with general inflation, as measured by either the CPI-U or the chained CPI-U. The dif­ference between the FEHB premium and the voucher amount is a major contributor to the budgetary effects under both alternatives.

Other Effects

An advantage of both alternatives is that they would increase enrollees’ incentive to choose lower-premium plans: If they selected plans that cost more than the voucher amount, they would pay the full additional cost. For the same reason, both alternatives would strengthen price competition among health care plans participating in the FEHB program. Because enrollees would pay no premium for plans that cost no more than the value of the voucher, insurers would have a particular incentive to offer such plans.

Both alternatives also could have several drawbacks. First, because the value of the voucher would grow more slowly over time than premiums would, partici­pants would eventually pay more for their health insur­ance coverage. Some employees and annuitants who would be covered under current law might therefore decide to forgo coverage altogether. Second, many large private-sector companies currently provide health care benefits for their employees that are comparable to what the government provides. Under this option, the govern­ment benefits could become less attractive than pri­vate-sector benefits, making it harder for the government to attract highly qualified workers. Finally, the option would cut benefits that many federal employees and annuitants may believe they have already earned.

Increase Federal Civilian Employees’ Contributions to the Federal Employees Retirement System

The federal government provides most of its civil­ian employees with a defined benefit retirement plan through the Federal Employees Retirement System (FERS) or its predecessor, the Civil Service Retirement System. The plan provides retirees with a monthly benefit in the form of an annuity. Those annuities are jointly funded by the employees and the federal agencies that hire them. Employees contribute a portion of their salary to the plan, and those contributions are subject to income and payroll taxes. Whereas agencies’ contri­butions to FERS do not have any effect on total federal spending or revenues because they are intragovernmental payments, employees’ contributions are counted as fed­eral revenues. Annuity payments made to FERS benefi­ciaries represent federal spending.

Over 90 percent of federal employees participate in FERS, and most of them contribute 0.8 percent of their salary toward their future annuity. The contribution rates for most employees hired since 2012, however, are higher. First, the Middle Class Tax Relief and Job Creation Act of 2012 increased the contribution rate to 3.1 percent for most employees hired after December 31, 2012. Then, the Bipartisan Budget Act of 2013 increased the contribution rate further, to 4.4 percent, for most employees hired after December 31, 2013.

Option

Under this option, most employees enrolled in FERS would contribute 4.4 percent of their salary toward their retirement annuity. The contribution rate would thus increase by 3.6 percentage points for employees who enrolled in FERS before 2013 and by 1.3 percentage points for employees who enrolled in FERS in 2013. The increased contribution rates would be phased in over the next four years. The dollar amount of future annuities would not change under the option, and the option would not affect employees hired in 2014 or later who already make or will make the larger contributions under the Bipartisan Budget Act. Agencies’ contributions would remain the same under the option.

Effects on the Budget

If implemented, the option would increase federal revenues by $45 billion from 2019 through 2028, the Congressional Budget Office estimates. Annual revenues would increase gradually in the first four years as the increased contribution rate was phased in. For example, drawing on payroll data from the Office of Personnel Management, CBO estimates that in 2019, approxi­mately 1.9 million FERS employees with an average annual salary of about $88,000 would see their contribu­tion rate increase by 0.9 percentage points, on average. By 2022, all federal workers enrolled in FERS would be contributing 4.4 percent of their salary toward their retirement annuity. Because the option would affect only current workers hired in 2013 or earlier, the govern­ment’s savings would gradually decline as those workers retired or left federal employment.

The estimate for this option is uncertain because both the underlying projection of federal workers’ salaries and the projection of the number of workers who would be affected by the option are uncertain. The estimate is based on past rates of employee retention and on CBO’s projections of growth in earnings. The amount of revenues raised by the option could diverge from the estimate if there are unanticipated changes in federal workers’ salaries or in the rates at which those workers leave federal employment. If salary growth is higher or lower than projected, then revenues under the option would also be higher or lower than projected. If employee retention declines as a result of the option and workers who leave the federal workforce are replaced with workers who are paid less, then revenues under the option would probably be lower than projected. In its estimate of the effect on the budget, CBO did not consider potential changes in employee retention that might result from this option.

Other Effects

An argument in favor of this option is that it would bring federal workers’ total compensation more in line with that of workers in the private sector. Federal employees receive, on average, more total compensation—the sum of wages and benefits—than private-sector workers in similar occupations and with similar education and experience. In fact, a substantial number of private-sector employers no longer provide health insurance for their retirees or defined benefit retirement annuities, instead offering only defined contribution retirement plans that are less costly. By con­trast, the federal government provides a defined benefit retirement plan, a defined contribution retirement plan, and health insurance in retirement. Therefore, even if federal employees hired before 2014 had to contribute more toward their annuity, their total compensation would, on average, still be higher than that available in the private sector. In addition, because this option would not change the compensation of federal employees hired after 2014, who are already contributing 4.4 percent of their salary toward their retirement annuity, the option would probably not affect the quality of new recruits.

An argument against this option is that it would cause retention rates to decline, particularly among highly qualified federal employees. In fact, recent research suggests that federal employees are about twice as likely to leave their jobs following reductions in take-home pay compared with similar reductions in future retirement benefits. The effects on retention appear to be stronger among workers who are rated more highly in terms of performance. In addition, employees who have served long enough to be eligible for a FERS annuity imme­diately upon leaving the federal workforce are forgoing annuity payments by remaining in federal service. Some of those employees might choose to retire instead of making larger contributions to the annuity in addition to forgoing payments. Also, some highly qualified federal employees have more lucrative job opportunities in the private sector than in the federal government, in part because private-sector salaries have grown faster than fed­eral salaries since 2010. More of those employees would leave for the private sector under this option.

The option would also further accentuate the difference in the timing of compensation provided by the federal government and the private sector. Because many pri­vate-sector employers no longer provide health insurance for their retirees or defined benefit retirement annuities, a significantly greater share of total compensation in the private sector is paid to workers immediately, whereas federal employees receive a larger portion of their com­pensation in retirement. If that shift by private firms indicates that workers prefer to receive more of their compensation right away, then shifting federal com­pensation in the opposite direction—which this option would do, by reducing current compensation while maintaining retirement benefits—would be detrimen­tal to the retention of federal employees. If lawmakers wanted to reduce the total compensation of federal employees while maintaining or increasing the share of compensation that is provided immediately, they could consider modifying the formula used to calculate federal annuities.