Analysis of the 2005-06 Budget Bill Legislative Analyst's Office February 2005

Employee Compensation (9800/9955)

A significant portion of state government's operating costs is for compensation of state employees. Figure 1 displays a breakdown of 2004-05 estimated state payroll (excluding benefits expenditures for items such as health insurance and retirement), which totals $18 billion. As shown in the figure, higher education (consisting of the University of California [UC] and California State University [CSU] systems) represents one-third of state employment costs. The Departments of Corrections and Transportation combined represent an additional one-quarter of state payroll.

The Governor's budget projects $19 billion in salary and wage expenditures for 327,000 authorized personnel-years (PYs) in 2005-06 (including $6.1 billion and more than 114,000 PYs in higher education). In addition, the state pays for benefits such as health insurance and retirement. These additional employment costs are generally around 30 percent of salary expenditures. Thus, when benefits are included, total estimated expenditures for employee compensation are projected to exceed $24 billion for the budget year, about one-half of which is supported from the General Fund.

Most State Employees Received Delayed 5 Percent Salary Increase. In the current year, most state employees received a 5 percent salary increase delayed from 2003-04, pursuant to renegotiated contracts. As shown in Figure 2, most bargaining units now have expired contracts or agreements  that will expire at the end of the current year. As a result, they will be negotiating with the state for new contracts.

Figure 3 shows the recent history of general salary increases for state civil service employees and the consumer price indices for the United States and California. 

Employee Pay and Benefit Increases—Item 9800

The budget includes $261 million ($198 million General Fund) for pay and benefit increases for (1) collective bargaining units with previously agreed upon provisions and (2) statutory dental and vision insurance increases. The budget does not include $150 million ($39 million General Fund) for salary and health insurance provisions that are scheduled to become effective in 2005-06.

Proposal for Employee Compensation Budget Item. In the annual budget act, Item 9800, Augmentation for Employee Compensation, includes a lump sum for any additional compensation items that take effect in the budget year. (Baseline costs are already included in department budgets.) During the fiscal year, the Department of Finance (DOF) allocates to department budgets, from the lump-sum appropriation, the amounts necessary to fund these additional cost items.

The budget proposes $261 million ($198 million General Fund) for negotiated compensation packages. (This excludes higher education.) This amount includes $217 million ($145 million General Fund) for the third year of raises for highway patrol and correctional officers (Unit 5 and Unit 6, respectively) and annualized costs from their current-year salary increases (described below).

Multiyear Raises for Highway Patrol and Correctional Officers. The agreements for highway patrol and correctional officers include four annual pay raises, the third of which is effective July 1, 2005. The budget-year salary increases are currently estimated to be 7.2 percent and 5.1 percent, respectively. These amounts are based on pay levels of local law enforcement and could change depending on future local pay increases. Supervisors and managers of these employees will receive a similar package.

Figure 4 (see next page) shows the projected ongoing cost of the negotiated general salary increases for all employees from 2003-04 through 2006-07, when all pay raises already agreed to in the last complete bargaining cycle would be fully implemented. As shown in the figure, a key factor driving the growing costs is the multiyear, formula-based raises negotiated for the highway patrol and correctional officers. Total costs were $245 million in 2003-04 and will grow to an annual cost of $1.4 billion by 2006-07. More than one-half of these costs is to be paid by the General Fund.

Some Items Funded in Department Budgets. Item 9800 excludes the full-year cost of the deferred pay raises that went into effect after the beginning of the current year. In previous years, all new employee compensation costs (even for provisions already in effect for part of the current year) were first appropriated in this budget item. The DOF, however, included these full-year costs in departments' budgets for 2005-06 rather than reflecting them here. According to data from the Department of Personnel Administration (DPA), the 2005-06 cost to annualize current-year pay raises is an additional $60 million ($17 million General Fund) that is included in departmental budgets.

Some Items Not Funded. Item 9800 also does not include funding for two items that, pursuant to current agreements, have 2005-06 costs:

• Engineers Contract. Like highway patrol and correctional officers, the contract for Unit 9, which consists primarily of Caltrans engineers, includes annual formula-based pay raises designed to eliminate their pay differential with local government and UC engineers. This formula is supposed to become effective in 2005-06; however, the Governor's budget currently provides no funding for this item. The DOF is awaiting updated salary survey data to budget the appropriate amount. A previous survey estimated a 4.8 percent increase, which would amount to an additional $48 million ($1.8 million General Fund) in 2005-06.
• Health Insurance Premiums. For bargaining units that deferred the 2003-04 pay raise, the administration has not budgeted the cost of increases in state health insurance premiums to maintain 80 percent pick-up of total costs, as negotiated. This is because the administration intends to negotiate a reduction in state health insurance costs beginning in 2005-06 (see below). If this is not successful, however, the additional cost to the state to maintain the formula would be $102 million ($37 million General Fund), according to DPA data.

Proposed Savings From Collective Bargaining—Item 9955

The budget assumes $741 million ($408 million General Fund) in employee compensation savings to be achieved through collective bargaining. These amounts do not reflect the offsetting cost of any benefits the administration might agree to provide to unions in order to secure the proposed changes. As a result, the Legislature will want to weigh the value of any savings with the cost of concessions granted to achieve them.

The administration includes a new budget component, Item 9955, for employee compensation changes it intends to seek in collective bargaining. These items would be negotiated in new contracts when current agreements expire. The most significant proposals relate to retirement. (The Governor also has a "defined contribution" retirement proposal that we discuss in "Part V" of the 2005-06 Budget: Perspectives and Issues.) The budget proposes $741 million ($408 million General Fund) in savings from these items. This amount includes:

• 50/50 Split of Retirement Contributions—$374 Million ($206 Million General Fund). Instead of fixed employee contributions, the state would split annual, variable contributions (employee plus employer share) to the Public Employees' Retirement System (PERS) with employees. For 2005-06, this would increase a miscellaneous employee's retirement contribution from 5 percent to approximately 11 percent. This amount would vary from year to year, depending on fluctuations in the contribution rates determined by PERS.
• Opt Out of PERS for a Pay Raise—$164 Million ($90 Million General Fund). For nonsafety employees who do not want to pay higher retirement contributions, they could instead opt out of PERS for future service (past service would not be affected). In return, they would receive a pay raise of half the ongoing, annual state cost (the "normal cost") of the retirement benefit. For 2005-06, this would amount to approximately 5 percent for a miscellaneous employee. In addition, employees would increase their take-home pay by keeping the funds they previously contributed for retirement. Because of Social Security legal issues, the administration would not offer this option to safety employees.
• Furlough—$109 Million ($60 Million General Fund). The Governor would have the authority to furlough state employees (excluding public safety and around-the-clock staff) for up to five workdays a year to generate savings during a fiscal crisis. The budget assumes the Governor exercises this authority for the full five days to achieve these savings in the budget year.
• Health Benefits—$55 Million ($30 Million General Fund). To reduce the cost of health benefits: (1) state employees who are retired from the military would be enrolled in a federal health insurance program, (2) new employees could enroll in the state program after a six-month probationary period (instead of after the first month, as is current practice), and (3) the state would reduce its contribution for health insurance by approximately $14 per month on average.
• Overtime Change—$36 Million ($20 Million General Fund). Currently, time off for sick leave and vacation count as time worked when determining overtime eligibility during a given work period. This change would end the practice.
• Eliminate Two Holidays—$3.1 Million ($1.7 Million General Fund). Employees would lose two holidays, leaving 12 remaining.

Concessions Would Reduce Savings. The identified savings do not account for any offsetting benefits the state might agree to provide to unions in order to secure these changes in collective bargaining agreements. The cost of any such benefits would offset the savings achieved from the proposed changes. As a result, when considering agreements for approval, the Legislature will want to weigh the value of any savings achieved with the cost of concessions granted to achieve them.