How government workforce reductions can impact public pension debt

Debt and workforce reductions are rapidly reshaping the public sector employment landscape across the United States. Facing mounting public debt, the federal government has recently initiated hiring freezes and workforce cuts in some departments, which have been quickly followed by states, counties, cities, and educational institutions implementing similar cuts to grapple with tightening budgets. While national, state, and local governments start to put some focus on right-sizing the government, public pensions should monitor these developments closely and consider adjusting their assumptions on payroll growth to avoid underestimating the costs of providing benefits.

At the federal level, despite Congress and the Trump administration recently passing a bill that will add trillions to the $37 trillion national debt, President Donald Trump has also moved to cut some spending by extending a federal hiring freeze through mid-October 2025. Even after this date, federal agencies will be restricted to hiring one new employee for every four departures, in an effort to reduce the size of their workforce. This push to downsize the federal workforce gained recent momentum when the Supreme Court lifted a lower-court injunction, clearing the way for federal layoffs under an executive order issued in February. The Supreme Court ruling affirms the administration’s authority to proceed with large-scale job cuts across various departments, including agriculture, state, commerce, and health and human services.

At the state and local level, governments must typically address their budget deficits. Louisiana Gov. Jeff Landry issued an executive order instituting a hiring freeze across all state government departments and agencies. The measure aims to achieve approximately $20 million in annual savings to address revenue shortfalls and protect essential services.

In Colorado, Gov. Jared Polis proposed hiring freezes and reductions in state programs to address an anticipated $1 billion deficit, driven by economic conditions, recent tax breaks, and rising Medicaid costs.

At the local level, Los Angeles Mayor Karen Bass unveiled a proposed $13.9 billion municipal budget for fiscal year 2025-26, which includes more than 1,600 layoffs and the consolidation of four city departments to eliminate a nearly $1 billion deficit.

Orange County, California, interim Chief Executive Officer Michelle Aguirre ordered department heads to implement a hiring freeze, reduce discretionary spending, and lower service levels over a three-month period.

This pattern of tightening public sector payrolls across all levels of government could contribute to a larger long-term trend that public pension systems need to monitor and address. Hiring freezes and workforce reductions could create a technical challenge for public pension plans: When payroll growth falls short of actuarial assumptions, it can lead to an underestimation of the amount of money that needs to be saved today to pay for pension benefits promised to workers.

Pension systems rely on an assumed rate of payroll growth to calculate their annually required contributions. Most systems use a “level-percent of payroll amortization method,” which bases their contribution planning on the assumption that future payroll growth and salaries will increase at a level rate. When actual payrolls fail to grow at the assumed rate, the calculations used to determine a government’s contributions to the pension plan end up short of what is actually needed.

Missing on this assumption leads to unforeseen unfunded liabilities (pension debt) and necessitates future cost increases. To avoid this, public pension plans need to either lower their payroll growth assumptions or transition to a method that is less sensitive to payroll fluctuations.

One method that some pension systems have adopted to insulate their plans from this particular risk is to remove the payroll growth assumption altogether. This can be done by switching from the “level-percent” amortization method to the “level-dollar” approach when calculating the annual required contributions. Using a “level-dollar” approach means that plan actuaries simply apply the dollar amount needed to amortize pension debt without connecting this payment to the assumed payroll. This results in a more secure method of pension funding, as it means that, at the very least, the plan has one less assumption imposing risks for underfunding.

Adopting a “level-dollar” amortization method can be done in several ways. Michigan lawmakers directed their pension for teachers to use a level-dollar method to amortize any debt on their new tier of benefits in 2017.

Arizona’s plan for public safety employees applied a level-dollar policy with a new tier of benefits beginning in 2017, and all tiers began using level-dollar for any new debt starting in 2020. By removing the payroll increase assumption from their amortization calculations, these plans have removed the impact that an increasingly volatile and unpredictable hiring rate has on their long-term funding viability.

Workforce reductions are necessary, but they also raise potential technical challenges for public pension systems. The impact of these trends can be lessened by pension plans making proactive changes to payroll assumptions. To uphold both fiscal sustainability and the retirement promises made to public workers, state and local governments should consider adjusting their payroll growth assumptions or removing them altogether from the funding calculation by adopting level-dollar amortization policies.

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