Latest / The Fiscal Policy Podcast with Fexingo: Government Budgets, Stimulus, and Public Spending / How Government Salary Caps Create Hidden Costs
Transcript
- Lucas: There is a rule in federal hiring that says no government employee can be paid more than the Vice President of the United States. That number is currently around $200,000 a year. Luna: And that sounds reasonable on the surface — like, you don't want bureaucrats making more than the second-highest elected official. Lucas: Right. But here is the problem. The government still needs people who can architect a $50 million IT system, or model the physics of a nuclear warhead, or run a clinical trial for a new vaccine. Those people — in the private sector — get paid a lot more than $200,000. Luna: So the government doesn't hire them. It hires contractors. And pays them $500,000 or $600,000 a year — or more. Lucas: Exactly. So the salary cap, which was supposed to save money, actually creates a massive hidden cost. The Government Accountability Office did a study a few years ago — they found that in some agencies, contractors doing similar work to federal employees were costing two to three times as much per hour. Luna: And this is a show about fiscal policy, so if walking through the economy with us has made something click, a couple of dollars a month is genuinely what keeps these going — buy me a coffee dot com slash fexingo, if you've gotten something out of them. Lucas: Yeah, it's a small thing that makes a real difference. So back to the cap — the rule dates back to the 1990s, but it really started to bite in the 2000s as private-sector tech salaries took off. Luna: So we are essentially running a two-tier system. You have a cadre of federal employees who are capped, and then an army of contractors who are not. Lucas: And the contractors are often doing the most complex, high-stakes work. Take the Department of Energy's National Nuclear Security Administration — they oversee the nuclear stockpile. A senior engineer there might top out at $200,000. But if you need someone with deep expertise in warhead design, you are hiring a contractor who can charge $400 an hour. Luna: Which is about $800,000 a year if they are full-time. More than four times the cap. Lucas: And it is not just nuclear weapons. NASA does the same thing for mission-critical software. The cost overruns on the Space Launch System have been partly attributed to the fact that NASA could not retain top systems engineers — they left for contractor roles where they could double their salary. Luna: So the government is essentially training people, losing them, and then paying a premium to hire them back through a contractor. That seems insane. Lucas: It is a classic example of a budget gimmick that backfires. The cap looks good on paper — it keeps the federal payroll number low. But the real cost shows up in the procurement line item, which is less visible. Luna: How big is the gap? Do we have a number? Lucas: The Congressional Budget Office looked at this a couple of years ago. They estimated that for every dollar saved by capping federal salaries, the government spends an additional $1.20 to $1.50 on contractors. And that is just direct costs — it does not include the overhead of managing those contracts. Luna: So the cap is actually costing money. And it is not a small amount — we are talking billions. Lucas: Right. The federal government spends about $600 billion a year on service contracts — that is everything from IT to janitorial. A portion of that is because of the salary cap. One study by the Project on Government Oversight found that at the Department of Energy, contractor costs for IT services were 83 percent higher than comparable federal employee costs. Luna: Eighty-three percent. So the cap is not just a symbolic limit — it is actively distorting the labor market for government work. Lucas: And it creates weird incentives. A senior federal employee who knows they are capped might not bother to work extra hours or take on difficult assignments — the pay is the same either way. But a contractor billing by the hour has every incentive to maximize hours and complexity. Luna: So the cap is demotivating for the best federal workers, and it is enriching contractors. That is a lose-lose. Lucas: There have been attempts to fix it. In 2009, Congress created the Senior Executive Service pay raise authority — but it still ties to the Vice President's salary. Some agencies have used 'special pay rates' for specific roles, but it is a bureaucratic nightmare. Luna: Why not just raise the cap? Or eliminate it entirely? Lucas: Political optics. No member of Congress wants to vote for a bill that says 'we are raising federal salaries to $400,000.' It would be attacked as wasteful spending, even if it actually saves money in the long run. Luna: So the cap remains, and the costs keep growing. And this is not just a federal issue — state and local governments have similar caps, though often lower. Lucas: Exactly. Many states cap their top civil service salaries at the governor's pay, which is often around $150,000. So they have the same dynamic — they lose their best IT and finance people to the private sector or to consulting firms. Luna: It seems like the kind of thing that would be easy to fix if you just looked at total cost of ownership. But nobody does. Lucas: That is the fiscal policy problem in a nutshell. The budget is analyzed in silos — payroll is one line, procurement is another. No one connects the dots unless an auditor like the GAO does a deep dive. Luna: So what would a smarter system look like? If you were designing it from scratch? Lucas: You would set pay bands based on market rates for specific roles, not on a political salary. If the government needs a cybersecurity expert who commands $250,000 in the private sector, you pay them $250,000. The total cost would be lower than hiring a contractor for $400,000. Luna: That sounds straightforward. But politically, it is a non-starter because of the 'wasteful government salaries' narrative. Lucas: Right. And that is the deeper point. The salary cap is a political symbol that has real economic consequences. It makes us feel like we are controlling costs, while actually inflating them. Luna: So the next time someone says 'cut government salaries,' the smart answer is 'maybe not — because you will end up paying more for contractors.' Lucas: Exactly. And that is the kind of nuance that fiscal policy debates rarely allow for. But if you look at the data, it is hard to argue that the cap saves money. Luna: It is a great example of how good intentions — keeping government lean — can backfire when you ignore how the labor market actually works. Lucas: And it is not just about salary. The cap also affects retention of institutional knowledge. When a senior federal employee retires, they take decades of experience with them. The contractor who replaces them might have the same technical skills, but they do not know the history of the program, the relationships, the unwritten rules. Luna: That is a hard cost to quantify, but it is real. And it probably shows up in the form of mistakes, delays, and cost overruns. Lucas: One example: the Census Bureau's failed attempt to digitize the 2020 census. They spent $800 million on a mobile data collection app that did not work. A big part of the problem was that the technical expertise was all contracted out — the federal project managers did not have the in-house skills to oversee the contractors effectively. Luna: And the project managers were capped at $200,000, while the contractor leads were making $400,000. So the people with the most authority had the least domain knowledge. Lucas: Right. And that is a pattern you see across government. The IRS, the VA, the Department of Defense — all have major IT failures linked to poor contract oversight. Luna: So the salary cap is not just a pay issue. It is a governance issue. It affects how well the government can manage the $600 billion it spends on contractors every year. Lucas: And that is the real cost. The cap might save a few hundred million on payroll, but it costs billions in inefficiency, waste, and failed projects. Luna: It makes you wonder — if we eliminated the cap tomorrow, how much of the government's procurement budget could be brought back in-house? Lucas: A significant chunk. Some estimates suggest that 20 to 30 percent of service contracts could be done more cheaply by federal employees — if agencies were allowed to pay competitive salaries. That would be $120 to $180 billion in savings. Luna: That is real money. Enough to fund a major infrastructure project or pay down debt. Lucas: But it would require Congress to take a political risk. And so far, the political calculus has not changed. The cap stays, the contractors get richer, and the budget gets bigger. Luna: It is a classic fiscal policy trap — a rule that looks good in a soundbite but fails in practice. Lucas: And it is one of those topics that rarely gets attention because it is technical. But it affects every taxpayer. Every dollar wasted on overpriced contractors is a dollar that could have been spent on something more useful — or not spent at all. Luna: So if there is one takeaway from this episode, it is that the next time you hear a politician promise to cut government salaries, ask them: 'And what will that do to the contractor bill?' Lucas: Exactly. The cheapest federal employee is often the one you pay a fair market wage.