Cost-of-Living Allowances for Federal Employees in Nonforeign Areas Should Be Based on Spendable Income

The purpose of a cost-of-living allowance is to enable a Federal employee in a nonforeign area to maintain purchasing power similar to that of a comparable Federal employee in Washington, D.C. In a May 1979 report to the President, the Office of Personnel Management (OPM) recognized the reasons for adopting spendable income as the base for cost-of-living allowances but did not propose this change. Instead, it favored eliminating the program. In June 1979, President Carter proposed locality pay rates as part of his pay reform proposal for all General Schedule employees. This proposal would have replaced the cost-of-living allowance program with locality pay rates, but the legislation expired without congressional action. President Reagan's pay reform proposal would empower the President to designate pay areas, establish locality rates of pay for General Schedule employees, and eliminate the nonforeign area cost-of-living allowance program.

By applying the cost-of-living allowance rates to base pay, employees are compensated for items that are not living costs such as income taxes, retirement, life insurance, savings, and charitable contributions. Federal employees receiving the same basic pay incur essentially the same cost for these items, regardless of their place of employment. Paying cost-of-living allowances as a percentage of base pay overcompensates employees in the nonforeign areas by about $41.4 million annually. In Alaska, private sector salaries are substantially higher than salaries in the 48 contiguous States, and the Government already pays special higher rates to a few occupation groups to recruit and retain well-qualified personnel. Adopting spendable income as the base for cost-of-living allowances would reduce payments in Alaska; however, that money may have to be added to special pay rates for all or nearly all employees in Alaska to recruit and retain personnel. This problem should not arise in other nonforeign areas, because Federal salaries there generally are competitive with private sector pay. As long as the nonforeign cost-of-living allowance remains in effect, GAO believes it should be based on spendable income rather than base pay. This change would make the cost-of-living allowance consistent with cost-of-living programs administered by the Departments of Defense and State, eliminate allowances for expenses which are not related to place of employment, and save at least $23.2 million annually.

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