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Rethinking Teacher Pensions

Article by Michael J. Podgursky April 12, 2012 //   7 minute read

Just about every day brings bad news about the fiscal challenges faced by state and local governments regarding pubic employee pensions.   Last week, for example, Mayor Emmanuel and Governor Quinn began to lay the groundwork for significant cuts in Illinois pensions in response to  $27 billion in unfunded pension liabilities.   These cuts will likely involve not only involve new employees, but also currently active employees and retirees.   They are likely to be modeled on similar cuts recently enacted in Rhode Island.   Cuts are being considered in many other states as well, and, as the examples above indicate, are being considered by both Democratic and Republican political leaders. It is typically the case that reform of educator pensions, covering teachers and other certificated K-12 staff, are folded into these larger discussions -- in effect mixing teachers with policemen, firemen, prison guards, clerks, and other state and local workers in  “one-size-fits-all” fixes.   However, Bob Costrell, another Fellow at the George W. Bush Institute, and I have argued that given that reform discussions are under way, it is a good time to ask whether traditional public sector pension plans are the best way to spend tax dollars to recruit and retain a high quality teaching workforce.  In short, is this money well spent?  A careful look at the incentive effects of these plans, and their labor market effects, suggests not. The typical teacher plan is more accurately described as a final average salary defined benefit plan.   In these plans the pension at retirement is determined by years of service multiplied by a percentage factor or multiplier times final average salary, which is usually the average of three or four years of the highest salary.   For example, in Missouri the multiplier is 2.5 percent.  Thus, a teacher with thirty years of service and a final average salary of $50,000 would earn an annual pension of .025 x $50,000 x 30 = $37,500  (the teacher would also get 75 percent of the district’s contribution toward her health insurance added in as well as regular COLA adjustments).   A wild card in many plans is when that teacher can collect the pension.  In Missouri, a teacher can collect it at age 65, or when a teacher has 30 years of experience, or (and this is typical) when the teacher’s age and teaching experience totals 80 (commonly known as the “Rule of 80”).   Thus a teacher entering at age 24 who worked continuously can collect a full pension at age 52.   Moreover, this teacher could also begin collecting a reduced pension as early as age 49 (referred to as “25 and out”). Bob Costrell and I have shown that these types of educator plans have powerful “pull” and “push” incentives over a teacher’s career.   Mid-career teachers would suffer massive losses in pension wealth if they leave early and, beyond a certain point, pension wealth falls if teachers continue working.   Rather than providing smooth accrual of wealth over a work life, the charts describing these powerful incentives resemble “peaks” and “valleys.”  In other work we show that this back-loaded system of benefits also produces huge losses in pension wealth for teachers who move from one state to another during a teaching career.   We have argued that such harsh penalties have no economic rationale, and almost certainly hinder the ability of public schools to recruit academically talented, but mobile young college graduates.   This is particularly true as pension plans divert an ever larger share of their operating budget to cover the unfunded liabilities accrued by senior teachers and retirees. New research shows that that these mobility penalties may inflict significant costs in another important area – recruitment of school leaders.    Teachers who move into school leadership positions typically do so after roughly 12-14 years of teaching experience (at a median age of 38) – when the penalties for mobility are very high   Thus, economic theory would predict that we would see very little mobility of young principals across pension system borders.   In fact this is exactly what we find.  An analysis of administrative data from Missouri shows that pension borders greatly reduce leadership flows across schools. Missouri provides a unique situation for testing this hypothesis since educators in the two large urban districts, St. Louis and Kansas City, are in their own pension systems, while the rest of the educators are in a state teacher plan.   There is no reciprocity for service between these plans. This is of considerable policy interest because the two urban systems have lost their accreditation and would benefit greatly by recruiting talented school leaders from better-run suburban districts.  This analysis finds that the pension system penalties nearly extinguish such flows.   More generally, these estimates suggest that removing a pension border that divides two groups of schools will increase leadership flows between the groups by roughly 100 percent. With nearly 22,000 miles of pension system borders in the United States, this is potentially a huge efficiency cost for public schools. (The full working paper on principals may be found here.) In an efficient labor market, human capital can flow to where it is most productive.   Ironically, while states have made significant strides in reducing licensing mobility barriers – for example, letting fully qualified principals in Kansas work in a Missouri public school – the invisible mobility barriers due to pension plans have grown in recent decades. Is this the best way to spend compensation dollars to attract the highest quality educators to public schools?   Rather than spending billions of dollars annually to shore up existing plans, this might be a good time to begin thinking about alternatives better designed to attract talented and mobile young college graduates to the profession.   An important facet in any reformed plan should be tying benefits to contributions.   This will give mobile educators a much fairer shake. This post was written by Dr. Michael Podgursky, Fellow in Education Policy at the George W. Bush Institute.

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