Incentives in State Pension Plans: The Case of Teachers

By Patrick Coate, PhD

Earlier this week, my colleague Theodore Cangero wrote about funding gaps in state pension programs. These can have negative consequences not only for state budgets but for residents currently employed in industries with state pensions whose regulations sometimes have adverse consequences for workers or the public. One well-studied example is public school teachers.

Most states have pension plans for teachers, and most of those plans have underfunded liabilities. This cost is borne partially by taxpayers and partly by young teachers, as states make programs less generous to young teachers. Researchers have found over 10 percent of current teachers’ earnings is set aside to pay for pension liabilities, which may make it harder to recruit and retain new teachers. An Urban Institute study cited in the New York Times reports that in AIER’s home state of Massachusetts, it is impossible for a new teacher to ever break even on their pension contributions.

Even well-funded pension programs, however, can provide disincentives to work, and they otherwise distort the labor market for teachers. Pension plans often take a long time to fully vest, but also, by providing relatively generous benefits that cannot be collected while working, they provide incentives to retire early. Thus the system creates undesirable incentives at both ends of a teacher’s career.

Early in their careers, young teachers who otherwise might be geographically mobile and able to help smooth demand for teachers between local labor markets are tied to particular states by pension plans, among other state-specific rules. One analysis of teachers in Oregon and Washington shows that even teachers living near the state border are far more likely to move 75 miles or more within their current state than across state lines. In Missouri, Kansas City and St. Louis operate separate systems from the rest of the state, making moves even within-state difficult. Then, as shown in the Times report and other research, pension incentives also cause early retirements of experienced teachers that are still of working age and whose experience could make them among the most effective teachers in their schools. In an illustrative example, the Times shows a representative teacher’s pension value exceeds total contributions by age 50, but dips below contributions again by age 65.

Current pension reform focuses primarily on reducing benefits. This may alleviate the underfunding issue (although it won’t solve it entirely), but the other issues remain. Introducing defined-contribution plans, or at least relaxing rules that create incentives that tie teachers to states and then entice them to retire at a relatively young age, could help create better incentives for teachers and enable a more flexible and efficient labor environment.

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