States can reduce school district free-riding in teacher pensions

Many states are struggling with underfunded teacher pension systems. In 22 states, local school districts set teacher salaries, but are not required to pay the full amount needed to fund the related pension benefits.

At the same time, teacher pension systems determine benefits based on teachers’ late-career salaries. Thus, a district can add salary late in a teacher’s career for about the same cost as adding it earlier, but the teacher receives a much larger pension benefit from the late-career raise.

What would happen if districts were forced to pick up more of the pension costs?

In a new working paper, Maria Fitzpatrick attempts to answer this question by looking at the natural experiment that resulted from Illinois’ 2005 change to teacher pension rules. The new law required districts to pay the full pension costs of end-of-career salary increases above six percent, the trigger that prompted pension benefit increases.

Fitzpatrick estimates the pre-2005 cost of backloading teacher salaries at $250 million annually. After the new law was passed, those annual costs decreased by 60 percent.  Pension fund assets also likely increased, because school districts continued to offer about 10 percent of near-retirees late-career salary increases between six and 10 percent. More research is need to discover why districts continued to offer high salary increases in the face of new disincentives.