The Economic Policy Institute (EPI), a D.C. think tank aligned with teacher unions, has released yet another in a series of reports purporting to show that public school teachers are “underpaid.”
Many papers, articles, and reports have been written attempting to compare teacher to non-teacher compensation. Making such comparisons presents many challenges. Obviously, working conditions and hours of work differ (e.g., teachers have summers off and a shorter on-site workday), as do job security and the mix of salary and benefits.
However, in today’s economy, there is one very big difference that is not so visible to the naked eye but was cleverly pointed out in a study by Jason Richwine and Andrew Biggs several years ago. The pension benefits for public school teachers (and most public employees) are far more generous than for private sector professionals. Moreover, the way that the U.S. Department of Labor measures those teacher pension benefits greatly understates this gap because the Labor Department underprices the teacher benefit.
The vast majority of private sector professionals have individual retirement savings accounts to which employers make a contribution. These are called “defined contribution accounts” and go by tax code names such as 401(k) or 403(b). The vast majority of public school teachers, however, are in “defined benefit plans,” which provide an essentially risk free payment at retirement for the life of the teacher. In either case, employers make contributions on behalf of the employees, but the problem comes in making a true apples-to-apples comparison of these payments.
A simple example illustrates the point. Let’s say that the Fordham Institute contributes $1 to a 403(b) plan for its employee (we’ll call him Mike). D.C. Public Schools makes a contribution of $1 for Mary, a public school teacher, to its teacher retirement fund. Mike invests his $1 in a low risk government bond and earns 2 percent for twenty years. The D.C. teacher retirement fund, by contrast, assumes that it will earn 7.5 percent over the long run and gives out benefits to Mary accordingly. Moreover, these promises to Mary are legally binding and can’t be cut, so from Mary’s point of view, this is a risk free benefit.
At the end of twenty years, Mike has $1.49 in his account, but Mary has a benefit worth $4.25. Obviously, the $1 paid to Mary was worth a whole lot more than the $1 paid to Mike, even though the bean counters at the U.S. Department of Labor recorded the contributions as equal. In fact, a simple economic calculation shows that Mary’s $1 was really worth $2.86 in an apples-to-apples comparison with Mike’s. To be clear, the Labor Department measures one dollar of the $2.86, but they miss the larger cost, which is the return Mary receives from the opportunity to invest her $1 risk free at a rate much higher rate than Mike. Mike and the other employees at the Fordham Institute would love to have that opportunity, but unlike Mary, they must settle for 2 percent.
Similar logic applies to the employee contributions. If Mike and Mary make a pre-tax contribution of $1 toward their own retirement plans, the U.S. Department of Labor, understandably, does not count this as an employer-provided benefit. However, as with employer contributions, Mary’s pre-tax dollar is actually worth $2.86 compared to Mike’s $1, with the difference guaranteed by the taxpayers. This hidden benefit is not minor. In Missouri, teachers contribute 13.5 percent of their salaries toward their pensions. In California and Texas, it’s 9.2 percent and 7.2 percent, respectively. All of these teacher contributions are guaranteed juiced-up returns at taxpayer expense.
In today’s low-return environment, the pension promises being made to state and local employees in general, and public school teachers in particular, have become very expensive and difficult to maintain largely because the largesse of the pension plans assumes long run returns on the order of 7.5 percent (or higher). Failure to hit these targets, as well as underfunding generally, has resulted in pension costs consuming a progressively larger share of the education dollar. Robert Costrell has calculated that over the past decade, on a per student basis, teacher pension costs have risen from $500 to nearly $1100.
Among other problems, EPI estimates fail to make an apples-to-apples comparison of compensation costs and are, consequently, flawed and greatly understate the true cost of teacher benefits.
Michael Podgursky is a professor in the Department of Economics at the University of Missouri. His most recent publication for the Fordham Institute was Charting a New Course to Retirement: How Charter Schools Handle Teacher Pensions.