The Value of Generous Pension Plans: Lessons From Public-School Teachers

Abstract:

Many public-sector US workers earn relatively low salaries but receive generous pensions upon retirement. This paper examines whether this compensation structure is optimal from the perspective of workers’ welfare and how it impacts the composition of the workforce. Examining the short-run retirement responses to a reform that reduced salaries and future pension benefits of public school teachers in a staggered fashion, I estimate retirement elasticities of salaries and pensions and use them to construct bounds to the substitution effects of these two forms of compensation, allowing them to be different. I find that workers are more responsive to changes in salaries than to same-dollar changes in pensions. I also provide suggestive evidence that a lack of salience of pension benefit changes could explain this result. Lastly, I use the estimated elasticities to evaluate the workforce composition effects of an alternative budget-saving policy that reduces pensions more but leaves salaries unchanged. This policy would lead to fewer, older, and lower-quality teachers retiring compared with the actual reform.