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  • Apr 01 2016

Friday Freakout: Who’s to Blame? Public School Districts’ Teacher Pension Dilemma

According to a recent article in the U.S. News & World Report, several big-city public school systems face immense fiscal challenges.

The leading suspect? Public pensions.

This answer shouldn’t be surprising. School pension costs have doubled over the last 10 years from $500 per student to more than $1,000 per student, and public schools are now experiencing what many financial experts warned they would. Today, taxpayers are unable to afford state and local government employee pension entitlements to the tune of $5.8 trillion, of which $1.7 trillion is unfunded, according to the Federal Reserve.

The pension time-bomb was set long ago, however. Investing guru Warren Buffet wrote about problematic pensions in his 2014 annual letter to Berkshire Hathaway shareholders. In this letter, Buffet wrote:

Local and state financial problems are accelerating, in large part because public entities promised pensions they couldn’t afford. Citizens and public officials typically underappreciated the gigantic financial tapeworm that was born when promises were made that conflicted with a willingness to fund them. Unfortunately, pension mathematics today remain a mystery to most Americans.

But Buffet’s awareness of the issue didn’t begin in 2014. Not by a long shot.

In this annual letter, he references a much earlier memo (begins page 118), dated October 14, 1975. The memo discusses the major issues with pensions’ “promise now—pay later” formula. Clearly, at least some people have been concerned about the pragmatism of public pensions for decades before our current crisis.

An Overview of How Teacher Pensions Work

As Buffet notes, though, most people don’t really understand how pensions work. So here’s a quick overview.

More than 88 percent of all public school teachers are covered by defined benefit plans. Under these plans, a teacher’s retirement benefit is based on a combination of factors: how many years he or she worked, some percentage (also known as a “multiplier” or “accrual factor,” for instance 2 percent), and a final average salary (FAS). For example, the annuity (annual benefit) for a teacher who retires after 25 years of service, exits with an FAS of $60,000, and works in a state that provides 2.5 percent of her FAS per year is

(0.025 per year) x ($60,000) x (25 years) = $37,500 per year

This benefit is payable for life starting at the teacher’s eligible retirement age. Many states add an annual cost-of-living adjustment on top of this base benefit, so that the benefit increases by regular intervals.

Because the level of benefits does not depend on how much is contributed to fund these benefits, and because these benefits are difficult to understand in the first place—strong incentives have been created to significantly underfund these plans. That means that a plan has less in assets than what it owes for pension obligations (benefits).

Couple this with various features of the plans themselves—for instance, early retirement provisions allowing teachers to retire in their early-to-mid 50s, unrealistic assumptions about investment returns, and cost-of-living adjustments not tied to any inflation index such as the Consumer Price Index—and you have a system that carries a hefty price tag. And that price tag is contributing to the financial instability, and even collapse, of some major city school systems.

Is the Pension Squeeze the Fault of School Choice?

The City of Detroit, which filed for bankruptcy in 2013, cannot afford to pay its teachers past April 8. While L.A. Unified managed to reduce a $225 million deficit to a $72 million deficit this year, rising pension and healthcare costs are projected to drive the deficit as high as $450 million in 2018–19. Chicago Public Schools faces a $1.1 billion deficit, plus a “crushing pension burden” to go along with it.

Now, if I were to walk into a room full of economists or financial experts and suggest that school districts’ pension-driven financial problems are due to school choice, I would likely be laughed out of the room.

But that’s just what Randi Weingarten, president of the American Federation of Teachers, claims. In the U.S News article, Weingarten states that choice is at the root of districts’ financial issues:

The real culprit of the school systems’ troubles, Weingarten says, has been state governments’ support for expanding charter schools, voucher plans and other school choice policies, which she argues has eaten into the budget for traditional public schools.

“There is a common thread in how the Philadelphia crisis started, what happened in Michigan, and what’s happening in Illinois, where there is abandonment by these Republican governors or legislatures of urban city school districts,” she says.

Put simply, Weingarten’s insinuation is patently false.

First, the states Weingarten cites are experiencing the worst pension crises, Pennsylvania, Michigan, and Illinois, do not even have strongly funded private school choice programs. Michigan has none, and fewer than 3 percent of the state’s students in Pennsylvania and likely fewer in Illinois are currently using any private school choice program.

With such miniscule impact, it is literally impossible for private school choice to be at the crux of pension funding issues in those cities.

Furthermore, the claim that private school choice and charter schools “siphon” resources from public schools is one education myth that just won’t die. But this claim has been debunked in numerous ways.

The truth is that school choice programs can improve the fiscal health of public school districts. Between 1990 and 2011, there were 10 private school choice programs in operation. Those programs saved a total of $1.7 billion. Another fiscal analysis on the Milwaukee Parental Choice Program demonstrated net savings of $37 million in FY 2009 from the program.

Additionally, Nevada’s education savings account (ESA) program would generate $700,000 in savings for school districts for every one million dollars spent on the program. And an ESA bill that was introduced in Oklahoma but missed legislative deadline would also provide a modest fiscal benefit for school districts—about $30,000 for every $1 million dollars spent.

As to charters, there is a funding gap of 28.4 percent (or $3,814 per student) between charter schools and traditional public schools. In a district like Philadelphia, where dollars are being squeezed from classrooms to pay for pension benefits, only 36 cents from each district school dollar goes to classrooms, according to a report by NPR. But charters, which get significantly less funding than traditional district schools, are able to direct more funding into classrooms.

The bottom line is simple: Teacher pension benefits can be costly to provide under some plans. This is certainly not to say that teachers don’t deserve these benefits. But charter schools and private schools did not create the financial quagmire some states now face. The problem of “promise now—pay later” preexists programs like these by decades.

And it’s certainly true that such programs are not draining resources from public schools and making districts, as Weingarten implies, unable to meet their financial obligations. The truth is that teacher pensions are inherently expensive and are underfunded for a variety of reasons. The issue is complicated, to be sure. But that’s no excuse to ignore the facts.

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