Pension-spiking, free-riding, and the effects of pension reform on teachers' earnings

Abstract

In many states, local school districts are responsible for setting the earnings that determines the size of pensions, but are not required to make contributions to cover the resulting state pension fund liabilities. In this paper, I document evidence that this intergovernmental incentive inherent in public sector defined benefit pension systems distorts the amount and timing of income for public school teachers. I use the introduction of a policy that required experience-rating on earnings increases above a certain limit in a differences-in-differences framework to identify whether districts are willing to pay the full costs of their earnings promises. Because of the design of the policy, overall earnings of teachers near retirement did not change. Instead, districts that previously provided one-time pay increases shifted to smaller increments spread out over several years. In addition, some districts that did not practice pension-spiking prior to the reform appear to begin providing payments up to the new, lower limit, perhaps due to increased salience of the fiscal incentive. Therefore, the policy was ineffective at decreasing pension costs.

Dynamic Incentives in Retirement Earnings-Replacement Benefits

“…Related literature This paper contributes to two strands of literature. First, a recent literature has started to document responses to the dynamic incentives embedded in the computation of earnings-replacement benefits in pension systems (Fitzpatrick, 2017;Mannino and Cooperman, 2015). Our paper is most related to Fitzpatrick (2017), who provides evidence of increases in teachers' earnings as a response to Illinois's 4-year benefit-calculation window, and shows that these responses are sensitive to a policy that increases the costs to employers of earnings spiking.…”

“…The potential costs of these behavioral responses are well-know to economists (Gruber, 2016), and have been present in news coverage and policy discussions. 1 Still, the empirical evidence on behavioral responses to these incentives is remarkably scarce, with the exception of Fitzpatrick (2017), who documents this behavior for public education pension schemes in the US. To the best of our knowledge, there is no evidence on whether behavioral responses to such incentives occur in country-wide private-sector pension systems, whether there are real or reported earnings changes, or whether self-employed workers and employees respond differently given the different incentives and restrictions they face.…”

Causes and Consequences of the Crises in State and Local Pension Funding: Research to Inform the Development of a Road Map for Reform

“…This spike will lock in a permanently higher DB benefit based just on the increased final average salary but is underfunded due to employer and employee contribution rates applied to the systematically lower prior years of earnings. Although anecdotal cases of salary spikes have led to limits in their practice in pension reforms in states such as California and Tennessee, curtailing spiking is likely to have a limited impact on pension solvency (Fitzpatrick, 2017;Goldhaber, Grout, and Holden, 2018).…”

Analysis of Balance of Income and Expenditure and Optimal Retirement Age of Pension Insurance Co-Ordination Account Based on Improved Machine Learning Algorithm

“…Fitzpatrick suggested a complete OLG model idea, modified it, and used it as a vital analysis tool [ 15 ]. Lu and Tang suggested the standard to measure economic welfare and the way to improve it and advocated that income distribution should be equalized and the government should play an intervention role in income redistribution [ 16 ].…”