Teacher salary hikes face major headwinds – politics and pension underfunding

FILE PHOTO: Participants take part in a march in Phoenix, Arizona, U.S., April 26, 2018 in this picture obtained from social media.  Christy Chavis/File Photo via REUTERS   THIS IMAGE HAS BEEN SUPPLIED BY A THIRD PARTY. MANDATORY CREDIT. - RC16A9026150
Editor's note:

This article originally appeared in Real Clear Markets on May 23, 2018.

In recent months teachers in five states have struck for better pay or benefits. Perhaps unsurprisingly, the five states—Arizona, Kentucky, North Carolina, Oklahoma, and West Virginia—spend less than the national average on each pupil enrolled in public schools. They pay their teachers substantially less than the nationwide average salary, which in the 2015-2016 school year was $58,064. More importantly, teachers in all five states saw the purchasing power of their salaries shrink over the first six years of the economic recovery. In this they were hardly alone. Public school teachers in 39 states saw their real wages fall between 2009 and 2015. Teachers in Arizona, Oklahoma, and West Virginia suffered wage losses of 9 percent or more.

The plight of teachers is traceable to a couple of developments. The electoral success of conservatives has shifted political control in many statehouses to officeholders who are determined to hold down spending, including on the public schools. The economic recovery may have lifted state and local revenues in the great majority of states, but frugal lawmakers in many of them have kept public spending in check, sharply cutting state aid to local schools in the early years of the economic recovery.

For the nation as a whole, the Census Bureau estimates that by 2015 public school spending per pupil was within 1 percent of its level in 2009. In 16 states, however, it was down 5 percent or more. In Arizona, spending per pupil dropped more than 12 percent after we adjust for inflation. To be sure, Arizona’s income growth rate lagged that of the U.S. as a whole. Nonetheless, the state’s real GDP per capita was 1.5 percent higher in 2015 compared with 2009. Its real spending per pupil was lower.

If voters and lawmakers do not support funding increases to keep school budgets in line with student enrollments, teachers’ workloads will rise or their compensation must fall. About $8 out of every $10 in school budgets is used to pay for staff salaries and benefits. This means local boards of education will find it hard to avoid cutting compensation or boosting class size when forced to deal with a big cut in state aid.

If voters and lawmakers do not support funding increases to keep school budgets in line with student enrollments, teachers’ workloads will rise or their compensation must fall.

In the Great Recession, school budgets were partly protected as a result of a massive dose of federal aid, courtesy of the Obama Administration’s stimulus program. The counter-cyclical aid ended soon after the GOP regained control of Congress in the 2011. States and localities had to finance school budgets on their own when federal stimulus dollars ceased. It turns out that many state governments had a smaller appetite for this burden during the recovery than they did before the Great Recession.

A second challenge to teacher salaries is the burden on their employers of paying for pension and health benefits. An overwhelming share of public school teachers are covered by traditional, defined-benefit pensions. Teachers who work for a specified number of years under a plan become eligible for a pension that is usually calculated as a percentage of final salary, with the replacement rate rising in proportion to a teacher’s years of tenure under the plan. Unlike typical private-sector workers in traditional plans, most covered teachers must make annual contributions into their pensions, with school systems or state agencies picking up the remaining tab.

If teacher pensions had been adequately funded by their sponsors, the story would end there. Like most other traditional pensions, however, public teacher pensions have been underfunded (see here and here). Plan sponsors overestimated returns plans would earn on their investments. This means the publicly administered reserve funds to pay for teacher pensions are too small to cover expected future benefits. Under government accounting standards, state and local pension funds held enough assets in 2015 to cover about 72 percent of their future obligations.  This left a funding gap of 28 percent of promised future benefits, or roughly $1.4 trillion. Joshua Rauh, a Stanford expert on state and local pensions, believes a more accurate estimate of the unfunded liability is much larger, about $3.8 trillion or nearly half of promised future benefits. At some point state and local governments and school systems will have to raise additional money to pay for the unfunded obligations. Alternatively, future obligations will have to be scaled back, possibly by reducing the accrual of future pension credits.

BLS numbers suggest states and school systems have been ramping up their contributions into teacher pension plans. The BLS conducts a survey of public and private employers to determine the hourly cost of wages, salaries, and employee benefits for a range of occupations. The survey shows that the employer cost of paying for teacher retirement benefits has increased sharply since the mid-2000s. In 2004, the employer contribution for teacher retirement benefits amounted to a little less than 8 percent of teachers’ salaries. By 2017, the employer contribution for retirement benefits represented more than 19 percent of teachers’ salaries. Retirement plan contributions for comparable workers in the private sector have also edged up, but by much less than for school teachers.

If an employer pays $10 per hour to fund a worker’s future pension, it cannot use the same $10 to pay for the worker’s hourly salary. The BLS estimates suggest that teachers’ real hourly compensation increased about 9 percent between 2004 and 2017 while their average real hourly salary declined about 3 percent. Unless teachers’ retirement plans became more generous over the period—and they probably didn’t—their employers have increased contributions in order to make up for past underfunding or in recognition of the fact that future pensions are more expensive to pre-fund. In either case, there is less room in school budgets for salary hikes.

The path to higher teacher pay faces two headwinds. Policymakers and voters in many parts of the country appear to be more skeptical than in the past of the moral claims of public schooling. This is particularly evident in statistics on state spending for post-secondary institutions. State spending cuts for higher education have been bigger and have extended over a longer period than has been the case for K-12 schools. Even if lawmakers and voters were willing to boost K-12 funding as fast as they did before the Great Recession, a bigger fraction of the spending would have to be devoted to teacher retirement benefits. Not only are these benefits more expensive than was recognized before the recession, many teacher plans are closer to the date when pension reserves will be depleted. Public dollars spent on future teacher pensions cannot be spent on current wages.