Association for Public Policy Analysis & Management

Public sector employees in the US receive a large part of their lifetime compensation in the form of defined benefit pensions, financed in part with employees’ salary contributions. Combined with different wage structures, these pension plans can affect workers’ decisions on the optimal retirement age and, in turn, the composition of the workforce. In this paper I study the retirement effects of a reform which increased all Wisconsin teachers’ contribution to the pension fund, and at the same time changed the structure of their salaries in some districts, away from a lock- step schedule and towards individually-based salaries. I first show that the reform increased the retirement age of high-quality teachers working in individual-salaries districts compared with lower quality teachers. I then build and estimate a life-cycle model of consumption and retirement, and I use it to show that a) the reform reduced welfare of all teachers, and b) an alternative budget-cutting policy which, instead of increasing contributions, reduces pension benefits by an equal amount, increases welfare for all teachers and induces higher-quality teachers to remain longer in the labor force.