Retirement Age Effects of Pension and Salary Reforms: Evidence from Wisconsin Teachers

Abstract

Many US workers receive a large portion of their lifetime compensation in the form of retirement pensions. How do changes in pensions vis a vis salaries affect labor supply and retirement? This paper examines the retirement responses to a reform that changed salaries and pensions of public school teachers in a staggered fashion. On one hand, the reform lowered older teachers' gross salaries and, in turn, their future pension benefits; on the other it increased employees' contributions to the pension fund, lowering net salaries but leaving pensions unchanged. I use the staggered timing of implementation of these two provisions to estimate bounds to the income and substitution effects of salaries and pensions. These estimates suggest large substitution effects and more moderate income effects. They also indicate that workers are more responsive to changes in salaries than to equally sized changes in pensions. I find support for three possible explanations for this finding: a) a lack of salience/information on pensions, and b) credit constraints. I use the estimated elasticities to evaluate the effect of an alternative budget-saving policy that reduces pensions instead of net salaries. This alternative policy would lead to fewer, older, and lower-quality teachers retiring compared with the actual reform.