Dropout Nation

Last year, in an amazingly act of defensive puffery, the Teachers Retirement System of Texas released 16 pages of flackery declaring that its defined-benefit pension was a “Great Value” for Lone Star State taxpayers. Attempting to beat back efforts by state legislators to address its growing pension deficit, TRS proclaimed that the annuities it pays out “stimulates” local economies and contributes to $970 million additional state and local tax dollars (without so much as mentioning that much of the pension’s contributions are derived from teachers — who earn their income from state and local taxes — and from forms of local governments also known as traditional districts). From where it sits, TRS makes “prudent financial decisions” without having to think about “crisis.”

Yet even as TRS released this shoddy white paper, its executive director, Brian Guthrie, admitted in its annual financial report that it deferred recognizing $6.9 billion in investment losses in order to avoid adding to the pension’s already-massive $26.8 billion deficit. Based on those unrealized losses alone, TRS’ pension deficit would likely be $33.7 billion, or 26 percent greater than it reports to the public. But this is only the tip of the iceberg. Based on Dropout Nation‘s analysis of TRS’ pension, based on a new calculation for estimating pension deficit developed by Moody’s Investors Service — which only assumes a 5.5 percent rate of return on investments instead of the inflated 8 percent assumption used by TRS — the Texas teachers’ pension’s deficit is more-likely around $36.3 billion, or 36 percent higher than it is currently reports; districts (and taxpayers), would have to pay out an additional $2.1 billion a year for the next 17 years in order to make up the shortfall. That would be 66 percent more than the $3.2 billion Texas districts paid out in teachers’ benefits in the 2009-2010 school year, according to the U.S. Census Bureau. That estimate doesn’t take into account the $6.9 billion in losses. If those losses were added in, the pension deficit is likely $45.6 billion, which would mean $2.7 billion in additional payments over 17 years to address the deficit. That would be 84 percent more than districts paid out in teachers’ benefits in 2009-2010.

If one then adds TRS’ $27.5 billion in unfunded retired teacher healthcare liabilities (for which there is a fund for which TRS assumes a more-realistic rate of return of 5.2 percent), the Texas system’s likely actual deficit is between $63 billion and $72 billion. This means that Lone Star districts — and ultimately, taxpayers — would have to pay between $3.7 billion to $4.3 billion a year over the next 17 years just to make up the underfunding — or more than the $3.2 billion paid out in 2009-2010. All of which makes one question how TRS defines “prudent” fiscal management. It also brings up the question of whether it is more focused on crisis management than on addressing its pension deficit.

None of this is surprising. As your editor has noted on these pages, in The American Spectator, and elsewhere for most of the past decade, the full cost of the decades of deals between states, districts, and affiliates of the National Education Association and the American Federation of Teachers are coming to roost. This is weighing heavily on states and districts, especially as the increased costs of  Medicaid and healthcare, driven in part by the Affordable Care Act (or ObamaCare, as others call it), are also putting the squeeze on budgets. But the full costs of defined-benefit pensions, which along with retired teacher healthcare costs, is the most-expensive part of a traditional teacher compensation system which has proven to be both too costly to bear (as well as ineffective in spurring student achievement and rewarding high-quality teachers for their work), have long been hidden by the kind of loose accounting and actuarial rules that wouldn’t be tolerated from companies in the private sector. From overly-inflated assumed rates of returns on investments that are not even close to the actual long-term performance of the S&P 500, to the use of techniques such as deferring investment losses in order to keep from revealing the true levels of pension deficits, pension systems have done plenty to hide the true moral hazards that taxpayers will have to bear.

But thanks to Moody’s, as well as the efforts of the Government Accounting Standards Board, and the work of researchers such as former Manhattan Institute scholar Josh Barro, University of Rochester professor Robert Novy-Marx and Joshua Rauh of Northwestern University, reformers can now get a better sense of the hidden fiscal woes that will play as much a part in driving reform of American public education as the all-too-public data on dropout factories, failure mills, and warehouses of mediocrity are failing our children. And when one looks at Texas’ teacher pension, along with that of two other states, as Dropout Nation has done, the likely real costs are greater than families and other taxpayers may realize.

New Jersey’s teachers’ pension, for example, reports a $11 billion pension deficit (as of 2011, the latest year available); this doesn’t include any unrealized gains or losses (though the pension would report a $2 billion decline in assets between 2011 and 2012). But when one uses the Moody’s calculation — which assumes a rate of return that is 2.5 points lower and more-realistic than the 7.95 percent assumed by the Garden State pension — the actual pension deficit is more likely to be $15 billion. New Jersey districts — and taxpayers — would have to pay out an additional $878 million a year over 17 years just to make up the underfunding. That’s a 25 percent increase over the $3.2 billion Garden State districts paid out in teachers’ benefits in 2009-2010. This, by the way, doesn’t include the $14 billion in unfunded retired teacher healthcare costs (as of 2010, the latest year reported by the state treasury department) that must be borne by taxpayers — or the even larger $24 billion in future retirement healthcare liabilities for teachers still working (including Baby Boomers heading out of the profession over the next few years).

Then there is Colorado’s pension system, which is still smarting from the National Council on Teacher Quality’s report last year on its pension deficits and that of other state systems. It reports a $1.2 billion deficit (as of 2011) for the pension it runs for the state’s districts, and a $638 million pension deficit for the Denver district. This doesn’t include any unrealized losses for either fund. Based on Dropout Nation‘s analysis using the Moody’s approach (and a 5.5 percent assumed rate of return versus the eight percent used by the Colorado pensions), the deficits for both pensions would be, respectively, $1.7 billion and $865 million. Taxpayers in the state and in Denver would have to pay an additional $102 million and $51 million a year just to make up the underfunding. This would be 21 percent more than the $720 million paid in teachers’ benefits paid out by the entire state in 2009-2010.

Meanwhile California’s Teachers Retirement System, which has one of the nation’s largest officially-reported pension deficits, reports this week that it had a $64 billion underfunding for 2011, the latest year available. But this is an understatement because of its 7.5 percent assumed rate of return on investments, which is inflated by 2 percentage points. More than likely, based on Dropout Nation‘s analysis, CalSTRS’ underfunding is $87 billion, or 36 percent higher than officially reported. This means that taxpayers would have to pay an additional $5.1 billion a year for the next 17 years just to make up the underfunding, or more than the $4.5 billion it says it needs to stay afloat. Regardless, that $5.1 billion a year is a major increase over the $7.6 billion paid out in 2009-2010 for teachers’ benefits, something that the Golden State is already struggling to handle even with a recent tax increase courtesy of last November’s passage of Prop. 30.

For reformers in Texas, New Jersey, and Colorado, along with the rest of the school reform movement throughout the nation, it is time to further the much-needed conversation about the real cost of teachers’ compensation for everyone — including taxpayers and teachers themselves — and continue the battle NEA and AFT affiliates over how we compensate all teachers. An unaffordable and ineffective system of compensating teachers is no longer acceptable.

Editor’s Note: Updated to include CalSTRS latest annual report and to double-check estimates.