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Grout and Stevens (2003) define public service as "...any service provided for a large number of citizens, in which there is a potential significant market failure, broadly interpreted to include equity as well as efficiency, justifying government involvement-whether in production, finance or regulation" (p. 216). Examples of public services available in most of the developed world range from such fundamental needs of modern life such as water, electricity, and waste management to services that, while important, could be considered less essential, like public transportation or social services. The on-going contentious battle in the United States over government-provided health-care captures the essence of the debate over the boundaries of government involvement in service provision, especially in more capitalistic societies like the U.S.
The need for public services can be generated by the supply side of the market, with some services like public transportation and utilities relying on government involvement to prevent market failure or abusive monopolies, while other services are motivated from by the demand side, as seen with national defence and law enforcement services with the government providing for the general service on behalf of the citizens rather than the citizens paying for it directly (Grout and Stevens, 2003).
Much like an electricity network or a fire department, education is a service that the most governments in the developed world finance and in which they are deeply invested. In the 19th century when most education systems were private and available only to those who could afford it, education reformers fought for equal access to education for all income levels, arguing that an educated citizenry could alleviate the effects of poverty and create a more cohesive society (Thattai, 2001). Today, an educated populace is linked to a nation's economic success, especially in fields such as mathematics, science and medicine (Lain, 2007). Consequently, it is critical that the government be invested in improving the quality of the education in order to promote student achievement and equality along racial, gender, and economic lines (Rand, 2009).
Economic success is only one reason the government has a vested interest in the quality of the education its funds provide and is intricately involved in the provision of education to the point where it directly manages schools and is the main employer in the education sector (Grout and Stevens, 2003). Especially in the United States, where falling test scores in mathematics and science are worrisome in a world dominated by technology and scientific innovation, there have been multiple attempts to reform the public education sector in order to improve student performance-one of the key indicators of a functioning educational system (McClusky, 2006).
According to Chait (2009), it is generally accepted that skilled teachers are valuable, but in recent years, it has become apparent that state governments and school districts do not have adequate systems for attracting, developing, and retaining effective teachers and that improvement in this area would yield long-term dividends for both teachers and students. To develop such systems, some reforms have linked teacher pay to student performance and in support of this process, the U.S. federal government created the Teacher Incentive Fund (TIF) which provides discretionary grants to high-need school districts that develop and implement performance-based teacher and principal compensation systems (USDoE, 2009). TIF grants are also intended to support career ladders for teachers-a critical tool for retaining the best teachers-as well as improving instructional skills throughout the entire school (Chait and Miller, 2009).
The purpose of this paper is to examine the economic case for performance-based pay reform programs in the U.S. public education system using the TIF program as an example. It will first make the case for continued public funding of education through a discussion market failures and equity concerns in that sector. Second, the paper will analyze general performance-based pay program reforms in U.S. public education, identifying its objectives and key features and providing economic evidence to support the argument that the reform is achieving its objectives. It will then provide a brief description of the TIF program: the service it provides, the stakeholders, and its objectives and how it supports wider teacher pay reforms. Finally, the paper will draw conclusions about whether the performance-based pay programs like TIF should continue to be implemented.
Market Failures and Equity Concerns in Public Education
Stiglitz (2000) identifies two current major issues-a slowdown in productivity and increased inequality-and both have played a central role in the debate over U.S. public education reform. He further explains that while the reasons behind the decreased productivity are undecided, economic experts and policy makers agree that improvements in human capital are vital to increasing productivity growth and that a strong education system is critical to that goal (Stigliz, 2000).
Bipartisan consensus on the importance of education exists, but there are major controversies over how best to achieve a high-quality education system that is available to all members of the community, regardless of income (Stigliz, 2000). Education is not a "pure public good" (Stiglitz, 2000) and economists generally agree that it possesses qualities that imply that market provision could lead to potentially serious market failures, leading to lower levels of educational attainment in a population than would maximize societal welfare (Friedman, 1962 and Smith, 1976  as cited in Mitch, 2008, pp136). Markets are imperfect in that they can create, according to Riley (2006) an 'unacceptable' distribution of income and too high a level of social exclusion where people with low income are denied access to essential goods, services and opportunities. Ball (1993) put it more succinctly: "...unequal distribution of income in society may bias certain market[s] in favour of the rich and against the poor" (p. 10). This bias extends to the education market, where democratic control of schools can lead to a system of 'winners' and 'losers' (Chubb and Moe, 1990). Such an inequitable outcome is labelled by economists as "market failure" (Bator, 1958 and Cowen, 1988 as cited in Mitch, 2008, p. 136).
The source of market failures discussed thus far result in economic inefficiency in the absence of government intervention. But even if the economy were Pareto efficient Stiglitz (2000) identifies two more arguments for government intervention: income distribution and the fact that individuals may not act in their own best interest. Education differs from other commodities in significant ways, a fact made evident by the controversy over whether increases in educational expenditure lead to increased student performance (Stiglitz, 2000). While many economists believe that expenditures make a greater difference in student performance than earlier studies suggested (Stiglitz, 2006), the research shows the overwhelming importance of teacher quality, which it is not closely related to salaries, education, or experience (Hanushek, 1971).
However, these are not the only arguments in favour of a public education system; there are "merit-good" and "equity" arguments as well (Grout and Stevens, 2003). Mitch (2008) states that one of the more common factors in the failure of education markets is the difficulty parents have in borrowing money to finance their children's education because of imperfections in capital markets. Thus, if education were truly equal, it should be provided outside of the scope of capital markets, where students who merit an education but cannot afford one would benefit. Mitch (2008) identifies a second problem with education, in that it possesses "...the non-excludability and non-rivalry features of public goods" (p. 136). Much like the early education reformers who touted the wider societal benefits of equality in education, he argues that if education leads people become involved members of their communities and less prone to criminal behaviour, it benefits society as a whole, not just the individual (Mitch, 2008).
Analysis: Impact of Performance-Based Pay for Teachers
In the U.S., local communities traditionally have been responsible for their own primary and secondary public education systems, which they mainly finance through local taxes, with additional support from the state and federal governments. Through this local ownership system, school boards have the power to determine schools' curriculum and to hire and fire teachers (Stiglitz, 2000). Likewise, school boards are responsible for paying the teachers in their employ and an overwhelming majority do so according to salary schedules based on years in service and the highest degree attained (Winters et al, 2008). According to a national survey, close to 100 percent of traditional public school teachers are employed in school districts that use these types of schedules (Pudgursky, 2007). Thus, nearly 3.1 million public school teachers are paid primarily according to their years of experience and education level-two variables which weakly correlate with student achievement (Hanushek, 2003, as cited in Pudgursky, 2007). This compensation structure can create a system that rewards teachers who merely remain employed for a long period or who complete advanced degrees, rather than teachers who perform their jobs effectively.
It is this structure that has come under attack by both policy makers and researches in recent years and has been the focus of reform (Winters et al, 2008). There is strong consensus that the way teachers are paid does little to attract talented candidates to the profession or to high-need schools (Chait and Miller, 2009). Nor does the current system reward the most effective teachers. Some reformers call for federal funding to innovative programs designed to develop better teacher payment models, specifically ones that recognize and reward teaching excellence and generate equal access for children in poverty (Chait and Miller, 2009).
Following the influential A Nation at Risk report, a number of school districts experimented with performance-based pay programs in an effort to improve student achievement and reform the nearly universal single salary schedule (Pudgursky, 2007). The emphasis on performance-based pay programs recognizes the consensus that teacher quality is the cornerstone of education (Winters et al, 2008). Recent panel data analyses suggest that teacher quality is one of the most important predictors of student achievement (Rivkin et al, 2005 as cited in Winters, 2008). Performance-based pay supporters suggest that it induces teacher productivity through the provision of financial incentives, much like workers in private companies who receive pay increases and bonuses based on performance (Winters et al, 2008).
However, Winters et al (2008) identify important differences in motivation between the public education sector and private firms, perhaps the most important being the generally held expectation that teachers be, in part, internally motivated to provide high-quality service in a way that private workers are not. One argument asserts that performance-based pay policies penalize teachers because of this expectation, while workers in private companies may be compensated in an attempt to encourage them to reach their potential, not because they have already done so. Another consistent criticism of performance-based pay policies is that it does not recognize teachers who, out of love for their profession and students, are already motivated to provide the best quality education services they can (Winters et al, 2008). Criticisms stemming from these discussions claim a lack of support by teachers for performance-based pay reform and have thwarted reformers' attempts to develop and implement such programs (Murnane and Cohen, 1986).
Research on these programs highlighted other inherent difficulties. Hurdles exist in creating reliable and unified processes for identifying effective teachers, measuring their effectiveness, eliminating preferential treatment, and standardizing assessment systems across school districts (Pudgursky, 2007). Murnane and Cohen (1986) offer one of the most influential critiques of merit-based pay programs, arguing that previous reforms failed because teaching does not easily lend itself to performance-based compensation-which Goldhaber et al (2005) termed the "nature of teaching" hypothesis (as cited in Pudgursky, 2007, p.922). Given the hypothesis' influence and the fact that subsequent critics often raise the same arguments, it is, therefore, worth devoting some attention to arguments against teacher performance-based pay programs.
Difficulty in teacher performance monitoring is a major argument against performance-based pay (Pudgursky, 2007). Unlike other professions, teacher performance is difficult to measure because input is not readily measured in a fair and reliable manner, and, unlike an attorney's billable hours or a truck driver's deliveries, a teacher's output is not marketed (Pudgursky, 2007). Thus, it is argued that the value of education services provided by an individual teacher cannot be readily measured, since student achievement is influenced by many other factors that the teacher does not control (Pudgursky, 2007). This argument had more relevance before major technological advances introduced computerized data systems throughout school districts; however, it is important to note that there are still concerns about the reliability of teacher value-added estimates and some researchers express caution in interpreting teacher effects purely as an attribute (Pudgursky, 2007).
Pudgursky (2007) identifies team productivity as a second argument against performance-based pay programs. Teachers work as members of a team and introducing individual performance-based pay incentives might diminish inter-teacher cooperation and consequently reduce, rather than increase, overall school performance (Pudgursky, 2007). Some critics further argue that these programs can destroy team dynamics between teachers as well as administrators, especially if administrators must reward individual teacher performance (Pudgursky, 2007). However, this argument is problematic, considering that most teachers work in a relatively small teams and economic literature suggests incentives may work quite well in small teams because of mutual monitoring and reciprocation and the ease of communication among team members (Kandel and Lazear, 1992).
Another criticism of performance-based pay programs concerns the issue of multi-tasking when relying on tests or other quantitative measures of teacher performance, which is problematic when a worker's performance is multi-dimensional, but only certain aspects are measured and become the basis for incentives (Pudgursky, 2007). When an organization's overall mission and the activity to which incentives are attached are not aligned, employees tend to shift work toward the rewarded activity, neglecting other activities critical to the organization's success (Pudgursky, 2007), which can occur when teachers focus on "teaching the test" to prepare students for standardized examinations, rather than teaching the fundamentals test is designed to measure.
A performance-based pay program tends to attract and retain individuals who perform well the activity to which incentives are attached and repel those who do not (Pudgursky, 2007). However, in one of his own case studies outside of teaching, Lazear (2000) discerned a more subtle, but important factor in gains from performance-based pay systems arising from labor market selection. He found that sorting effects were both substantial and roughly equal in magnitude to motivation effects (Pudgursky, 2007) and noted that this effect can explain productivity gains (Lazear, 2000). In other words, the incentive system not only raised the productivity of the individual worker, but also raised the overall quality of the general workforce (Pudgursky, 2007). Some researchers further speculate that this selection will be a significant factor in teacher labour market. Studies of teacher turnover consistently find that where ability is defined by a teacher's performance on the ACT or National Teacher Exam, high-ability teachers are more likely than low-ability teachers to leave the profession (Murnane and Olsen, 1990 as cited in Pudgursky, 2007 p.930); however, this trend may be attributed to wage constraints within the profession rather than the attraction of other market opportunities (Pudgursky, 2007).
A recent study by Hoxby and Leigh (2004) found evidence that the migration of high-ability women out of teaching between 1960 and the present was primarily the result of "push" of low teacher pay compensation rather than the "pull" of greater non-teaching opportunities (Pudgursky, 2007). Pudgursky (2007) states that although higher remunerative opportunities for both high and low-ability teachers increased outside the profession, it was the education system's limited pay compensation that accelerated the exit of high-ability teachers. Assuming that high-ability teachers were more effective in the classroom, he further speculates that it is likely that a performance-based pay program would have kept more of them teaching (Pudgursky, 2007).
Over the last decade, researchers have begun to exploit massive longitudinal student achievement data files across the country to undertake "value-added" studies of teacher effectiveness (Pudgursky, 2007). The results have important consequences for the performance-based pay debate: on the one hand it suggests that credential-based pay reforms are not likely to have substantial effects on student, while on the other, it points to substantial student achievement gains if the mix of low and high-performing teachers can be adjusted (Pudgursky, 2007). Multiple studies carried out in school districts throughout the U.S.  consistently found evidence of large variation in achievement scores between classrooms and teachers, suggesting that teachers can have a substantial effect on student achievement growth, particularly if teacher effects are cumulated over a number of years (Pudgursky, 2007). Given these results, reform programs that tie pay to student performance over time would be most effective in recruiting or retaining more high-ability teachers and encourage low-productivity teachers either to improve, leave, or transfer to non-teaching positions (Pudgursky, 2007).
The Teacher Incentive Fund (TIF) Program
The TIF program is one of the many performance-based reforms implemented recently. Its objectives are:
Improving student achievement by increasing teacher and principal effectiveness; Reforming teacher and principal compensation systems so that teachers and principals are rewarded for increases in student achievement; Increasing the number of effective teachers teaching poor, minority, and disadvantaged students in hard-to-staff subjects; and Creating sustainable performance-based compensation systems (USDoE, 2009).
The program, which is open to local and state education agencies as well as non-profit organizations, conducts in-classroom evaluations of participating teachers throughout the year and assesses success by improvements in student achievement, as well as other factors (USDoE, 2009). TIF, which is currently active in 31 U.S. states, also provides long-term support to participants through the Center for Educator Compensation Reform (CECR), which offers workshops, lectures and conferences throughout the country, as well as on-line resources like its electronic library and program database (CECR, 2010).
A unique feature of TIF is that funding from the federal government goes directly to participating teachers, rather than the general state or local school budgets (Chait and Miller, 2009). This direct funding is designed to compensate the participating teachers, who assume increased roles and responsibilities and it also pays teachers in critical subject areas, like mathematics, science, and special education (Chait and Miller, 2009). Although the program was implemented by the Bush administration in 2006, it garners strong bi-partisan support. The current U.S. administration has proposed a dramatic increase in the program's funding from $97 million in 2009 to $487.3 million in 2010 (Chait, 2009). Since TIF has existed for a relatively short time, its effectiveness is uncertain (Sawchuk, 2009); however, annual program growth and a dramatic increase in funding indicate that its initial impact on teacher performance is a positive one, which can be proved only with additional long-term research.
Hanushek (2007) argues that to improve the quality of education or, at the very least, ensure that all students receive a minimum standard educational experience, historically states have developed a variety of policies and regulations designed to guide the actions of local districts. To be sure, these policies and regulations must be adaptable to the local districts' specific needs and culture (Hanushek, 2007). Similarly, school budgetary decisions, which are ultimately political involving a variety of social priority tradeoffs, must reflect the district and students' changing needs (Hanushek, 2007).
As a result, budgetary decisions cannot be divorced from education policy; therefore, since the policy objective is to raise student performance, the school's financial system must support it (Hanushek, 2007). The way that funds are distributed to schools introduces incentives for their behaviour and ignoring that fact introduces a structure that limits both efficiency and performance (Hanushek, 2007). Therefore, for student achievement to improve the school financial system must be harmonized with the policy structure, as well as provide and support improved incentives within schools (Hanushek, 2007).
Transforming teacher salary schedules is becoming an increasingly central theme in general education reform, however, knowledge about designing effective programs is limited and so funding for further piloting and evaluation will be important (Rand, 2009). Pay for performance should also be combined with other reforms, such as assistance to educators to promote continuous improvement in educational practices (Rand 2009). Reform programs must emphasize the capacity to structure, apply, and evaluate alternative incentives, which is what the U.S. government through the TIF program is attempting to do. While providing structure and funding, TIF is designed to encourage local flexibility, innovation in teacher pay reform and enable future research to examine their contribution to education reform (CECR, 2010).