Tying teachers' pay to their classroom performance should, says Victor Lavy, improve the current educational system both by clarifying teaching goals and by attracting and retaining the most productive teachers. But implementing pay for performance poses many practical challenges, because measuring individual teachers' performance is difficult. Lavy reviews evidence on individual and school-based incentive programs implemented in recent years both in the United States and abroad. Lavy himself evaluated two carefully designed programs in Israel and found significant gains in student and teacher performance. He observes that research evidence suggests, although not conclusively, that pay-for-performance incentives can improve teachers' performance, although they can also lead to unintended and undesired consequences, such as teachers' directing their efforts exclusively to rewarded activities. Lavy also offers general guidelines for designing effective programs. He emphasizes that the system must measure true performance in a way that minimizes random variation as well as undesired and unintended consequences. It must align performance with ultimate outcomes and must be monitored closely to discourage gaming if not outright fraud in measured output. Goals should be attainable. Incentives should balance individual rewards with school incentives, fostering a cooperative culture but not at the expense of free riding. All teachers should be eligible for the incentive offered, but only a subset of teachers should be rewarded in practice. If too many teachers are rewarded, teachers may not need to exert much extra effort to benefit. Many of the practical challenges faced by performance-related pay, Lavy says, can be addressed through careful design of the system. He emphasizes that setting up a performance-related pay system that works is not a one-time task. Even with the best preparation, initial implementation is likely to be problematic. But if the effort is seen as ongoing, it should be possible to make progress gradually in developing incentives that motivate the desired teaching behaviors and that will be perceived by teachers as fair and accurate. (Contains 60 notes.)