Friday, December 1, 2023

Old Pension Scheme Is Both Bad Economics and Bad Politics

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Invoking the Old Pension Scheme is a pledge made by both Congress and the AAP. In Rajasthan and Chhattisgarh, Congress has already reinstated the Old Pension Scheme, and the AAP has declared it will do the same in Punjab. Reversing reform would be bad for both politics and the economy. This is why.

The Old Pension Scheme:

Pensions for employees of the federal and state governments were set at 50% of the most recent basic salary. The Old Pension Scheme, or “OPS,” was attractive because it promised a retiree an assured or “defined” payment before a new pension scheme went into effect for anyone entering government service after January 1, 2004. As a result, it was referred to as a “Defined Benefit Scheme.”

For instance, if a government employee retired with a basic monthly pay of Rs 10,000, she would be guaranteed a pension of Rs 5,000.

Along with increases in dearness allowance, or DA, announced by the government for long-serving employees, retirees’ monthly payments also increased.

The government provides its employees and pensioners with DA, which is calculated as a percentage of the base income, as a type of adjustment to counteract the steadily rising cost of living. Two times a year, usually in January and July, DA increases are announced. A retiree receiving a pension of Rs 5,000 per month will see her monthly income increase to Rs 5,200 per month with a 4% DA raise.

The government currently pays a minimum pension of Rs 9,000 per month and a maximum of Rs 62,500. (50 per cent of the highest pay in the Central government, which is Rs 1,25,000 a month).

In what ways was the OPS a problem?

The primary issue was that the pension liabilities was still unfunded, meaning that there was no corpus created specifically for pensions that would grow over time and could be used to make payments.

Every year, pensions were included in the budget of the Indian government; however, there was no clear strategy for future payment cycles. Every year, the government anticipated payments to retirees ahead of the Budget, and as of this writing, all pensioners had been covered by current taxpayers. The “pay-as-you-go” system produced concerns with intergenerational equity, forcing the current generation to shoulder the ever increasing cost of pensions.

The OPS could not be maintained. Since pensioners’ benefits increased annually, like present employees’ salary, pensioners benefited from indexation, or what is known as “dearness relief,” which would result in rising pension liabilities (the same as dearness allowance for existing employees). Additionally, improved medical facilities would lead to longer payouts due to an increase in longevity.

Pension liabilities for the federal government and the states have increased during the past three decades. The cost of pensions for the Centre in 1990–1991 was Rs. 3,272 crore, and the total cost for all the states was Rs. 3,131 crore. The Center’s bill increased by 58 times to Rs 1,90,886 crore by 2020-21, while the States’ bill increased by 125 times to Rs 3,86,001 crore.

What was the plan to deal with this circumstance?

The Old Age Social and Income Security (OASIS) initiative was the subject of a report ordered in 1998 by the Union Ministry of Social Justice and Empowerment. The report was delivered in January 2000 by an expert group led by S A Dave, a former SEBI and Unit Trust of India chairman. The OASIS project’s main focus was on unorganised sector workers who lacked old-age income security; it was not intended to change the government pension system.

Just 3.4 crore persons, or less than 11% of the estimated total working population of 31.4 crore, had some form of post-retirement income security, according to the 1991 Census data. This might have been a government pension, Employees’ Provident Fund (EPF), or the Employee Pension Scheme (EPS). The remaining employees lacked any means of securing their financial future after retirement.

According to the OASIS research, investors should consider three different types of funds that will be offered by six fund managers: safe (which allows up to 10% equity participation), balanced (which allows up to 30% equity investment), and growth (which allows up to 50% equity investment). The remaining amount would be invested in government or business bonds.

Each person will have their own retirement account and be expected to contribute at least Rs 500 annually.

At least Rs 2 lakh would be taken out of the retirement account after retirement to buy an annuity. (An annuity provider invests the money and offers a fixed monthly income for the rest of the person’s life; at the time the piece was written, that amount was Rs 1,500.)

A high-level expert group (HLEG) was established by the Ministry of Personnel, Public Grievances and Pensions under the leadership of B K Bhattacharya, a former chief secretary of Karnataka, to investigate the situation facing government employees a year and a half after the Project OASIS report was delivered.

For government personnel, the HLEG recommended a hybrid defined benefit/defined contribution plan. It suggested that both the company and the employee contribute 10% in the first tier. Pension payments would be made as annuities using the accrued savings.

In the second tier, there was no cap on the employee’s contribution, but the employer’s match was capped at 5%. Accumulated funds could be converted into an annuity or withdrawn in one big sum. These earnings would be exempt from taxes.

The report was turned in on February 22, 2002, but the government did not like it.

The origin of the New pension Scheme:

The Project OASIS report’s New Pension System, which was originally intended for workers in the unorganised sector, served as the foundation for pension changes. The government then adopted the New Pension System for its own personnel.

On December 22, 2003, the Central Government Employees’ New Pension Scheme (NPS) was announced. In contrast to several other nations, the NPS was intended for potential employees; starting on January 1, 2004, it became a requirement for all new government hires.

This was Tier 1, and payments were required. The defined contribution consisted of 10% of the employee’s base pay, a dearness allowance, and a matching contribution from the government. The government’s share of the basic pay and dearness allowance increased to 14% in January 2019.

People have a variety of options to choose from, including low-risk, high-risk, and pension fund managers pushed by both public sector banks and financial institutions and private businesses.

Nine pension fund managers that are sponsored by SBI, LIC, UTI, HDFC, ICICI, Kotak Mahindra, Adita Birla, Tata, and Max are offering plans under the NPS. These players’ varied plans have risk levels that range from “low” to “extremely high.” The 10-year return for the Central Government NPS Scheme launched by SBI, LIC, and UTI was 9.22%; the 5-year return was 7.99%; and the 1-year return was 2.34%. Returns on high-risk investments could reach 15%.

The NPS has amassed a sizable subscriber base over the past eight years, and its assets under administration have grown. State governments had 58,99,162 subscribers as of October 31, 2022, while the federal government had 23,32,774 customers. 15,92,134 subscribers were in the corporate sector, while 25,45,771 were in the unorganised sector. In total, 41,77,978 people subscribed to the NPS Swavalamban programme. As of October 31, 2022, the combined assets under control of all of these subscribers totaled Rs. 7,94,870 crore.

Why is the OPS problematic for both politics and economics?

The total pension bill for states has increased dramatically over the past 30 years, from Rs 3,131 crore in 1990–1991 to Rs 3,86,001 crore in 2020–21. In total, states lose a fourth of their tax income to pension payments. For certain states, it is far greater (see chart). Pensions as a percentage of the state’s own tax receipts are close to 80% for Himachal, close to 35% for Punjab, 24% for Chhattisgarh, and 30% for Rajasthan.

States are left with hardly anything from their own tax revenues after paying this expenditure, including the wages and salaries of state government employees.

It cannot be considered smart politics to fund a few former government personnel with a portion of taxpayer funds.

The wider issue of intergenerational equity is also present. The pension of someone who retired in 1995 may very well be the same as that of someone who retires in 2025 due to today’s taxpayers funding retirees’ ever-increasing pensions and Pay Commission awards that have nearly brought old retiree pensions up to current levels.

As things stand, the current generation of taxpayers not only pays for the pensions of individuals who began working for the government prior to 2004, but they also contribute to the 10% payment that the state governments have been providing for those who began working after that year.

Congress-led governments in Rajasthan and Chhattisgarh are converting to the Old Pension Scheme after supporting pension changes pioneered by the NDA. The party has pledged to reinstate OPS in Gujarat and Himachal as well.

In the near term, this does benefit state governments in that they save money by not having to provide the 10% matching contribution to employee pension funds. Employee take-home pay will increase as a result because they will no longer contribute 10% of their basic pay and dearness allowance to pension funds.

Even though they make up a small portion of the workforce and are better off than many others, the party has given in to employee requests, but the solution is worse than the issue some government workers are facing because they fear their pension may not be equal to 50% of their final wage drew (as in the OPS).

Compare this to the majority of the workforce, which has both old age income security and a high electoral salience.

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