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Why the Old Pension Scheme is both bad economics and bad politics

The Congress and AAP are promising to switch to the Old Pension Scheme. Turning the clock back on reform is bad politics, and certainly bad economics. Here's why

Old Pension Scheme | AAP | Congress | BJP | Gujarat ElectionIndia Old Pension Scheme: An elderly man joins a protest for old age pension in Jantar Mantar, New Delhi. (Express Photo/File)

Old Age Pension Scheme, AAP, Congress: Congress and AAP are promising to switch to the Old Pension Scheme. Congress has already reverted to the Old Pension Scheme in Rajasthan and Chhattisgarh, and AAP has said it would do the same in Punjab. Turning the clock back on reform is bad politics, and certainly bad economics. Here’s why.

What was the Old Pension Scheme?

Pension to government employees at the Centre as well as states was fixed at 50 per cent of the last drawn basic pay. The attraction of the Old Pension Scheme or ‘OPS’ — called so since it existed before a new pension system came into effect for those joining government service from January 1, 2004 — lay in its promise of an assured or ‘defined’ benefit to the retiree. It was hence described as a ‘Defined Benefit Scheme’.

To illustrate, if a government employee’s basic monthly salary at the time of retirement was Rs 10,000, she would be assured of a pension of Rs 5,000. Also, like the salaries of government employees, the monthly payouts of pensioners also increased with hikes in dearness allowance or DA announced by the government for serving employees.

DA — calculated as a percentage of the basic salary — is a kind of adjustment the government offers its employees and pensioners to make up for the steady increase in the cost of living. DA hikes are announced twice a year, generally in January and July. A 4 per cent DA hike would mean that a retiree with a pension of Rs 5,000 a month would see her monthly income rise to Rs 5,200 a month.

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As on date, the minimum pension paid by the government is Rs 9,000 a month, and the maximum is Rs 62,500 (50 per cent of the highest pay in the Central government, which is Rs 1,25,000 a month).

What were the concerns with the OPS?

i) The main problem was that the pension liability remained unfunded — that is, there was no corpus specifically for pension, which would grow continuously and could be dipped into for payments.

The Government of India budget provided for pensions every year; there was no clear plan on how to pay year after year in the future. The government estimated payments to retirees ahead of the Budget every year, and the present generation of taxpayers paid for all pensioners as on date. The ‘pay-as-you-go’ scheme created inter-generational equity issues — meaning the present generation had to bear the continuously rising burden of pensioners.

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ii) The OPS was also unsustainable. For one, pension liabilities would keep climbing since pensioners’ benefits increased every year; like salaries of existing employees, pensioners gained from indexation, or what is called ‘dearness relief’ (the same as dearness allowance for existing employees). And two, better health facilities would increase life expectancy, and increased longevity would mean extended payouts.

Over the last three decades, pension liabilities for the Centre and states have jumped manifold. In 1990-91, the Centre’s pension bill was Rs 3,272 crore, and the outgo for all states put together was Rs 3,131 crore. By 2020-21, the Centre’s bill had jumped 58 times to Rs 1,90,886 crore; for states, it had shot up 125 times to Rs 3,86,001 crore.

Old Pension Scheme | AAP | Congress | BJP | Gujarat Election In 30 years, the cumulative pension bill of states has jumped to Rs 3,86,001 crore in 2020-21 from Rs 3,131 crore in 1990-91.

What was planned to address this situation?

In 1998, the Union Ministry of Social Justice and Empowerment commissioned a report for an Old Age Social and Income Security (OASIS) project. An expert committee under S A Dave, a former chairman of SEBI and Unit Trust of India, submitted the report in January 2000. The OASIS project was not meant to reform the government pension system — its primary objective was targeted at unorganised sector workers who had no old age income security.

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Taking the 1991 Census numbers, the committee noted that just 3.4 crore people, or less than 11 per cent of the estimated total working population of 31.4 crore, had some post-retirement income security — this could be government pension, Employees’ Provident Fund (EPF), or the Employee Pension Scheme (EPS). The rest of the workforce had no means of post-retirement economic security.

The OASIS report recommended individuals could invest in three types of funds — safe (allowing up to 10 per cent investment in equity), balanced (up to 30 per cent in equity), and growth (up to 50 per cent in equity) — to be floated by six fund managers. The balance would be invested in corporate bonds or government securities. Individuals would have unique retirement accounts, and would be required to invest at least Rs 500 a year.

Post retirement, at least Rs 2 lakh from the retirement account would be used to purchase an annuity. (An annuity provider invests the amount and provides a fixed monthly income — which was Rs 1,500 when the report was prepared — for the remainder of the individual’s life.)

A year-and-a-half after the Project OASIS report was submitted, the Ministry of Personnel, Public Grievances and Pensions set up a high-level expert group (HLEG) under B K Bhattacharya, a former chief secretary of Karnataka, to look into the situation for government employees.

The HLEG suggested a hybrid defined benefit/ defined contribution scheme for government employees. In the first tier, it recommended a 10 per cent contribution by the employer and the employee. The accumulated funds would be used to pay pension in annuity form.

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In the second tier, no limit was specified for the employee, but the employer’s contribution would be matching but limited to 5 per cent. Accumulated funds could be withdrawn in lumpsum or converted into annuity. These incomes would be tax exempt.

The report was submitted on February 22, 2002, but it did not find favour with the government.

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What was the origin of the New Pension Scheme?

The New Pension System proposed by the Project OASIS report became the basis for pension reforms — and what was originally conceived for unorganised sector workers, was adopted by the government for its own employees.

The New Pension Scheme (NPS) for Central government employees was notified on December 22, 2003. Unlike some other countries, the NPS was for prospective employees — it was made mandatory for all new recruits joining government service from January 1, 2004.

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The defined contribution comprised 10 per cent of the basic salary and dearness allowance by the employee and a matching contribution by the government — this was Tier 1, with contributions being mandatory. In January 2019, the government increased its contribution to 14 per cent of the basic salary and dearness allowance.

Individuals can choose from a range of schemes from low risk to high risk, and pension fund managers promoted by public sector banks and financial institutions, as well as private companies.

Schemes under the NPS are offered by nine pension fund managers — sponsored by SBI, LIC, UTI, HDFC, ICICI, Kotak Mahindra, Adita Birla, Tata, and Max. The risk profiles of various schemes offered by these players vary from ‘low’ to ‘very high’. The 10-year return for the NPS Scheme-Central Government floated by SBI, LIC, and UTI stood at 9.22 per cent; the 5-year return at 7.99 per cent, and the 1-year return at 2.34 per cent. Returns on high-risk schemes could be as high as 15 per cent.

Over the last eight years, the NPS has built a robust subscriber base, and its assets under management have increased. As on October 31, 2022, the Central government had 23,32,774 subscribers, and states had 58,99,162 subscribers. The corporate sector had 15,92,134 subscribers, and the unorganized sector 25,45,771. There were 41,77,978 subscribers under the NPS Swavalamban scheme. The total assets under management of all these subscribers stood at Rs 7,94,870 crore as on October 31, 2022.

What view did the UPA government take?

It was the NDA government under A B Vajpayee that took up the gauntlet on pension reform. The NPS became effective for new recruits in government from January 1, 2004, and the new government led by the Congress that came to power that year bought into the reform fully.

On March 21, 2005, the UPA government introduced a Bill in Lok Sabha to give statutory backing to the Pension Fund Regulatory and Development Authority of India, the regulator for the NPS. The Bill was referred to the Standing Committee on Finance chaired by the BJP’s B C Khanduri.

The committee’s July 2005 report showed the new government had rooted for the defined contribution feature of the NPS. In its deposition before the committee, the Ministry of Finance said this was the best time for India “to be starting a system of pension reforms”, given its relatively young working population.

Less than two years later, to get states on board for pushing through pension reforms, then Prime Minister Manmohan Singh and then Finance Minister P Chidambaram called a meeting of Chief Ministers and dwelt at length on the implications of pension on government finances, and exhorted them to allow accumulated funds in the public account to be invested in a pattern similar to that of non-government provident funds.

Why is the OPS both bad economics and bad politics?

In 30 years, the cumulative pension bill of states has jumped to Rs 3,86,001 crore in 2020-21 from Rs 3,131 crore in 1990-91. Overall, pension payments by states eat away a quarter of their own tax revenues. (See chart) For some states, it is much higher. For Himachal, it is almost 80 per cent (pensions as a percentage of the state’s own tax revenues); for Punjab it is almost 35 per cent; for Chhattisgarh 24 per cent; and for Rajasthan 30 per cent.

If wages and salaries of state government employees are added to this bill, states are left with hardly anything from their own tax receipts. Funding a small number of former government employees by utilising a chunk of taxpayers’ money cannot be good politics.

There is also the larger issue of inter-generational equity. Today’s taxpayers paying for the ever-increasing pensions of retirees, with Pay Commission awards almost taking the pension of old retirees to current levels, means the pension of someone who retired in 1995 may well be the same as that for someone who retires in 2025.

As it is, the current generation of taxpayers are not only footing the pension bill of those who joined government service before 2004, they are also contributing to the 10 per cent contribution the state governments have been making for those who joined from January 1, 2004.

After having backed pension reforms piloted by the NDA, Congress-led governments in Rajasthan and Chhattisgarh are switching to the Old Pension Scheme. The party has promised to revert to OPS in Himachal and Gujarat too.

This does bring state governments some short-term gains: they save money since they will not have to put the 10 per cent matching contribution towards employee pension funds. For employees too, it will result in higher take-home salaries, since they too will not set aside 10 per cent of their basic pay and dearness allowance towards pension funds.

But while the party has caved in to employee demands — even if they account for a small percentage of the country’s workforce and are better taken care of than many others — the remedy is worse than the problem faced by some government employees, who are concerned their pension may not be the same as 50 per cent of their last salary drawn (as in the OPS).

Contrast this with the bulk of the workforce which has no old age income security, but which also does not have much electoral salience.

First published on: 17-11-2022 at 07:11 IST
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