Debate over old pension scheme divides State governments and Centre

The Centre has launched a propaganda war to discredit this decision against the new scheme.

A member of the All Assam Government NPS Employees’ Association at a protest demanding restoration of the old pension scheme in Guwahati on November 8, 2022. | Photo Credit: PTI

In moves that are gathering momentum, a number of State governments are announcing or implementing decisions to reverse their shift to the new pension scheme (NPS) designed largely by the Centre. Arguing that the NPS has not delivered on its promises, they have decided to restore the old pension scheme (OPS).

All of these States—Rajasthan, Chhattisgarh, Jharkhand, Punjab, and most recently Himachal Pradesh—are ruled by parties other than the BJP. The Central government, given its commitment to the NPS, and State governments ruled by the BJP and its allies are not in favour of such a shift, especially since the new scheme was introduced by the Atal Bihari Vajpayee government. Rather, they have joined the criticism by mainstream economists that such a shift was bound to precipitate a fiscal crisis in States opting for the reversion, and attribute the move to a cynical effort to garner some voter support at the expense of fiscal prudence.

Under the OPS, those who were members of the scheme, which consisted mainly of regular employees of the Central and State governments, made no contribution while they were in service and were eligible for a pension on retirement equal to half of the last drawn pay (the “defined benefit”). In addition, as was the case with their salaries prior to retirement, they were eligible for a dearness allowance linked to inflation, which was a proportion of their basic pension.

The design of this scheme meant that the pension bill of institutions offering its benefits was funded out of their current revenues. The understanding was that such payments ensuring the security of employees after their retirement were a necessary commitment to employees in the civil services. Finding the resources needed to fund the scheme was also, therefore, the responsibility of the state. This is by no means an Indian innovation. Similar schemes have been in operation in a number of countries.

Outside of the civil services, a mandatory retirement savings scheme applies to institutions that employ 20 workers or more. In such institutions, the employee is required to contribute around 10 per cent of his/her salary to the scheme, which is matched by a contribution from the employer, and the sum thus accumulated is managed by the Employees’ Provident Fund Organisation. On retirement, the employee is eligible for a lump sum payment, a part or all of which has to be invested in schemes that offer a regular annuity payment, which serves as the pension.

In a country where most workers are either employed in small informal sector units or are “self-employed”, most citizens were left out of this scheme as well. To provide for those who could not earn enough to save for when they can no longer work, official social protection schemes included one offering a non-contributory pension for those below some officially defined poverty line, though the sum paid to the pensioner in these schemes is paltry.

In sum, the current controversy about a return to the OPS is of relevance largely to schemes operated by the Central and State governments. The decision to scrap the OPS and replace it with the NPS was justified on the grounds that the OPS was not fiscally sustainable. The increased life expectancy of government employees, resulting from improved access to health services, and the increases in per person pensions resulting from increases in the dearness allowance warranted by inflation resulted in an increase in the pension bill of the Centre and the States.

On the other hand, revenues were not rising fast enough. This meant that other expenditures, including social sector spending, had to be curtailed, if the fiscal deficit and the level of borrowing relative to GDP was not to rise.

This argument gives rise to two obvious questions. First, why were revenues not keeping pace with increases in the pension bill? Second, what determines the level of the deficit and borrowing that are considered as the binding limits beyond which they cannot be raised? The answers to these questions differ for the Centre and the State governments.

In the case of the Centre, revenue growth has been tardy because of the fiscal fallout of the embrace of neoliberalism, which involved adopting a lenient tax regime to incentivise the private sector, which was expected to lead development now. In 2019-20, for example, the effective tax rate on profit-making companies surveyed by the tax authorities was just 22.5 per cent, whereas the required statutory rate (without exemptions and concessions) was 34 per cent for companies with an income above just Rs.10 crore.

Neoliberalism also meant that the fiscal deficit must be capped, because of the need to appease finance capital, which considers deficit financed spending as reflective of a profligate state and as inimical to its interests. So that sets a limit on aggregate spending growth. If that limit falls below the rate at which the pension bill rises, then either tax revenues will have to be raised or other expenditures will have to be curtailed.

Given the neoliberal commitment to incentivise private profit-making, the potential for increases in tax revenues was ignored. So, expenditure had to be curtailed to ensure adjustment. But, given inherited expenditure commitments, a fiscal crunch was the likely outcome. Just as the Centre voluntarily offered tax concessions to the corporate sector and chose to rein in its fiscal deficit, it chose to voluntarily withdraw the OPS in 2004.

Weakening fiscal federalism

In the case of the States, the issue is more complex. State revenues have been squeezed by the Centre that has addressed its own fiscal problems by whittling down revenues from taxes that have to be shared with the States and relying on cesses and surcharges that are not part of the divisible pool.

As had been pointed out by the Finance Minister of Tamil Nadu to the Union Finance Minister, the share of cesses and surcharges in the Centre’s revenue has risen from 10.4 per cent of gross tax revenue in 2011-12 to 26.7 per cent in 2021-22. Secondly, State revenues have been battered by the implementation of the GST regime, and the Centre has inadequately compensated them for the shortfall and has brought to an end the compensation regime as of July 2022.

In addition, forced to enact Fiscal Responsibility and Budget Management Acts of their own, there are stringent limits set on deficit spending by the States, which do not have the flexibility, unlike the Centre, to unilaterally raise the fiscal deficit even in the midst of a crisis. This pushed them into following the Centre and replacing the OPS with the NPS.

To divert attention from the fact that neoliberalism and the weakening of fiscal federalism were responsible for the crisis in response to which the OPS was being abandoned, the Central government and the advocates of neoliberalism defended the NPS as being a win-win solution.

Under the NPS, public employees hired after 2004 have to contribute 10 per cent of their pay (the “defined contribution”) to a fund, with the employer providing a counterpart contribution of up to 14 per cent of the salary. The accumulating sums are invested in funds managed by designated “independent” pension fund managers paid for their services. When employees retire, they have the choice of taking out sums amounting to a maximum of 60 per cent of the corpus and investing the rest in an annuity scheme, returns from which constitute the pension. This scheme is mandatory for government employees, but private sector employers and their employees are also eligible to join versions of the scheme.

The argument was that while the employee contributes to the creation of the corpus that finally delivers the pension, the government still contributes a share and the management of those funds by professional fund managers will raise the sums received by the employee at and after retirement. But the pension received is not defined and would depend on how well the corpus is managed by the fund manager.

There are many market risks that the employee is subject to here. The market may not deliver expected returns or may even wipe out a large part of the savings in the event of a crash, as happened with American pensioners during the 2008 financial crisis. Moreover, the professional fund manager, who receives a fee whatever the outcome, may not be as smart or savvy as is presumed. There are enough instances to suggest that this is highly probable. Since there is no guaranteed benefit but only a defined contribution, these risks are significant.

In practice, the Indian experience thus far has not been too comforting, as a federation of Central government employees’ unions underlined in a letter to the Cabinet Secretary. It quoted many examples where the NPS fell way short of the OPS.

The NPS falls short

A defence establishment official who retired after more than 13 years of service received only 15 per cent of what he was eligible for under the OPS. Another with a basic pay of Rs.34,300 received Rs.2,506 as monthly pension after more than 15 years of service, whereas under the OPS, he would have been entitled to Rs.17,150 as pension. There is no shortage of such case histories.

As noted, the government, too, still carries a burden. It contributes to the pension fund, so it records an outgo in its budget, even if not of the same magnitude as earlier. The real beneficiaries of the shift are the fund managers earning fees and commissions for managing other people’s money with no commitment to ensure a guaranteed return.

Moreover, if they are pressured to deliver larger returns, the push to allocate more of the corpus to instruments that promise higher returns intensifies. But that increases the risk of loss that can worsen the already poor returns accruing to pensioners.

Given actual experience, the argument that the NPS offers more than the OPS has been dropped. The emphasis now is on the argument that returning to the OPS would only deliver a fiscal crisis and that opposition State governments are reverting to it only to woo voters. It is also held there is no reason why a small section of civil servants should enjoy this benefit, making them a protected elite.

This is a peculiar argument. None would argue that because a multinational executive earns many multiples of what a senior civil servant is paid, the former should be deprived of his negotiated salary. There are two issues here. Civil servants are paid to serve the interests of the state and, through it, society, and pensions are part of the rewards that are provided for that service. It is not a special benefit that accrues because of special state largesse.

And second, what is important is to expand the net of those eligible for defined benefit pensions to secure their retirement future, and not to deprive even the few who have it of the benefits of the scheme.

The Centre, however, is working hard to push the opposition-led State governments into abandoning the return to the OPS. It has launched a propaganda war to discredit their decision. The Pension Fund Regulatory Development Authority is also refusing to return the corpus accumulated by these States and their employees under the NPS, even though they would now not be availing of pensions under that scheme.

The fear is that if employees in some States are able to regain the benefit of the OPS, the demand for a similar shift from employees of the Central government will only intensify. Acceding to that demand would be to accept that the shift to the NPS was wrong. But as the experience with demonetisation has shown, the government at the Centre is unlikely to admit that it made a mistake.

C.P. Chandrasekhar taught for more than three decades at the Centre for Economic Studies and Planning, Jawaharlal Nehru University, New Delhi. He is currently Senior Research Fellow at the Political Economy Research Institute, University of Massachusetts, Amherst, US.

The Crux

• The governments of Rajasthan, Chhattisgarh, Jharkhand, Punjab, and Himachal Pradesh have announced their decision to restore the old pension scheme (OPS) for government employees.
• The Central government is not in favour of such a shift, especially since the new pension scheme (NPS) was introduced by the Atal Bihari Vajpayee government. It claims that restoring the OPS is vote bank politics, and will precipitate a fiscal crisis.
• Under the OPS, members were eligible for a pension on retirement equal to half of the last drawn pay (the “defined benefit”) along with a dearness allowance linked to inflation.
• The Centre chose to withdraw the OPS in 2004. To divert attention from the fact that neoliberalism and the weakening of fiscal federalism were responsible for the crisis that led to this withdrawal, it defended the NPS as being a win-win solution.
• Under the NPS, employees have to contribute 10 per cent of their pay (the “defined contribution”) to a fund, with the employer matching the contribution of up to 14 per cent of the salary. The accumulating sums are invested in funds managed by designated “independent” pension fund managers paid for their services.
• There are many market risks involved. The pension received is not defined and will depend on how well the corpus is managed by the fund manager.
• Given actual experience, the argument that the NPS offers more than the OPS has been dropped and the Centre has launched a propaganda war to discredit their decision.