In a democracy, pursuit of long term public good often entails a short-term political price. The Unified Pension Scheme (UPS) approved last week by the Union government for its employees is an effort to reconcile the necessary National Pension System (NPS) – a fiscally prudent contributory pension scheme introduced in 2004 – with the increasing demand of employees to guarantee a defined-benefit pension as in case of the Old Pension Scheme (OPS).
Let us demystify these acronyms – UPS, NPS, and OPS. All large economies have a contributory pension system by which the employee and the employer contribute a fixed percentage of wages to a fund which keeps growing with returns on investments.
Employees’ pensions after retirement are drawn from this pension fund and there is no burden on the future taxpayer. For instance, in the United States employees and employers pay 6.2% each of wages (subject to a maximum) throughout their working lives, and the pension is paid from this fund after retirement. Similar funds and contributory pension systems are in place in all OECD countries.
The table below shows that the annual contributions to the pension fund and disbursements match more or less evenly, and healthy reserves have been built over the years to meet shortfalls, if any. Even then, as populations are ageing, there are concerns that outflows from the pension fund will exceed the inflows in future, and these countries are responding by increasing the retirement age and readjusting pension contributions and disbursements.
In India, however, the pension system for public servants is radically different. Under the OPS, applicable to all government employees recruited before 2004, there is no pension contribution by the employee or the employer. Pensions are drawn from taxpayers through budget allocation, thus imposing a huge burden on future taxpayers for past services rendered.
We also have a very generous pension scheme unlike in the OECD countries. Employees get 50% of last pay drawn; and the pension amount keeps increasing with price indexation (dearness allowances) and wage indexation (generous periodic pay revisions).
For instance, in the US, average pension in 2021 was $ 16,920 per person, or about 25% of the per capita income. But in India, the average pension was about Rs 5,34,000, or about 277% of the per capita income! Not surprisingly, the pension burden is rising alarmingly – about three times in the Union in the decade from 2012-13 to 2021-22, and about eleven times in states during the 18 years from 2004-05 to 2021-22. As a result, 18.2% of total government revenues in the Union and states was spent on pensions for government employees, who only constituted 3.2% of the total workforce in the country.
It is this worrisome and unfunded mounting pension burden that led to the introduction of the NPS for all Union government employees recruited from January 1, 2004. Under the NPS, the employee contributes 10% of the wages and the Union contributes 14% towards a pension fund managed by a Pension Fund Regulatory and Development Authority (PFRDA). The employees recruited since 2004 derive pension benefits after retirement from this fund, and there will be no future burden on tax payers.
Since 2004, all states except West Bengal embraced the NPS. But as the share of employees recruited after 2004 kept increasing, there were demands from government employees to revert to the unfunded, index linked generous OPS at the cost of the future tax payer. Many non-BJP governments succumbed to the pressure. In Himachal Pradesh, Punjab, Rajasthan, Madhya Pradesh, Chattisgarh and Jharkhand, governments reverted to the OPS, and in states where the BJP regained power, they are in the process of switching back to the NPS. In Karnataka and Telangana, Congress promised reversion to OPS, but mercifully the governments maintained a discreet silence after coming to power. In Andhra Pradesh, the government introduced a guaranteed pension scheme, while continuing the contributory, funded system.
The UPS announced by the Union government last week is a response to employees’ demands for an assured pension not dependent on market vagaries. There is a legitimate concern that pension funds invested in the stock market may not yield adequate returns, or may even be depleted in volatile market conditions or disappear if the market crashes.
The UPS now guarantees benefits – assured pension, family pension, and minimum pension, inflation indexation, and lump sum payment on superannuation. These guarantees apply irrespective of whether the accumulated contributory pension fund yields adequate returns or not. In effect, the Union government is assuming the responsibility to cover the gap between UPS and NPS. UPS increases the Union’s expenditure, but future payments are met from present increased contributions. There will be periodic actuarial analysis to determine the Union’s contribution to meet pension costs. Therefore, the contributory nature of the pensions is kept intact.
The states would do well to embrace a similar system of guaranteed pensions met from a contributory pension fund. The basic principle should be that future taxpayers will not be burdened with the payments for past services rendered to earlier generation.
While the UPS is a fair reconciliation of long-term good with short-term pain, there are dangers ahead. In a contributory pension scheme without defined benefits (as in the NPS), the employee draws a pension from the fund kept out of government account and managed by PFRDA. But if government is to guarantee defined benefits irrespective of the returns on pension fund, future governments must be in robust fiscal health. Unfortunately many states are indulging in fiscal profligacy, promising and implementing unsustainable welfare programmes with borrowed money. These states are borrowing heavily for expenditure on salaries, pensions, interest payments and welfare. Sooner than later, many of these states will fail to meet their payment obligations, and will not be able to borrow endlessly. A future Union government may go down the same path. That is what happened in Sri Lanka, Zimbabwe and Venezuela. Such a crisis will destroy our growth momentum and perpetuate mass poverty. We need to build a renewed national consensus to evolve a politically viable framework for fiscal prudence to protect the future.
Dr. Jayaprakash Narayan is the founder of the Lok Satta movement and Foundation for Democratic Reforms. His email is drjploksatta@gmail.com and he posts on X @jp_loksatta.
Vriti Bansal and Sumedha Kuraparthy are research and advocacy leads at respectively at the Foundation For Democratic Reforms.
This piece was first published on The India Cable – a premium newsletter from The Wire & Galileo Ideas – and has been updated and republished here. To subscribe to The India Cable, click here.