Ajit Ranade: A truly secure nest egg is one that’s fully funded

If you say that instead of contributing 14% of basic pay towards pension, the government will now contribute 18.5%, then it looks like a minor tweak, with some generosity thrown in. But that is not the whole story. 

It is not just the government’s contribution that has gone up steadily from 10% to 14% to 18.5%, but the new scheme has become an ‘assured income’ scheme. Under the new Unified Pension Scheme (UPS), the retired government employee is assured of an income that is 50% of the average salary drawn in the last year before retirement. 

To qualify for this benefit, the retiree must have put in at least 25 years of service. Else it is pro-rated. This 50% assurance begins to sound like the Old Pension Scheme (OPS), which too had an assurance of half of one’s last drawn salary. UPS is thus not a minor tweak, but an abandonment of the principle of ‘no assurance.’ 

Also read: Mint Quick Edit | Unified Pension Scheme: Old meets the New

The transition from OPS to NPS was a hard-fought reform, the debate over which lasted for more than 10 years, starting with the Dave Committee of 1994, if not earlier. It was a paradigm shift from ‘defined benefits’ to ‘defined contribution.’ 

It shifted the burden of building the retirement nest egg from employer to employee. In OPS, the employee made zero contribution, whereas in NPS, both the employer and employee build the retirement kitty together. The extra bounty comes from the stock market, which over a long run beats fixed-income earnings. 

Government employees have retirement access to the provident fund too, which is built jointly over their working life and whose annual interest is determined by the labour ministry, not by markets, nor the Reserve Bank of India or finance ministry.

The counter to people alarmed by the new UPS is that the principle of employee contribution has not been abandoned, which is also a crucial element of pension reform. That is true. But the assured income element means a liability comes on to the government, even if it is supposed to be small. 

This could lead to a slippery slope of an increasing government contribution (from 18.5% to 28%, then 50% and so on). As such, even a dearness allowance (i.e. inflation adjustment) has been added. Don’t be surprised if the ‘tweak’ leads us all the way back to OPS.

Indeed, the reason for modifying NPS in the first place is political. As discussed in a Mint column (‘The Old Pension Scheme Wildfire Must Be Stopped’, 8 November 2023), a mis-reading of the 2022 Himachal Pradesh state election narrow victory led to the bringing back of OPS in that state. 

Also read: Unified Pension Scheme will not be rolled back, says government official in response to trade union demand

Several other states in copycat fashion have decided that OPS is a vote catcher and have brought it back. This is Gresham’s Law on the spread of bad ideas. It has become a political hot potato, never mind that 97% of the workforce is not affected at all by OPS or UPS. 

The remaining 3% who constitute government employees, both at the Union and state levels, are the vocal minority who have politically influenced this move away from NPS to UPS. In 2021-22, of the combined state and Union government revenues, 18.2% was spent on pensions alone. 

This component is increasing much faster than growth in GDP or tax revenues. It is gobbling up the revenue space of governments at all levels, edging out spending on health, education and social services. 

The average pension paid in the country today is nearly ₹6 lakh per annum, and under the OPS philosophy (or UPS ‘assured income’ framework), it will rise much faster than India’s per capita income. The states that are embracing OPS are marching rapidly towards fiscal bankruptcy. 

Since 1991, the share of states’ revenues paying for pensions has gone up from 7.9% to 27.4%. Guess who is getting crowded out? There is deep-rooted intra- and inter-generational inequity in such a pension arrangement for government employees. 

It is unfair to the country’s 97% non-government workers and unborn future generations who will surely face a higher tax burden to keep financing ‘assured incomes.’ 

The NPS was designed, crucially, to move from an unfunded to a fully funded pension obligation, with zero liability on the government on retirement.

So, why was NPS not tweaked this way back in 2004 itself when it was rolled out? Why is this wisdom in hindsight, even as pension reform was discussed and debated for more than a decade? 

One of the reasons could be that the design of NPS did not take care of the transitional batch of employees who were just 10 years away from retirement when they had to switch from OPS to NPS in 2004. 

Their nest egg did not have enough time to build up and hence now they discover that their pension benefits are sharply lower than their colleagues who retired just a year earlier than them. This surely must have caused anger and heartburn. 

But it could have easily been taken care of with a special fiscal provision without abandoning the principle of ‘no assured income.’ All other younger cohorts who join NPS afresh would have no memory of the government-funded juicy fruit of OPS, and in any case have a long ramp to build their nest eggs. They would not protest against NPS.

Also read: Unified Pension Scheme: a suitable compromise for pensioners?

A fully funded pension scheme for all government employees is a must to make fiscal room for truly universal old-age income security for the elderly.