The majority view on the Old Pension Scheme (OPS), at least in opinion spaces, is that it’s detrimental to public finances. Simply put, the OPS, which has been largely disbanded but is slowly coming back, involved paying retired personnel a pension from government revenue as long as they lived. The amount was 50% of the last pay drawn. This held for all employees who joined government service before 2004. Therefore, the government’s liability extends for a prolonged period of time. Those who joined after 2004 contribute from their salary to the new pension scheme (NPS) instead of the provident fund (PF), with the government contributing a similar amount, as with PF. On retirement, one gets payouts from the pension fund in perpetuity. But the government bears no liability. Theoretically, the pension fund cannot guarantee a return, unlike the old scheme which assured payments linked to the last drawn salary, with periodic adjustments made for inflation-based changes in dearness allowance.
The OPS is of disadvantage to the government, while the NPS disfavours the employee. That’s why some states have been looking to go back to the OPS, which critics term populist. There are arguments on both sides if populism is kept aside.
The crux is the ability of budgets to support such expenditure. Going by Reserve Bank of India (RBI) data, in 2021-22, all states had a salary bill of ₹9.74 trillion and a pension bill of around ₹4 trillion; numbers for 2022-23 are not yet available. Hence, pensions would be around 40% of the salary bill and will keep increasing for two reasons. First, there would be more people retiring every year; and second, pension is indexed to the dearness allowance twice a year, and the payouts will be progressively higher for every pensioner. The argument goes that as the payout burden keeps rising, states will have to commit more of their funds to pensions, leaving less for capital expenditure and other development efforts. There can be no dispute on this point.
However, if one applies the Rawlsian theory of justice to public finance, which was originally used more in the context of freedom (to ensure every citizen is entitled to the same rights), then the argument for not reviving the OPS is flawed. This is so because switching to the NPS discriminates between old and new government employees.
In the same organization, employees who do the same work cannot be treated differently in terms of pay packages because of an arbitrary cut-off date.
This is significant because in the government sector, salaries and perquisites get linked to one’s designation, but there is silence on post-retirement benefits. Proponents of the OPS may have a convincing argument here. In fact, there was the concept of OROP (one-rank, one-pension) which was adopted for the military, which follows the OPS to a greater extent. So, why not have this for all government employees?
Critics may aver that a high pension burden can jeopardize public finances if the OPS is re-adopted. Here, we must understand the ethos that drives private and public sector compensation packages. The public sector under the government offers smaller pay packages than the private sector, but throws in perquisites such as generous pensions. The private sector usually offers few if any perquisites, but follows the concept of cost-to-company (CTC), which subsumes all benefits in the pay package. Even the employer’s PF contribution, which is mandatory, is counted as part of the employee’s CTC. A logical response would be to have the government follow a similar CTC policy.
But if the government takes the CTC approach, then its salary bill would get inflated, which would again attract the attention of critics. These structures are a legacy of past decisions and correcting them is a challenge, as it creates a disequilibrium in some other area. The idea of deferred payments in the form of pensions from the exchequer was a way to offer old-age social security as well as control immediate government expenses. In a way, this is analogous to the government issuing extremely long-dated paper to stretch out its debt payments over an elongated span of time.
A broader issue is the role of the state in any economy. Principles of public finance focus on redistribution of income, which is done through a progressive tax structure and spending on schemes for the poor as well as investments in infrastructure, where private enterprise does not venture. Over the years, this line of thinking has changed and attention has shifted to making government revenue work better. This has led to the onus of capital formation falling on the government. Facilities that were free are now being priced based on market principles. Subsidies are being scorned at, and with the spread of capitalist principles, there has been a tendency for state spending to get aligned more with private interests. One could even say we have seen a capitalist capture of public policy all across the world. The last area which is now being looked at closely is the ‘committed expenditure’ of governments, of which salaries and pensions are a significant component. In the West, health-care is another issue that is often brought up for discussion.
There are evidently strong arguments on both sides. A way out would be to go back to the drawing board and balance compensations by raising the salaries of those under the NPS to assure them parity. Perquisites can also be reworked so that within the same government department, there is a similar compensation structure. Also, we should recognize that pensions have a strong spending multiplier value for the economy as people with few alternative avenues of income tend to spend their pensions, which helps even out demand across all age groups.
India’s Pay Commission could consider this proposal and rationalize structures in its next set of recommendations.
These are the author’s personal views.
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The Old Pension Scheme is fiscally risky but there's a case for it too
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09.11.2023
The majority view on the Old Pension Scheme (OPS), at least in opinion spaces, is that it’s detrimental to public finances. Simply put, the OPS, which has been largely disbanded but is slowly coming back, involved paying retired personnel a pension from government revenue as long as they lived. The amount was 50% of the last pay drawn. This held for all employees who joined government service before 2004. Therefore, the government’s liability extends for a prolonged period of time. Those who joined after 2004 contribute from their salary to the new pension scheme (NPS) instead of the provident fund (PF), with the government contributing a similar amount, as with PF. On retirement, one gets payouts from the pension fund in perpetuity. But the government bears no liability. Theoretically, the pension fund cannot guarantee a return, unlike the old scheme which assured payments linked to the last drawn salary, with periodic adjustments made for inflation-based changes in dearness allowance.
The OPS is of disadvantage to the government, while the NPS disfavours the employee. That’s why some states have been looking to go back to the OPS, which critics term populist. There are arguments on both sides if populism is kept aside.
The crux is the ability of budgets to support such expenditure. Going by Reserve Bank of India (RBI) data, in 2021-22, all states had a salary bill of ₹9.74 trillion and a pension bill of around ₹4 trillion; numbers for 2022-23 are not yet available. Hence,........
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