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

Source: The post is based on the article “Why the Old Pension Scheme is both bad economics and bad politics” published in The Indian Express on 17th November 2022.

Syllabus: GS 2- Governance

News: The government in Rajasthan and Chhattisgarh has reverted to the Old Pension Scheme. Punjab is also expected to follow the same but there are concerns associated with it.

What was the Old Pension Scheme (OPS)?

OPS fixed pensions of the central and state government employees at 50 percent to the last drawn basic pay. The amount of the pensions also increased with the hike in dearness allowances announced by the government for serving employees.

However, a New Pension System came into effect for those joining government service from January 1, 2004 which promised an assured or ‘defined’ benefit to the retiree. It was described as a ‘Defined Benefit Scheme’.

What were the concerns with the OPS?

Lack of proper funds: The pension liability remained unfunded and there were no mechanisms through which money could be raised and given to the pensioner.

Unsustainable: OPS was unsustainable because the liability of pension kept on increasing every year due to the increase in dearness allowances (DA) and increase in life expectancy rates.

Burden on states: OPS took away a quarter of the tax revenues of the state. Further, if salaries of state government employees are added to the bill, states hardly get anything from their own tax receipts.

Burden on the taxpayers: Taxpayers face the burden of ever-increasing pensions. The current generation faces a burden of older employees as well as they are also paying for newer employees under NPS.

What was planned to address this situation?

Old Age Social and Income Security (OASIS) commission: It was set up in 1998 with the objective of targeting unorganized sector workers who had no old age income security. The committee found that less than 11% of the estimated total working population had some post-retirement income security.

It recommended investment 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). This investment could be further invested in corporate bonds or government securities.

It also recommended that individuals could have unique retirement accounts and they would be required to invest at least Rs 500 a year into that account.

Out of those money at least Rs 2 lakh would be used to purchase an annuity after the retirement. The income from the annuity will then be used to provide a fixed monthly income to the retired employee.

HLEG: It was a high-level expert group set up to look into the situation for government employees. It suggested a defined contribution scheme for government employees.

In the first tier, it recommended a 10 percent contribution by the employer and the employee. The accumulated funds would be used to pay pension in annuity form.

In the second tier, the employer’s contribution would be matching with the contribution of the employees but limited to 5 per cent. However, no limit was specified for the employee. This contribution could be later withdrawn or converted into annuity.

What was the origin of the New Pension Scheme (NPS)?

The OASIS report became the basis for the NPS. It was made applicable for all new recruits joining government service from January 1, 2004.

The defined contribution under NPS was 10 percent of the basic salary and DA by the employee and a matching contribution by the government. However, the government increased its contribution to 14 percent of the basic salary and DA in 2019.

NPS gave the opportunity to the employees to choose from a range of schemes from low risk to high risk.  The return from the investment in these schemes depends on the number of years and choice of the scheme.

NPS has become effective and its assets under management have also increased. Therefore, moving to OPS from NPS will again acts as a burden on the exchequer and its impact should be taken into account while reverting back.

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