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Old is not gold: On the return to the old pension scheme

  • Category
    Economy
  • Published
    23rd Dec, 2022

Context

Few states in the country are promising to restore the Old Pension Scheme. Though the old pension scheme works as an electoral strategy but is an imprudent fiscal policy.

What is the Old Pension Scheme (OPS)?

  • It is often described as a ‘Defined Benefit Scheme’.
  • The scheme assures life-long income, post-retirement.
  • Under OPS, employees get a pension under a pre-determined formulawhich is equivalent to 50% of the last drawn salary.
  • They also get the benefit of the revision of Dearness Relief (DR),twice a year.
  • The payout is fixed and there was no deduction from the salary.
  • There was the provision of the General Provident Fund (GPF).
  • The Government bears the expenditure incurred on the pension. The scheme was discontinued in 2004.

Concerns associated with the old pension scheme:

  • The pension liability remained unfunded:As there was no corpus specifically for pension, which would grow continuously and could be dipped into for payments.
  • No fixed source of funding: The Government of India's budget provided for pensions every year; there was no clear plan on how to pay year after year in the future.
  • The burden on Government Budget: The government estimated payments to retirees ahead of the Budget every year, and the present generation of taxpayers paid for all pensioners as of date.
  • The ‘pay-as-you-go’scheme created inter-generational equity issues — meaning the present generation had to bear the continuously rising burden of pensioners

 Why is the OPS both bad economics and bad politics?

  • Rolling out a major amount of money: Overall, pension payments by states roll out a quarter of their own tax revenues. For some states, it is much higher.
    • For Himachal, it is almost 80 per cent(pensions as a percentage of the state’s own tax revenues)
    • for Punjab, it is almost 35 per cent
    • for Chhattisgarh 24 per cent
    • for Rajasthan 30 per cent
  • The high Budget deficit for Governments: If wages and salaries of state government employees are added to this bill, states are left with hardly anything from their own tax receipts.
  • Short-term gains for the state: States reverting to OPS can achieve some short-term gains as they need not put up the matching contribution of 10% towards employee pension funds.
  • Inter-generational equity: There is also the larger issue of inter-generational equity. Today’s taxpayers paying for the ever-increasing pensions of retirees, with Pay Commission awards almost taking the pension of old retirees to current levels, means the pension of someone who retired in 1995 may well be the same as that for someone who retires in 2025.
  • Limiting benefit:It will only benefit organized government sector employees.
  • Less spending on general welfare:An increase in the fiscal burden of OPS is going to take up a significant portion of the State’s budget, thereby curtailing its outlays on general welfare as a whole.

How NPS is a better option?

  • Freedom to allocate savings
    • The current clamour by government employees for the old scheme seems to be based on misconceptions about how the NPS works.
    • The biggest fear about the NPS is that it redirects subscribers’ money into the ‘volatile’ stock market.
    • But the fact is that NPS subscribers have complete freedom to allocate their savings to equities, corporate bonds or government securities, or any combination of the three.
    • Risk-averse investors can simply allocate all their money to bonds or gilts in NPS, altogether skipping stocks.
  • Beating Inflation:
    • The biggest challenge for any retirement saver is to beat inflation. Equities do this job better than any other asset class.
    • A 20-year analysis of Nifty50 shows that while it frequently delivered losses over one-year periods, stretching one’s holding period to 10 years reduced the loss probability to zero while fetching an 11-12 percent return.
    • While the EPFO has been struggling to declare an 8-8.5 percent return from its ‘safe’ debt portfolio, NPS managers have earned a 13-14 percent return on equities and 5-9 percent on bonds and government securities over a decade.
  • Greater control:
    • With NPS, an employee has greater control over his pension as he can save more or allocate more to equities.
    • In the old pension scheme, the employee’s pension is mandatorily limited to half of his last-drawn pay.

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