UPS Is OPS With Fiscal Speedbreakers; It Shows Hard-Won Bipartisan Reforms Can Easily Be Reversed

One has to raise questions about the value of first-past-the-post electoral democracy where even reforms undertaken under coalition governments can be undermined later, to the detriment of future generations. 

A hard-fought-for government pension reform, originating in the Atal Bihari Vajpayee-led National Democratic Alliance (NDA) government and implemented by the Manmohan Singh-led United Progressive Alliance (UPA) government, has now been eviscerated by the Narendra Modi government under pressure from a powerful vested interest group — government employees. 

The National Pension Scheme (NPS), which applies to all government staff joining work after 1 January 2004, is now being replaced by a so-called Unified Pension Scheme (UPS) just before another round of assembly elections gets underway.

While the old NPS stays for those who want it, it is more than likely that the UPS will take over. Government employees know which side of their bread is buttered thick.

UPS abandons the eminently sensible approach of defined contributions in favour of defined benefits, which means no matter how the underlying pension fund performs through market cycles, they will get their assured pensions.

Briefly, this is what the UPS does. First, it raises the pensions available for those who have put in 25 years to 50 per cent of average basic pay in the final year of service.

Besides, these pensions will also be indexed, which means they will keep rising with inflation. The government will be contributing more to the pension corpus every year, raising it from 14 per cent to 18.5 per cent.

The saving grace of the UPS is that it will be funded, which means that the government will provide money in the budget every year for current and future pension liabilities based on actuarial studies every three years on the expected longevity of retirees. 

The UPS is better than the old pension scheme (OPS) where pension liabilities were unfunded. Put simply, it meant that the year’s pension payments were paid out from current budgets, leaving the possibility that future pensioners will have to be paid from a decreasing cohort of new contributing entrants to government service — or from higher taxes.

OPS was a fiscally ruinous scheme for it shifted the burden of pensions to future generations. UPS spares future generations a bit, but pensions will still have to be funded by governments of the future.

If the tax base narrows after two decades due to a fall in birth rates and a narrowing base of people entering the job markets, it will be faced with the same situation as OPS.

The difference between OPS and UPS is simple: if the former is fiscally irresponsible, the latter is fiscally more responsible, and stretches the pain over a longer timeframe. UPS is OPS with fiscal speed-breakers in place. It won’t careen off the cliff suddenly.

There is, however, no guarantee that a future government will not defund UPS, for a lot depends on the state of government finances (both central, and state, assuming the latter accept the UPS), when large pensions fall due during a difficult fiscal period. An elected government will be driven by short-term electoral considerations, not concern for a future fiscal crisis.

For example, if India were in a period of war or pandemic, a government could choose to defund UPS in order to save money in the short run.

So why did this happen?

Primarily, because state government employees have a huge impact on politics in some states. By offering the benefits of OPS to employees, some Congress governments opted for OPS over the last few years, putting pressure on the Modi government to modify the NPS. UPS is the result.

In states like Uttarakhand and Himachal, where government jobs are a beacon of hope for young job-seekers, OPS was a huge draw. Rajasthan, Himachal, Punjab and Jharkhand were among the states that dumped the NPS in favour of the OPS. Pressure mounted as government staff in Maharashtra and Karnataka began asking for a reversion to OPS.

It was in this context that the Modi government set up a panel under then Finance Secretary T V Somanathan (now cabinet secretary) to consider changes to the NPS. UPS is the fruit of its labours. (Maharashtra has already announced the adoption of the UPS before a forthcoming assembly election).

So what are the real pros and cons of the UPS?

The pros are limited.

As a funded scheme, UPS designed to avoid burdening the fisc or current pension contributors because more money has to be paid to retired staff.

The scheme allows the government to fill any gap in the performance of NPS funds through yearly budgetary provisions, assuming the underlying NPS fund underperforms. The inflation-indexed portion of pensions will also have to be funded by taxpayers when the need arises. 

Secondly, the scheme is now a hybrid, where the contributions are defined, and so are the benefits. OPS is a defined benefits scheme, while NPS is a defined contributions scheme.

But the cons outweigh the pros. 

First, there is the immediate impact of raising the government’s contribution to the pension fund from 14 per cent to 18.5 per cent. Somanathan says that this year’s budget will be impacted to the tune of Rs 6,250 crore, with another Rs 800 crore going towards payment of arrears.

But the amounts will clearly rise year after year as the size of government employment rises, and pay packets also keep rising along the 10-year pay commission recommendations and dearness allowance hikes.

Second, the UPS will burden the government very heavily in years where the fiscal challenges are higher than before (as during Covid, for example). 

Third, the rising burden will force governments to actually restrict future increases in staff, or opt for more contractual employment. One should not rule out the possibility of governments opting for Agniveer-like schemes for administrative staff in future. This implies that giving out more benefits to current employees will impact the expansion of government employment in future.

The bottomline is this: just as OROP — one rank, one pension — pressured defence finances, forcing a shift away from spending on badly needed military equipment and technology to personnel (both current and retired), UPS will, in due course, force a slowdown in government staff expansion.

Government staff have been mollified for now by dashing the hopes of youth who want more jobs in the public sector.

UPS is more sensible than OPS, but it won’t stop the erosion in public finances that will ultimately impact the provision of public goods to the citizen.

Democratic politics has undermined another reform. Who says reforms are irreversible?