Plugging the pension hole

BS OPINION

The Central government has belatedly acted on the time bomb that has been ticking away in the form of its mounting pension liabilities. It has decided to switch over to a system of 'defined contribution', from 'defined benefits', for pension payment to its new staff (precious little can be done with regard to the existing commitments).

This covers only civilian recruits, and not the defence forces that account for something like half the government's manpower. Still, it is a move in the right direction. As a result of the change the Centre will be paying the pension liability for its new civilian staff as it accrues.

This is superior to the present system, under which pension is paid when it becomes due, out of current revenue, since the new system recognises a liability as soon as it accrues and not just when it becomes payable. Indeed, all budgeting by the government should switch to the accrual system, but that is a larger issue.

The Centre's pension bill has gone up by over 21 per cent annually through the nineties, partly as a result of Pay Commission bonanzas and partly because of court verdicts. Continuing with the present system would have made the fiscal situation impossible; as it is, the pension liability will keep climbing for many years hence.

So the government's next objective should be to devise a system whereby some of its existing younger employees can be persuaded to opt for the defined contribution system, perhaps by making it more attractive for those who leave the government's service ahead of the retirement age.

Limited as the scope of the present decision is, it shows the way for state governments, which too have to fill a bottomless pension pit. The pension crisis is acute for large states like UP that do not have a commensurate resource base.

UP's pension bill has gone up from 0.4 per cent to 1.2 per cent of state GDP in the course of the nineties. But the chances are that progressive states like Tamil Nadu, which have already been examining how best to cap their burgeoning pension liabilities, will be the first to act.

Another welcome decision is to allow for several pension providers which can deliver pensions under the supervision of the regulator intended to be appointed for the whole system. With these in place it should be easier for employees to have a portable system of pensions whereby they can take their accumulated benefits with them as they change jobs.

Mobility in employment is to be encouraged as a way of increasing efficiency and productivity. An employee also needs to be able to change his pension provider as that alone will enforce competition between pension providers and promote efficiency among them.

Two caveats are in order. The decision to offer tax incentives for pension contributions is understandable, since it has been argued that the country needs to mobilise long-term savings and make them available for funding infrastructure projects. But such incentives only introduce distortions into the calculus and end up in sub-optimal decisions.

Since the government has been moving out of the tax incentives business, it should look afresh at this issue. The second decision which needs review is the business of setting up a separate regulatory authority for pensions.

The system is beginning to recognise that regulators are mushrooming all over the place, often to no great purpose. There is no reason why the existing insurance regulator, which also supervises the life assurance business, cannot supervise pensions as well.