The India Fix: Why are cash-strapped states rushing to give their employees outsized pensions?

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For the past few months, a single thread has featured in politics across states: what sort of pension scheme should apply to government employees?

In several states, the Congress and the Aam Aadmi Party have promised a sop to babus in the form of increased pensions. This involves a return to the so-called Old Pension Scheme, as it existed before 2004. So far, Rajasthan, Chhattisgarh, Jharkhand and Punjab have passed orders to restore the old regime. The matter is a key issue in the upcoming Gujarat elections and the just concluded Himachal polls.

A generous payout

Government employees who had joined before 2004 were paid a fixed pension, calculated at half of the salary received at retirement. On top of this was added a “dearness allowance” component that increased with the cost of living. This generous payout was footed completely by the government.

This flush pension benefit was one of the primary reasons behind the significant demand for government jobs in India, going a long way in explaining the very Indian phenomenon of young men and women going to great lengths to obtain one. Without access to a massive pool of funds like taxes, the private sector could obviously never offer a perk like the Old Pension Scheme.

The other side of the coin: this extremely generous payout was untenable fiscally for a poor country like India. Not only was the massive pension bill footed completely by the taxpayer, it would rise with time, given that government salaries, to which the pensions were directly benchmarked with, would do too.

Putting the brakes

As a result, in 2004, the Union government pushed a “New Pension Scheme”. This involved contributions from both the government as well as government employees. The money was invested in the market, much like retirement saving plans in countries like the United States.

The fiscal pressure this relieved on the Indian state was so great that it led to a rare moment of political consensus. While the New Pension Scheme was introduced by the Bharatiya Janata Party-led National Democratic Alliance government in 2004, it was the Congress-led United Progressive Alliance government that baked it into a federal law. Not only was this a moment for parties to come together, it was a moment of federal unity across the Indian Union.

Speaking at a chief minister’s conference for pension reform in 2007, Prime Minister Manmohan Singh made the pitch that it was in the interest of the states to follow the Union’s lead. “Even in the states, all of you must be faced with the rising cost of pension liabilities which compete for your limited resources,” said Singh. “Therefore, we need better management of our pension liabilities so that state finances can be managed in a healthy, sustainable way in future. This is a very important basis for the changes in the pension system.”

Singh pushed the somewhat obvious argument that the Indian state could not spend such a large sum on its own employees given that in a poor country, it has basic welfare obligations to fulfil. “The rising pension bills at all levels of government would be increasingly difficult to finance in future, given the other demands that are there on our resources, particularly for enhancing our expenditures on essential social sectors such as health, education and rural development,” the economist-prime minister argued

Arguments such as Singh’s worked and all states signed onto the New Pension Scheme, with the exception of West Bengal.

So why did this consensus break down?

The power of the babu

The first reason is, of course, the pushes and pulls of electoral politics. This is, at first blush, an odd argument given that government employees in India are, in pure numbers, a small proportion of the population. According to the government of Punjab itself, its decision to go back to the Old Pension scheme would benefit only 1.75 lakh people: 0.6% of the state population. Meanwhile, pension is, astoundingly, more than 34% of Punjab’s own tax revenue.

Yet, since the Indian organised sector is so small, public sector employment forms a big proportion of it. As a result, sops to them help the government reach out to a powerful class. Thus even if this population is tiny, governments are ready to spend vast sums on it since it helps them reach out to an influential segment that drives narratives before an election, which in turn can influence a large proportion of the vote.

To add to this is the fact that unusually for a democracy, Indian bureaucrats have an immense amount of influence within governments – a baleful hangover from colonial times when the entire administration was run by unelected babus. Even now, much of local governance is run by bureaucrats not local government, making politicians sensitive to their concerns, given that bureaucrats can make or break the implementation of policy.

Naturally, a switch to a system where pension is neither fixed nor paid solely by their employer is resented by government employees, placing them on the same footing as private sector workers. Thus the Opposition has found a quick way to gain a powerful segment of support, even as it ignores the fiscal implications.

Federal breakdown

However, this is not all about the vote: at least one part of this move back to the Old Pension Scheme arises from India’s current chaotic federal environment.

Note that currently, states are paying both Old Pension payouts, for employees who joined before the New Pension Scheme and New Pension Scheme contributions for employees who will retire in the future. However, by exiting the New Pension Scheme, a state will stop these latter payments. Thus even if states end up paying much more towards pensions overall, this money will be paid out only later, thus easing financial pressure on a state in the present moment.

This ridiculous situation arises since states are squeezed fiscally and policed strictly on their fiscal deficit (the gap between revenue and expenditure). For a state politician, this means the room to manoeuvre going into the next election is very small. As a result, she is forced to implement schemes that would harm her state in the future just to have enough money to try and win the next election.

Related to this of course is the federal breakdown the Indian Union is currently experiencing. Under Prime Ministers Atal Bihari Vajpayee and Manmohan Singh, the Union and states worked together to pull off this major policy reform. Now, however, the politics between the BJP and the Opposition has entered a particularly bitter phase, with the Modi government ready to even jail its opponents using draconian Central agencies.

In a more ideal world, the Union government – which, according to the Constitution, has vast financial resources – should have reached out to the states and offered them more options to ensure that they do not exit the New Pension Scheme. However, given that there are few federal channels now not hostage to partisan party politics, this seems unlikely. In this hyper-competitive sphere, Opposition parties will take any weapon they can get to throw against the BJP’s juggernaut. If that means fiscally destructive policies such as the Old Pension Scheme, so be it.