Memo to Modi govt: Don't mess around with the provident fund any more
What the government is essentially trying to do is to force Indians into a pension scheme - that is taxable - using existing funds in the EPF. This is patently wrong
When policies are constructed by mindless bureaucrats based on suggestions by economists in search of theoretically ideal models of taxation, what you will get is the EPF kind of fiascos. Twice in less than two months the NDA government has had to back down on changes it wanted to make in the employees' provident fund (EPF) scheme.
One was the budgetary provision to tax 20 percent of withdrawals on retirement (with 40 percent going to investment in annuities and another 40 percent being tax-free even if withdrawn); the second was the tightening of rules on premature withdrawals, making it difficult for the relatively less well-off to get their money back when they need it.
The political storm in parliament forced the government to postpone the tax proposal; the violent protests by garment workers in Bangalore this week forced the suspension of rules that prevent premature withdrawals.
The message the government should get from these two egg-on-the-face ideas is simple: don't mess with the EPF. It occupies an emotional space in the ordinary employee's mind that it is simply unable to comprehend.
People consider EPF to be "my own money" and so attempts to snatch it away through taxation or rules of withdrawal will be violently resisted.
The salaried classes - including workers at the bottom of the pyramid - are a key voter base for the NDA and one wonders why the Modi government is trying to destroy it. Like the annual Diwali bonus, tax-free and hassle-free withdrawals from EPF are part of an employee's assumptions about what is his which the government cannot touch.
On the other hand, one must try to understand where the government is coming from, and why it is doing things to upset its core voter base.
Here are the arguments one hears often.
First, there is the tax principle that income must be taxed at some stage. EPF is EEE - exempt under section 80C at the time of contribution, interest earned is exempt, and so is withdrawal. This is why the babus want to tax it on withdrawal, to make it EET.
Second, the government wants to make India a "pensioned" society but does not want to pony up the resources for it. So it is effectively trying to convert the EPF into a pension scheme. Hence the need to partially ban withdrawals. The problem is employees are entitled to dip into EPF savings when they need the money and if they are unemployed; this is what government sought to prevent by saying only the personal contribution can be withdrawn prematurely. This has led to riots in Bengaluru, and this could easily spread.
Third, the government wants to bring tax parity between the national pension scheme (NPS) and the EPF. All new government employees joining government service after 2004 are under NPS, and the scheme is also open to any Indian who wants to subscribe to it.
Fourth, the pension scheme already embedded in the EPF - the family pension scheme (FPS) - is simply unviable since the pension payouts are underfunded by adequate corpus. Even the EPF can become unviable in a falling interest rate scenario.
What the government is essentially trying to do is to force Indians into a pension scheme - that is taxable - using existing funds in the EPF. This is patently wrong, and the government has to rethink its pension plans - or it may find the voters willing to put the NDA itself out on pension in 2019.
So what should the government do to make EPF both viable and acceptable to employees of all kinds?
The first thing to understand is: don't f*** around with the EPF, especially rules and taxes relevant to the lower middle and working classes.
The only thing that should be changed about the EPF is its defined benefits structure (which guarantees returns), but even here the lowest earners need protection. It is best to convert EPF into a hybrid of defined benefits and defined contribution (which does not guarantee returns. The lowest contributors to EPF must be sequestered into a defined benefits scheme, which can be subsidised by the government. The rest of the contributors should be graduated to a defined contribution scheme, including the NPS.
You cannot creat a pensioned society by using EPF money. Pension has to be an additional scheme to the EPF. One way to do it is to cap EPF contributions at 16 percent (8 percent each from employee and employer) and create an additional contribution of 4 percent (1 percent employee and three percent employer) that can be invested in NPS, but with the proviso that all of the maturity proceeds will go into annuities. No withdrawals at all till death. Then the dependents get the corpus. Employees will not object as this scheme is additional to EPF. The pension will also be taxable as income.
Last, the family pension scheme should be scrapped, and merged into the NPS.
There can be other better suggestions, but the main lesson for the government to learn is: don't mess with the EPF. It is sacred for most employees.
The government's mind has been addled by suggestions by babus and economists looking at western models of pension products when we are nowhere near being even a middle income society.
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