Tamil Nadu, a pioneer in pension reforms two decades back, now reverses course

Ahead of the Assembly elections this April-May, Tamil Nadu Chief Minister M K Stalin, who also leads the DMK, announced the Tamil Nadu Assured Pension Scheme (TAPS). Incumbent on the DMK’s return to power, the scheme would become effective January 1, 2027.

Tamil Nadu has an estimated 9.3 lakh government employees and about 7.05 lakh pensioners. While only a small percentage (2%) of the electorate, government employees are viewed as a vital constituency by parties in the state. This is because they are the ones tasked with implementing government schemes and, thus, are seen as a group that can shape the public narrative.

TAPS guarantees a pension of 50% of the last drawn monthly salary to all state employees retiring on or after January 1, 2027. The employees are required to contribute 10% of their monthly salary towards pension, while the state will contribute the balance towards 50% of the employee’s salary.

According to a government press release, the state will incur a one-time expenditure of Rs 13,000 crore, while the scheme will cost Rs 11,000 crore annually.

Like serving employees, pensioners too will benefit from salary increases twice a year, with hikes in Dearness Allowance (DA) in January and July. The DA is essentially a cost-of-living adjustment granted to government employees to protect them from rising prices, and the percentage increase is linked to the Consumer Price Index-based retail inflation over the preceding six months.

Further, TAPS will ensure that upon the pensioner’s death, their nominee will receive 60% of the amount as family pension.

What pension scheme will TAPS replace?

Tamil Nadu became the first state to reform its pension system in 2003, noting the unsustainability of rising pension costs. Then Chief Minister J Jayalalithaa took the political call to replace the prevailing Old Pension Scheme, with a new Contributory Pension Scheme (CPS).

“Tamil Nadu has the highest pension-related commitments when compared to other States in the country. It is also one of the fastest-growing components of the total revenue expenditure,” C Ponnaiyan, the state Finance Minister, said while presenting the Budget for FY 2002-03.

The CPS applied to all those who joined government service on or after April 1, 2003. Both the employee and the state contributed 10 per cent of the salary (Basic Pay + Dearness Allowance) towards CPS.

How does TAPS compare with CPS?

Tamil Nadu has fared well under the CPS, with wages, salaries and pensions as a percentage of the State’s Own Tax Revenue dropping by almost 10 percentage points over the last two decades.

Reporting on the state’s pension liability in 2020-21, then-Finance Minister P Thiaga Rajan noted that the state had 3,44,834 employees in service before April 1, 2003, when CPS became effective. The total expenditure towards pension and other pensionary benefits stood at Rs 28.250.59 crore in 2020-21. Employees recruited on or after April 1, 2003, in Tamil Nadu, and enrolled under CPS were 5,88,166. As many as 28,893 who joined after April 1, 2003, have exited the CPS following their retirement or other reasons.

The TAPS will definitely raise the pension liabilities sharply in 2026-27, the first year if the Budget for the year provides for the one-time expenditure as well as the annual increase in cost. In subsequent years, the increase may be moderate since there won’t be the one-time expenditure component.

Thus far, Tamil Nadu has arrested the sharp increases in the pension liabilities over the last two decades. But this may change now, depending on how the state chooses to go ahead.

NPS at Centre, CPS in the state

Notably, Jayalalithaa’s move preceded the Atal Bihari Vajpayee-led NDA government’s nationwide reform of pension architecture. In 1998, the Centre appointed the Old Age Social and Income Security (OASIS) committee chaired by S A Dave to design a sustainable pension system for India. The committee’s report, published in 2000, called for the establishment of a sustainable, efficient and equitable contributory pension scheme. It prepared the entire pension reform architecture — a pension regulator, pension funds, etc — and moved from a defined benefit regime to a defined contribution system. The New Pension Scheme (NPS) was thus introduced in 2004 and covered all central government employees who joined service on or after January 1, 2004.

Jayalalithaa paused after the AIADMK failed to win a single seat in the 2004 Lok Sabha elections. She also lost the Assembly elections in 2006. However, successive governments in the state, be it the DMK or the AIADMK, did revert to the Old Pension Scheme. Remarkably, neither yielded to the temptation of keeping the contributions of the employees and the state government as cash balances in the Budget.

As part of its pension reforms, the Centre introduced a Permanent Retirement Account Number for each employee. Both the employee and the government contribute towards the pension, and these are invested according to the employee’s choice and risk capacity in the pension funds set up by banks and financial institutions. The Centre’s contribution has increased over the years from 10 per cent in 2004 and stood at 14 per cent in 2019.

Following sustained demands, the Central government introduced the Unified Pension Scheme in 2024, assuring each employee receives 50 per cent of the last 12 monthly average basic pay as pension. This led the Centre to increase its contribution to 18.5 per cent towards the pension, while 10 per cent of the employee’s basic salary, plus dearness allowance, is set aside for this.

Instead of using the national pension fund architecture, Tamil Nadu toyed with the idea of creating its own pension fund, and eventually investing the sums collected under the CPS into low-yield instruments such as the LIC Superannuation Fund and Treasury bills. These fetch returns far lower than the interest rate (of approximately 7.1 per cent) the state government actually pays on CPS accumulation.

If the state continues to invest the contributions towards pension in low-yield instruments, it will continue to incur high pension liabilities, which would have to be funded from the state Budget. The contributions and the returns therein may fall short of the guaranteed pensions to be honoured, resulting in a higher burden on the exchequer.

If it opts to follow the Unified Pension Scheme model, the employees may have some choice in how their contributions should be invested (in low-risk pension funds with corpus invested in government securities, bonds, etc, balanced pension funds with investments in both bonds and equities, and growth pension funds with a higher percentage of investments in equities). This will also give employees the possibility to gain from the superior performance of stock markets in the long term over their working years.