End employed poverty: Mandatory 35% payroll deduction for low-wage employees hurts formal job creation

By Manish Sabharwal and Jayshri Patil

A father of modern medicine, Renaissance physician Paracelsus, warned, “The dose makes the poison.” His insight that anything powerful enough to help has the power to hurt has important lessons for policymakers hoping to finance social security through taxes, debt, and laws mandating employers to make payroll deductions. Employer-financed social security does not conflict with formal job creation, but there are trade-offs if policymakers get this balance wrong. Our labour law mandates 35% payroll deduction for low-wage employees (below Rs 21,000 a month), which hurts employee attractiveness, population expansion, and firm expansion of employers with the productivity that can pay high wages. Our primary job challenge is employed poverty, not unemployment (this has remained 4-8% since 1947) and we propose three changes to our employer payroll deduction regime.

Payroll deductions for social security do not imply employer financing; a cost-to-company (CTC) regime means benefits come out of salary and are not over and above it. Our big payroll deducted social security plans of pension (Employees’ Provident Fund Organisation) and health insurance (Employees’ State Insurance Scheme) have had mixed results. Almost half of EPFO’s accounts are dormant or orphaned, and the average terminal settlement is tiny compared to needs and savings. The unfortunate carving of a defined benefit Employees’ Pension Scheme out of the well-designed defined contribution, EPFO, has a funding deficit of crores or rupees. ESIS gets abysmal customer service ratings, only pays out 55% (excluding 6% for administrative expenses and depreciation) of its annual collections as benefits, and sits on an accumulated cash surplus of `46,000 crore over five years belonging to employees.

Competition for EPFO: In a CTC world, mandatory contributions reduce the net salary rather than gross salary. While compulsory savings are reasonable, establishing contributions greatly exceeding the savings rate for the corresponding income bracket can propagate informal employment. The EPFO holds `39,308 crore in dormant PF accounts. Failure to deposit in a PF account for three consecutive years renders it inoperative and may incur penalties. Reactivating it entails a payment of `550. The mandatory deductions are disproportionate, particularly when lower-income individuals have minimal savings rates. EPFO’s operating charges make it among the world’s most expensive mutual funds. Employees should get to opt out of the obligatory contribution to EPFO and pay their monthly contributions to the National Pension Scheme that new civil servants adopt.

Competition for ESIS: A key component of social security is an investment in the health and well-being of individuals. ESIS has India’s worst health insurance claims ratio and offers rotten care while sitting on `46,000 crore of idle financial investments. Employees should be allowed to pay their monthly health insurance premium to the Employees’ State Insurance Corporation or buy a plan from any Insurance Regulatory and Development Authority health insurer. The insurance industry would gladly create the infrastructure to ensure these policies are seamlessly portable when employees move from one company to another.

Employee choice: Household savings as a percentage of GDP dwindled to 12% in 2020-21 and 5% in 2022-23, representing a 47-year nadir. The dearth of discretionary purchasing power impedes economic growth. Frustrated with organisational indifference, employees often relinquish hard-earned income. Making EPF voluntary 12% will reduce the gap between gross and net wages. Such a revision would give individuals greater autonomy over savings investment and return, enhancing the accountability of organisations and schemes to their clientele.

Employee efficiency: A revamp of our benefits regime is overdue because employment has shifted from a lifetime contract to a taxicab relationship. Tethering contributions and benefits to individual employers no longer aligns with the trend of employees holding multiple positions. Implementing a system that facilitates seamless benefits transfer between employment is essential. All EPFO contributions must be made into an Aadhar number, and identity cards must be uploaded to DigiLocker. EPFO and ESI must drop their individual numbers to create traceability, portability, and access. This will also enable EPFO products to be offered to self-employed and gig workers.

Employer efficiency: The central and state governments issue multiple numbers to employers; this reduces the ease of doing business and makes it impossible for the State to triangulate the activities, health, and compliance of employers. EPFO and ESI must drop their employee numbers and become the first adopters of the Goods and Services Tax Network as the universal enterprise number. This transition should extend to all employer numbers issued by the Indian government.

Low productivity informal employment has many parents. One of them is our mandatory payroll deduction regime in a CTC salary model. Bad urbanisation hurts formal employment by creating a big gap between real (what employees care about) and nominal wages (what employers care about). We should not add to this with a policy-mandated difference between what employees call chitthi-waali (gross) and haath-waali (net take-home) salary. Without a massive increase in high-productivity formal employers, there will be no jump in high-wage employees. Reducing employed poverty requires three flick-of-a-pen reforms.

(The writers are with Teamlease Services. Views expressed are personal opinions.)