The Unintended Consequences of Basic Salary Reform

This is a guest post by Suman Joshi.

There’s never a dull day in the political economics of the country. Recently, Business Standard carried a report which said that the Centre is planning to reform labour laws. As per the proposal, the government will mandate private companies to structure salaries in a way that basic income + allowances amount to at least 50% of total salaries  for calculating social security benefits.

The road to hell is paved with good intentions. While the intent of the government may be to increase social security cover, if this is implemented, it will have significant bearing on corporate affairs and human resources within organisations.  We can analyse this based on intended and unintended consequences .

The intended consequences could be:

  1. Social security contributions will increase and hence, the government will not need to further plan for social security of people
  2. The government will be able to mobilise more funds for social-sector spending through increased tax inflows since direct taxes take into consideration basic pay. If basic pay goes up, keeping the current rate of tax, the amount of tax will increase.

However, the unintended consequences could be disastrous.  Here are some which are top of mind.

  1. On a macro level, if the cash in hand with people reduces due to increased contribution to social security and increased taxation, it will lead to contraction in demand in the economy. At a time when private consumption is low, this move could be disastrous for the economy.
  2. Corporates, fearing higher wage bills, may actually reduce permanent hiring and resort to contractual employment which will be beneficial for both parties (companies and prospective employees) . If this happens, the primary intent of the move itself will be defeated as social security contributions will reduce with contractual employment
  3. The reduction in disposable income will also lead to reduction in investment opportunities. So an individual who otherwise would have invested in mutual funds or other instruments may stop doing so. Financial markets will not get the boost they need.
  4. From a perception point of view, the “less government, more governance” image that the government is trying to cultivate will take a hit. Corporates will see an absence of leeway to design innovative compensation packages, and will not be able to attract the best of talent from across the globe.

Here’s what the government should do: Anticipate the unintended consequences and get out of the way! Allow companies to design a compensation structure that suits their industry best, and just give a minimum contribution rate so that each industry comes up with its own best practices. The government needs to focus on making the market for financial planning robust so that the consumer is presented with the best options to plan for her social security, and stop adopting a paternalistic attitude towards an individual’s personal finance planning.

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