Putting Salary Reform into Perspective

This is a guest post by Karthik Krishnan. It is a rejoinder to our guest post earlier today by Suman Joshi, ‘The Unintended Consequences of Basic Salary Reform’.

A lot is being said about the government move to cap basic income + allowances at 50% of Gross Salary.  Some are calling it an overreach, some are talking about reducing the disposable surplus, and others are calling it a method to bring in more funds into EPFO, thus reducing the social security burden of the country.

A lot of what is being said on this account does not take into consideration the actual practice on the ground. Amazingly, the cap proposed by the government is more benign that the interpretation EPFO enforcement officials have taken.

For example, consider this simple query in the forum for HR professionals where an enforcement officer has decided that 65% of Gross should be PF eligible salary. Or this news from 2014 about how the EPFO is going after firms where the Basic is below 50% . Based on my experience of managing payroll and EPFO officials across five industries and six different states, they tend to demand that the PF Wages be 60% of the Gross minimum. Sometimes they achieve this by coercion; sometimes by issuing an evasion notice: the dreaded Form 7.

Their power comes from the definition of wages itself as per PF Act:

“basic wages” means all emoluments which are earned by an employee while on duty or on leave or on holidays with wages in either case in accordance with the terms of the contract of employment and which are paid or payable in cash to him, but does not include

– (i) the cash value of any food concession;

(ii) any dearness allowance that is to say, all cash payments by whatever name called paid to an employee on account of a rise in the cost of living, house-rent allowance, overtime allowance, bonus, commission or any other similar allowance payable to the employee in respect of his employment or of work done in such employment;

(iii) any presents made by the employer;

Now, as per any PF enforcement official, anything not mentioned above is part of Wages, their favourites being Special Allowance, Performance Allowance, Hardship Allowance and Transport Allowance.  The EPFO office is littered with such cases where the officials have issued attachment orders against top corporates of India to make them pay PF on these components from date of inception with interest.

Moreover, except for the fat cats in Information technology and some category A companies, the bulk of the country uses the PF to be capped at statutory limit method to increase take home of employees. The current cap is Rs.15,000 (for a long time, it used to be Rs 6500 and shot up to Rs 15,000 in a single day from September 2016), so even if your salary is Rs 40,000, you pay PF capped at Rs 15,000,  so change in allowance will not make a huge difference to this segment.

Moreover some states like Telangana have defined their minimum wages as Basic+DA and not gross salary, so as such the entire minimum wages (the bulk of the country in the organised sector is at this grade only) is already subject to PF. There are many adventurous people in this space who are operating at PF wages of even 30% of the Gross, and those are the segments which are likely to be worst affected. This segment was brought into the organised sector by being a little lax on enforcement, with officials looking away from MSME-segment employers who keep the PF wages below 60%. There is no way this group is going to settle for a lower take-home, so the option before the employer is to go back to the unorganised sector and skip the whole process , which unfortunately is no more possible due to the massive data collation that the department does, so employers will be forced to increase the CTC to maintain the same take-home in most cases.

In all this, I haven’t yet spoken about the other major social security ESI cause. ESI always has been on Gross and is not bothered with classification of allowance.

So, in effect, this move by the government will not even touch the higher echelons of the salary bracket–aka people who can read this piece. It will affect the bottom-of-the-pyramid people, but not by much. Just as strict enforcement of PF has led to rapid increase in organised workforce, we will settle into a rhythm with the establishment bearing the cost.

In parting, I just want you guys reading this to know that the government is pegging the limit lower than what they have been on the ground, where they used brute force. So why the fuss?

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.