Fixing Pensions and Public Pay (Part 1) | Reform That Works

Taimur Khan Jhagra

This piece is part of a longer article carried by Profit on 30 July 2023. It is being reproduced here with minor edits as part of a series, Reform That Works. This 4-part set of blogs uses the former minister’s experience in government to comment on transformative possibilities for public sector in Pakistan.

If there is one reform that will unlock Pakistan from its state of perpetual inertia, it is the transformation of the public sector. While this series is primarily about transforming public sector pay and pensions, I also argue that such complex transformations necessarily require bold, assertive, and mission-driven civil service reform. This is necessary not just because public sector is critical to economic growth, but also because its stagnation presents a major obstacle to a wider reformed environment within which contemporary economic growth needs to happen.

Pakistan’s public sector revenue and expenditure numbers throw up only one clear conclusion. While government machinery in most states exists to serve citizens, in Pakistan, our 250 million citizens exist to finance the state.

Let me make my case.

Rs 3 trillion is the cost of public sector salaries across the country. Rs 1.5 trillion is the national pension bill. Add the pays of all project employees, as well as the workforces at public sector companies and autonomous bodies, and the total wage bill is closer to Rs 6 trillion. With the salary bill for the military added, our national wage bill approximates Rs 7 .*

An additional Rs 7.3 trillion is simply the cost of debt servicing that . So even before we have spent a single rupee on the people of Pakistan who are not government servants, the state has spent over Rs 14 trillion. This figure of 14 trillion already exceeds total national revenue, which equals roughly Rs 13 trillion (Rs 12 trillion collected by the federal government and an additional Rs 1 trillion by the provinces).

 This means that the state needs to borrow up to a trillion rupees just to meet salary and pension expenses. This also means that every single rupee spent on the ordinary citizen -you, me – or on our services - public schools, hospitals, defence equipment at the borders, police forces, the national electric grid, gas pipelines - is financed through additional debt.

Eight trillion rupees of additional debt are used to provide what are widely accepted as poor-quality services to the citizens of Pakistan.

Clearly, this needs to change. A productive economy needs a public sector that both creates, and operates on, value-driven decisions.

Fixing the Pension Challenge

Pensions are a significant chunk of the public sector wage bill. The cost of pensions nationally will be over Rs 1.5 trillion in FY23/24. Our pension bill is guaranteed to grow at 22-25% per year for the next 35 years, since we know almost exactly how many people will retire each year.

The cost of inaction can be calculated from the fact that just 20 years ago, cumulative national pension payments were around Rs. 25 billion. Pensions have risen 50x in just 20 years! They double roughly every 4 years!

Unlike most countries, pensions in Pakistan are unfunded with terminal benefits defined (called Defined Benefit). Most countries have moved from and introduced Defined Contribution (DC) pension programmes. (A funded pension scheme in simple terms is one to which beneficiaries make routine, if modest, contributions over a stipulated period of time in active service to qualify for sustained benefits post-retirement.)

India did this in 2004 under a World Bank project; the same project in Pakistan failed, and the result is the Rs 1.5 trillion pension bill that must be funded through the budget.

Remember, without reform, within a decade, most pensioners will not be getting a pension. We simply won’t have the money. The reform actions listed below may be the only way to make the pension bill sustainable, and the good news is that much of it has been executed successfully in KP. Our story on pensions, one of the most explosive reform areas to touch anywhere in the world, proves that real reform in Pakistan is possible.

  1. Introduce a contributory pension programme for new employees: It took a lot of work, but this has now been rolled out for all new employees in KP. The government contributes 12% and employees contribute 10%, and it applies to new government employees hired since July 1, The scheme is managed by third-party providers, although in the longer term, the government can set up a pension management firm, provided it can get the right capacity.
  2. Change the pension hierarchy: There are famously 13 tiers of pension beneficiaries in our pension rules. This seems to include everyone, from the pensioner’s widow, children, and parents to even brothers, sisters, and grandchildren! In KP, these have been reduced so that only the pensioner’s widow, children and parents are entitled to benefit from the pension to a retired employee after his or her death. The federal government has recently followed suit, and other provincial governments should follow.
  3. Increase the early retirement age: The minimum early retirement age remains 45 in all provinces except KP and Punjab, where it has been increased to 55. This should also be done across the board, including in the federal government. This step alone reduces the pension bill by Rs 20 billion annually in KP.
  4. Streamline the Pension Rules: The spirit of the original Defined Benefit Pension Plan was simple. You get 70% of your last drawn pay. Over time, this rule has been bent. Many of the violations have also been fixed in KP. For example, all governments, through an illegal notification, were allowing employees to draw up to 120% or 130% of their basic drawn pay as their first pension. This has been reversed. Many employees were drawing double pensions (one for themselves and one for a relative), or a pay and a pension. These practices have been stopped through targeted changes to Additionally, the original way last drawn pay was defined was as the average of the last 3 years; it is now the pay drawn in the last month. The definition needs revert to the original one, which is a fairer representation of the base pay on which a pension should be based.
  5. Introduce a pension tax to cover Defined Benefit employees: Even with all the above pension reforms made, the real challenge is how to finance the unfunded pensions of employees on the Defined Benefit Programme. Remember that without a financing mechanism, the pension bill will grow for the next 35 years, even if all new employees are transitioned to a contributory pension programme. There are not too many solutions. One way is a pension tax deduction from employee pay, increasing progressively, so that the defined benefit programme is funded in a pay-as-you-go manner, with working employees helping finance the pensions of those who have left. In KP, a deduction of about 5% of pay is already applied as a pension tax for officers drawing executive pay. Given Pakistan’s tax shortfall, there is no justification for any employee who expects to draw a pension, to not pay a pension .
  6. Transitioning existing employees: Important as part of the overall pension strategy is to create pathways for existing employees. This will require both compensating and creating a transition pathway for early-career employees; initiating golden handshake programmes; and making the existing pension programme more cost-effective so that employees pay for it. Such measures help equalize the cost-benefit assessment of the two programmes. This improves the incentive for most employees to switch to the funded pension programme.
  7. Increase retirement age: Finally, a short-term relief measure may be to allow an increase in the retirement age from 60 to 63 or 65 years, which will create a window of a few years in which the pension bill will not be disproportionately affected.

Ultimately, as important as it is, Pakistan will not create the fiscal space it needs by just reforming pay and pensions. It will still need to raise significantly greater revenue. Tax-to-GDP will need to increase. Savings in other areas such as procurement and the development budget will still need to be found.

But reforming pay and pensions will achieve four major objectives. First, it will help create a more responsive and delivery oriented public sector that can help transform Pakistan. Second, it will trim a disproportionately expansive public sector. Third, the pensions challenge alone, because it is unfunded, can sink our fiscal equation in the coming years, and resolving it will finance one of our most complex challenges. And finally, if we can reform pay and pensions, as political an issue as one can face in government, it will mean that we don’t need to shy away from any reform at all.

In my next piece, I comment on the problem of public wages, and how to think differently about them.

*Author estimations are used in this post. These are based on data from multiple publicly-available budget documents of the Government of Pakistan and provincial governments. In some cases, estimations are required because the KP and Punjab budgets released for 2023-24 are for four months only, and because the accounting of some departments such as education and health is treated differently in some provinces, where staff in the districts may be either attributed to the provincial or LG budgets. For consistency, estimates assume consolidated pay and pensions for staff under the LG head as well, since the source of funding for LG is still the provincial consolidated fund.

Taimur Khan Jhagra, Former Finance Minister, Government of Khyber Pakhtunkhwa


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