Social Security Payments : Tax or Savings

The tax-to-GDP ratio is the ratio of tax collected compared to national gross domestic product (GDP)

Tax or Saving : Social security payment
Tax or Saving : Social security payment

Developing countries like India aim to increase their tax to GDP ratio to address deficits in their domestic budgets

In public accounts of India, social security payments such as provident fund (EPF, GPF, PPF) or pension (National Pension System) or National Small Savings Fund (NSSF) are classified as savings of contributors and liabilities of Government as a borrower as opposed to tax revenue. This is at variance with the practice in OECD countries such as the USA, UK or EU where a part of social security payments, those which are compulsory, are classified in their public accounts as tax revenue of the respective Governments and not liabilities. Classifying social security payments as tax bulges the tax to GDP ratio of OECD countries when compared to India while India reports a higher Savings to GDP ratio when compared to OECD countries.

The liabilities on account of defined benefit plans of OECD countries may be understated in their public accounts.

Further, in India, these social security payments are based on defined contribution plan as opposed to a defined benefit plan in OECD countries. Defined contribution plans limit the liability on public accounts to the contribution of the State which in case of India are largely funded annually in public accounts whereas the determination of liability in Defined benefit plans such as Obamacare requires an actuarial valuation of unfunded liability in public accounts which is not practiced due to current practices of primarily cash-based accounting of public accounts vis a vis accrual-based accounting in private sector.

Thus, the liabilities on account of defined benefit plans of OECD countries may be understated in their public accounts due to cash-based accounting coupled with the fact of overstatement of tax revenues and tax to GDP ratio on account of classification of compulsory social security payments as tax revenues. This may have a bearing on relative Credit Ratings of India vis a vis the OECD countries.


Note:
1. The views expressed here are those of the author and do not necessarily represent or reflect the views of PGurus.

Nirmal Ghorawat

1 COMMENT

  1. Sharp comment. This well know but not acknowledged widely in economic theory or practice. The work of Laurence J. Kotlikoff “The Deficit is not a Well-Defined Measure of Fiscal Policy” is seminal work in this arbitrary labeling of fiscal policy.

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