ECONOMYENXT – The non-contributory nature of Sri Lanka’s Public Services Pensions (PSP) scheme has become a significant burden on the country, as pension benefits are funded directly from government revenue through general taxation, a research article by the Institute of Policy Studies finds.
“With approximately 700,000 public sector pensioners, this system imposes a substantial financial strain on the government.”
According to IPS, about half of these pensions benefit the top 20% income group.
The think tank recommends a gradual transition to a contributory scheme, and structural reforms.
The full article is reproduced below:
Transforming Public Pensions in Sri Lanka Toward Fiscal and Social Stability
Easing the pension burden in Sri Lanka demands structural reforms and a transition to a contributory model.
By Priyanka Jayawardena
Introduction
Recent economic challenges have made addressing Sri Lanka’s pension-related financial burden a pressing priority.
Public sector pensions are fully funded through tax revenue, consuming 12% of government income.
This imposes a heavy strain on resources, since public service pensions are largely not progressive in nature.
According to the Institute of Policy Studies of Sri Lanka (IPS), about half of these pensions benefit the top 20% income group.
This setup exacerbates inefficient fiscal policies, limiting funds for critical sectors like health and education.
This piece examines the challenges and proposes solutions for easing Sri Lanka’s pension burden.
Analysis
What is the current pension burden in Sri Lanka?
The Public Services Pensions (PSP) scheme is the largest pension program for permanent public sector employees in Sri Lanka.
However, its non-contributory nature has become a significant burden on the country, as pension benefits are funded directly from government revenue through general taxation.
With approximately 700,000 public sector pensioners, this system imposes a substantial financial strain on the government.
As of 2023, total Public Services Pensions payments reached LKR 372.3 billion (approximately $1.15 billion), representing 7.9% of the government’s recurrent expenditure and 12.1% of its revenue.
With over 1.35 million public sector employees, financial demands are rising, especially for new pensioners who receive higher payments compared to existing and deceased pensioners.
For example, total pension payments increased by 20.5% in 2023, driven primarily by a 4.2% net increase in the number of pensioners. This trend is unsustainable, given the country’s limited fiscal capacity.
Nearly 43% of government revenue is spent on public sector salaries and pensions, leaving little for investments in innovation, training, and infrastructure.
The 2022 economic crisis worsened the situation, with revenue shortfalls affecting salaries, pensions, and essential services like medicine and fertilizer.
Who benefits from the pensions?
The Public Services Pensions overwhelmingly benefit the high-income groups.
A Commitment to Equity (CEQ) analysis shows 50% of PSP benefits go to the top 20% income group, while only 11% reach the bottom 40% (Figure 1).
This is primarily because PSP beneficiaries are from the better-off segment; around 44% of PSP recipients belong to the richest 20% of the population (Figure 2).
This analysis clearly demonstrates that PSP is not a pro-poor spending program.
Source: Author’s calculations, based on the 2019 Household Income and Expenditure Survey (HEIS) data from the Department of Census and Statistics (DCS).
Public sector employees, who represent 15% of the workforce, enjoy stable incomes and pensions throughout their careers.
This contrasts sharply with the 67% of Sri Lankans in informal, unstable employment. Should the government prioritize stable employees’ pensions over broader social security needs?
Source: Author’s calculations, based on HIES-2019 data from the DCS.
What is the proposed National Contributory Pension Fund?
To reduce fiscal pressure and ensure sustainable benefits, the government proposes a Contributory Pension Fund.
Under this model, employees would contribute 8% of their basic salary, with the government adding 12%.
Initially, this scheme would apply to new recruits, transitioning gradually to a contributory system.
A similar scheme introduced in 2003 to bolster state finances was discontinued in 2006.
Insights from that experience can guide the success of the current proposal.
Implications
Reducing the pension burden requires structural reforms and a shift to a contributory model.
The interventions should create a retirement system that balances the needs of both current and future generations. Key recommendations include:
Strengthening legislative and administrative frameworks
Mandate contributions through legislation: Require contributions from employees and the government for all new hires. Define contribution rates, benefits, and eligibility in law.
Leverage technology: Use digital tools to track contributions, estimate benefits, and manage accounts, enhancing transparency and reducing costs.
Gradual transition to a contributory scheme
Enroll new employees: Begin with new public sector hires to grow the contributory pool gradually.
Incentivize voluntary transitions: Offer matching contributions or additional benefits to encourage current employees to transition voluntarily.
Enhancing pension fund management and governance
Adopt best investment practices: Employ professionals to manage fund assets, diversify investments, and conduct regular audits to minimize risks.
Establish transparent governance: Form a governing body with representatives from the government, unions, and independent experts. Publish annual financial reports and investment strategies to ensure accountability.
By implementing these reforms, Sri Lanka can transition to a sustainable pension system that ensures fairness while freeing resources for critical development priorities.
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