The invisible burden on low-income workers equivalent to a 35% tax

“This tax is as high as 35%, the same as what people earning above ₹1 crore pay,” said Harsh Roongta, founder of Fee Only Investment Advisers.

How so? That’s because of compulsory contributions to state insurance schemes and pension funds that are “akin to a tax” because of the difficulty in accessing the benefits or funds offered.

Assume Mr. A, based in Mumbai, has an annual income of ₹1.8 lakh (monthly income of ₹15,000). He has to pay an annual professional tax of ₹2,500. This is a tax imposed on salaried and self-employed workers by some state governments.

Next is the contribution to the Employees’ State Insurance Corporation (ESIC), which runs a scheme that protects workers against contingencies such as sickness, maternity, disability and death due to employment injury, provides medical care to insured persons and their families and unemployment allowance.

The ESIC contribution is 4% of an employee’s salary. Mr. A’s contribution is ₹7,200, of which 0.75% is by the employee ( ₹1,350) and 3.25% by the employer ( ₹5,850). But here is the catch.

“Getting claims from ESIC is notoriously difficult, while contributions are mandatory. It is akin to a tax in that sense because had it not been mandatory, the same amount could have been used for a better insurance product,” said Roongta. details on ESIC can be found later in the article.

Then there is the trio of contributions to the Employees’ Provident Fund Organisation (EPFO), namely the Employees Provident Fund (EPF), the Employees’ Pension Scheme (EPS) and the Employees’ Deposit-Linked Insurance (EDLI).

EPS contribution

Notably, 12% of the employee’s basic wages, dearness allowance, and retaining allowance goes towards EPF. Employers contribute the same amount, but only 3.67% of it goes towards EPF, while the remaining 8.33% goes towards the EPS.

After a September 2014 amendment, the EPS contribution has been restricted to only those new employees whose monthly wages are up to ₹15,000. For others, the entire 12% goes into EPF. It is ₹43,200 in the case of Mr. A – ₹21,600 each by Mr. A and his employer.

EDLI is a social security benefit that provides life insurance to private sector employees. The employer contributes 0.5% of the employee’s salary to EDLI (up to ₹900 per annum). It is ₹900 for Mr. A.

“The opaque way with which the EPFO operates makes it difficult for a lot of employees to get hold of their own money. The three mandatory EPFO contributions are surely a tax for all practical purposes,” said Roongta.

The employer also incurs administrative costs of ₹75 per month, totalling ₹900 per year.

Mr. A’s in-hand salary comes in at ₹1.54 lakh after deductions such as professional tax ( ₹2,500), ESI contribution ( ₹1,350) and EPF contribution ( ₹21,600) from ₹1.8 lakh. His cost to company (CTC) is ₹2.09 lakh, which includes all employer contributions (see graphic).

The total “invisible tax” amount, including all employer and employee contributions, is ₹54,700, which is 35% of Mr. A’s in-hand salary.

To be sure, late finance minister Arun Jaitley, in his budget speech in February 2015, famously said that “both EPF and ESI have hostages rather than clients,” highlighting the issue of dormant EPF accounts and low claim ratios of ESIs.

“The low-paid worker suffers deductions greater than the better-paid workers, in percentage terms,” Jaitley said.

EPF vs NPS

EPF and the National Pension System (NPS) and their benefits are quite different. Jaitley advocated giving a choice between EPF and NPS, a defined contribution pension scheme that has emerged as an attractive retirement planning investment avenue.

He also said that contributions to EPF should be optional, without affecting or reducing the employer’s contribution for employees below a certain threshold of monthly income. Those willing to contribute to NPS and EPS can do so. Currently, it is forced.

The Finance Act, 2016, in order to bring all pension plans under one umbrella, had amended the Income Tax Act, 1961, to allow one-time tax-free portability from recognised PF/approved superannuation funds to NPS. Following this, the Pension Fund Regulatory and Development Authority had set out the mechanics for such transfers in March 2017.

“However, till date, the corresponding enabling provision under the EPF Act has not been notified,” said Anurag Jain, co-founder and partner at ByTheBook Consulting LLP, a tax consulting firm.

ESIC: A reality check

According to Roongta, the premium of ₹7,200 per annum paid to ESIC on Mr. A’s behalf is unjustified given the poor claims performance track record of the corporation and ESI being a group insurance scheme.

“A much better health insurance plan can be bought from health insurance companies with the same or lower premium amount having a much better claims settlement performance. It is time ESIC is held answerable for the ridiculous premium being charged against abysmal services,” he says.

The claims performance track record can be gauged by comparing the incurred claims ratio (ICR) of ESIC with that of other health insurance companies. ICR measures the claims that an insurance company pays out every year as a percentage of the premiums. The higher it is, the more serious an insurance company is about paying claims.

While other health insurance companies pay claims to third-party hospitals, ESIC has its own hospitals. That said, the ICR in ESIC’s case is a derived one.

“It is 83% after factoring in ESCI’s inefficient cost structure. Even with that generous assumption, it compares… with the approximately 90% ICR for health insurance companies where the payouts are made directly to third-party hospitals,” said Roongta.

He said payments to third-party hospitals are a more reliable measure of the ICR because it is based on standard tariffs rather than the inefficient cost structures of a captive healthcare provider like ESIC. That said, the ICR for some health insurers goes above 100%. They recover their administration costs and make a profit via their investment income.

“Health insurance companies make their profits from the investment income, which is normally around 8% of premiums collected. For ESIC, it is a whopping 41%, which indicates the amount of profiteering that ESIC has made over the years from its hapless and captive subscribers,” said Roongta.

Lack of infrastructure and delays in settling claims are the other pressing issues with ESIC.

“The quality of healthcare services provided under ESI often falls short due to a lack of adequate infrastructure, understaffed hospitals, and outdated equipment. Employees may not receive timely or effective treatment, leading to dissatisfaction and a reluctance to rely on ESI facilities,” said Jain.

The cumbersome administrative process causes delays in claim settlements, approvals for medical treatment, and issuance of benefits.

“This bureaucratic inefficiency can deter employees from using the scheme and create additional stress for employers in managing compliance,” Jain added.

(Some of Roongta’s views were first published in the Business Standard.)