The invisible burden on low-income earners that amounts to a 35% tax paid by crorepatis

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

Why? Because mandatory contributions to state insurance and pension funds are “tax-like” due to the difficulty of accessing the benefits or funds offered.

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

Next is the contribution to the Employees State Insurance Corporation (ESIC), which administers a plan that protects workers against contingencies such as illness, maternity, disability and death due to work accidents, provides medical care to insured persons and their families and unemployment benefits.

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

“Getting ESIC claims is notoriously difficult, while contributions are mandatory. It is similar to a tax in that sense because if it were not mandatory, the same amount could have been used for a better insurance product,” Roongta said. More details on ESIC can be found further down 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

It is noteworthy that 12% of the employee’s basic salary, dearness allowance and retention allowance go towards the EPF. Employers contribute the same amount, but only 3.67% goes towards the EPF, while the remaining 8.33% goes towards the EPS.

Following an amendment in September 2014, the EPS contribution has been restricted to only those new employees whose monthly salaries are up to ₹15,000. For the rest, 12% goes to the EPF. ₹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 a maximum of $100,000). ₹900 per year). It is ₹900 for Mr. A.

“The opacity with which the EPFO ​​operates makes it difficult for many employees to access their own money. The three mandatory contributions to the EPFO ​​are, without a doubt, a tax for all practical purposes,” Roongta said.

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

Mr. A’s salary in hand amounts to ₹1.54 lakh after deductions like professional tax ( ₹2,500), ESI contribution ( ₹1,350) and the EPF contribution ( ₹21,600) of ₹1.8 lakh. Its cost to company (CTC) is ₹2.09 lakh, which includes all employer contributions (see chart).

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

To be sure, late Finance Minister Arun Jaitley, in his Budget speech in February 2015, said that “both the EPF and the ESI have hostages instead of customers”, highlighting the problem of dormant EPF accounts and low complaint rates of the ESIs.

“The low-paid worker suffers larger deductions than the higher-paid worker, in percentage terms,” Jaitley said.

EPF vs NPS

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

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

The Finance Act, 2016, in order to bring all pension schemes under one umbrella, amended the Income Tax Act, 1961 to allow for one-time, tax-free portability of recognised or approved pension funds to the NPS. Following this, the Pension Fund Regulatory and Development Authority laid down the mechanisms for such transfers in March 2017.

“However, till date, no relevant enabling provision has been notified under the EPF Act,” said Anurag Jain, co-founder and partner at ByTheBook Consulting LLP, a tax consultancy firm.

ESIC: A review of reality

According to Roongta, the cousin of ₹The $7,200 per year paid to ESIC on behalf of Mr. A is not justified given the corporation’s poor claims performance record and given that ESI is a group insurance plan.

“You can get a much better health insurance plan with the same or lower premium and with much better claims settlement performance. It is time for ESIC to be held accountable for the ridiculous premiums charged for poor services,” he says.

ESIC’s claims performance record can be measured by comparing ESIC’s Incurred Claims Ratio (ICR) with that of other health insurance companies. The ICR measures the claims an insurance company pays each year as a percentage of premiums. The higher it is, the more serious the insurance company is in 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 derivative.

“It’s 83% after accounting for ESCI’s inefficient cost structure. Even with that generous assumption, it’s comparable… to the ICR of about 90% of health insurance companies, where payments are made directly to third-party hospitals,” Roongta said.

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

“Health insurance companies make their profits from investment income, which typically accounts for around 8% of the premiums collected. In the case of ESIC, it is a whopping 41%, which indicates how much profit ESIC has made over the years from its hapless captive subscribers,” Roongta said.

Lack of infrastructure and delays in resolving claims are other pressing problems faced by ESIC.

“The quality of healthcare services provided under ESI is often poor due to lack of proper infrastructure, understaffed hospitals and outdated equipment. Employees may not receive timely or effective treatment, leading to dissatisfaction and reluctance to trust ESI facilities,” Jain said.

The cumbersome administrative process causes delays in the settlement of claims, approval of medical treatments and issuance of benefits.

“This bureaucratic inefficiency can discourage 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 Business standard.)