With inflation continuing to rise in the United States, consumers are feeling the pain when it comes to their purchasing power. Thus, high inflation puts pressure on employers to raise wages and salaries. So, many employers are resetting their pay strategies and increasing their payroll budgets for 2022, and/or looking for other ways to motivate and retain employees.
So, does inflation actually play a role in wages and salaries? Let’s first define the term inflation. Inflation is the rate of increase in prices over a given period of time and is typically a broad measure, such as the overall increase in prices or the increase in the cost of living in a country. The rise in prices, which is often expressed as a percentage (inflation rate), means that a unit of currency effectively buys less than it did in prior periods. The long-term average inflation rate in the U.S. has been about 3.2 percent, but consumers had grown used to a more moderate annual price increase averaging only 1.75 percent from 2010 to 2019. The author of this article will not explain why inflation occurs, however, will try and define why it is or isn’t important when it comes to wages and salaries.
While an inflation rate four times higher than normal is wreaking havoc on employee’s personal budgets, pay increases are failing to keep pace with rising prices. The Bureau of Labor Statistics (BLS) reported on June 10, 2022, that real average hourly earnings, what take home pay is worth given inflation, fell 3 percent from May 2021 to May 2022, even as wages and salaries were rising.
The Consumer Price Index (CPI), which is an index of the variation in prices paid by typical consumers for retail goods and other items, also plays a role in looking at inflation as it relates to wages and salaries. In May of 2022, the year-over-year increase in consumer prices hit a 40-year high of 8.6 percent according to the BLS and many economists expect that the CPI will remain elevated through 2022 and into 2023. As the BLS stated in their June 3, 2022 news release, numbers are important to understand the effects of inflation, so here are a few more to keep in mind:
- Over the 12-month period ending in May, average hourly earnings increased by 5.2 percent, down just slightly from the April year-over-year increase of 5.5 percent.
- For the 12-month period ending in March, wage and salary increases ranged from 4 percent for construction and maintenance occupations to 7.8 percent for some service occupations.
- In addition, hourly wages have been rising faster than salaries, with annual wage growth reaching 6.1 percent in May, according to the Federal Reserve Bank of Atlanta’s wage tracker.
So, while average hourly earnings over the last 12-months ending in May increased by 5.2 percent, and the average price of consumer goods (CPI) rose by 8.6 percent, the gap between both has continued to grow since mid-2021. As the inflation rate keeps growing employees’ expectations for higher wages and salaries increases, as well. To help cover this gap, some employers are revising their payroll budgets for 2022 upward.
A survey in March 2022, by Salary.com of 1,173 compensation decision-makers showed that 73% of U.S. organizations surveyed were targeting a payroll budget increase of 4 percent or more this year, and 43% of organizations surveyed grew their merit salary increase budgets by 5 percent or more. A similar study of 2,000 employers released on June 2, 2022, from advisory firm Aon, showed that U.S. companies average budgeted salary increases in 2022 reached 5.2 percent, up from 4.5 percent last year, including merit increases and promotions. What this means is that the employers surveyed are increasing their overall payroll budgets, to include: wages, salaries, and variable pay plans, e.g., incentives, bonuses, and commissions, by a total of 4 percent to 5.2 percent, while merit increases are increasing at a rate of 5 percent or more. It is important for employers to realize that the 5 percent in merit increases is part of the total 4 percent to 5.2 percent of the total payroll budget increase and not a separate stand-alone percentage rate, as merit increases are part of the total payroll budget percentage.
With all of this being said, employers are still asking the question, “Should inflation be a factor in the organizations pay strategy?”. Generally speaking, the inflation rate is not typically a factor in determining payroll budgets, as much as focusing on the supply and demand of talent. Rising prices typically don’t drive pay increase decisions. Wages and salaries are driven by changes to supply and demand of labor, which may be caused by demographic trends, labor participation rates, technological advances, and growth in productivity. Example: In 2020, inflation was a low 1.4 percent, but salary increase budgets in 2020 and 2021 were higher, between 2.5 percent and 2.8 percent. The reality tends to advantage employees in terms of real spending during low-inflation years, and works against them during high-inflation years.
As employers hire new employees, those new employees may be demanding higher wages and salaries in order to pay for the cost of higher retail goods and other items. While employers may have to pay higher wages in order to hire higher quality talent, they also need to make sure that by doing so it does not cause pay compression issues with their current employees. Wage or salary compression occurs when the pay of one or more employees is very close to the pay of more-experienced or tenured employees in the same job, or even those who are in higher-level jobs. Wage or salary compression is often the result of a market rate for a given job surpassing the increases historically awarded to long-term employees. To assist employees with covering the gap of wages and salaries versus inflation, employers are considering mid-year pay increases to focus on retaining “key” employees, targeted job families and top performers rather than granting across the board increases to all employees.
In lieu of increasing wages and salaries, employers are also looking at identifying opportunities to help employees offset costs to include: offering flexible and remote work options to decrease commuting costs, offering grocery store gift cards to ease the cost of food, covering gym membership expenses, offering gas cards to help ease the costs at the gas pump, offering prepaid gift cards that give employees the freedom to choose how to spend their funds, offering gift cards that may be enjoyed by the whole family to restaurants, streaming services, theme parks, and local attractions. Employers may also be offering more flexible bonus opportunities, stock awards, sign-on bonuses, retention bonuses, longevity pay, enhanced recognition programs, enhanced career development and learning opportunities, robust tuition reimbursement programs, incentive opportunities related to job tasks and goals, year-end bonuses, and improving employee benefits plans that work to create a strong culture and employee experience, but don’t drive up wages and salaries.
Understanding the difference between inflation and labor market growth to include wages and salaries is important for all employers to acknowledge. Increasing wages and salaries to current inflation rates is not a prudent business decision, but increasing payroll budgets for 2022 may be appropriate. Each organization’s current financial situation will determine if increasing payroll budgets or providing non-payroll type incentives as renumeration that do not ultimately impact wages and salaries are better ways to retain employees. Either way it gives an employer something to think about now and in the future.
For additional information on wages and salaries, payroll budgets, and inflation, please contact us at www.newfocushr.com.
Written by: Kristen Deutsch, M.B.A., CCP