PEO
Salary budgets stuck near 3% as labor supply, not inflation, sets the ceiling
By Anthony Beck, . Insurance Wire.
Salary increase budgets have historically remained near 3%, despite significant changes in inflation and economic conditions over the past several decades.
In an HRO Today podcast, CEO Elliot Clark discussed the relationship between inflation, labor markets and compensation planning with Lori Wisper, a senior compensation executive at Willis Towers Watson (WTW).
Wisper explained that salary increase budgets are driven primarily by labor supply and demand rather than changes in consumer prices.
Drawing on approximately 50 years of compensation data, she described 3% as a level toward which salary budgets have repeatedly returned under relatively stable labor market conditions.
The distinction matters because employees and employers often evaluate compensation increases differently.
Employees may measure raises against rising living expenses, while employers generally assess what they must pay to attract and retain workers in their respective labor markets.
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Why Salary Budgets Do Not Automatically Follow Inflation
Inflation measures changes in the prices consumers pay for goods and services. Salary increase budgets reflect what employers expect to spend on employee pay adjustments.
Although the two can influence each other, they are not interchangeable.
An employer facing limited competition for available workers may maintain modest salary increases even when consumer prices rise substantially.
Conversely, employers competing for workers with specialized skills may need to increase compensation faster than inflation to fill vacancies or prevent turnover.
Labor availability, employee turnover, recruiting difficulty and compensation offered by competing employers can all affect salary decisions.
This explains why a national salary budget average may remain relatively stable while compensation increases vary significantly between occupations and industries.
It also explains why applying the same percentage increase to every employee may not adequately address retention risks.
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The Difference Between Salary Budgets and Actual Raises
A salary increase budget represents the amount an employer plans to allocate toward compensation adjustments. It does not necessarily mean every employee receives that percentage increase.
For example, a company with $5 million in annual base salaries and a 3% increase budget would allocate approximately $150,000 toward salary adjustments.
That amount could be distributed differently based on employee performance, market compensation, promotions and retention needs.
Some employees may receive increases above 3%, while others receive smaller adjustments or none.
Employers may also maintain separate budgets for merit increases, promotions and market adjustments, depending on how their compensation programs are structured.
A 3% salary budget should therefore not be interpreted as a universal recommendation for individual employee raises.
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How Labor Supply Affects Compensation Planning
Labor supply and demand vary by occupation, geography and industry.
An employer hiring administrative employees in a market with many qualified applicants may face different compensation pressures than a business recruiting licensed healthcare professionals, skilled tradespeople or specialized technical employees.
Even businesses operating in the same industry can experience different wage pressures depending on their locations and workforce requirements.
Employers should evaluate current pay against comparable positions in their labor markets, considering factors such as job responsibilities, required experience, geographic location and competing employment opportunities.
Turnover rates, time required to fill vacancies and the compensation needed to attract qualified candidates can also indicate whether existing pay levels remain competitive.
For positions experiencing persistent recruiting or retention problems, market-based adjustments may be more appropriate than applying a uniform annual increase.
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What This Means for Employers Using a PEO
Professional Employer Organizations (PEOs) may provide compensation benchmarking, workforce reporting and HR consulting services that help clients evaluate salary decisions.
However, the usefulness of those services depends on the quality and relevance of the underlying compensation data.
A national average may provide general context but can overlook significant differences in regional labor markets and occupational demand.
For example, a 3% salary budget may be sufficient for certain positions while leaving other roles below prevailing market compensation.
Employers should determine whether their PEO's compensation benchmarking accounts for industry, location, job responsibilities and employer size.
They should also distinguish between salary budget recommendations and actual market pay levels.
An employer whose wages are already below market may need larger adjustments even when competitors are budgeting relatively modest annual increases.
Likewise, a business paying above-market wages may not need to match every increase reported in national compensation surveys.
PEOs can assist with benchmarking and compensation planning, but the client employer generally retains responsibility for establishing employee pay and making compensation decisions.
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Building a Compensation Budget Around Market Conditions
Wisper's discussion highlights why employers should not use inflation alone to determine annual salary increases.
Inflation remains relevant because it affects employees' purchasing power and perceptions of compensation. However, it does not establish the amount an employer must pay to remain competitive.
A practical compensation review should consider current salaries, market pay ranges, turnover, recruiting difficulty and the availability of qualified workers.
Employers should also evaluate whether their salary budgets provide enough flexibility to address positions where compensation has fallen behind the market.
The HRO Today discussion does not establish that 3% is the appropriate increase for every employer or that compensation pressures are uniform across industries.
The historical average provides a reference point, not a substitute for evaluating actual labor market conditions.
For employers preparing compensation budgets, the relevant question is not simply how much consumer prices have increased, but whether current pay remains sufficient to attract and retain the employees the business needs.
Source: https://www.hrotoday.com/video-and-podcast-lounge/educational-podcasts/the-land-of-3-percent/
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