Given recent economic trends, the reasons to justify raising U.S. salary increase budgets over 3% in 2019 are increasing.
The U.S. economy experienced a high pay growth period in the 1970s and 1980s in response to high inflation. But from the early 1990s to present, the Consumer Price Index (CPI) stabilized to 3% and below. Real salary increase, which measures the difference between wage growth and the increase to the CPI, has also reduced. Consider the following example:
|Decade||Average Real Salary Increase*|
* % Salary Increase Budget Less % Change in CPI = % Real Salary Increase 1
During 2017, the real wage increase reduced even further to 1.0%. In 2018, wage growth is projected to drop to 0.7% assuming budgets remain stable at 3%.
After the 2008 financial crisis, companies became very conservative in managing fixed expenses. It is understandable that the prevalence in variable pay increases and one-time bonuses increased after the 2008 financial crisis rather than increasing pay over 3%.
We are now approaching a different era.
The Bureau of Labor Statistics January 2018 Jobs Report states the following:
- The economy added 200,000 jobs last month.
- The January unemployment rate remained extremely low at 4.1% (same as December 2017).
- The average hourly wages have risen 2.9% over last year.
As 2018 progresses, we may see the 2.9% increase in hourly wages rise over the 3% mark. Interest rates are also increasing, which is expected to influence healthy inflation. Although 2.1% was the former projected rate of inflation for 2018, increasingly more economists are predicting inflation rising to 2.5% based on more recent data.
The guidance of the International Monetary Fund in its October 2017 World Economic Outlook suggests that “weak wage growth was one source of the surprising weak inflation that itself is a source of concern” and affects the sustainability of the global economic recovery. 2
- The growth forecast for the United States has been revised up given stronger than expected activity in 2017, higher projected external demand, and the expected macroeconomic impact of the tax reform, in particular the reduction in corporate tax rate and the temporary allowance for full expensing of investment. The U.S. GDP growth forecast has been raised from 2.3 percent to 2.7 percent in 2018, and from 1.9 percent to 2.5 percent in 2019. 3
- In advanced economies where output is close to potential, still-muted wage and price pressures call for a cautious and data‑dependent monetary policy normalization path. However, where unemployment is low and projected to decline further, such as in the United States, a faster pace of policy normalization may be required if inflation were to pick up more than currently anticipated.4
What does this mean?
Although the reduction of the U.S. corporate tax rate from 35% to 21% is not a reason in itself to raise salary increase budgets, the President’s Council of Economic Advisers October 2017 Report estimates that corporate tax reductions will, in the medium term, boost average U.S. household income annually in current dollars by at least $4,000, conservatively. With more optimistic estimates, income boosts are over $9,000 for the average U.S. household. 5
Hundreds of companies have already responded to the U.S. corporate tax cut from the Tax Cuts and Jobs Act 2017 by announcing one-time cash bonuses, salary increases, as well as increases to the 401(k) contribution. The Americans for Tax Reform website is maintaining a list of companies who are paying bonuses, increasing pay, and/or 401(k) contributions as a result of the reduction in corporate tax rates. As of February 9, 2018, 340 companies are on their list. In addition to the above practices, companies are also increasing training opportunities for their workforce. Additional resources on the tax reform effects to corporate tax cuts are available through the President’s Council of Economic Advisers, as well as other major Human Resources consulting firms.
The new tax plan clearly will bring about significant tax savings to employers, which will likely result in expanded long-term capital investment, hiring, training, and may even ripple into added compensation. This year is a period of transition — companies are likely adjusting and planning under the new tax law. The law will also allow multi-national businesses to repatriate funds back to the United States with a 5.25% tax. Repatriation is substantially better than the former 35% tax. Although a significant improvement, this reform will still incur costs that calls for planning.
In recent years, there has been a trend of companies adding or increasing the use of variable pay in lieu of increasing fixed compensation beyond 3%. Managing one-time bonuses or adding or increasing variable pay can be effective for the short-term; however, it is important to recognize that employees bear the burden of increased fixed expenses due to inflation. As interest rates and inflation rise, employees’ spendable income will erode, and, in some cases, workers will seek out other companies and higher rates of pay to ensure their fixed living expenses are met. Lower paid employees will feel the erosion of their disposable income more significantly than higher paid employees. The labor market will respond by a gradual adjustment to salary increase budgets over time. Compensation will gradually follow increases to the rates of inflation, although it tends to move more slowly in the marketplace.
During 2018, it is important to observe the following factors within our organizations and labor markets:
- Projected changes to salary increase budgets
- Increasing rate of inflation
- Economic health of our business and country
- Unemployment rates
- Financial capability
- Market rates for jobs
These economic indicators are important factors when determining the most appropriate salary increase budgets for 2019. This transition time is also an excellent opportunity to educate our management teams to ensure support of the rising U.S. salary increase budgets.
ERI’s Assessor Series® – Solutions for every compensation decision
2 International Monetary Fund. 2017. Seeking Sustainable Growth: Short-Term Recovery, Long-Term Challenges. Washington, DC, October.