Employers Guide to Giving Pay Raises for Inflation

As businesses gain momentum in 2024, many employers wonder how inflation will impact pay raises for staff – how will it affect what they can afford and what employees need? Pay raises often reward employee performance and contributions while helping a business enhance its reputation to compete for talent in the broader market. Inflation-based raises can help to align an employee's pay with changes to the standard of living and purchasing power.

Business leaders tell us they are struggling with financial issues but are a bit less concerned than last year. Six out of 10 leaders see economic conditions—like interest rates, inflation, and the potential for a financial slowdown—as their top challenges. Last year, inflation alone worried 10% more people.¹

Sixty-three percent of business and HR leaders report they find inflation to be extremely or very challenging for their organizations.¹ This challenge jumps to 72% of Baby Boomer leaders (aged 59 to 77) who find inflation a burden on their business and 67% for Gen Z (aged 18 to 26) and Gen X (aged 43 to 58) leaders.²

Inflation and pay increases usually go hand in hand, influencing each other, but different factors drive them. Inflation is about the rising cost of things like housing and groceries. Pay increases may depend on the balance between the number of people looking for work and the available jobs—typically related to supply and demand for labor. So, the big question on many employers' and employees' minds is, 'How will wages be adjusted for inflation?'

How Does Inflation Affect Pay Increases?

Although the inflation rate of increase is slowing down, it hasn't turned around completely. According to the Bureau of Labor Statistics (BLS), the inflation rate was 8.5% in 2022 and 3.2% in 2023. When inflation rises, people spend more on items like gas and everyday groceries.

The impact of inflation on an employee's pay is direct and substantial. When inflation is high, the elevated costs of goods and services erode the purchasing power of your income. To illustrate, if inflation climbs to 8% while your pay remains the same as when it was 4%, you effectively experience a 4% reduction in real wages. This means that every dollar spent to counter the surge in purchase costs represents a dollar that could have otherwise been allocated to savings or discretionary expenses. It becomes crucial for employees that their pay keeps pace with inflation to prevent a scenario where households struggle to meet the costs of essential items.

Many employees are urging their employers to raise wages to cope with the rising cost of living. While most organizations acknowledge inflation's effect on wages, the challenge lies in determining the appropriate amount for pay increases.

According to Brenton Dalgliesh, HR Tech Engineer at Paychex, "It's an unsettling feeling to see your take-home pay rise only to be undercut by increased insurance premiums and groceries. Over the past two years, employees have felt tension between sympathy for their employers' macro-economic realities and the daily gut punches from being unable to provide enough for their families."

Dalgliesh continues, "Businesses have been asking their HR Departments to do more with fewer employees. Instead of cutting wages, employees have been receiving their 3-4% merit increases; however, they're being asked to be as productive as 1.5 or 2 full-time equivalent (FTE) employees. "

Wages vs. Inflation

Inflation has been outpacing wages for several years. Currently, the BLS estimates that wage growth won't match inflation until some point in the fourth quarter of 2024. The gap between wage growth and inflation was at its widest in the third quarter of 2022; prices had jumped 12.8% since the start of 2021, while wages had climbed a smaller 9.1%, a 3.7-point gap.³

Should Companies Give Inflation Pay Raises?

Offering inflation-based pay increases or inflation-adjusted wages is worth considering to retain your top employees and offset the cost of inflation. Consider giving pay raises that keep up with inflation, as without these wage and salary increases people won't be able to afford as much as they may need to live at the same standards. According to SHRM,⁴ US employers, on average, increased compensation budgets by 4.4% in 2023. Adjusting wages for inflation and giving raises can help to foster employee retention and loyalty.

"At this point, giving employees a raise to offset inflation may be too little, too late," noted Dalgliesh. "As inflation approaches the Federal Reserve's 2% target, a raise of 3% to 4% starts to look beneficial unless you recognize the compounding effects of inflation over the past two years. Unless we enter into a deflationary period, which brings about its own problems, the increased costs of goods will likely remain where they are. A one-time increase on top of an employee's merit increase can help to offset the price of groceries and may remind your employees why they stuck with you instead of looking elsewhere."

Are Inflation Raises Mandatory?

Legally, there's no requirement to provide annual pay raises to your employees, and you might have valid reasons for not doing so. Businesses facing financial challenges may struggle to offer raises during tough years. If you decide against giving pay raises, it's crucial to communicate with your employees and explain the reasons behind your decision.

To prevent a high turnover rate, which can be costly for your business in the long term, it's often beneficial to consider pay raise requests from employees performing well. Alternatively, explore other means to retain valuable employees within your business, such as meaningful perks and benefits.

Cost of living adjustments may help employees manage rising prices for basic staples such as housing, energy, and food. A cost of living raise for employees is not based on job performance or a promotion. Instead, the pay increases are given to counteract inflation and help employees maintain their earning power. With inflation continuing to impact purchasing power, businesses have seen an increased need to implement cost of living raises.

How Much Should Wages Increase With Inflation?

The 2023 cost of living adjustment (COLA) increase established by the Social Security Administration is 8.7%, which is significantly larger than the COLAs in recent years. However, due to the rising cost of living and inflation, the usual annual wage hikes might not allow employees to live comfortably or feel adequately rewarded for their work. To determine the right wage increase for your business in 2024, consider factors like your company's revenue to determine the feasible raise for your employees.

Some employers give larger raises to exceptional employees to retain them while providing standard raises to the rest of the workforce. This approach helps maximize your budget and encourages better performance and productivity.

How To Calculate a Pay Increase Based on Inflation

There are several factors to consider when calculating a standard for base pay and wage increases, along with options to shape a total compensation package. These being:

• Inflation
  At the top of the list is having a good understanding of inflation in your relevant economy. Assess movements over a few years as price changes often lag from leading indicators.
• Cost of Living
  When inflation drives up the price of goods and services, currency is devalued and the cost of living increases. With the expected adjustment for cost of living for 2024 at 8.7%, if you give an employee an annual salary increase of $10,000, you will need to adjust that amount to $10,870 to account for inflation. This creates an inflation-adjusted salary.
• Merit
  When employee performance exceeds expected contributions, merit-based pay raises come into play. Keep detailed documents to support your decisions, and be transparent with employees to help encourage others to give their best. Merit increases can help to reinforce what high performance looks like and that it is rewarded.
• Length of Service
  Consider giving raises to employees who achieve milestones, such as reaching five years with your company. Raises for tenure can demonstrate to your employees that you appreciate their dedication and aim to keep them on your team long-term.
• Commitment
  Pay raises can also be used as a lure to retain employees and reduce unwanted turnover. Turnover is expensive and can negatively impact morale, brand reputation, and company culture. However, not all employees leave because of their pay, so it's essential to have a handle on employee metrics by using listening tools (such as engagement surveys, exit interviews, etc.) to know why employees stay or go.
• Reputation
  Paying competitive wages and rates that keep pace with inflation and the general cost of living can help you boost your employer brand and stand out as an employer of choice in a competitive market.

Consistent Pay Raises Can Help Keep Employees

Being consistent with your pay raises and keeping rates competitive with market forces can help boost an employer's ability to hold onto employees longer and maximize their contributions and performance. Adjust pay raises to align with inflation, cost of living, and other essential factors to create a positive employee experience – where people want to stay and do their best work. Paychex offers solutions to help with payroll, benefits, and HR guidance, along with suggestions on improving employee retention. And specifically, our Paychex Flex® solution enables employers to schedule reminders for individual employees, so you won't lose focus on providing employees with timely reminders about pay increases.

¹ 2024 Priorities for Business Leaders, Paychex

² Gen Z to Baby Boomers: Business Priorities for 2024, Paychex

³ Overview of BLS Statistics on Inflation and Prices : U.S. Bureau of Labor Statistics

⁴ US Employers Boost Pay Budgets Despite Recession Concerns (shrm.org)

⁵ Salary Increase Budgets Hit Two-Decade High (shrm.org)