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QUESTION:  What is the difference between cost-of-living and geographic pay differentials?

 

Wage and salary differentials reflect the local demand for and supply of labor.

 

Cost of living is dictated by the local demand for and supply of goods and services.

 

ERI subscribers may also come across the term "buying power," which is the inverse of cost of living. Cost of living is the cost of purchasing goods and services, as determined by the demand and supply of goods, services, and property. For example, if the cost of living is 10% higher in an area, the buying power is approximately 10% less in that area.

 

This demand for and supply of goods and services are defined in terms of the data ERI surveys for Assessor Series cost-of-living databases. This data is downloaded from existing sources and includes: rental rates, housing prices, income taxes, property taxes, gasoline prices, medical costs/services, major retail grocery and drug store prices, etc. Cost-of-living differentials, as reported by ERI, reflect cost models at different income levels (e.g., an auto of "x" value driven "x" miles/kilometers, home rental with no mortgage income tax deductions, home ownership with income tax mortgage deductions, etc.). Local wages and salaries do not indicate the local cost of living. Cost of living indicates the comparable local buying power for any given salary.

 

Most compensation professionals agree that when a company is hiring from the local work force (that is, when no transfer or relocation occurs), wages and salaries are set according to market pricing of wages and salaries only. In general, branch pay should be dictated by market pricing of wage/salary differentials only.

 

While employees may find it more desirable for their pay to be adjusted for local cost-of-living variances, this is an extremely unusual practice, and in many cases will not be cost effective for the employer. That is, in many cases the employer would be competing against organizations with relatively lower compensation costs and, thus, be at a competitive disadvantage.

 

In most cases, cost-of-living is considered only when an employee incurs new expenses due to an "internal" move from one branch office to another. In this situation, the new salary would be set according to the destination market (local wage and salary level). Then, any cost-of-living allowance would be awarded separately from salary and for a finite period of time.

 

It is undesirable to build a cost-of-living adjustment into salary, as the integrity of the current salary administration program will be compromised. For instance, the transfer of personnel into an office where locally hired employees would be earning lower salaries than the transferee's "cost-of-living adjusted salary" is an undesirable and avoidable situation. The transfer of personnel into an area where local competitors' employees would be earning higher salaries than the transferee's "cost-of-living adjusted salary" is an equally undesirable and avoidable situation. Better solutions would include the award of a one-time (lump sum) moving bonus or a gradually decreasing three-year cost-of-living allowance, which is awarded separately from the new locally adjusted competitive salary. Each organization's unique situation (tax considerations, cash-flow, etc.) will dictate the best method for handling cost-of-living allowances.

 

A random telephone survey by ERI's Director found that only 2% of ERI subscribers pay "the same for all jobs nationally, but vary levels by the cost of living."  All other surveyed subscribers stated that they ignore cost of living and concentrate on the demand and supply/ local market pricing to administer geographic pay differentials.

 

Cost of Living v. Market Pay Rates

 

There are many reasons why employers decide to pay the local market pay rate (what it takes to attract, retain and motivate a competent worker) instead of paying according to local costs:

 

•No two employees have the same living costs. Even if they hold the same job and earn the same money, their family circumstances and spending practices vary.
 

•The cost of living depends on family lifestyle and the total budget available from all income earners in the family. Family expenses differ according to many variables, such as the number of income earners, the total budget available, size of home, whether renting or buying, how many dependents, number and value of automobiles, and more. Every cost-of-living statistical model uses a different standard market basket of goods and services.
 

•It is quite difficult to come up with only one cost figure that properly fits every employee lifestyle, but it is quite simple to determine what other employers pay for the job you do.
 

•Pay is usually set once a year according to local salary levels, corporate pay strategy, and budget, but costs change constantly. Prices go up and down all the time, and employees would be quite upset if their wages were cut because the price of bread dropped this week, for example.
 

•Companies pay for you to do work, at a competitive rate, rather than give you amounts based on your expenses. Employers are not even legally allowed to question job applicants about their family circumstances, so they are not about to set pay according to your spending pattern.
 

•People don't usually live where they work. Most employees live in a town where the costs fit their family budget and where the prices are lowest for their lifestyle. They work where their employer is located, and that usually is not within walking distance of home. Basing pay on home location and family expenses would require different pay scales for every worker and even different rates for the same job done by people in the same community, if, for example, one was a single renter and the other was a homeowner with five dependents.
 

•Relevant living costs are already covered by pay surveys. If wages and salaries are influenced by living costs, then the competitive market pay surveys reflect those costs. If you wish to research livings costs, see ERI's Relocation Assessor, which calculates cost-of-living levels based on earnings level, family size, home size, and automobile usage. The application reports the cost-of-living differential between a base city and destination city to determine the amount an employee must earn in the new location to "remain whole" (not lose buying power).