Are Growing Benefits Slowing Wage Growth?

November 2, 2015

Wages have been growing slowly for years. Theories abound for why wage growth has flattened, from sidelined workers holding wages down to fears that “secular stagnation” is ushering in an era of permanently gloomy pay growth.

But there’s another explanation that’s getting less attention: Growing reliance on benefits, or what economists call “non-wage compensation.” These are things like health insurance, paid vacation, free meals and more. Recent anecdotes suggest many employers are offering benefits to workers rather than wage gains. Is this trend behind the apparent slow down in wages?

Why Benefits?
When it comes to compensation, pay and benefits are two sides of the same coin. Workers can take their pay in cash, employer-provided benefits or – as for most workers – some mixture of the two. To most employees, these various forms of compensation are substitutes: more of one makes people willing to accept less of the other.

Bottom line: If companies are offering better or more expensive benefits to workers, economists predict that should pull down wage growth.

The Evidence
Aside from anecdotes, there’s some evidence that employers today are shifting from wages to benefits. The best data come from the Employer Costs for Employee Compensation survey from the U.S. Bureau of Labor Statistics. It shows benefits used to make up 29 percent of total compensation in 2004. By 2015, benefits had risen to 31.5 percent of total pay – a 2.5 percent jump.

That’s a small percentage shift. But with roughly $9.5 trillion dollars per year in total U.S. compensation, that’s a shift of nearly $240 billion from wages to benefits – the equivalent of $750 for every man, woman and child in the U.S.

Common HR Practice
This shift from wages to benefits will come as little surprise to experts in the recruiting world. The link between wages and benefits is well known among hiring managers, who commonly recommend boosting benefits as a way to attract talent during company salary freezes.

There’s also plenty of historical precedent. Our current system of employer-provided health insurance is partly the result of a giant shift from wages to benefits. Before WWII, employer-provided health insurance in the U.S. was rare. During the war, economy-wide price and wage controls prevented companies from competing for workers by raising wages. Instead, they turned to offering workers health insurance. Congress struck a deal to make those new benefits tax-free, and our current system was born.

Survey Says
Interestingly, many workers today welcome the shift toward benefits. In Glassdoor’s most recent Employment Confidence Survey, nearly 80 percent of workers we surveyed said they would actually prefer new or additional benefits to a pay increase. This preference for perks rather than pay was especially strong among younger workers aged 18-34 (89 percent). But even among older workers, two-thirds said they’d prefer a raise in benefits rather than cash.

Tax Reasons
Why might workers prefer benefits to pay? One reason is tax benefits. Because wages are taxed but most employer-provided benefits are not, there are strong economic incentives to pay workers in-kind – especially in high-tax states like California and New York.

For example, a married couple in Silicon Valley earning $250,000 per year can face a marginal income tax rate of 47.2 percent (9.3 state, the rest federal). That means they can either accept $10 in free meals, parental leave or other benefits from their employer, or just $5.28 in after-tax salary. That’s a powerful reason to take benefits rather than cash.

Health Care Cost Shifting?
But not all shifting from wages to benefits is great for workers. One example of a negative effect is the rise in health insurance costs. In recent decades, skyrocketing health care costs have boosted insurance premiums for companies. That rise can be thought of as workers getting “more” health benefits – even though it’s the same insurance, it’s much more valuable. And those rising health costs crowd out what’s left over for companies and workers to bargain over, putting downward pressure on wages.

There’s been a lot of academic research on the link between rising health care costs and wage growth. (For example, the Progressive Policy Institute provides an excellent backgrounder.) Taking a more academic approach, a working paper from the National Bureau of Economic Research finds a 10 percent rise in health insurance premiums leads to a 2.3 percent drop in wages – an example of substitution between pay and benefits that has likely harmed workers in recent years.

Bottom Line
Wage growth has been notoriously slow in recent years, hovering around 2 percent compared to the 3-4 percent annual growth of normal times. Many factors are behind the slowdown, from slack in the labor market to stubbornly weak productivity growth. But there’s mounting evidence today that the gradual shift from wages to benefits may also be a contributing factor – something economists will be watching closely in coming years.