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The actual value of money is in its buying power: what can you actually get with a given dollar figure?

As employers, we provide buying power in exchange for labor.

However, our side of that exchange, the providing of buying power, is constantly eroded by inflation. Inflation is the continuous reduction of buying power for a given dollar figure.

Companies typically ignore inflation entirely when decided how to adjust compensation over time. And companies are awfully stingy about "raises", so we're always hearing stories about people's raises not even meeting inflation. In other words, those "raises" are actually "reduced pay cuts".

If you don't want to be giving your employees continuous pay cuts, you need to continuously adjust compensation to at least match inflation.

Does it even matter, though?

The impact of not adjusting for inflation doesn't seem that big, historically, because the recent U.S. inflation rate has generally stuck to ~2% (and even less). It still added up though, since inflation is compounding.

And then the pandemic hit, and we started seeing 6%, and then 7%, and all the way up to 9% year-over-year inflation. And that meant, unless we did something to account for it, that we were (in effect) decreasing our employee pay truly significantly.

Just how big of a difference is it? Looking at the Bureau of Labor and Statistics (BLS) data, we see that the CPI (Consumer Price Index) went from 258 in January 2020 to 307 in December 2023. That's a staggering 16% decrease in the buying power of a dollar!

As a consequence, if you had the same absolute compensation in January 2020 as you did in December 2023, you experienced a 16% pay cut.

Once we realized just how big of an impact this was making on our employees (and ourselves, since we're employees, too!), we decided to change our compensation mechanism to ensure that it always accounted for inflation. That way we could be sure that we were, at the very least, always providing our employees with the buying power we'd originally offered when they joined our team.

A quick aside: Yes, it's not our fault, as the employer, that inflation shot up so aggressively. (Though it is the fault of some other companies.) Just as it's not our fault that our idiotic U.S. health care system ties health care to employment, putting us on the hook for that, too. Certainly, it sucks that the cost of running a business constantly goes up, and up, and up. But being a good employer means that we have to account for the dumb reality that others have built for us.

Anyway, seeing those dramatic numbers we changed our approach to compensation. And now that we're doing it this new way I can't imagine doing it the old way.

Here's what we do, and I encourage other employers to do the same:

  • Set compensation in "Dollars per CPI" ($/CPI), which makes the number an inflation-proof quantity of buying power, rather than an inflation-ignorant, plain dollar figure. In other words, if I wanted to pay someone $100k in today's dollars (with the CPI at ~300), I'd set their salary to $100k/300CPI, or $333/CPI.
  • At each payroll, look up the current CPI and then multiply the employee $/CPI by that to get their current absolute compensation. For example, if the CPI increased to 312 that same employee's absolute salary would now be ($333/CPI) * 312CPI, or ~$104k.
  • To give someone a raise (i.e. an increase in buying power), bump their $/CPI. So if you want to give the above employee a 3% raise, you'd do that by changing their rate to $333/CPI * 1.03 = $343/CPI.

This does add a layer of extra work during payroll, but you could automate all of it. In cases where automation isn't an option, you can still choose exactly how and when you adjust for inflation. It doesn't have to create unbearable overhead.


Which CPI numbers do I use?

CPI is pretty complicated, and it absolutely does not represent the truth of how we experience inflation. The CPI is an averaged-out, best-guess at how the cost of living is changing, biased by the definitional whims of politicians and academics. It probably under-estimates inflation as real people actually experience it.

And it varies by region! Each city and state has its own little micro-economics and its own inflation rate. Tech hubs have much higher local inflation than other locations, for example.

Which is to say that there is no "true" CPI to use for this. The important thing here is making a good faith effort to account for inflation in employee compensation, balancing practicality and reality while acknowledging that this is a messy problem with no "right" answers.

At my company, we use the "Consumer Price Index For All Urban Consumers (CPI-U)", since that sorta averages out all of the differences and since we're a remote-first company with employees in several cities and states. But you could use an index for a more specific region.

Does this make it more expensive to compensate employees?

Potentially, though that fully depends on how you are currently doing your compensation.

If your prior approach wasn't at least matching inflation, then you were, in effect, making your employees compensate you for inflation. So if it does make things more expensive, that's probably how it should be.

But also note that, if all you did as an employer was ensure your employees' buying power stayed the same, you'd probably be doing better than most employers even if you didn't also add in raises. It's a pretty strong recruitment message to be able to say, "We'll make sure your buying power never goes down."

What if I can't afford it?

If you can't afford to keep employee salaries up with inflation, then you may not have a viable business. That's not a value judgement; running a business is hard and the world around us is constantly throwing surprises our way to make it even harder. Businesses fail. Mine almost has a few times. Someday it probably will.

But! If you're running your company as honestly and ethically as you can, and doing your best by your employees, it's very possible that your employees would rather take a pay cut than have the business go under and find new employment.

The important thing here is to understand and acknowledge that, if you don't keep up with inflation, you're asking your employees to sacrifice their own buying power to keep your company afloat.

But future compensation is unpredictable!

Since there's no way to know what the CPI will be in a year, or even a month, neither you nor your employees can know exactly how much they'll be getting paid at any point in the future.

Employees will probably be okay with this, since they'll know that, whatever the pay, it'll be more with every paycheck (in the absence of an explicit, intentional pay cut).

It's harder on the employer side, definitely. We need to be able to project out our runways, allocate budgets, etc. We can deal with this a few ways:

  • By deciding how frequently to recompute absolute pay (monthly, quarterly, yearly)
  • By deciding how to compute the CPI numbers (trailing month, trailing quarterly average, trailing yearly average, etc)
  • By including models of CPI change in budget and runway predictions.

Which is all to say that you can choose your own level of uncertainty via the details of how you approach this.

What if CPI goes down?

It almost never does and, in those rare moments, it's been a tiny decrease for a short period of time. If you are using rolling averages to smooth things out I'd be surprised if you ever see a decrease. Still, you should plan for what you'd do in that scenario.

Some options:

  • Pay employees the reduced amount. It won't feel good to an employee, but since you're actually providing the same buying power, then you at least aren't experientially giving them a pay cut.
  • Always pay employees at least as much as you did the last time. You'll be briefly, and barely, bumping their buying power until the CPI starts going up again. That'll cost you very little and will make employees happier. (This is our plan.)

Just do your best

As the saying goes, "There's no ethical consumption under capitalism."

And, its corollary, "There's no ethical employment under capitalism."

Unfortunately, U.S.-style capitalism has saddled private businesses with the entire responsibility for the welfare of our selves and our employees. I don't want to be responsible for that. I don't know any small business owner who wants to be responsible for that! And yet, we are responsible for it. So we'll just have to keep doing the best we can under this garbage system.