The first minimum wage in America came in 1938 when Congress enacted the Fair Labor Standards Act (FLSA); the same statute we use today (with many modifications, of course) to distinguish between exempt and nonexempt employees. Back then, the minimum wage was set at $0.25 per hour. A year later, it increased by a nickel to $0.30 per hour. After that, Americans had to wait six years and survive a World War before Congress granted them another ten cents an hour. Amazingly, it took almost 20 more years, until 1956, before the minimum wage reached $1.00 per hour. In all, it took almost 50 years (until 1975) for the minimum to reach $2.00 per hour.
For virtually all of that time, from 1938 to 1976, the vast majority of Americans described their pay increases in terms of the amount of additional money they received ("Honey, I got a two hundred dollar raise today, let's go celebrate.") But somewhere along the line, the way we calculate and discuss pay increases took a dramatic shift. And American business hasn't been the same since.
THE PERCENTAGE INCREASE
I have never successfully tracked down how or when the notion of a pay increase as a flat dollar amount (or a certain number of dollars per hour) morphed into the percentage increase. I suspect the shift happened subtly and quietly over time. After all, it wasn't the kind of thing anyone cared to publicize. At its core it was elitist, perhaps even racist. When companies began awarding salary increases as percentages of workers' current wages, it had the instantaneous effect of enriching the well-to-do.
After all, 5% of $50,000 ($2,500) is five times greater than 5% of $10,000 ($500). This difference was explained away (and still is) by saying that small increases are less noticeable to people who already make big money. The flip side, which is also true (but less often mentioned openly), is that people who make less money will be satisfied with (and grateful for) smaller increases. It is impossible to say for sure, but I suspect that this kind of thinking has led directly to the growing gap in real dollars between the salaries paid to lower-level and higher-level employees. In 1982, a typical CEO earned 42 times more than the average production employee. Today's CEO makes nearly 500 times more than that same worker.
While dramatically accelerating earnings for the highly paid, percentage increases also place a huge drag on the earning-power of lower-level employees. Take a look at the table below to see how long it takes someone who makes $30,000 a year to earn an additional $20,000 versus the time it takes for someone earning $80,000 per year to earn the same $20,000 (assuming both get 5% annual raises):
The higher-paid person achieves their $20,000 increase in half the time (6 years versus 12 years). Even more dramatic are the TOTAL EARNINGS that separate the two people in the above example. Over the 12-year period, the person who starts off making $30,000 earns $477,534 while the person who starts off making $100,000 earns $1,273,371; a difference of almost $800,000.
And this example is based on two relatively low paid individuals -- imagine how exaggerated the situation becomes when we start talking about executives who earn upwards of $250,000 per year!
A TRAVESTY, A SHAM AND A SHAME
To me, differences of this magnitude are unconscionable. Yet the shift from flat dollar increases to percentage increases has become so ingrained in American business that it is taken for granted and barely noticed.
What's more, it contributes to a host of other irregularities. In today's working world, employees link their self worth to those same percentage increases. I routinely hear complaints from individuals making more than $100,000 a year about receiving a paltry 3% increase when they discover someone else who is earning $30,000 per year has received a 7% raise. Such people are conveniently blind to the fact that their 3% increase ($3,000), in real dollars, is actually 43% larger than the other person's 7% ($2,100) raise.
Another odious byproduct of this discriminatory pay practice is the deleterious effect it has on business. Granting increases on a percentage basis creates an inflationary cost spiral that eventually results in major problems for companies. The seemingly harmless practice of increasing salaries a few percentage points per year ultimately buries companies in a sea of red ink and forces them to raise prices and/or cut costs. Eventually the only costs left to cut are the very same salaries which caused this mess to begin with, thereby bringing this absurd situation around full circle.
THE ILLUSION OF FAIRNESS
I long ago learned to check my wallet when someone who earns more than me talks about fairness. What appears fair through one one end of the telescope looks awfully biased from the other end. Ask someone who makes $30,000 which is more fair, giving everyone a $5,000 raise or a 5% increase and guess what answer you get? Ask the same question to someone who makes $200,000 and you get the opposite answer. Who is right? It's just another example of the Golden Rule -- He who has the gold, makes the rules.
WHAT CAN BE DONE?
I have no doubt that this practice must be stopped, but how? Here is my solution:
1) First, there needs to be a recognition and acceptance of the poor motivational value of base salaries. (See the July 28, 2008 entry titled Why Are Base Salaries Such Notoriously Poor Motivators?) Without this recognition, companies will be reluctant to stop throwing money down the drain.
2) Second, there needs to be a clear understanding of what base salaries (and base salary increases) are for. (See the July 24, 2008 entry titled Common Misconceptions About Base Salaries.) This will help get things back into line.
3) Lastly, companies need to make better use of incentives. Unlike base salaries, incentives:
- Are not inflationary (they must be re-earned every year)
- Are self-funding (if you don't get the performance, you don't have to pay)
- Are forgiving (if you make a mistake and pay an incentive for the wrong reasons you get to try again next year)
- Have greater impact on a person's behavior (base salary increases are forgotten in a day while incentives can motivate all year long)
- Take the pressure off base salary increases by giving employees another way to earn money (often much more money than they could ever hope to get from a salary increase)
THE BOTTOM LINE
Like so many other subtle and pernicious business and social practices, the tendency toward percentage increases has slowly invaded the fabric of our lives. The first step toward changing this is to recognize the problem. Next we must create relevant and effective solutions. And like so many other important changes, someone has to be willing to go first. That is often the biggest problem. Who will lead? Getting the rest to follow is not so tough. After all, everyone, it seems, wants to be the first to be second.