Some remote companies such as Atlassian have begun altering their pay structure to pay workers different amounts depending on the geographic region where employees live. No doubt the company leadership responsible for such decisions has correctly determined that the cost of living is not the same everywhere, and has naively assumed that the way to address this imbalanced cost of living is simply to pay people more who live in higher cost areas. However, I’d like to make the case that this “solution” solves one issue and introduces several others in the process, arguably resulting in a worse outcome for most employees.
Envy
The reasons for the differences in cost of living by region are complex, but they are largely driven by the market rules of supply and demand. Supply related issues are a complex topic for another day, but generally speaking, demand is the primary driver of regional pricing trends. The cost of living is higher in places where a larger number of people want to live.
Given that, it stands to reason that most employees of a company would prefer to live in places that have a high cost of living, assuming that these employees are a roughly representative sample of the population.
However, not all employees have the same preferences. There are some people who actually prefer living, for example, further away from cities, away from the coasts, and perhaps even away from scenic areas. Their priorities are simply different, and as a result, they are at their happiest in a low-cost region. This is awesome for them, in some ways, because they might be able to save a bit of money on rent and housing, as long as they continue to live there.
However, consider then, from their perspective, how it might feel to be perpetually locked into a lower pay bracket than their colleagues simply because of this preference. They then have to choose between living where they like, and getting paid more.
And perhaps that’s a tired argument. Perhaps just because they feel bad doesn’t mean they’re being treated unfairly.
But inevitably, those paid less for the same job, regardless of the reason, will feel worse, and this will inevitably result in them reducing the quality and quantity of their output, trusting their employer and its management less, and being less willing to cooperate with their coworkers who they feel are being treated better than them unfairly.
Discarding how people feel, whether their feelings are rational or not, is a mistake.
Solve one problem, get two more
You might be saying, “Tough luck, they can get a cheaper house and cheaper rent just because they prefer that, but the rest of us would be miserable there. Why shouldn’t we try to give them the same quality of life as the rest of us?”
And I’d largely agree, but the problem is that you’re making the assumption that the individual circumstances of these employees are nearly identical, when the reality is that even very similar employees often have extremely disparate circumstances.
Let’s make up some examples to illustrate the myriad assumptions being made and how “equalizing” pay based on regional cost of living creates multiple brand new inequalities:
Income and cost of living are not one-to-one
Let’s say Employee A lives in an area with an average cost of living of $80k, and Employee B lives in an area with an average cost of living of $40k. The employer considers this cost of living disparity, and sets Employee A’s salary at $100k, and Employee B’s salary at $50k. Now let’s assume both employees, miraculously, are exactly average, and spend exactly the average amount of money on necessities like taxes, housing, utilities, food, healthcare, and transportation. Now they’re both making exactly 125% of the cost of their necessities. Problem solved, right?
Although both employees have the same role, Employee A, who lives in the much more expensive city, has $20k of disposable income, while Employee B will only have $10k. Employee A is given a substantial and tangible reward just by virtue of living somewhere more expensive.
This also strongly incentivizes Employee B to move to a more expensive city simply to gain the same extra disposable income.
Unplanned expenses and family necessities
“Well that’s easy to fix,” you might say, “just factor in what percentage of their income an employee typically spends on necessities, and scale only that part of their income, and leave the rest the same.”
It’s an interesting approach. So in this case, perhaps Employee A would be paid $90k, and Employee B would be paid $60k. Now after their incredibly average costs of living are subtracted, both have $10k left. Neither should have anything to complain about, right?
Now let’s say that Employee A gets into a car accident, and as a result they have to spend a few days at the hospital.
Well in a large city, hospitals can often cost much more money. So for an injury that might have cost Employee B $20k, Employee A is instead spending $50k.
Obviously Employee B is going to have an easier time weathering the unexpected bill, because both have the same amount of “disposable” income, but these unexpected costs are frequently much higher for one of them.
Putting aside the fact that the obvious solution here is to nationalize the entire US healthcare system, this is just one example that illustrates that often unplanned expenses also scale with the cost of living, and this means that the actual expenses for a person living in a place with a higher cost of living can be much more volatile, and this can put extra strain on their financial security.
Another example might be if both Employee A and Employee B have children. And let’s assume they both have the same number of children. Both employees may need to occasionally pay for child care, and let’s again assume they both need to do so just as frequently. Employee A’s child care costs are likely to be substantially higher, because they are likely having to pay somebody else who is subject to the same high cost of living.
So although we theoretically equalized their disposable income, the fact that these extra expenses are also subject to differences in cost of living means that Employee A has to spend substantially more of their leftover pay than Employee B does, even if both require the same extra services.
While these two examples have showed where this solution is sub-optimal for the employee living in the more expensive city, if you had another pair of employees who were both, for example, living with their parents and thus had no housing costs and therefore neither is spending anywhere near the average cost of living, then the employee from the more expensive city is once again given a substantially higher amount of disposable income.
No matter how you fiddle with the ratio of how much income you consider part of “necessary” spending, employees all have different life circumstances, and as such their costs will never fit into a one-size-fits-all pattern that will satisfy everybody. Somebody will always be unfairly advantaged or disadvantaged by the decision.
The one-way economic mobility advantage
Let’s assume that our imaginary employer sticks with the solution from the first example, as flawed as it is, since it’s making fewer assumptions about how employees will be spending their money.
Perhaps you’re thinking, “clearly it’s impossible to get it perfect, but at least it’s better.” We’ll see about that.
Let’s consider some other more subtle problems now.
Imagine that Employee B, rather than living where they do because they prefer living in a lower-cost area, actually wants to make a move to the city where Employee A lives.
If Employee B were able to put away 50% of their disposable income for a down payment on a home and/or moving costs, they would be able to save $5k per year. If Employee A also wanted to move somewhere, they would be able to save $10k per year while still spending twice as much of their disposable income as Employee A. They could even save $15k if they were able to cut their spending to the same dollar amount.
This means Employee A would be able to save money 2-3 times as fast as Employee B assuming both wanted to live in the same city. And the disparity grows if both want to trade places. In that scenario, if you assume that the difference between home prices or rent for these two employee’s regions matches the cost of living difference, Employee A would only have to spend half of what Employee B would, meaning they could reasonably save money 4-6 times faster.
And while the second solution of only scaling a portion of somebody’s income would partially equalize this as well, that’s just considering the process of saving money, but let’s say that we also need to borrow money, for example to take out a mortgage on a house.
Even ignoring that Employee A already has a substantial advantage in just being able to save money for a down payment much more quickly, mortgage lenders mainly consider income as a means of determining your borrowing power. And Employee A’s income is double that of Employee B’s. So again, assuming both want to buy a home in the same region, Employee A would be able to purchase a home nearly twice as expensive as what Employee B would be allowed to purchase. Employee B wouldn’t qualify for the increased income until they actually live in the more expensive city, and therefore might not even qualify for the cheapest possible homes in Employee A’s city, and this would probably lock Employee B into renting.
“But Employee B can just rent in Employee A’s city, get the increased salary, and then buy a home” you might say. Yes, that is one solution. And it’s a solution that Employee A has the privilege of not having to do either when moving to a cheaper city or an similarly expensive one. This solution imposes extra costs and complexity to move economically up, but not down or laterally. In other words, it specifically punishes those who started out living in a less expensive city, and advantages those who already lived somewhere expensive when they started.
The other problem with that solution is that what you can rent is also predicated on your income. Many landlords will want proof of your income, and will require it to be a certain multiple of your rent in order to even allow you to rent from them. And again, since you won’t qualify for the increased pay until you live in that city, Employee B genuinely might not be able to afford the cheapest rent in Employee A’s city. It might literally be impossible to move to Employee A’s city, even though Employee A has the same role at the same company, and can comfortably afford to do so.
“The employer can just let you tell them when you want to move to a more expensive city, and give you the increased pay in order to qualify for the mortgage or rent that you’ll need,” you may now be telling me.
If you’ve ever applied for a mortgage or an apartment, you’ll know that the method that lenders and landlords typically use to verify income is to ask for something like 3 months of pay stubs or bank statements. So this is a non-starter unless your company is willing to pay you extra money for 3+ months before you even begin the process of planning your move. That seems unlikely in itself, but let’s imagine a company is willing to do that.
So why shouldn’t employees living in less expensive areas just periodically claim to be moving to a more expensive city in order to get paid better?
“Ah, but then the company can just order you to pay back the difference if after so many months you don’t make the move.”
And honestly, this solution isn’t terrible, but there are still problems. For one, you are potentially handing out zero-interest pay advances, and it might still be worth it to some employees to take advantage of that. If you charge interest in the event that somebody does have to pay it back, you are financially penalizing your employee perhaps for having a family emergency or even just being unable to close on a house or secure an apartment in a tight market. And depending on how the employee uses those funds while trying to make their move, they may not have enough of that extra salary sitting in their bank account to make paying it back easy or even possible. If somebody is living paycheck to paycheck, or close to it, spending any of that extra income could result in them being unable to afford the cost of living in their own region when they start having to pay back their employer, effectively bankrupting them.
And even if somehow you managed to make all of this as fair as possible, the issue remains that all of these extra worries, hoops, and processes are just not even a concern for Employee A. They can effectively move anywhere, any time, just by virtue of starting in the more expensive city.
Cascading issues at scale
If policies like these are implemented at enough companies in the future, they will begin having measurable effects on the economy as a whole.
If you incentivize people with more pay to live in more expensive areas, which are typically already more desirable areas, you will create further demand in these areas, which will potentially create a feedback loop of further raising the cost of living, which will necessitate widening the pay scale further, and so on.
As the pay scale becomes even more skewed, the issues I presented before become more and more pronounced.
So what should we do?
Pay people the value of the work they produce, full stop.
I think it’s fairly clear that in almost all scenarios, scaling pay relative to the cost of living where an employee lives will give unfair advantages to those who already live in expensive cities. In every case I’ve outlined where we could hypothetically take away that advantage, inevitably we end up arbitrarily giving that same advantage to some other group on any basis other than merit.
The actual solutions are likely to involve some philosophical debate.
What metric do we look at to determine whether this policy has successfully improved our lives?
If by any metric the policy appears to have neither positive or negative affect, should we keep or discard it?
Is it right to use cost-of-living adjusted pay scales if it slightly improves the lives of a lot of employees, and substantially worsens the lives of a tiny few?
If you are actually trying to answer that last question in your head, no doubt you are imagining specific groups as your hypothetical winners and losers. Now imagine the same number of people are affected in the same exact way, but reverse which people are positively and negatively affected. Is your opinion changed?
I think the average working-class employee would agree that slightly but measurably improving the lives of most employees while making private jets wholly unaffordable for all executives is a fair exchange.
Perhaps another fair exchange would be improving the lives of the 80% of workers with the lowest net worth, at the expense of a decreased income for the wealthiest 20%.
But the truth is, in a city with a higher cost of living, there are certain backgrounds that are statistically more likely. People with more wealth and more power tend to be more likely to already reside in these wealthier places.
Based on that, it is my hypothesis that these policies will see the wealthier groups of employees, perhaps those who have already paid off their mortgages and have investments earning them substantial passive income, that will see the largest gains in income.
And thus, the least wealthy employees, those who have been unable to afford homes and have spent most of their paycheck on rent, who have no money for investments, and have had no choice but to live in low-cost regions, will see no increase in pay (or perhaps even a decrease, depending on how these policies get implemented), and will have obstacles placed between them and the ability to get that higher pay they’ve rightfully earned by fulfilling the same responsibilities as their higher-paid colleagues.
If you my opinion, given that we are living in a time of unprecedented wealth disparity, we should definitely not implement policies that benefit the wealthy at the expense of the less wealthy.
And, should all else be equal, I believe rules ought to be as simple as possible.
Pay people the value of the work they produce. No less, and no more complex than that.
