Cost of Living Adjustments based on Location Doesn’t Make Sense

Cost of Living Salary Differences

Companies pay differently based on location. Our original article about why companies do it is linked below. This article will explain why it shouldn’t be done.
Why do companies pay differently based on location?

Why Cost of Living is a Crazy Reason

Cost of Living Adjustments to salary and compensation doesn’t make sense for many reasons.

Savings are higher in “high cost” areas

Someone making $130k you can save a lot more money in a high cost area than someone making $50k in a low cost area. The first person could find a cheap place to live and save maybe $50k/year. The second person literally cannot save $50k/year because his after tax income is less than $50k a year.

Equal Work Equal Pay

Employers should pay workers based on the value of the work given the market environment. Two people delivering same amount of value to the company should be paid the same. Why pay Bill in Arizona less than Tom in San Francisco?

Perverse Incentives

Many people see the difference in compensation and move to these so called “high cost” areas because they know they’ll be paid more. Companies then complain they need to be in the high cost areas and pay more because the talent is there. It’s a vicious cycle.
Employers claim they can’t find good software engineers in Phoenix Arizona but because they’re paying $89k instead of $120k in SF. The smart software engineers think “oh so you’ll pay me more if I move to SF, okay I’ll move”. You don’t need to open an office in SF and pay $120k there to find good talent, you just need to pay $120k in Arizona to find good talent.

Case Study

Suppose person A works in San Francisco CA and person B works in Phoenix AZ. Both are software engineers for the same big software company. Salaries are based on Glassdoor median salary for that city. Rent is based on what I found listings for in that city.
San Francisco California:
-$120k salary
-$37,133 income tax
–20,047 federal
–9,180 FICA
–7,906 state
-$82,867 after tax take home
-$2000 monthly rent (20.0% of gross salary)
-$58,867 after rent


Phoenix Arizona:
-$87k salary
-$21,450 income tax
–12,315 federal
–6,656 FICA
–2,480 state
-$65,550 after tax take home
-$1400 monthly rent (19.3% of gross salary)
-$48,750 after rent

While both pay roughly the same percentage of salary in rent, the San Francisco employee is much better off. Food is roughly similar in both locations and represent a small percentage of total income regardless. Assuming a tech company that provides food, food cost is negligible. This means disposable income for the SF employee is $59k while the disposable income for the Phoenix employee is $49k, a difference of $10k a year.

Some argue that $49k in Arizona gets you more than $59k in SF. However, you can save the $59k in SF and later spend it in Taiwan or Thailand for example. You can’t save more in Arizona than in SF, it’s literally impossible based on the math.

So why do companies still do it?

HR consultants tell them to. People are used to it. Those are the two main reasons.
An employee’s incentive isn’t to advocate for higher pay in Phoenix, because that’s hard. His incentive is to just move to San Francisco or New York and get paid more.

Like this content? Share with your friends!Share on LinkedIn
Linkedin
Share on Facebook
Facebook
Tweet about this on Twitter
Twitter
Share on StumbleUpon
StumbleUpon
Share on Tumblr
Tumblr