Wages, Benefits, and Opportunity Cost
I’ve written before about how to use the idea of opportunity cost to focus on your decision making – a good rule of thumb when making a choice is to make the opportunity cost explicit. Don’t just say to yourself “I’m going to do X” when making a choice – say “I’m going to do X, instead of doing Y,” when Y is what seems like the next most desirable option to you. After all, it’s easy to say, “I’m going to spend my evenings working on writing a novel.” But it becomes a little trickier when you phrase it as “I’m going to spend my evenings working on writing a novel, instead of spending my time going out with my friends.” You may still decide pursuing your writing project is a good idea, of course, but that decision should be made while fully aware of what it will cost you.
I was recently reminded of an example of this sort of thing from an old job of mine. Different employers handle paid time off in different ways, but one system I’ve encountered that I really liked was one that made the opportunity cost explicit.
At the time, I was taking a job as an analyst with a healthcare and insurance provider. As is often the case, the first few days on the job were spent at an orientation, where you sit through some standard presentations, fill out your paperwork for taxes and payroll, and make your benefits selection. But the way this company offered PTO had an interesting twist that I hadn’t seen before that point, although I’ve since learned it’s not unique to them. Every employee started out with a certain amount of PTO – say, 15 days of PTO, equal to three work weeks of paid time off. However, you had the option to select more vacation time than the standard offering. If you wanted, you could choose to have 20 rather than 15 days of PTO – and if you made that choice, it showed a small deduction that would come out of each paycheck due to that selection. Adding up those deductions across 26 paychecks per year, and it came out equal to the value of 5 days of pay. So, employees had a choice – you can get more vacation time per year, in exchange for a slightly smaller paycheck every pay period. This was a very popular choice – most of the employees I talked to went with at least an extra 5 days, and many chose an extra 10 days. Getting a little less in each paycheck was, to them, worthwhile in exchange for having four or five weeks of vacation time rather than three weeks.
Of course, you might have picked up on something slightly ironic about referring to those extra weeks as additional “paid time off.” Because selecting that option came with a corresponding paycheck deduction, you weren’t really getting two extra weeks of “paid” time off – you were getting two extra weeks of out-of-office time, in exchange for the equivalent of two weeks less pay. Or put another way, it was paid time off, but the time off was paid for by the employee, not the employer. And that’s why I think this was such a great system – it made the opportunity cost explicit. (The initial allotment of 15 days PTO is paid by the employee as well, it’s just not made as explicit.) There is a trade-off to be made between more wages and more benefits, and in at least this one area, employees were able to decide whether and to what degree that trade-off was worth making.
And this is a case where I think it’s worth generalizing the lesson. There is no objectively “correct” mix of wages and benefits appropriate for total compensation – different mixes can be better for different people facing different constraints and with different preferences. Over time, regulators have required ever more expansive and comprehensive benefits to be provided to employees, which puts a heavy thumb on the scale for the wage-benefit tradeoff. I’m not saying that higher benefits and lower wages is a bad thing in itself – for many people, it makes perfect sense. But it’s also easy to see how for some, it makes far more sense to prefer lower benefits and higher wages. Someone who is young and just starting out on their career may well prefer to take less vacation time and lower benefits in exchange for a bigger paycheck, in order to build up a strong financial foundation at the outset of their career, or to make it easier to save up for a down payment on a house, or any number of reasons. Should it really be a crime for them to be able to make that decision for themselves?