January 28, 2025

Wage Compression: What It Is, Plus How To Fight It

The math seems simple enough — more years of experience should equal higher pay. But when a veteran accountant discovers they’re earning just a few thousand dollars more than their fresh-out-of-college colleague, that simple math falls apart.

As starting salaries climb to meet market demands, many businesses face an uncomfortable reality: The pay gap between their new hires and experienced employees is shrinking. This wage compression silently erodes workplace morale and productivity while driving experienced employees to work for competitors.

This guide explores the root causes of wage compression, its impact on businesses, and proven strategies to get it under control before it affects your company culture.

What is wage compression?

Wage compression — also called pay compression, salary compression, or compensation compression — happens when there's little difference in pay between employees despite big differences in their skills and time with the company. This creates a pay inequity that can affect everything from employee morale to turnover.

The issue can surface between tenured employees who get small, incremental pay increases each year and new hires with in-demand skills who start at a higher pay grade. You might also see it between managers and their direct reports, where supervisors earn only slightly more than the workers they manage.

There are a few factors behind wage compression. Some of the most common include:

External labor market shifts that force higher starting salaries for new hires
Growing demand for specific skills that pushes up market rates
Internal policies that limit raise budgets for current employees

Salary compression isn't the same as salary inversion, which is more severe. In salary inversion, new employees actually earn more than current employees in similar or more senior roles. This usually happens in competitive job markets where starting salaries have risen sharply.

Wage stagnation is another related but distinct problem. It happens when salaries stay flat over time instead of growing with the economy, which means they don’t keep pace with inflation or the cost of living. Wage compression specifically refers to the shrinking gap between different experience levels or job roles. A company might have wage stagnation without compression, or vice versa.

Causes of wage compression

We've touched on some basic reasons why pay compression happens, but let's dig deeper into what's really driving the pay equity gap:

Market forces. These play a huge role in pushing your compensation structure out of balance. Depending on your business, when minimum wage goes up, it can ripple through your entire pay structure. Suddenly, new employees might have starting salaries that are almost as much as people who've been there for years.
High demand, low supply. The same thing happens when workers with certain skills are in high demand. Companies have to offer more competitive wages to attract new hires but often can't bump up existing employees' pay to match.
Internal policy. Internal policies and practices can make things worse. Maybe your business hasn't updated its salary ranges in years or you’ve had to freeze wages to cut costs. Add in different pay rates based on location and cost of living adjustments, and you've got a recipe for wage compression.
Changes in rules and regulations. These can shake things up, too. For example, if overtime rules change, hourly workers can end up bringing home more than their supervisors.

Impact of wage compression on business

When wage compression creeps into your company, it doesn't just affect paychecks. It can ripple through your entire organization. Here's how:

Team morale takes a hit. When experienced employees realize they're making almost the same as new hires, morale can drop fast. Your most talented tenured employees might feel undervalued and stop putting in extra effort. Some might even start looking for new jobs where their experience counts for more. High turnover often follows, especially among your top performers — exactly the people you can't afford to lose.
Teamwork suffers. Pay compression turns coworkers into competitors. Instead of helping new team members learn the ropes, experienced employees might hold back, questioning why they should train a newbie who's making almost as much as they are.
Costs climb. While wage compression might seem like it saves money in the short term, it gets expensive fast. Every time a frustrated employee quits and increases your turnover rate, you're looking at recruitment costs, training time, and lost productivity.
Attrition grows. Employee attrition happens when people retire, resign, or leave a company for any other reason, leaving positions vacant. Employees who feel undervalued due to compressed wages may seek opportunities elsewhere, negatively impacting team productivity and morale.

3 strategies to address wage compression

Wage compression is a serious issue, but there are ways to mitigate the damage and keep salary gaps from shrinking again:

1. Understand the situation

Before you can fix pay compression, you need to know exactly where it's happening in your company. Start by looking at all your salary data and comparing what new hires make versus experienced employees. Pay close attention to nuances in the data, because they can tell different stories. For example, in a remote workforce, salary gaps may be intentional. By regularly setting benchmarks, watching the data, and adjusting accordingly, you can spot the signs of wage compression and limit the effects before they become a problem.

2. Make smart pay adjustments

Once you know where the problems are, it's time to take action. If you can, update salary ranges to reflect current market rates. The first step is to establish compensation bands and size your workforce against those bands. Then, you can make a one-time adjustment to salaries and repeat annually. Be crystal clear about how the pay structure works and how it's related to different roles so employees understand exactly how their compensation is calculated.

3. Work within budget constraints

Let's be realistic: Not every company can afford to hand out big raises right away. But that doesn't mean you're stuck with wage compression. When budget limits make immediate pay adjustments tough, consider offering other valuable benefits.

One smart option is an Earned Wage Access benefit like EarnIn. EarnIn lets employees tap into their earnings (up to $150/day with a max of $750 per pay period¹) whenever they need them, not just on payday. This puts your workers in control of their finances and shows you're committed to their financial well-being — all without costing your company.

Other benefits that offset salary compression include:

Offering more paid time off. Even an extra few days of vacation helps employees feel more valued, especially when money's tight.
Creating clear paths for advancement. Show your experienced staff exactly how they can move up and earn more, giving them a reason to stick around. Just make sure you don’t overpromise.
Providing learning opportunities. Paying for certifications or training programs tells employees you're investing in their future, even if you can't boost their pay right now.
Adding flexible work options. Letting people work from home a few days a week or adjust their own hours can save them money on commuting and childcare costs and improve job satisfaction.
Giving performance bonuses. One-time bonuses in addition to base pay for great work can help bridge pay gaps while you work on more permanent solutions.

Frequently asked questions

How often should companies check for wage compression?

Don't wait for wage compression to become obvious to everyone. By then, it's already a problem. Take a good look at all your pay rates once a year, and do a deep dive into your whole compensation plan every few years. Keep an eye on what other companies are paying, too, especially for highly skilled jobs that demand more competitive wages.

What’s the best way to talk to employees about wage compression?

Be straight with your team. If the wage compression has already gotten serious, chances are they already know. Talk openly about how you set salary ranges for new employees and what you're doing to keep them fair for veterans. Make sure managers know how to handle these conversations, too. They're often the first group employees share concerns about wage compression with.

Remember, employees have the right to discuss their pay with each other. It's better to lead these conversations as an employer than avoid them.

Is wage compression legal?

While wage compression itself isn't against the law, it can lead to legal headaches if you're not careful. If wage compression creates pay inequities that look like discrimination — whether based on gender, race, or other factors — you could be breaking laws like the Equal Pay Act. If you spot any patterns that don't look right, take steps to fix the situation right away.

Create a more supportive workplace with EarnIn

By offering EarnIn’s financial wellness solutions, employees gain access to a portion of their earned wages on-demand¹, promoting financial flexibility and reducing stress at no extra cost to you. Additionally, they’ll benefit from other features such as free Credit Monitoring², Early Pay³, and more. This practical benefit not only helps to improve employee morale but also strengthens loyalty, retention, and overall productivity.

Show your team that their well-being matters. Integrate EarnIn into your compensation strategy.

CTA: Unlock better financial wellness for your team with EarnIn

Please note, the material collected in this post is for informational purposes only and is not intended to be relied upon as or construed as advice regarding any specific circumstances. Nor is it an endorsement of any organization or services.

EarnIn is a financial technology company not a bank. Banking Services are provided by Evolve Bank & Trust, Member FDIC. The FDIC provides deposit insurance to protect your money in the event of a bank failure. More details about deposit insurance here.

A pay period is the time between your paychecks, such as weekly, biweekly, or monthly. EarnIn determines your daily and pay period limits (“Daily Max” and “Pay Period Max”) based on your income and financial risk factors as outlined in the Cash Out Maxes section of our Cash Out User Agreement. EarnIn reserves the right to adjust the Daily Max and Pay Period Max at its discretion. Your actual Daily Max will be displayed in your EarnIn account before each Cash Out.

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Your VantageScore 3.0 from Experian® indicates your credit risk level and is not used by all lenders, so don't be surprised if your lender uses a score that's different from your VantageScore 3.0. Learn more.

Early Pay is an optional feature that requires you to open a Deposit Account with Evolve Bank & Trust, Member FDIC and update your direct deposit routing with your employer. The FDIC provides deposit insurance to protect your money in the event of a bank failure. More details about deposit insurance here. This Deposit Account will receive your paycheck and will redirect it to the bank account you link to your EarnIn account. EarnIn will set aside the necessary funds from your paycheck to cover any tips, Lightning Speed fees, and Cash-Out balances from the previous pay period. Any remaining funds will be sent to your linked bank account. If you opt for Lightning Speed transfers, Evolve Bank & Trust will charge you a $2.99 fee to transfer your paycheck to your linked bank account on the same day your employer processes payroll, which may be up to 2 days before your scheduled payday. If you do not opt for Lightning Speed transfers, Evolve Bank & Trust will automatically transfer your paycheck to your linked bank account for free, by your regular payday. Early Pay is available to eligible EarnIn members in select states, and additional restrictions may apply. For more information, please refer to our FAQ.