Labor Costs to the Firm

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Labor Costs to the Firm
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• 1. Economics of Fringe Benefits

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Fringe Benefits as a Proportion of Compensation

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Relative Growth of Fringe Benefits

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• 2. Theory of Optimal Fringe Benefits

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Worker Indifference Map

• The indifference curves show the combinations
  of wages and fringe benefits that yield the
  same amount of total utility.

Wages

• Fringes benefits are somewhat substitutable
  for wages even though most fringe benefits are
  in-kind benefits (benefits for a specific good
  or service).

I3
I2

• Workers substitute wages for fringe benefits
  because wages are taxed, but fringe benefits are
  not.

I1

• They also may substitute wages for fringe
  benefits to insure money is available for health
  insurance and retirement.

Fringe Benefits
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Employers Isoprofit Curve

• An isoprofit curve (WF) shows the combinations
  of wages and fringe benefits that yield the
  same amount of profits.

• We assume that competition will yield a normal
  profit.

• This curve shows the combinations of wages
  and fringes the firm can afford to provide,
  given the prices of wages and fringe benefits.

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Wage-Fringe Optimum

• The optimal combination of wages and fringe
  benefits is at B, where the isoprofit curve is
  tangent to the highest attainable indifference
  curve (I2).

• Here the firm will provide W0 wages and F0
  fringe benefits.

• Points A and C are also attainable
  combinations of wages and fringe benefits, but
  they yield less total utility since they are on
  a lower indifference curve (I1).

A
C
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Fringe Benefit Growth

• A decrease in the price of fringe benefits due
  to tax advantages, scale economies, and
  efficiency considerations fans the normal
  isoprofit line outward.

• This allows the worker to attain a higher
  indifference curve (I2 rather than I1).

• In the process, fringe benefits expand from F0
  to F1.

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Causes of Fringe Benefit Growth

• Tax advantages to employers
• Fringe benefits reduce the taxes the employers
  pay.
• Employers pay half of the Social Security tax.
• If employers substitute fringe benefits for
  wages, their taxes will be reduced.
• The Social Security tax rate and base have
  increased over time
• This rotated out the isoprofit curve and
  increased fringe benefits.

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Causes of Fringe Benefit Growth

• Economies of scale
• The are significant scale economies in the
  provision of fringe benefits.
• Firms have grown in size over time and lowered
  the per unit cost of fringe benefits.
• This rotated out the isoprofit curve and
  increased fringe benefits.

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Causes of Fringe Benefit Growth

• Efficiency considerations
• Employers prefer to have lower turnover to
  protect their training investments and reduce
  recruiting costs.
• Fringe benefits such as pensions reduce worker
  turnover.
• Over time, training by firms have increased and
  so firms have had increased incentive to use
  fringe benefits to reduce turnover.

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Causes of Recent Decline in Fringe Benefits

• The share of compensation in fringe benefits has
  fallen from 29.2 in 1994 to 27.4 in 2000.
• The main factor has been the fall in the share
  due to health insurance from 7.0 to 5.9.
• Due to double digit annual rises in health
  insurance premiums in the late 1980s, firms
  shifted more of the cost to workers.
• Also, there has been a slowdown in the health
  insurance inflation rate.