## How to Set Compensation for Government Employees ## Source details **Canonical URL:** [How to Set Compensation for Government Employees](https://www.imf.org/-/media/files/publications/howtonotes/2024/english/htnea2024003.pdf) ## Other formats - [Markdown version](/-/media/files/publications/howtonotes/2024/english/htnea2024003.pdf.md) - [Structured JSON version](/-/media/files/publications/howtonotes/2024/english/htnea2024003.pdf.json) --- ### Introduction and main messages - In 2022, the global simple average for spending on compensation of employees as a share of total spending was about 26 percent. - Spending on the compensation of employees (“the wage bill”) accounts for a significant share of government expenditure. - Total compensation spending is determined by compensation levels and the number of employees; this note focuses on compensation aspects and complements the IMF Board Paper on Managing Government Compensation and Employment. - Core guiding principles: - Monitor recruitment and retention trends and benchmark against the private sector to inform compensation-setting. - The bulk of compensation should come from base salaries. Salary scales establish base salaries for jobs, grades, and notches/steps, ensuring consistency, transparency, and equity. - Use non-salary elements (for example, allowances) to differentiate compensation where appropriate, but recognize they can complicate systems, reduce transparency, and hinder mobility. - Exercise caution with performance-related compensation: theoretically useful but in practice “fraught with difficulties” and proven effective only in limited cases. - Good practice: conduct regular reviews of compensation systems (for example, via pay commissions) within a medium-term staffing strategy to reform pay structures that are not fit for purpose and introduce necessary ones. ### Terminology highlights - “Compensation” includes base (or basic) salaries and wages, allowances, performance-related bonuses, in-kind benefits, social contributions paid by the government as an employer, and any other benefit an individual receives because of their government employment. - Wages: paid on an hourly basis; salaries: paid based on a theoretical number of hours during a pay period. Government employees are generally paid salaries. - “Government employees” here: individuals directly employed by the government (including contractual employees), excluding personnel paid by private companies to which functions are outsourced. - The note focuses on general government (central and sub-national) rather than SOEs, though relevance to SOE pay-setting is noted. ### Determining the right levels of compensation — purpose and approach - Objective: recruit, retain, and motivate qualified personnel required to deliver public services; compensation is the price of the labor input into public service delivery. - Monitor recruitment and retention metrics: - number of (qualified) applicants per job opening - acceptance and rejection rates of job offers - voluntary departures and reasons (exit surveys) ### Government-private sector compensation premium - Definition: the average difference in compensation between the government sector and the private sector, statistically controlling for educational attainment and other individual characteristics. - Cross-country variation: estimates vary widely, with greater dispersion and higher average premia in EMEs and LIDCs than in AEs. - Example interpretation: a 12.9 percent compensation premium in EMEs indicates government employees, on average, earn 12.9 percent more than in the private sector in EME countries (controlling for education and other individual characteristics). - Considering total rewards (monetary and non-monetary), a somewhat negative compensation premium should generally be sufficient for government compensation to be competitive because government jobs often include greater job and income security, more predictable working hours, and other nonmonetary benefits. ### Caveats and measurement issues - Premium estimation should, in principle, reflect all monetary benefits (pension contributions, health insurance, other fringe benefits) but household survey data may omit some elements (for example, long-term incentives like stock options), biasing comparisons for certain groups. - Comparisons are generally more appropriate with the formal private sector; where the formal sector is small, the entire private sector (including informal) may be informative, though comparability issues persist. ### Additional calibration considerations - Excessive pay compression (low ratio of highest to lowest compensation) can hinder recruitment, retention, and motivation of highly skilled workers; compression can be measured by the ratio of average compensation in the highest and lowest deciles. - Fiscal space constraint: unduly generous pay can prevent hiring necessary staff, crowd out other inputs, or require higher taxation. - “Efficiency wages” may justify compensation above market-clearing levels to ensure adequate living standards, reduce turnover, encourage effort, and mitigate adverse selection. Example: The Gambia had extremely low pay until 2022 that left lowest-paid employees barely able to purchase food. - Corruption: empirical evidence finds a significant negative relationship between government employees’ compensation and corruption; increasing compensation can reduce corruption, but relying on pay increases alone may require unrealistically large raises; control, monitoring, and enforcement also matter. - Political and social pressures: compensation is sometimes used for short-term political goals or social protection; compensation is a poorly targeted and difficult-to-reverse form of social protection. - Length-of-tenure-related increases: moderate tenure-related increases are justifiable if productivity gains outweigh declines in motivation, but large or indefinite tenure-related increases are not advisable because they rarely reflect productivity and create upward pressure on spending (“wage drift”). - Indexation to inflation: automatic indexation is generally not advisable as it limits flexibility and can make inflation more persistent; if fiscal space permits, pay can be raised in line with inflation to preserve purchasing power. ### Determining the right composition of compensation — observed structures - In most countries, government compensation comprises a base salary and non-salary components (allowances, bonuses). - About 60 percent of countries have a compensation system featuring a base salary and one or more non-salary components. - Non-salary components’ share of total compensation can range from about 25 percent of compensation spending to more than 90 percent. ### Policy guidance on salary scales and base pay - The base salary should be the primary component of compensation and is normally determined by a salary scale that defines pay for specific job roles, grades, and steps. - Salary scales: - Ensure consistency, transparency, equity, and visibility over future earnings. - Are generally based on job classification (skills, duties, supervisory responsibilities, sometimes education or experience). - Provide rules for movement: across the scale through passage of time and up the scale through promotions. - Competitive promotions should be used to reward performance and maintain motivation and should be granted according to performance. - Publishing salary scales and compensation policies promotes transparency. - Non-salary components should not substitute for appropriate base-salary adjustments. - Examples where salary-scale adjustments are preferable to allowances: - Rewarding scarce skills or senior positions (for example, increasing base salaries or adjusting salary grade ranges for IT specialists rather than introducing an “IT allowance”; using a higher salary level for managerial positions rather than a “managerial allowance”). - Broad-based pay increases: base salary increases are generally preferable to allowances or top-ups granted to a large majority of employees (for example, 13th- or 14th-month payments that do not differentiate pay could be implemented as higher monthly salaries for transparency). ### Non-salary components — use, risks, and examples - Non-salary components can be used to: - Attract workers to underserved regions - Compensate for job-specific risks or hardship (dangerous areas, night shifts) - Encourage certain behaviors (for example, using public transit) - Reflect higher cost of living for foreign missions (diplomats) - Caution: non-salary components should be used sparingly; base salary increases affect future pension and entitlement costs and can be designed to match the net present value of non-salary payments. - Risks of proliferation and complexity: - Excessive non-salary components can create lack of transparency, inequities, and inefficiencies, hinder internal mobility and recruitment, and increase administrative costs. - Country examples and magnitudes: - Over 60 different schemes have been identified in Ghana. - 247 schemes were identified in Kenya, the latter accounting for 48 percent of total compensation spending in 2019. - Common funds (fonds communs) in Burkina Faso used to pay bonuses out of fines and fees were opaque; the 2019 budget reformed these bonuses, notably by capping them. - France reformed and streamlined most bonuses and allowances in the 2010s; the non-salary component now consists of a monthly allowance linked to job characteristics, expertise and hardship allowances, and a performance bonus. - Tax and budget classification distortions: - Non-salary components sometimes receive a lighter tax treatment, encouraging their use over higher base salaries (example: 13th- and 14th-month payments in Costa Rica and allowances in Eswatini). - Allowances can be recorded under use of goods and services rather than compensation of employees (for instance, per diems) and can become de facto income top-ups if paid for trips involving no additional personal costs. - Examples of outdated or poorly targeted non-salary components: - Israel: “car allowance” was revised because it disincentivized the use of public transportation. - Chad: teachers receive a “chalk allowance” meant to compensate for chalk dust exposure even if they hold administrative positions away from classrooms. ### Good practices on compensation system review - Regular planned reviews of compensation systems are recommended to ensure consistency and fitness for purpose. - Excessive non-salary share can undermine base salary structure and hinder pay progression from promotions. - Reviews are especially relevant within a broader, medium-term strategy for government employment. - Dedicated pay commissions can be useful institutions to conduct these reviews. ### Box 1 — Targeting compensation increases: options and trade-offs - Authorities might opt for: - Type I - Across-the-board salary increase - Type II - Targeted salary increases - Type III - Changes in compensation structure - Channels and trade-offs: - Percentage salary increase - Objectives: Increase attractiveness of all gov't jobs; offset impact of inflation - Advantages: Maintains existing salary differentials - Drawbacks: Can be the costliest or contribute most to inflation pressures - Fixed amount salary increase - Objectives: Increase purchasing power of the lowest-paid gov't employees - Advantages: Progressive - Drawbacks: Compresses the payscale (unless this is an objective) - Differentiated percentage increases (greater increases for higher grades) - Objectives: Decompresses the pay scale - Drawbacks: Risk of "leakage" to positions without staffing challenges - Job regrading (shifting jobs to higher grades) - Objectives: Best for targeting certain sectors/occupations - Drawbacks: Legislation may be needed - Increase speed of length-of-tenure-related salary progression - Objectives: Improve retention - Advantages: Encourages longer careers in government sector - Drawbacks: Higher "wage drift" and faster growth in compensation spending - Change bonuses and allowances - Objectives: Target the pay increase at specific criteria - Advantages: Easiest to target based on narrow criteria (e.g., geography, task) - Drawbacks: Risk of proliferation of bonuses and allowances; can be less transparent ### Performance-related compensation — potential and practical challenges - Theoretical potential: - Rewarding performance could improve the quality of public services; many countries have introduced performance-related pay since the early 1990s with mixed results. - Modalities: - Performance-related pay can be awarded through base salary increases or through non-salary components (bonuses). - Drawback of base salary increases: they cannot be reversed (at least in nominal terms) if performance is not sustained. - One-off performance bonuses avoid permanence but may encourage short-term behavior. - Prevalence and intensity: - Most OECD countries have some form of performance assessment. - 18 OECD countries use performance-related compensation in the form of bonuses and 21 in the form of performance-related base salary increases. - Denmark and Japan use performance-related compensation more extensively, through a combination of one-off bonuses and base salary increases, for up to 40 percent of an employee’s base salary. - South Korea moved from a seniority-rewarding system to one extensively linking pay to performance. - Design challenges and constraints: - Defining performance through clear and measurable objectives and deciding how to link performance to pay and for whom are necessary design steps. - Functional characteristics of a job affect incentive design (e.g., compliance/enforcement roles vs. service providers). Example: an experiment on tax collectors in Pakistan showed performance incentives improved revenue collection but could also increase bribery. - Measuring performance by outcomes versus inputs: - Outcomes appropriate for standardized delivery with verifiable outputs, but narrow outcome measures risk neglect of unmeasured responsibilities. - Inputs (e.g., presence) provide a basic measure but can be problematic where sick leave and health care provision are inadequate. - Individual versus collective measurement: - Individual-linked pay can undermine teamwork. An experiment in Mexico found better education outcomes when incentives were offered jointly to students, teachers, and school administration rather than to only one group. - Evidence on impact: - In countries with longstanding performance-related compensation, studies report little evidence of higher government employee motivation or better quality of public services. - The OECD notes few member countries have succeeded in designing an effective system of bonuses. - Complexity of performance assessments and multitasking are commonly reported difficulties. - Mitigations and recommendations: - Keep performance-related pay to a modest share of total compensation. - Link rewards to career progression through competitive promotions, which requires a robust performance assessment framework. - Consider withholding performance-related pay from underperformers where dismissal is difficult, to provide an incentive to seek alternative employment. *IMF | How to Note NOTE/2024/003, How to Set Compensation for Government Employees, Céline Thévenot and Sébastien Walker, April 2024.* ### Introduction and Main Messages ......................................................................................... ### Introduction and Main Messages ### Key messages - Spending on the compensation of employees (“the wage bill”) accounts for a significant share of government expenditure. In 2022, the global simple average for spending on compensation of employees as a share of total spending was about 26 percent. - Total compensation spending is determined by compensation levels and the number of employees; this note focuses on compensation aspects and complements the IMF Board Paper on Managing Government Compensation and Employment. - Core guiding principles: - Monitor recruitment and retention trends and benchmark against the private sector to inform compensation-setting. Unduly high compensation is an inefficient use of resources; insufficient compensation can hinder recruitment, retention, and motivation. - The bulk of compensation should come from base salaries. Salary scales establish base salaries for jobs, grades, and notches/steps, ensuring consistency, transparency, and equity. - Use non-salary elements (for example, allowances) to differentiate compensation where appropriate, but recognize they can complicate systems, reduce transparency, and hinder mobility. - Exercise caution with performance-related compensation: theoretically useful but in practice “fraught with difficulties” and proven effective only in limited cases. - Good practice: conduct regular reviews of compensation systems (for example, via pay commissions) within a medium-term staffing strategy to reform pay structures that are not fit for purpose and introduce necessary ones. ### Terminology highlights - “Compensation” includes base (or basic) salaries and wages, allowances, performance-related bonuses, in-kind benefits, social contributions paid by the government as an employer, and any other benefit an individual receives because of their government employment. - Wages: paid on an hourly basis; salaries: paid based on a theoretical number of hours during a pay period. Government employees are generally paid salaries. - “Government employees” here: individuals directly employed by the government (including contractual employees), excluding personnel paid by private companies to which functions are outsourced. The note focuses on general government (central and sub-national) rather than SOEs, though relevance to SOE pay-setting is noted. --- ### Determining the Right Levels of Compensation ### Purpose and basic approach - Government compensation systems should recruit, retain, and motivate qualified personnel required to deliver public services. Compensation is the price of the labor input into public service delivery. - Monitor recruitment and retention metrics: number of (qualified) applicants per job opening, acceptance and rejection rates of job offers, voluntary departures and reasons (exit surveys). ### Government-private sector compensation premium - The government-private sector compensation premium is the average difference in compensation between the government sector and the private sector, statistically controlling for educational attainment and other individual characteristics. - Estimates vary widely across countries, with greater dispersion and higher average premia in emerging market economies (EMEs) and low-income developing countries (LIDCs) than in advanced economies (AEs). - Example interpretation: a 12.9 percent compensation premium in EMEs indicates government employees, on average, earn 12.9 percent more than in the private sector in EME countries (controlling for education and other individual characteristics). - Considering total rewards (monetary and non-monetary), a somewhat negative compensation premium should generally be sufficient for government compensation to be competitive because government jobs often include greater job and income security, more predictable working hours, and other nonmonetary benefits. ### Caveats and measurement issues - Premium estimation should, in principle, reflect all monetary benefits (pension contributions, health insurance, other fringe benefits) but household survey data may omit some elements (for example, long-term incentives like stock options), biasing comparisons for certain groups. - Comparisons are generally more appropriate with the formal private sector; where the formal sector is small, the entire private sector (including informal) may be informative, though comparability issues persist. ### Additional calibration considerations - Excessive pay compression (low ratio of highest to lowest compensation) can hinder recruitment, retention, and motivation of highly skilled workers. Compression can be measured by the ratio of average compensation in the highest and lowest deciles. - Fiscal space: compensation is budget-bound. Unduly generous pay can prevent hiring necessary staff, crowd out other inputs, or require higher taxation. - “Efficiency wages” arguments may justify compensation above market-clearing levels to ensure adequate living standards, reduce turnover, encourage effort, and mitigate adverse selection. Example: The Gambia had extremely low pay until 2022 that left lowest-paid employees barely able to purchase food. - Corruption: empirical evidence finds a significant negative relationship between government employees’ compensation and corruption. Increasing compensation can reduce corruption, but relying on pay increases alone may require unrealistically large raises; control, monitoring, and enforcement also matter. - Political and social pressures: governments sometimes use compensation/employment for short-term political goals or social protection; compensation is a poorly targeted and difficult-to-reverse form of social protection. - Length-of-tenure-related increases: moderate tenure-related increases are justifiable if productivity gains outweigh declines in motivation, but large or indefinite tenure-related increases are not advisable because they rarely reflect productivity and create upward pressure on spending (“wage drift”). - Indexation to inflation: automatic indexation is generally not advisable as it limits flexibility and can make inflation more persistent. If fiscal space permits, pay can be raised in line with inflation to preserve purchasing power; if pay levels are “too high,” rises may be less than inflation (or none); if “too low,” rises may need to exceed inflation. --- ### Determining the Right Composition of Compensation ### Observed structures and magnitudes - In most countries, government compensation comprises a base salary and non-salary components (allowances, bonuses). - About 60 percent of countries have a compensation system featuring a base salary and one or more non-salary components. - Non-salary components’ share of total compensation can range from about 25 percent of compensation spending to more than 90 percent. ### Policy guidance - The base salary should be the primary component of compensation and is normally determined by a salary scale that defines pay for specific job roles, grades, and steps. - Salary scales: - Ensure consistency, transparency, equity, and visibility over future earnings. - Are generally based on job classification (skills, duties, supervisory responsibilities, sometimes education or experience). - Provide rules for movement: across the scale through passage of time and up the scale through promotions. - Competitive promotions should be used to reward performance and maintain motivation and should be granted according to performance. - Publishing salary scales and compensation policies promotes transparency. - Non-salary components should not substitute for appropriate base-salary adjustments. Examples where salary-scale adjustments are preferable to allowances: - Rewarding scarce skills or senior positions (for example, increasing base salaries or adjusting salary grade ranges for IT specialists rather than introducing an “IT allowance”; using a higher salary level for managerial positions rather than a “managerial allowance”). - Broad-based pay increases: base salary increases are generally preferable to allowances or top-ups granted to a large majority of employees (for example, 13th- or 14th-month payments that do not differentiate pay could be implemented as higher monthly salaries for transparency). --- ### The Challenges Raised by Performance-Related Compensation ### Main cautionary points (from introduction summary) - Performance-related compensation can, in theory, incentivize productivity but in practice is difficult to design and implement effectively in the government context and has been proven effective only in limited cases. - Automatic or de facto automatic performance-related increases that are granted broadly dilute the intended performance incentive and functionally act as tenure-related or across-the-board increases. *Italicized source attribution: IMF | How to Note NOTE/2024/003, How to Set Compensation for Government Employees, Céline Thévenot and Sébastien Walker, April 2024.* ### Box 1. Targeting Compensation Increases: Which Options for Which Policy Objective? ### Box 1. Targeting Compensation Increases: Which Options for Which Policy Objective? ### Overview - Table B1.1 maps options for increasing pay levels depending on policy objectives and discusses their advantages and drawbacks. - Depending on policy objectives and country circumstances (including fiscal space), authorities might opt for: - Type I - Across-the-board salary increase - Type II - Targeted salary increases - Type III - Changes in compensation structure ### Channels to increase government employee compensation: objectives, advantages, drawbacks - Percentage salary increase - Objectives: Increase attractiveness of all gov't jobs; offset impact of inflation - Advantages: Maintains existing salary differentials - Drawbacks: Can be the costliest or contribute most to inflation pressures - Fixed amount salary increase - Objectives: Increase purchasing power of the lowest-paid gov't employees - Advantages: Progressive - Drawbacks: Compresses the payscale (unless this is an objective) - Differentiated percentage increases (greater increases for higher grades) - Objectives: Decompresses the pay scale - Drawbacks: Risk of "leakage" to positions without staffing challenges - Job regrading (shifting jobs to higher grades) - Objectives: Best for targeting certain sectors/occupations - Drawbacks: Legislation may be needed - Increase speed of length-of-tenure-related salary progression - Objectives: Improve retention - Advantages: Encourages longer careers in government sector - Drawbacks: Higher "wage drift" and faster growth in compensation spending - Change bonuses and allowances - Objectives: Target the pay increase at specific criteria - Advantages: Easiest to target based on narrow criteria (e.g., geography, task) - Drawbacks: Risk of proliferation of bonuses and allowances; can be less transparent ### Non-salary compensation: classification, uses, and cautions - Five broad categories of non-salary components (Figure 4): - Labor market adjustment (e.g., regional attractivity) - Job-related (e.g., risk allowance) - Task-related (e.g., night work) - Commuting cost (e.g., public transit) - Living cost (e.g., diplomats) - Uses - Attract workers to underserved regions - Compensate for job-specific risks or hardship (dangerous areas, night shifts) - Encourage certain behaviors (for example, using public transit) - Reflect higher cost of living for foreign missions (diplomats) - Caveat on non-salary components - Non-salary components should be used sparingly when there is need for further compensation differentiation. - The base salary component can be linked to additional costs for future and sometimes current pensions and other entitlements; salary increases can be designed so their overall cost has the same net present value as a non-salary payment by factoring in these additional costs. ### Risks, proliferation, and tax treatment of non-salary components - Risks of proliferation and complexity - Excessive non-salary components can create lack of transparency, inequities, and inefficiencies. - Complex allowance systems hinder internal mobility and recruitment and can lead to administrative costliness. - Country examples and magnitudes - Over 60 different schemes have been identified in Ghana. - 247 schemes were identified in Kenya, the latter accounting for 48 percent of total compensation spending in 2019 (Gupta and others 2016 and Kenya Salaries and Remuneration Commission 2021). - Common funds (fonds communs) in Burkina Faso used to pay bonuses out of fines and fees were opaque; the 2019 budget reformed these bonuses, notably by capping them (IMF 2019b). - France reformed and streamlined most bonuses and allowances in the 2010s; the non-salary component now consists of a monthly allowance linked to job characteristics, expertise and hardship allowances, and a performance bonus. - Tax and budget classification distortions - Non-salary components sometimes receive a lighter tax treatment, encouraging their use over higher base salaries (example: 13th- and 14th-month payments in Costa Rica and allowances in Eswatini). - The cost of these non-salary components is then understated by the compensation budget, given the lower revenue resulting from such tax expenditures. - Allowances can be recorded under use of goods and services rather than compensation of employees (for instance, per diems) and can become de facto income top-ups if paid for trips involving no additional personal costs. ### Examples of outdated or poorly targeted non-salary components - Israel: “car allowance” was revised because it disincentivized the use of public transportation (OECD 2021). - Chad: teachers receive a “chalk allowance” meant to compensate for chalk dust exposure even if they hold administrative positions away from classrooms. ### Good practices on compensation system review - Regular planned reviews of compensation systems are recommended to ensure consistency and fitness for purpose. - Excessive non-salary share can undermine base salary structure and hinder pay progression from promotions. - Reviews are especially relevant within a broader, medium-term strategy for government employment. - Dedicated pay commissions can be useful institutions to conduct these reviews. ### Performance-related compensation: potential and practical challenges - Theoretical potential - In theory, rewarding performance could improve the quality of public services; many countries have introduced performance-related pay since the early 1990s with mixed results. - Modalities - Performance-related pay can be awarded through base salary increases or through non-salary components (bonuses). - Drawback of base salary increases: they cannot be reversed (at least in nominal terms) if performance is not sustained. - One-off performance bonuses avoid permanence but may encourage short-term behavior. - Prevalence and intensity - Most OECD countries have some form of performance assessment. - 18 OECD countries use performance-related compensation in the form of bonuses and 21 in the form of performance-related base salary increases (OECD 2017 and OECD 2018). - Denmark and Japan use performance-related compensation more extensively, through a combination of one-off bonuses and base salary increases, for up to 40 percent of an employee’s base salary. - South Korea moved from a seniority-rewarding system to one extensively linking pay to performance. - Design challenges and constraints - Defining performance through clear and measurable objectives and deciding how to link performance to pay and for whom are necessary design steps. - Functional characteristics of a job affect incentive design (e.g., compliance/enforcement roles vs. service providers). Example: an experiment on tax collectors in Pakistan showed performance incentives improved revenue collection but could also increase bribery (Khan, Khwaja, and Olken 2016). - Measuring performance by outcomes versus inputs: - Outcomes can be appropriate for standardized delivery with verifiable outputs, but narrow outcome measures risk neglect of unmeasured responsibilities (Holmstrom and Milgrom 1987). - Inputs (e.g., presence) provide a basic measure but can be problematic where sick leave and health care provision are inadequate. - Individual versus collective measurement: - Individual-linked pay can undermine teamwork. An experiment in Mexico found better education outcomes when incentives were offered jointly to students, teachers, and school administration rather than to only one group (Behrman, Parker, Todd, and Wolpin 2015). - Evidence on impact - In countries with longstanding performance-related compensation, studies report little evidence of higher government employee motivation or better quality of public services (The Work Foundation 2014). - The OECD notes few member countries have succeeded in designing an effective system of bonuses (OECD 2021). - Complexity of performance assessments and multitasking are commonly reported difficulties. - Mitigations and recommendations - Keep performance-related pay to a modest share of total compensation. - Link rewards to career progression through competitive promotions, which requires a robust performance assessment framework. - Consider withholding performance-related pay from underperformers where dismissal is difficult, to provide an incentive to seek alternative employment. *Source: IMF staff.* --- _Source: https://www.imf.org/-/media/files/publications/howtonotes/2024/english/htnea2024003.pdf_