What is cost of living adjustment (COLA)? And how it works

A cost-of-living adjustment (or COLA) is an increase in the benefits or pay a person receives to offset the pressure of inflation. If a person’s income stays stable, they have less purchasing power as the prices of goods and services increase. In other words, they’re getting paid less relative to the cost of living. Thus, a cost-of-living adjustment is meant to address and counteract this change.

Do companies have to offer cost-of-living adjustments?

Unless it’s required by law, it’s generally up to each company to decide whether to offer this benefit and, if so, how much to provide as a cost-of-living adjustment.

As recently as 2010, offering cost-of-living adjustments was uncommon among employers. For instance, only around 10% of U.S. employers provided these adjustments to their employees. More recently, however, employers have become much more likely to provide cost-of-living adjustments, particularly in light of the tight labor market. In 2023, 80% of employers plan to provide base pay increases due to inflation. That increase in the number of employers willing to offer cost-of-living adjustments is a significant change in the labor market. 

Note that a cost-of-living salary adjustment does not go to a single employee or just a group. For it to be a true cost-of-living adjustment, the employer must offer this raise to every employee—not just a select few. COLA is not merit-based or related to employee performance. 

What are the benefits of providing cost-of-living adjustments?

Companies trying to decide whether to provide COLA must weigh the benefits and costs of doing so. The clear cost of offering these benefits is the financial outlay required. Providing cost-of-living adjustments means paying employees more and having less money to spend in other areas. 

However, the following benefits of providing cost-of-living adjustments may offset this financial strain:

• Increased employee loyalty: Holding on to great employees can be challenging, but offering benefits like cost-of-living adjustments will inspire greater company loyalty in those employees and make them more likely to stick around. 
• Better morale: Employers who offer cost-of-living adjustments show employees that they care about their concerns and livelihoods. This will boost morale around the company. 
• Greater productivity: COLA alleviates some financial stress and strain for employees, making them better able to focus on their work. Output and productivity will also likely increase for workers who receive these pay increases. 

All these benefits help contribute to the success of the company. Employers must decide for themselves whether the benefits of giving these pay increases are strong enough to outweigh the costs. 

How is the cost-of-living adjustment calculated?

Each company that decides to offer a cost-of-living adjustment is free to calculate the adjustment using any method of their choosing. They may, for instance, take into account the consumer price index, the inflation rate, or other indicators. 

Since companies aren’t obligated to provide a cost-of-living adjustment, there’s no required way to calculate it. The amount they offer as a salary adjustment for the cost of living may change yearly, but it may also stay the same. These decisions are all within the purview of the employer.