Why 3% Feels Like Nothing—And What HR Can Do About It

Every year, the same ritual plays out in organizations across the country. Employees approach performance review season with hopeful anticipation—maybe this will be the year they get that substantial raise. They can buy that new car. Start the kitchen remodel. Put their kid in a private school.

Here’s the uncomfortable truth: for an employee earning $60,000 annually, a 3.5% merit increase translates to roughly $2,100 per year—or about $80 per paycheck after taxes. That’s coffee money. It’s not life-changing. To make matters worse, rent increases and other cost-of-living increases gobble up the additional dollars an employee brings home, sometimes leaving them with less disposable income than the year before.

A Decade of 3%: The Historical Reality

If you think this year’s modest merit budget is an anomaly, think again. WorldatWork’s Salary Budget Survey—the longest-running survey of its kind, now in its 52nd year—tells a remarkably consistent story over the past decade. And since the peak of the Great Resignation, we’re starting to see things slowly inching back to 3.0%.

Source: WorldatWork Salary Budget Survey, 2015-2026

The pattern is clear: for nearly a decade before COVID (2015-2020), salary budgets hovered stubbornly around 3%. The pandemic and subsequent inflation surge drove budgets to a 20-year high in 2022-2023—but even that “historic” spike only reached 4.1-4.4%.

Now, as WorldatWork notes, we’re seeing a “return to pre-pandemic norms,” with projections settling back toward the familiar lower 3.0% territory.

Most organizations have never had, and likely never will have, merit budgets significantly above 4%. Planning your reward strategy around this reality, rather than against it, is essential.

The Research Done on “Meaningful” Pay Raises

What makes a pay increase actually matter to an employee? A landmark study by Mitra, Tenhiälä, and Shaw published in Human Resource Management examined this question through the lens of psychophysics—specifically, Weber’s Law, which explains how humans perceive changes in stimulus intensity.

Their findings are sobering. The researchers identified a concept called the Smallest Meaningful Pay Increase (SMPI)—the threshold at which an employee actually registers a raise as psychologically significant. Below this threshold, raises essentially go unnoticed; they fail to trigger positive behavioral intentions or emotional responses.

In a study of 177 U.S. hospital employees, the SMPI threshold was approximately 5 percent of base pay. For behavioral intentions (willingness to work harder), the threshold was 4.2%. For affective reactions (feeling pleased rather than indifferent), it was 5.6%. A replication study of 495 Finnish university employees found even higher thresholds—approximately 8 percent for behavioral change and 7.2% for positive emotional response.

The implication is stark: if your organization’s average merit increase is 3.5%, you’re operating well below the psychological threshold where employees perceive raises as meaningful. You’re spending payroll dollars on increases that generate neither gratitude nor motivation.

Think about that as a compensation professional. Our role is to recruit, retain, and engage employees through financial incentives. If we can’t engage employees with their salary, then we need to ensure we’re finding other ways to create a meaningful work experience.

Why a 5% vs. 3% Increase Doesn’t Matter

Many organizations believe they’re rewarding high performers by giving them a larger percentage increase than average performers. But let’s examine what that differentiation actually looks like in practice.

Consider two employees, both earning $60,000:

• Star Performer: Receives a 5% increase → New salary: $63,000
• Standard Performer: Receives a 3% increase → New salary: $61,800

The difference? $1,200 per year. That’s $100 per month. Or about $4.60 per workday after taxes.

Think about that: you’re telling your star performer—the one who exceeded expectations, drove results, outperformed their peers, and probably put in more hours—that their exceptional contribution is worth approximately one coffee per day more than the person who just showed up and did their job.

Get real… a few dollars a day is meaningless to most employees.

The uncomfortable truth is that within a 3-4% merit budget, meaningful differentiation is mathematically impossible. If your budget is 3.5% and you want to give top performers a truly meaningful 7% increase (above the SMPI threshold), you’d need to give average performers essentially nothing. Few organizations are willing to do this, so they split the difference and end up rewarding everyone inadequately.

As BalancedComp notes in their analysis: “A typical 1% pay difference between higher-performing and average-performing employees sends the message that ‘performance does not pay here,’ leading to higher turnover, quiet quitting, and other toxic employee responses that drain productivity from the organization.”

A Better Framework: Separating the Tools

The solution isn’t to wish for larger merit budgets—they’re not coming. Instead, HR and compensation professionals need to use different compensation tools for different purposes, each designed to do what it does best.

Merit Increases: Accept What They Are

For most employees – merit increases are nothing more than a means to keep up with inflation. While the idea of cost of living adjustments are taboo everywhere except government, we must ask the questions: “What is the purpose of merit, if it is centered around inflation?” and “How much do we truly care to differentiate an all-star’s pay from a standard performer?”

Stop calling it “merit pay” if it’s really an inflation adjustment. With inflation hovering around 3% and merit budgets at 3.5-3.7%, these increases are primarily about maintaining purchasing power—not rewarding performance. Consider rebranding them honestly as “annual salary adjustment” or “cost-of-living increase,” and set appropriate expectations.

Use merit increases for what they do well: keeping employees’ salaries from falling behind inflation and moving pay toward market midpoints over time. This is valuable—employees who lose purchasing power year over year become retention risks—but it’s not a reward mechanism.

Bonuses: Reward Past Performance

If you want to meaningfully recognize exceptional past performance, variable pay is a better option than merit pay. A $3,000 bonus delivered as a lump sum has far more psychological impact than a $3,000 annual raise spread across 26 paychecks.

Bonuses also offer advantages that merit increases don’t: they can be tied directly to specific accomplishments, they don’t compound into base salary (protecting the organization’s long-term cost structure), and they can vary year to year based on both individual performance and company results. They’re the right tool for saying “thank you for what you did.”

Promotions: Where Real Increases Happen

Here’s where compensation can actually change an employee’s life. According to Mercer’s 2025 data, employees who receive promotions see average pay increases of 8.5%—more than double the typical merit increase. Other research suggests promotion-related raises typically range from 10-20%, depending on the scope of the new role.

For our $60,000 employee, a promotion with a 10% increase means a new salary of $66,000—a meaningful $6,000 annual improvement that will actually be felt in their lifestyle and financial picture. That’s the difference between an increase that registers psychologically and one that doesn’t, not to mention the new title and recognition for a job well done.

Promotions are the right tool for saying “we’re investing in your future potential.” They signal genuine organizational commitment to an employee’s career growth and come with the compensation change to back it up. If you want to truly reward and retain your best people, focus your energy on accelerating their path to promotion—not fighting for an extra percentage point in the merit budget.

Recognition: Worth More than Money

The value of meaningful recognition is often overlooked by businesses. Organizations that understand that personalized rewards and recognition can be just as valuable as monetary rewards are likely to engage and retain employees more effectively than those Organizations that do not. Dan Ariely’s study in this TED Talk helps to objectively demonstrate how important recognition is in driving employee engagement and is a must-watch for any compensation professional.

A Realistic Compensation Strategy

Given everything we know—10 years of 3% budgets, psychological thresholds of 5-8%, and the meaninglessness of small differentials—here’s how to build a compensation strategy that actually works:

1. Reframe merit increases honestly. Communicate to employees that annual increases are designed to keep their purchasing power stable and move them toward market rates. This isn’t a failure—it’s a legitimate and valuable function. But calling it “merit” creates expectations it can’t fulfill, or that merit isn’t rewarded as much as it should be.

2. Use bonuses to recognize past performance. Allocate a separate budget for variable pay that rewards exceptional contributions. Even modest bonus pools, delivered thoughtfully, have more motivational impact than the same dollars spread into base salary.

3. Make promotions your primary retention and reward lever. Invest in clear career pathways, regular promotion conversations, and the budget to make promotion-related increases meaningful. This is where employees can actually see their compensation change in ways that matter.

4. Set expectations early and often. Don’t let employees spend 11 months imagining a 10% raise before learning they’ll get 3.5%. Share your compensation philosophy, market data, and budget constraints throughout the year.

5. Differentiate meaningfully or don’t differentiate at all. If your budget can’t support spreads large enough to matter (at least 3-4 percentage points between performance levels), consider whether false differentiation is doing more harm than good.

Conclusion

The gap between what employees expect from merit increases and what organizations deliver isn’t going away. WorldatWork’s 52 years of data suggest 3-4% budgets are the long-term reality, not a temporary constraint. The COVID-era spike was an anomaly, not a new normal.

HR and compensation professionals can make a meaningful difference not by fighting this reality, but by working with it. Accept that merit increases are inflation adjustments. Use bonuses to reward the past. Use promotions to invest in the future. And above all, stop pretending that $23 per week is a meaningful way to tell someone they’re a star.

The goal isn’t to make employees happy with small raises. It’s to stop pretending small raises should make them happy—and to build systems that actually recognize and reward contribution in ways employees can feel.

References

Mitra, A., Tenhiälä, A., & Shaw, J. D. (2015). Smallest meaningful pay increases: Field test, constructive replication, and extension. Human Resource Management. DOI:10.1002/hrm.21712

WorldatWork. (2015-2026). Salary Budget Survey. Annual reports.

Mercer. (2025). QuickPulse U.S. Compensation Planning Survey.

BalancedComp. (2024). The Definitive Merit Increase Matrix for 2025.