A recent Globe and Mail article noted that Canadian employers are increasing their incentive programs as a way to entice their employees to work harder. Instead of focusing on year-end bonuses and long-term incentives such as stock options, companies are concentrating on immediate awards to inspire short-term performance.
The rationale for doing so is based on the notion that you get more of the behaviour you want when you reward it. Since companies pay employees for their work, why would additional incentives be needed? They are used to incentivize performance related to a specific goal that is beyond expectations.
Interestingly, companies have not yet found a single type of incentive that motivates everyone making it difficult to develop universal short-term incentive plans. Notably, those under 40 prefer cash rewards while those above 40 prefer non-cash awards.
This division is interesting because the tax treatment of cash and non-cash awards in Canada differs. Cash awards, including gift cards, are taxable as ordinary income, but non-cash awards have been given special tax treatment. Non-cash awards to employees that total less than $500 annually are not taxable. If a non-cash award exceeds $500 annually than only the amount in excess of $500 is taxable.
Take an employee living in Ontario in 2012 whose annual income is $80,000, thereby facing a combined federal and provincial marginal tax rate of 35.39 per cent. The after-tax value of a $500 cash award is $323.05. If this cash award is used to purchase a good or service, which is taxed at a rate of 13 per cent, then the total value of the good or service that can be purchased without leaving the employee out of pocket is $285.88.
If, instead, the employee accepted the good or service outright through a non-cash award then that employee would receive the full $500 value, nearly 75 per cent greater value of that obtained using the cash award. I wonder if younger employees are doing these tax calculations in their head before making their decision on what type of reward structure is more motivating.
Of course, there are two complications. First, it can be very difficult to match non-cash gifts to preferences, which results in a deadweight loss. According to economist Joel Waldfogel, gifts are 16 per cent less valuable to the receiver. This would imply that the value of the $500 non-cash gift to the employee is $420 which still far exceeds the after-tax value of the cash gift.
Second, scientific research has shown that monetary rewards are actually very limited motivational schemes. Research proves that monetary rewards are very good for motivating tasks that rely solely on mechanical skills. Skills that are in the “if this then that” category. However, for tasks that require more complicated cognitive skills and creative thinking, monetary rewards actually lead to much poorer performance. For these more complex tasks, rewards do not work.
If companies want to motivate employees to be more productive then they need to pay their employees a high enough salary so that money as a motivator is off the table and focus on the three factors that we know lead to better performance: autonomy (self-direction); mastery, purpose. Building an organization and work life around these three factors makes us all better off.
Lindsay Tedds is an Assistant Professor of economics in the School of Public Administration at the University of Victoria.