Loyalty Tax has become one of the quietest yet most harmful compensation patterns inside modern organizations.
It starts with a Slack DM.
Not a formal complaint. Not a resignation letter. Just a screenshot passed between two senior engineers. It’s a job posting from your own careers page.
The role? Identical to theirs. The salary range? It starts $20,000 above what they your loyal, three-year veterans are currently making.
Silence.
Then, the inevitable psychological shift. In that micro-moment, their tenure didn’t feel like an asset. It felt like a tax. They have been paying a Loyalty Tax for the privilege of not quitting.
Welcome to the Compression Crisis.
For decades, companies relied on the “Black Box” model of compensation. You could pay market rate to acquire talent and offer 3% cost-of-living adjustments (COLA) to retain them, banking on the friction of job-switching to keep the discrepancies hidden. Ignorance was an asset class.
That asset is worthless today.
Between the EU Pay Transparency Directive, NYC’s Salary Transparency Law, and the brute force of crowdsourced data on Blind and Levels.fyi, the black box hasn’t just been opened; it’s been smashed to pieces.
If your compensation strategy relies on your employees not knowing what their peers make, you don’t have a strategy. You have a ticking time bomb.
The Math of Mediocrity
Let’s look at the mechanics of how we got here.
Most organizations operate on a legacy operating system:Â The Merit Matrix. You know the drill. You get a budget of 3.5%. You give your superstars 5%, your solid citizens 3%, and the underperformers 0%. You pat yourself on the back for differentiation.
Here is the problem.
The external market for talent doesn’t care about your internal 3.5% budget. In high-demand sectors, the market rate for skills moves dynamically, often jumping 10% to 15% year-over-year.
Do the math.
If the market moves 10% and you increase pay 3%, you have mathematically engineered a 7% deficit against the market value of your talent. Compound that over three years. Your most loyal employees are now paid 20% below the new hire you just brought in to sit next to them.
This is Salary Inversion. And in an era of transparency, it is an insult.
When a tenured employee sees a new hire making more for the same work, the psychological contract is breached. It’s not just about the money; it’s about status. It signals that you value the *potential* of a stranger more than the *proven performance* of an incumbent.
Mental Model: The Market-to-Mining Ratio
To fix this, we need to shift our mental models. Stop thinking about “Merit Increases.” Start thinking about Market Realignment.
I use a concept called the Market-to-Mining Ratio.
- Mining: The cost to extract value from existing employees (Retention).
- Market: The cost to buy that value externally (Acquisition).
When the cost of Mining drops significantly below the Market (say, < 80% comp ratio), you create an arbitrage opportunity for your competitors. They can pay your employee 15% more and *still* get a bargain compared to the open market, while your employee feels like they won the lottery.
You are essentially subsidizing your competitor’s talent acquisition strategy.
The Strategic Redesign: Monday Morning Tactics
You cannot fix structural compression with spot bonuses. That’s like treating a broken leg with a band-aid. You need surgery.
Here is how to lead a strategic compensation redesign without bankrupting the P&L.
1. Decouple Market Adjustments from Performance
This is controversial, but necessary.
Stop wrapping market corrections into the “annual review.” When you tell a high performer they are getting a 15% raise because “they did a great job,” but 12% of that was just to get them to the midpoint of the salary band, you are lying to them. You are conflating performance with market value.
The Fix: Run a bi-annual market sweep. Identify anyone below 85% of the midpoint. Adjust them. Communicate it as a “Market Alignment Adjustment,” not a raise. *Then*, layer performance bonuses on top.
make sure they know the difference. One is for the role; the other is for the human.
2. Implement “Zero-Based” Compensation Reviews
Every three years, wipe the slate clean. Forget what everyone *is* making.
Ask your managers: “If we were hiring for this role today, knowing what we know about this person’s output and the current market, what would the offer letter say?”
If the number on that hypothetical offer letter is significantly higher than their current pay stub, you have identified a compression pocket. Fix it proactively. Don’t wait for them to bring you a counter-offer. By the time a counter-offer lands on your desk, they have already mentally checked out.
3. Radical Transparency as a Filter
If you can’t explain why Employee A makes more than Employee B to their faces, your compensation structure is flawed.
Use transparency as a forcing function for fairness. When you design comp bands, assume they will leak. Because they will. If a compensation decision cannot withstand the scrutiny of a leaked spreadsheet, do not make it.
The Courage to kill the “Peanut Butter” Approach
The biggest enemy of fixing compression is the egalitarian instinct to spread the budget like peanut butter—a thin layer for everyone.
“We only have 4%. Let’s give everyone something.”
Stop it.
This approach guarantees you under-reward your stars and over-pay your underperformers. In a compression crisis, you must be ruthless. You might need to give 0% to the bottom 20% of your workforce to fund the 15% corrections needed for the critical few who drive the business.
This requires difficult conversations. It requires managers to actually manage, rather than hide behind a “standard increase” policy.
The Final Verdict
We are moving from an era of Information Asymmetry (employer knows all) to Radical Symmetry.
The Loyalty Tax is no longer a viable revenue model for HR. You can either correct your compression issues voluntarily, on your own timeline, or the market will correct them for you—violently, and usually at the worst possible moment.
Review your bands. Check your compression ratios. And ask yourself the uncomfortable question:
*If my best people saw the offer letters going out today, would they stay?*
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