NEW YORK – The bad news: this year will be another year of modest pay increases. The worse news: inflation might eat up those gains.

The only good news may be that workplace standouts might eke out bonuses and other cash incentives from employers.

Companies are relying less on salary increases and more on incentives like year-end bonuses to retain employees without boosting fixed costs, a new survey said Thursday.

U.S. employers are planning to increase base salaries by 3.7 percent this year, just a bit higher than the average 3.6 percent rise they granted in 2005, according to a survey by Mercer Human Resource Consulting.

If the projections play out, workers’ wages could fall behind creeping inflation. The Labor Department’s overall Consumer Price Index picked up in the second quarter, pushed higher by record energy prices, and is on pace for a 4.7 percent rise for 2006, a little more than a percentage point higher than 2005’s 3.4 percent.

For 2007, pay raises are expected to stay at 3.7 percent.

Of the 950 employers surveyed by Mercer, representing nearly 12 million workers, about 85 percent said they plan to offer short-term incentives in 2006. A quarter said they increased the number of employees eligible for cash awards, and a quarter said they’re giving bigger awards. Only about 5 percent decreased the number of employees eligible and the amount of cash given.

“Once I give you a salary increase, it sticks. But with incentives, you have to re-earn it every year. Companies are very reticent about fixed costs these days,” said Steven Gross, a senior consultant at Mercer and employee compensation specialist.

Mercer’s data fell mostly in line with the projections released last month by the Conference Board. The nonprofit research group said pay raises would rise by 3.5 percent this year and next, while inflation would grow by 3.1 percentage points this year and 3.3 percentage points in 2007.

Charles Peck, compensation specialist at the Conference Board, said in an interview Thursday inflation last outpaced salary increases in the early 1980s, which saw double-digit inflation.

The modest pay increases have been the trend for the past several years – hovering between 3.3 and 3.8 percent since 2002, according to Mercer’s data. Mercer’s survey was conducted between April 1 and May 1.

Companies are wary about raising pay because of rising costs, Gross said. Several companies’ recent quarterly earnings reports have cited high costs, especially for energy, as hurting performance.

“Companies are still struggling with the ability to raise prices. To raise salaries, they have to be more productive or pass the cost onto the consumer,” Gross said.

Companies have met price pressures almost exclusively by squeezing base salaries, said Jared Bernstein, senior economist at the Economic Policy Institute, a labor union-funded think tank.

“Employers know that a bonus is for now, whereas a base pay change is forever,” Bernstein said.

Another increasingly popular way employers deal with labor costs is by differentiating pay increases, Gross said. They gave high performers on average a 5 percent pay increase, twice the average raise for low performers.

Rising benefit costs have also crimped employers’ ability to commit to big pay raises.

“Benefits are a very important ingredient. Healthcare, also retirement benefits – they’re very expensive. Companies are limiting salary increases to offset some of the increases in these benefits,” Peck said

Health benefit costs rose 6.1 percent in 2005 to more than $7,000 per employee, Mercer said in a survey released in November, and they are projected to rise 6.7 percent this year.

Salary increases in the coming years will rely mostly on the economy’s performance – whether hiring will heat up, which will lead employers to raise base pay to stay competitive, and whether growth can keep up with inflation, Gross said.

The industries planning the biggest pay raises are energy companies, which will be granting 4.8 percent raises on average, and the legal, consulting and accounting sectors, which are planning a 4.5 percent average raise, Mercer’s survey said.

AP-ES-07-27-06 1557EDT

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