How To Calculate The Cost of Living Abroad?

Correct calculation of the cost of living in the destination country should take into account important parameters that are not included in the cost of living index, such as housing, education, vehicles and special expenses arising from the nature of the mission

When a company decides to place an employee abroad, it must take into account the cost of living in the target area. This is true even if the company has decided to pay its employee wages equivalent to the local employee’s wages (as is common, for example in the US), due to the fact that the level of expenses of the employee is different from that of a local employee, as detailed in this article.

 The Magic Number

In many cases, the company “solves” the problem by achieving the “magic number”: the cost of living index factor. This index compares the average cost of living between the two cities, for example Tel Aviv and Brussels. According to The Economist, the cost of living index for Brussels is 104 relative to the index for New York, whereas the index for Tel Aviv is 87 relative to New York. A simple calculation (100X104 /87) show the cost of living index of Brussels compared to Tel Aviv is 120. Hence, the employee’s salary in Belgium should be higher by 20% compared to his salary in Israel.

Simple? Not exactly. The use of a simplistic average cost of living index ignores, for example, the employee’s children’s tuition. While education in Israel is state education, it is not customary in Belgium to send the children of the employee to a local school and the existing alternatives range from the annual tuition fee of €30,000 (International School of Brussels) to €3,000 (Jewish School of Brussels).

This is meaningless for an employee without children of school age, but an employee with two school-age children will face more expenditure than €60,000 per year, which makes the factor of 120 that we computed earlier, irrelevant.

It is important to understand what makes up the cost of living index, how it is calculated, what is included and mainly what is excluded from it. Measuring the total current cost of living generally includes all current consumption items:

• Current expenses (electricity, gas, water, cable TV, internet, taxes and home insurance)
• Food at home
• Food away from home
• Alcohol and tobacco
• Entertainment (classes, clubs, movies)
• Clothing and shoes
• Personal care (haircuts, cosmetics and toiletries, dry cleaning)
• Healthcare
• Public transportation (buses, trains, taxis)
• Home maintenance (renovations and home repairs, electrical appliance repair, cleaning, gardening)

The cost of living index usually does not include the three “heavy” expenditure items which will be detailed below:

• Housing
• Education
• Vehicle

When referring to the cost of living, it is imperative to take into account the following data:

1. The standard cost of living index usually pertains to a couple with two children. Distribution of data for individual and couples without children is significantly different. For example, a family with children spends a relatively large part of its income on food whereas a couple without children would spend a large proportion of its income on entertainment and food away from home.

2. In many countries there is a significant difference between the level of expenses of expatriates and locals. For example, the level of spending on food in restaurants for employees in countries like India and China will be much higher than that of the local employee.

3. Most of the cost of living indexes are measured by Western companies. These companies are still largely bound by the colonial concept aimed at copying the lifestyle of the country that sends expatriates to “colonial countries”. Accordingly, these companies measure the cost of imported drinks and foods in countries such as Vietnam, Romania and Uganda – which are naturally the most expensive. This is not required in relation to Israeli expatriates who display a high level of adaptability to local conditions.

4. 4. Most cost of living indexes take into account an “adjustment premium”: a period of six months to a year required for expatriates to adapt to local market conditions and consumer effectiveness equivalent to a local resident. This premium is completely unnecessary when it comes to Israeli employees who are endowed with high adaptability and ability to excel in informal communication that allows them to match, and even bypass the locals in no time.

Housing: It’s hard to be flexible

Housing is often the main expenditure item of the expatriate. In different countries the rental cost of a 3-bedroom apartment reaches sums of over $5,000 per month (Hong Kong, Tokyo, Singapore). Rental rates for employees’ apartments tend to be expensive especially in underdeveloped countries (Eastern Europe, India, South America, Africa) as appropriate housing inventory for expatriates is low. Apartment prices can be even higher, especially in neighborhoods close to international schools.

Organizations often find it difficult to adapt to the high rents. The tendency is to treat the range of rent of the locals as a reference. This approach is not practical because the expatriates compare themselves with the community of expatriates in the destination area and display a lack of willingness to be flexible. Bear in mind that in Israel, the rental prices of expatriates’ apartments are very expensive relative to ordinary rental apartments. The monthly rental prices for three bedroom apartments in central Israel where expatriates live range from $3,000 to $8,000 – far beyond the usual amounts we know.

When addressing the housing issue one has to be aware of the following aspects:

1. Many countries have contract conditions and special payment terms. For example, in South Korea a standard lease is for 24 months and the tenant is required to pay the whole amount in advance. In addition, to ensure the rights of the tenant in South Korea, it is common to register a kind of mortgage on the leased property (Keun Mortgage). It is recommended to use a local agent to help the company / employee during negotiations with the landlord.

2. Rent cost tends to be higher when the company pays the cost and not the employee (a phenomenon known in the language of human resources as OPM, “Other People’s Money”). When a company sets a rent budget it tends to perceive the budget as the upper limit of the rent, while the employee tends to perceive it as the starting point for negotiations … it is better, therefore, to include the cost of rent in the salary of the expatriate (except for tax considerations, see the next section).

3. Tax laws in many countries see expatriates’ rent as a deductible expense. Some of these countries (e.g. Japan) make recognition for tax purposes conditional on the company paying the rent directly.

4. The cost of housing does not comprise rent alone. One must take into account additional expenses such as maintenance fees, parking fees, property taxes condo fees and insurance costs.

Tuition: Preference for International Schools

As mentioned earlier, tuition for the employee’s children can be a very significant factor when determining the cost of living. Most Israeli companies finance their employees’ children’s tuition at an international school in non English-speaking countries. Tuition for international schools ranges from $15,000 to $40,000 per year per child. And many countries do not recognize this expense for tax purposes.

For a family with two school-age children departing on a mission in Paris, the expense of the employer for tuition is considered a benefit for the employee, hence it is grossed up in their salary. Annual tuition at the American School in Paris is about €33,000 per child (i.e. about €66,000 for two children). Because the cost of this benefit is considered wages, it is grossed up in the salary. Taking into account the level of the marginal tax (55% income tax and national insurance), the annual cost for the company reaches – €145,000!

When addressing the tuition item, one must be aware of the following aspects:

1. It is not acceptable to pay tuition for private schools in English-speaking countries (USA, UK, Australia.) The only exception in this regard is traditional families interested in Jewish – religious schools.

2. Even in nonEnglish-speaking countries, there are usually several alternatives for private schools that offer studies in English. A careful examination of the various schools should be made and the differences in costs, which often reach significant amounts, should be taken into account

A company must take into account the fact that the first employee sent to a specific destination area sets the “standard” for the following employees who will go on a mission to the same area: If an expensive private school is selected – this is where most children of the next expatriates will study.

3. School cost calculations must take into account the fact that the cost does not consist of the tuition only. In most cases items are added up as mandatory; such as the registration fee, capital fee, supplemental program in English and optional items like transportation and meals. The company should include the mandatory items in calculating costs and predetermine the policy regarding the optional items.

Car: Not necessarily a company car

Vehicle policies are typically derived from the market customs of the destination country and not those of the country of origin. For example, it is not customary to provide a company car in the US labor market. A company that gives an Israeli expatriate a company car will be anomalous in providing this benefit in the US market and will create an unlikely gap between the expatriate and the domestic employees.

In contrast, employees in managerial positions or sales positions in Italy get a company car that is a part of their salary and benefits and, therefore, an Israeli expatriate sent to Italy for an equivalent job should get a company car – regardless of whether he is or is not entitled to a company car in Israel.

When deciding to provide company cars, the following points should be examined:

• What type and level of vehicle is customary for the specific job?
• Is it customary to replace the vehicle every few years?
• Does the company finance all vehicle expenses or just some of them?
• If the benefit is taxable, does the company pay the cost of the tax?

If the employee purchases a car, consider the following costs:

• Is leasing a car instead of buying it a practical alternative?
• Cost of acquisition (does the expatriate have enough money to purchase a vehicle or two or does he need help in coming up with the money (a loan or an advance)
• Level of depreciation of the vehicle (given that the employee comes for a limited period)
• Car insurance costs (in many cases the employee will be considered a “new driver ” which will raise the cost of insurance)
• Costs of taxes and fees imposed on the vehicle
• Fuel costs

In summary, the calculation of the cost of living for the employee and his family is not a simple matter. Proper planning and realistic budgeting of the mission will help prevent friction and conflicts with the employee regarding funds during the mission and will ensure a level of expectations appropriate to the reality in the destination country.