Major League Baseball luxury tax

Major League Baseball (MLB) has a luxury tax, called the “competitive balance tax”, in place of a salary cap in order to level the spending an individual team can spend on their roster. In many other professional sports leagues in North America there is a salary cap that limits what each team can spend on their players. If a league lacks a salary cap or a luxury tax, any team can spend all the money they can afford on players. This means teams with more limited financial resources cannot afford the top talent, putting them at a competitive disadvantage against rich teams.

Major League Baseball implemented the “competitive balance tax” in 1997 to keep a competitive balance in the league. At the beginning of each year, a threshold is set by the Commissioner's Office of Major League Baseball that limits how much a team can spend on their players. In Major League Baseball, the “competitive balance tax” allows teams to go over the threshold, but at a premium. The goal of this is to encourage big spending but to still maintain balance in competition. Major League Baseball's tax has undergone several changes since 1997.[1]

History of the Major League Baseball luxury tax

1997–1999

The 1994 Major League Baseball season was cut short due to the Major League Baseball strike. A primary source of conflict leading to the strike was the tremendous power club owners had over the salaries of players on their respective teams. Small market teams felt handcuffed by their relatively anemic budgets while players from larger market teams were unwilling to accept the substantial pay cuts that a salary cap would likely have imposed. This resulted in a compromise in the Collective Bargaining Agreement of 1996, which imposed Major League Baseball's first luxury tax.

The first agreement stated that the top five salary teams in each year would pay a 34% fine on each dollar a team spent beyond halfway between the salaries of the fifth and sixth team. For example, if the fifth highest salary team had a payroll of $100 million and the sixth highest salary team had a payroll of $98 million, the top five teams would pay 34% on each dollar they spent over $99 million.[2] Below is the amount each team paid from 1997 to 1999, when this system was in place.

MLB Team 1997 1998 1999 Total
Baltimore Orioles $4,030,228 $3,138,621 $3,475,048 $10,643,897
New York Yankees $4,431,180 $684,390 $4,804,081 $9,919,651
Los Angeles Dodgers $0 $49,593 $2,663,079 $2,712,672
Boston Red Sox $0 $2,184,734 $21,226 $2,205,960
Cleveland Indians $2,069,496 $0 $0 $2,065,496
Atlanta Braves $1,299,957 $495,625 $0 $1,795,582
New York Mets $0 $0 $1,137,992 $1,137,992
Florida Marlins $139,607 $0 $0 $139,607
Total $11,966,468 $6,552,963 $12,101,426 $30,618,857

[3]

2002–present

The system today is based on the 2002 collective bargaining agreement. The luxury tax was eliminated from 2000 to 2002, and the MLB brought it back with a new change to the system. Instead of putting a level between the 5th and 6th team, they decided to set a threshold that a team could not pass without a fee. This allowed teams to control their own fate more, as they were not being compared to other teams. This meant they would get punished only if they passed a certain level, rather than if they were in the top 5 in the year for salary. The 2002 CBA set the threshold for the 2003–2006 seasons, was updated for the 2007–2012 seasons in the 2006 CBA, and was updated again for the 2013–2016 seasons in the 2012 CBA. The 2016 CBA has set the threshold for the 2017–2021 seasons. The tax threshold for the 2003–2021 seasons are listed in the table below.[2]

[3][4][5]

Just as with the old system, teams would have to pay a percentage of every dollar by which their payroll exceeded the set threshold. Under the 2002 and 2006 CBAs, the agreement brought about a progressive taxation system. They agreed that first time offenders would pay a fee of 17.5% of excess payrolls (later increased to 22.5%), second time offenders would pay 30%, and third time offenders would pay 40%. In the 2012 CBA, after seeing teams go over more than three times, the agreement added a 50% taxation level when teams went over the limit four or more times. Under the 2016 CBA, first time offenders would pay a fee of 20% on the dollar, second time offenders would pay a 30% on the dollar, and third or subsequent time offenders would have to pay 50% on the dollar (These offenses must be in consecutive years for these percentages. If a team falls below the threshold one year the penalty re-sets the next year to the "first offense").[2]

From 2003 to 2017, in every year at least one team has surpassed the tax threshold; only eight different teams have passed the threshold in that period. Below is a breakdown of how much each team has paid since the inception of the new competitive balance tax in 2003, through the 2017 season.

Team Years surpassed Total tax paid
New York Yankees 2003–2017 $319.6 million
Los Angeles Dodgers 2013–2017 $149.7 million
Boston Red Sox 2004–2007, 2010–2011, 2015–2016 $25.1 million
Detroit Tigers 2008, 2016–2017 $9.0 million
San Francisco Giants 2015–2017 $8.8 million
Chicago Cubs 2016 $2.96 million
Washington Nationals 2017 $1.45 million
Los Angeles Angels of Anaheim 2004 $927,059

[3][6]

Allocation of taxes paid

On December 2 in each contract year the Commissioner's Office notifies every team that exceeded the tax threshold that they must pay their tax by January 21 of the following calendar year. The Commissioner's Office then redistributes this money in a standard manner. The first $13 million will be used to defray clubs' funding obligations under the MLB Players Benefits Agreements. Of the remaining sum, 50% of the remaining proceeds collected for each Contract Year, with accrued interest, will be used to fund player compensation as described in the MLB Players Benefits Plan Agreements and the other 50% shall be distributed to clubs that did not exceed the Base Tax Threshold in that Contract Year.[4]

Other MLB revenue sharing policies

Major League Baseball also has policies improving the competitive balance off of the field. As a part of their base plan of revenue sharing, each team sends in 31% of their local net revenues into a putative pool. Local net revenues is described as gross revenue from ticket sales, concessions, etc. minus central revenue from television and radio deals minus actual stadium expenses. This pool will then be distributed equally to all 30 teams, regardless of how much each paid. Teams that paid more than they were distributed are labeled as payors and teams that received more than they contributed were labeled as payees. This system is a direct way for poorer teams to get more money from the richer teams to level the competitive balance.[7]

Reaction across the league

The effectiveness of this tax is still uncertain among MLB owners, as they take different approaches to the situation. Because of increasing tax levels when the cap is exceeded in consecutive years, there is an incentive to re-set to the year one tax rate. That increasing incremental penalty can affect a team's decision regarding whether to retain a key player when they are already over the threshold, as they may be averse to paying a substantial fee.[8] Some owners have stated that they will spend whatever they want as long as it is beneficial to the team, whereas others admit that it can handicap the team a lot in the long run.[9]

Efficacy

The efficacy can be viewed in two different ways. As the years have gone on, the tax payments have increased into substantial amounts.[3] According to USA Today Sports, more teams have come close or surpassed the tax threshold in the recent years as salaries have risen, especially in the past few seasons, despite owners wanting to stay below the tax threshold. However, in 2015, teams in the middle of the payroll pack winning playoff games, as well as the World Series, as none of the teams that went over the tax threshold won a playoff series.[9] This contrasts strongly with dominance of the Atlanta Braves and New York Yankees dynasties in the 1990s.[1] Despite the success in 2015, the efficacy could be an outlier. According to fivethirtyeight’s Noah Davis and Michael Lopez, despite the new system, cash buys more wins now than they did in the past. They also state that some teams win less when they spend more, proving there is no strong correlation between payroll and performance.[10]

Purported proof a tax works

In professional sports, there is a want for a competitive balance from the commissioner's office, as they do not want the same teams to win every year, because of concern that failing teams will go bankrupt, making the league’s market smaller. A study in the Academy of Business Research Journal back in 2013 shows a relationship between all 30 MLB teams’ winning percentage, team salaries, operating income, operating profit margin, gross profit and team revenue from 2002-2010. This study purports to have proven that there is no difference in profit when there is a payroll increase, but there is a significant increase in winning percentage with an increase in payroll, so therefore teams can spend as they have to help their teams win, and general managers will prioritize wins over profits, allowing teams with more favorable revenue situations to spend more, leading to imbalance.[11]

Major League Baseball's luxury tax is justified by a working paper from the University of Zurich. The paper develops a game-theoretic model that addresses the effects of a luxury tax on competitive balance, team profits, and social welfare. This model has half the teams above a certain tax threshold, and the other half below. The teams above would pay taxable balance from their excess amount, and it would be redistributed to the teams below. This research proved that the small teams could have a larger salary than before, and the larger teams would not be affected as much. In other words, the total salaries of the league increased, helping the players, and the competitive balance and social welfare grew, helping the fans.[12]

References
  1. "Luxury Tax | FanGraphs Sabermetrics Library". www.fangraphs.com. Retrieved 2016-04-18.
  2. "MLB's Evolving Luxury Tax | FanGraphs Baseball". www.fangraphs.com. Retrieved 2016-04-18.
  3. Orinick, Steve. "Baseball Competitive Balance "Luxury" Tax". www.stevetheump.com. Retrieved 2018-02-21.
  4. "2017-2021 Basic Agreement" (PDF). MLBPlayers.com. December 1, 2016. Archived from the original (PDF) on April 28, 2019.
  5. "2016 CBA". espn.com. December 2, 2016. Retrieved December 6, 2016.
  6. Todd, Jeff (December 16, 2016). "Six teams set to pay luxury tax". mlbtraderumors.com. Retrieved December 19, 2016.
  7. Hunt, Justin (May 1, 2012). "To Share or Not To Share: Revenue Sharing Structures in Professional Sports". Texas Review of Entertainment and Sports Law.
  8. Lampe, Nick. "How is the luxury tax affecting this offseason?". Beyond the Box Score. Retrieved 2016-04-26.
  9. "Dodgers' tax bill comes due at record $43.7 million". USA TODAY. Retrieved 2016-04-26.
  10. Davis, Noah (2015-07-08). "Don't Be Fooled By Baseball's Small-Budget Success Stories". FiveThirtyEight. Retrieved 2016-05-03.
  11. Nelson, Susan Logan; Dennis, Steven A. (March 1, 2013). "Performance or Profit: A Dilemma for Major League Baseball". Academy of Business Research Journal.
  12. Dietl, Helmut M.; Lang, Markus; Werner, Stephan (June 2009). "The Effect of Competitive Balance, Club Profits, and Social Welfare in Sports Leagues". Institute for Strategy and Business Economics University of Zurich.
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