MLB Luxury Tax: Not so Luxurious for Small Market Teams

Major League Baseball actively enforces a luxury tax, rather than a salary cap, making it the only league of the four major American professional sports leagues: National Basketball Association (NBA), National Football League (NFL), and the National Hockey League (NFL), to not have a salary cap on spending. Major League Baseball’s salary tax, also known as the Competitive Balance Tax, is an outdated model from 2002 that sets teams to a specified limit on spending. The luxury tax boundary is declared in the Collective Bargaining Agreement each year, which is constituted by the Major League Baseball Players Association and Major League Baseball’s commissioner. As Corey Seidman notes in his NBC Sports Philadelphia article “Explaining MLB’s luxury tax in relation to 2020 Phillies,” the luxury tax is a boundary that causes teams to pay a tax if they exceed the payroll threshold. For the 2020 season, the threshold sits at $208 million, and first-time offenders pay a 20% tax on overages.

The penalties become increasingly harsh if a team’s payroll is over the luxury tax threshold for consecutive seasons. For second-year offenders, that tax rate rises to 30%. If a team remains over the luxury tax threshold for three consecutive years, they are taxed 50% on all overages. However, surtaxes are appended when teams exceed specific “milestones” past the luxury tax threshold, regardless of whether they are repeat offenders or not. If a team exceeds the tax by $20 million at any point, they are automatically issued a 12% surtax, while organizations that are more than $40 million over are penalized with a 42.5% surtax, and their top draft pick is lowered by 10 spots.

To put the luxury tax further into perspective, Mike Trout is nearly ubiquitously accepted as the best player in baseball. Per Spotrac, Trout will earn $37,666,666 in 2020, making him the highest paid player in the sport next season. Hypothetically, a baseball team that is already at the $208 million luxury tax threshold could sign a free agent player of Mike Trout’s caliber to a one-year contract, hand that player the largest contract in the sport for the 2020 season ($38 million average annual value), and then lose the player to free agency the following year. Under the current luxury tax system, the assumed first time-offending organization would be permitted to sign that player, and they would be fined a measly $9.6 million (pocket change to big market team owners). In essence, staying below the luxury tax is only a recommendation, and it is a recommendation that is often disregarded by richer teams.

Meanwhile, the NFL operates under a “hard salary cap.” Hard caps, like MLB’s salary tax, are enforced by their respective leagues in order to maintain balance between all teams and to ensure that no team has a spending advantage. Preventing big market teams from “buying championships” by signing all the best available players is the primary reason why the caps and taxes are created. However, hard salary caps allow no leniency and are the strictest systems in modern American sports. Monica Charlton outlines the NFL hard salary cap penalties in “A Brief History of the NFL Salary Cap,” mentioning that any team that surpasses the hard cap is subject to any of the following: suspension or dismissal of team staff (typically the general manager or owner), forfeiture of games for the duration of a team circumventing the cap, loss of future draft picks, voiding of player extension contracts, and fines up to $5 million. In addition, any attempt to sign or extend a player’s contract, subsequently putting them over the salary cap, automatically issues the team a $25,000 fine.

Teams such as the Yankees, Red Sox, and Dodgers are classified as big market teams due to their worldwide popularity, media market size/outreach, and city-based population. Big market teams are also some of the most valuable organizations in all of baseball. Oftentimes, these are the organizations that have the financial power to dominate their respective divisions and leagues for years. Big market teams have the financial ability to exceed the lenient luxury tax threshold and pay any penalties. Meanwhile, the opposite of big market teams is, unsurprisingly, the small market teams. Teams like the Tampa Bay Rays, Seattle Mariners, and Pittsburgh Pirates are lesser-known teams with small city populations, a poor media market, and/or a shared media market with rival clubs. Due to their overall unfavorable markets, they typically struggle to compete with the big market teams whose owners can easily afford to exceed the luxury tax and pay the fines.

 Small market teams practice a concept termed “tanking” more often than big market teams because big market teams have the financial means to add plenty of talent with the aid of their immense amount of revenue/income. Tanking teams discuss losing intentionally, behind closed doors, in order to receive higher draft picks in the following year’s draft. However, the value in tanking does not simply lie in the high draft picks and the production that comes from those elite players at the major league level. The ability to sign those incredibly young, controllable, cheap players with elite potential to long-term contract extensions (often buying out years of free agency) is the true intention behind tanking.

In recent events the White Sox offered their young stud, Eloy Jimenez, a six-year, $43 million contract. The Braves agreed upon an eight-year, $100 million contract extension with their 21-year-old superstar outfielder, Ronald Acuna Jr. Both players were acquired via international signings, but the ideology remains the same for tanking teams. Tanking teams follow a pattern where they lose intentionally, acquire young talent (usually through the draft), extend that player to an inexpensive contract, and then compete with the big market teams for the big fish in free agency. Tanking for draft picks only end successfully when teams draft well, but judging young talent is one of the most challenging tasks to accomplish in baseball when compared to other sports. Small market teams that rely on tanking defy the odds and make great picks every so often, but many times high draft picks are “busts,” and teams enter a cycle of tanking that lasts for years. Tanking hurts the baseball economy tremendously because it negatively affects league parity, and fans do not want to invest hard-earned money into watching a subpar team.

References

Charlton, Monica. (2018, July 12). A Brief History of the NFL Salary Cap.

Seidman, C., Salisbury, J., & NBC Sports Philadelphia Staff. (2020, January 9). A refresher on MLB’s luxury tax in relation to 2020 Phillies.

MLB Rankings. (n.d.). Retrieved April, 2020.