Major League Baseball Competitive Balance Tax

MLB baseball moneyMajor League Baseball (“MLB”) does not have a salary cap, hard or soft. However, MLB utilizes a Competitive Balance Tax, commonly known as a luxury tax, to prevent the wealthiest teams that operate in major markets (and thus have higher revenues to sign the most talented players) from gaining a significant competitive advantage over those teams located in smaller markets. The provision for a Competitive Balance Tax is contained in the 2012-2016 Basic Agreement (Art. XXIII, pg. 97).[1]

The luxury tax is a methodology utilized by MLB to discourage MLB teams from creating huge payrolls that could result in the league becoming imbalanced. The luxury tax is quite different from other methodologies utilized by other professional leagues for limiting payrolls. The luxury tax does not prohibit excessive spending as would be the case of a salary cap in the NBA or NFL. What it does do is imposes a monetary penalty, a financial punishment, on teams whose payroll exceeds a threshold amount as defined by the Basic Agreement. The luxury tax thus allows teams with lower revenues to compete in the market for MLB players with teams with higher revenues, providing for a more level playing field.

The following are the luxury tax thresholds for the years covered in the current 2012-2016 Basic Agreement:

Year Threshold
2012 $178 million
2013 $178 million
2014 $189 million
2015 $189 million
2016 $189 million

Any MLB team whose payroll exceeds the threshold at the end of the season will be taxed a percentage of the exceeding amount.

The tax rate is completely dependent on the MLB team’s tax history. Teams that have been “repeat offenders” are subject to paying a higher tax rate.

What follows is how the luxury tax rate is calculated for MLB teams above the threshold in the years 2013 through 2016:

  • 17.5% if the team didn’t exceed the tax threshold in 2012
  • 30% if the team exceeded the tax threshold in 2012 and paid 20%
  • 40% if the team exceeded the tax threshold both in 2011 and 2012, meaning they paid 30% in 2012
  • 50% if the team exceeded the tax threshold in the last few years and they paid anything over 40%[2]

The rule is simplistic, if a team exceeds the threshold, the team will pay. If the team exceeds the threshold for successive years, the team will pay more.

So, for example, if a team had a total payroll of $200 million in 2013 and the team didn’t pay any luxury tax the year before, the team would be assessed a 17.5% tax on $22 million or a total luxury tax of $3.85 million. If the team had paid the luxury tax for the first time in 2012, the team would have paid 30% or a luxury tax of $6.6 million.

Avoiding the luxury tax for just one year resets the MLB team’s tax rate.[3]

What follows are the total amounts of luxury tax payments by MLB teams from 2003 to 2014 (in millions of dollars):

Statistic: Luxury tax payments* by Major League Baseball teams from 2003 to 2014 (in million U.S. dollars) | Statista
Find more statistics at Statista

The definition of “payroll” under the Basic Agreement for luxury tax purposes is as follows: “Payrolls are for 40-man rosters and include averages of multiyear contracts; health and pension benefits; clubs medical costs; insurance; workman’s compensation, payroll, unemployment and Social Security taxes; spring training allowances; meal and tip money; All-Star game expenses; travel and moving expenses; postseason pay; and college scholarships.”[4]

The final numbers are not computed until the end of the season. Thus whatever the figures are on opening day, they can change for final calculations of “payroll” under the Basic Agreement.

The Yankees, Red Sox, and most recently the Dodgers, lead the MLB historically in the payment of the luxury tax as illustrated by the chart below:

Luxury tax paid per year by team (in millions of $)[5]

Team 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013
Luxury tax threshold 117 120.5 128 136.5 148 155 162 170 178 178 178
Yankees 11.8 26 34.1 26 23.88 26.9 25.69 18 13.8 18.9 29.1
Red Sox 3.15 4.1 0.498 6.06 1.49 3.4
Angels 0.927
Tigers 1.3
Dodgers 9.9

In 2014, the Los Angeles Dodgers paid $26,621,125 in luxury tax and the New York Yankee’s paid $18,300,000.[6]

The threshold for 2014 was $189 million in payroll. The Dodgers, per MLB’s calculations, had a payroll of approximately $277,737,083. As a team that exceeded the tax for a second straight season, the Dodgers had to pay at a rate of 30 percent, resulting in a tax of $26,621,125.[7]

In 2014, the Dodgers paid more than the Yankees, ending New York’s run of 15 consecutive seasons as paying the most in luxury tax.[8]

Dodgers’ President of Baseball Operations Andrew Friedman and General Manager Farhan Zaidi came from the Rays and Athletics, where the luxury tax wasn’t even a consideration. Now, it factors into each decision the Dodgers make.[9]

“It’s fun and exciting, but there is a different feeling of responsibility to fully vet out these options, because there is a lot more money involved,” Zaidi said during the winter meetings in San Diego. “It’s $1.40 for every dollar spent.”[10]

According to the Basic Agreement, the competitive balance tax is distributed by MLB as follows:

  • The first $2,375,400 of proceeds collected for each Contract Year shall be used to fund benefits to Players, as provided in the Major League Baseball Players Benefit Plan Agreements.
  • 50% of the remaining proceeds collected for each Contract Year, with accrued interest, shall be used to fund benefits to Players, as provided in the Major League Baseball Players Benefit Plan Agreements.
  • 25% of the remaining proceeds collected for each Contract Year shall be contributed to the Industry Growth Fund and, with accrued interest, used for the purposes set out in Article XXV.
  • 25% of the remaining proceeds collected for each Contract Year, with accrued interest, shall be used to defray the Clubs’ funding obligations arising from the Major League Baseball Players Benefit Plan Agreements.[11]

In July of 2014, Bud Selig identified the parity fostered by Major League Baseball’s economic reforms as the defining legacy of his stint as MLB commissioner. “Bud Selig has moved baseball to a situation where you do have competitiveness by small-market teams in an age where dollars should drive everything,” said Rick Burton, former commissioner of Australia’s National Basketball League and a professor of sports management at Syracuse University. “You want every team to believe that this year they can contend. I think baseball has that now, but I don’t think they had that back in 1998 or back in the mid-to-late 90’s.”[12]

The results are incredible:

  • 13 of 30 teams have played at least one postseason series the last two years.
  • 20 of 30 teams have played at least one the last five seasons.
  • Six different franchises have won the American League the last seven years.
  • Eight franchises have won the World Series the last 14 years.
  • The average payroll rank of the last 10 World Series winners is eighth.
  • In that time, the No. 1 payroll team has won just once–2009 Yankees
  • In 2014, 3 of the top 5 payroll teams and 6 of top 11 missed postseason.[13]

The Basic Agreement has also instituted a competitive balance lottery. The Competitive Balance Lottery, which was agreed upon as a part of the 2012-2016 Basic Agreement between MLB and the Major League Baseball Players Association, gives Clubs with the lowest revenues and in the smallest markets the opportunity to obtain additional draft picks through a lottery. The 10 Clubs with the lowest revenues and the 10 Clubs in the smallest markets were entered into a lottery for the six selections immediately following the first round of the First-Year Player Draft.[14]