The Captain's Blog

Major league baseball owners and players continued their impressive streak of labor peace by tentatively agreeing to a new five-year collective bargaining agreement. Although the final agreement has not been drafted, not to mention ratified, enough details have emerged to allow for an early analysis. So far, the conventional wisdom is the owners were the clear winner, but a closer examination suggests both sides did well, with the only losers being international amateur free agents.

According to reports, the tentative CBA contains some interesting changes, such as a 10-day disabled list, revised free agent compensation rules, and a new system for determining home field advantage in the World Series. However, the most consequential part of the agreement concerns adjustments to the luxury tax structure and revenue sharing system.

Rise in Luxury Tax Threshold, 2003-2021
Source: MLB

Starting in 2017, the luxury tax threshold will rise 3.2% to $195 million and then gradually climb to $210 million when the deal expires in 2021. Some have portrayed this modest increase as evidence of the MLBPA caving into ownership demands, but the 11.1% increase over the span of deal nearly doubles the 6.5% rise between 2011 and 2016. Not coincidentally, if you take Forbes revenue estimates for the industry (and assume 2016 growth mirrors 2015), then the 30% increase during the just-expired CBA would also be double the 15% bump that occurred during the preceding deal. Is that a coincidence? Perhaps, but the symmetry suggests the revised thresholds are fair to both sides.

Tax Rate Snapshots

Another reason the owners have been hailed as victors is the introduction of new surcharges that will be levied against extreme luxury tax offenders. In addition to an escalating tax rate, which climbs from 20% to 30% to 50% for repeat violations, teams will also be slapped with an additional 12% tax on payroll that is  $20-$40 million over the limit and a 40% surcharge for going beyond $40 million (rising to 42% for consecutive violations). Although this has been portrayed as a maximum rate of 92%, the surtaxes only apply to defined overages, meaning a team would have to maintain a payroll of approximately $350 million for three years to end up paying an effective tax rate that high. Still, a habitual offender like the Yankees would end up paying a 69% tax on a $250 million payroll in 2017 (see above), so the introduction of these surcharges is not inconsequential. However, under reasonable assumptions, they are likely to only apply to the Yankees and Dodgers.

2015 AAV Payrolls Compared to 2017 and 2021 Luxury Tax Thresholds

Note: Based on Average annual value of contracts plus pro-rated items, earned bonuses, and defined benefits of $12,626,624.
Source: MLB releases published by AP (2016 payrolls have not yet been released)

Aside from New York and Los Angeles, there are only two other teams within arms distance of the new threshold, which means 26 other teams are unlikely to approach the penalty. It’s hard to argue that the new scheme represents a quasi-cap when it is only relevant to four teams, and only two in a significant way. Though it is possible that other clubs will be deterred from becoming big spenders over the next five years, most would have had to increase spending significantly just to approach the luxury tax trigger (as illustrated in the chart above). So, even if other clubs pull up short of the new thresholds, the overall increase in their spending would still be a boon to the players.

The new luxury tax system isn’t as onerous as it seems, and certainly doesn’t rise to the level of a de facto cap for all but the Yankees and Dodgers. And, even for those teams, there is mitigation in the form of a revised revenue sharing system. According to reports, the owners have agreed to scrap the supplemental component of the revenue sharing system that used a series of performance factors to increase the shared pool from 34% of local revenues to 48%. And, which teams would have been expected to pay into that supplemental plan? The same big market teams that could run afoul of the stepped up luxury tax regime.

Using estimates I calculated in 2013, the elimination of this plan could result in a $20 million savings to the Yankees. That’s a highly speculative number, but without the supplemental scheme, several big market teams are assured of paying less into the revenue sharing pot. And, if, for example, the $20 million estimate for the Yankees is accurate, it would offset the increased luxury tax and lower the effective tax rate on the $250 million payroll illustrated above to only 33%. That would be a significant discount from the just expired system, which means a team like the Yankees would actually be afforded extra cushion under the new agreement, assuming they want to spend the savings instead of bank it as profit.

Unfortunately, not everyone was a winner in the new CBA. Foreign born amateurs bore the brunt of compromise as the players agreed to a hard cap on international signings in exchange for eschewing an international draft. Adding insult to injury, the new CBA also extended these rules to more players by increasing the eligible age from 23 to 25, leaving talented foreigners with little leverage when it comes time to negotiate a new deal. Full details have not yet been released, and it’s important not to extrapolate too much before the ink has dried, but it’s likely that international amateurs will end up paying the price for the MLBPA’s and owners’ continued good fortune.