The Captain's Blog

Was the CBA process hijacked from the players? Are payrolls likely to stagnate? And, is the deal so one-sided that the seeds of future discord have already been sewn? All of these assessments are based on the premise that the new CBA will discourage spending, but is that true?

As illustrated yesterday, the additional penalties imposed by the new luxury tax scheme are likely to only effect two teams: the Yankees and Dodgers. Even if other teams exceed the new thresholds, none are habitual offenders and all are unlikely to spend at levels that wouldn’t trigger the new surcharges. So, any analysis of the new system’s dampening effect should center on how it will influence the Yankees’ and Dodgers’ willingness to spend.

Comparative Tax and Rate for Hypothetical Payrolls (chart and graph), 2016-2021

Note: Assumes payroll is taxed at the maximum rate and surcharge (i.e., applies to habitual offenders). Green shading in the chart indicates where total tax is lower than would have been under 2016 rules.
Source: Proprietary

The new CBA will impose more stringent tax rates on habitual big spenders, but these gaudy percentages look more imposing when divorced from the proper context. As illustrated above, in dollar terms, the tax paid out on a commensurate payroll will gradually decrease over the agreement’s five year term. And, for  payrolls around $265mn or lower, the fine levied will be less from 2019 forward than it would have been under the 2016 rules. In other words, the new surcharges will only have a significant impact on sustained payrolls approaching $300 million.

The Dodgers and Yankees are capable of spending at the $300 million level, so, if other teams don’t pick up the slack, it’s fair to suggest that the new system, will, in fact, have a dampening effect on industry spending. But, that’s still only half the story. While the luxury system is more punitive to big market teams, the reported reduction in revenue sharing obligations are a benefit for those with big pockets. How much would the Yankees and Dodgers save under the new revenue sharing arrangement, which would eliminate the supplemental component of the system? More data is needed for a definitive answer, but let’s assume $20 million (see here for more details on the now-eliminated supplemental revenue sharing plan) and then apply that savings to the payroll analysis depicted above.

Comparative Tax and Rate for Hypothetical Payrolls Net of Revenue Sharing Benefit, 2016-2021

Note: Assumes payroll is taxed at the maximum rate and surcharge (i.e., applies to habitual offenders) and revenue sharing benefit is $20 million. Green shading in the chart indicates a surplus (revenue sharing benefit is greater than the luxury tax).
Source: Proprietary

By offsetting the luxury tax with the revenue sharing surplus, the actual tax that a habitual offender (i.e. Yankees and Dodgers) would pay would plummet, bringing the effective rate well below the 2016 level of 50%. In fact, there would be growing surpluses for payrolls approaching as much as $250 million. Is the $20 million estimate of revenue sharing largess too aggressive? Or, is it too conservative? Time, and more data, will tell, but what is certain is that even moderate reductions in revenue sharing would incentivize spending for big market teams. Granted, that doesn’t mean the Yankees and Dodgers would actually apply their savings to payroll (and, they may decide to hide behind the murkiness of the revenue sharing arrangement), but, if they choose to pocket the money, that decision would not be due to CBA restrictions. On the contrary, because the new CBA reportedly will allow teams to keep a larger share of local revenue, all teams, big market and small, will have an incentive to invest in growth (i.e., if fielding a winning team boosts attendance, a larger percentage of the marginal revenue will be retained).

We’ve established why the new CBA is not a deterrent to big market spending. But, what about everyone else? Off the bat, the increasing thresholds should have a catalytic impact on teams like the Red Sox and Giants, who have set the luxury tax limit as a de facto budget. And, with these teams also likely to share less revenue, they may be more willing to pay the tax from time to time. However, where the players really stand to increase their share of the pie is from the 20-25 teams who haven’t come close to spending near the luxury tax threshold, and who are primarily responsible for the $1.4 billion gap between actual payrolls and the amount teams could spend without incurring a tax (based on 2015 AAV payrolls released by MLB).

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. The gap between actual total payrolls and that implied by the 2017 luxury tax limit is $1.4 billion.
Source: MLB releases published by AP (2016 payrolls have not yet been released)

Because most teams have never even approached the luxury tax limit, there’s no reason to think higher thresholds will encourage them to spend more. And yet, there are other provisions in the CBA that just might give smaller market teams an incentive to increase their payrolls. For example, under the new rules, teams that are revenue sharing receivers (i.e., small market teams) will only forfeit a third round pick if they sign a high-priced free agent who was extended a qualifying offer. This compares to losing a first or second round pick under the current system, so, small market teams will be penalized significantly less when they dip their toe in the free agent waters.  On the flip side, teams like the Yankees or Dodgers would face stiffer penalties for signing free agents, especially if they are substantially over the cap, but that might simply encourage them to take the revenue sharing/tax savings illustrated above and use it to retain existing players. Regardless, even if the Yankees and Dodgers are induced to sign a free agent or two less, at least half the league will have the opposite motivation.

The hard cap applied to international amateurs is another incentive for small market teams to spend more on players who are currently in the union. Take the Padres, for example. This year, San Diego spent over $40 million on international free agents, but, under the new rules, they would be capped at around $5 million. What would they do with the difference? Again, it’s possible that ownership will keep the change, but there’s also a chance teams like the Padres could re-allocate funds from international players to free agents, especially now that the compensation tied to such decisions is less onerous.

Highly-touted amateurs like Yoan Moncada won’t take consolation in the redistribution of payroll resources from international market to existing MLB talent, but, though one can debate the moral obligations of this transfer, the fact remains that amateurs are not a part of the union. Also, that the MLBPA resisted an international draft isn’t inconsequential, even if the hard cap system is equally restrictive to top level talent. So, while a star like Moncada may have to settle for “only” $5 million, there are hundreds of marginal players in countries like the Dominican Republic who will still benefit from the existing academy system (even with all its documented abuses). For some of those players, the room and board alone may be a boon, much less the chance to have a professional baseball career, even if it’s spent entirely in the minors.

Who won the CBA battle? Baseball has a long history of labor discord, so it’s easy to understand the desire to keep score. However, as long as revenue keeps flooding in, both sides will be winners, and pundits will have the opportunity to renew the debate in five years when a new deal is once again agreed upon without a work stoppage.