SENIOR PROJECT ROUGH DRAFT

Running head: COMPETITIVE BALANCE TAX 1

The Competitive Balance Tax

Jarett Thoren

Rocky Mountain High School

COMPETITIVE BALANCE TAX 2

Abstract

The Competitive Balance Tax, Article XXIII of the 2003-2006 Basic Agreement between Major

League Baseball (MLB) and the Major League Baseball Players Association (MLBPA), requires

MLB clubs to pay a tax on the difference between the club’s annual salary and a predetermined

tax threshold if the team’s salary is above the designated threshold. Following a period of

sustained dominance by teams with large club salaries in the 1990’s, the tax was implemented

in 2003 in order to create a better competitive balance in Major League Baseball. The policy

outlines the tax thresholds for each year, and has accumulated money from a small portion of

teams since its inception. There are two primary views in regard to the Competitive Balance

Tax, and both hinge upon the effectiveness of the policy in its attempt to create an equal

playing field. However, if Major League Baseball wishes to attain the same competitive balance

as other professional sports leagues such as the NFL, the Competitive Balance Tax should be

replaced with a hard salary cap.


Policy Identification and Explanation

Article XXIII of the 2003-2006 Basic Agreement between Major League Baseball and the

Major League Baseball Players Association required MLB clubs, with a final Actual Club Payroll

that was in excess of a predetermined Tax Threshold designated for that year, to pay a

Competitive Balance Tax on the difference between the club’s Actual Club Payroll and the Tax

Threshold. Any team with an Actual Club Payroll above the applicable threshold would pay a

luxury tax of 17.5 percent of the difference between their payroll and the threshold, 30 percent

for a second consecutive year above the threshold, 40 percent for a third consecutive year, and

50 percent for four or more consecutive years (2003-2006 Basic Agreement, 2002).

This policy was enforced by Major League Baseball, and any team that did not pay the

full amount of the Competitive Balance Tax owed by the date January 21 of that contract year

would have its next Major League Central Fund distribution and any following distributions

reduced by a maximum of 50 percent until the obligation was fulfilled (2003-2006 Basic

Agreement, 2002).

The money that has been accrued by Major League Baseball from the Competitive

Balance Tax has been distributed in the following ways: the first five million dollars has been

reserved for potential tax refunds, and has been donated to the Industry Growth Fund [IGF] if

no refunds have been owed, 50 percent of the remaining amount has been contributed to

player benefits, 25 percent has gone to developing baseball in countries without high school

baseball, and 25 percent has been contributed to the Industry Growth Fund (2003-2006 Basic

Agreement, 2002).

Policy History and Background


Although free agency has existed in Major League Baseball since the league’s creation,

the Era of Free Agency didn’t begin until 1975. Until then, clubs in the MLB were able to

perpetually renew the services and contracts of five players each year under the Reserve

Clause. This eliminated competition for the services of top players in the league, allowed clubs

to determine the salaries of their best players, and led to the forming of players unions who

challenged the reserve clause. After the removal of the reserve clause in 1975, teams were able

to compete for the rights to sign the top players in the league, resulting in increased player and

club salaries (Major League Baseball Players Association [MLBPA], 2014).

As time passed, teams in larger media markets with higher revenues were able to offer

higher salaries to players than teams in smaller markets with less available expendable income,

and the gap between the teams with the highest Actual Club Salaries and the teams with the

lowest club salaries began to widen. This margin was first heavily scrutinized during the 1990’s,

when the New York Yankees, the highest spending team throughout the decade, enjoyed a

period of sustained dominance. New York won four World Series Championships in five years,

and the team’s success was contributed by many to the team’s large annual salary and New

York owner George Steinbrenner’s ‘excessive’ spending (Entertainment and Sports

Programming Network [ESPN], 2014). As a result of this spending, teams with lower club

salaries have had to attempt to find new methods to reach success, such as relying on young

players in the club’s farm system to perform at similar levels to the top-tier veteran players

being signed by teams with high payrolls (Chass, 2002).

Take for instance Tampa Bay, a small market team in the same division as the large

market New York Yankees and Boston Red Sox. In order to compete with large market teams


for a playoff spot over the last decade, the Rays have been forced to find a way to produce a

better overall team performance with an average payroll over the last ten years that is roughly

25 percent that of the average payroll of New York, and roughly 38 percent that of Boston

(ESPN, 2014).

Major League Baseball club owners called for a salary cap to limit team payrolls, similar

to those implemented in the National Basketball Association [NBA] and the National Football

League [NFL]. Because this would result in decreased player salaries, this proposal was met with

strong opposition by the players union (Staudohar, 2002). In the 2002 Collective Bargaining

Agreement, the MLBPA and MLB came to terms on a new agreement:

A compromise was reached in the form of a luxury tax, penalizing clubs with high

payrolls by imposing a surcharge above a certain amount and then distributing the tax

revenues to poorer clubs. The tax addresses baseball’s problem of wealthy teams in big

markets having a competitive edge over low revenue teams in smaller markets

(Staudohar, 2002).

In addition to the Competitive Balance Tax, MLB Commissioner Bud Selig also implemented a

new system of revenue sharing, which required all teams to donate 34 percent of their Net

Annual Revenue to a league-wide pool, which would then be distributed evenly amongst all

clubs (Staudohar, 2002). Major League Baseball had tried to limit spending with a tax previously

in 1996, but the tax was ineffective due to its floating limit on salaries (MLBPA, 2014). Since the

tax’s inception in 2003, the New York Yankees have surpassed the threshold every year, while

only four other teams have ever had to pay the luxury tax (ESPN, 2012).

Current Situation


In 2011, a new collective bargaining agreement led to an updated Basic Agreement as

well as an updated Competitive Balance Tax, with new predetermined tax thresholds for the

years of 2012 through 2016. As of now, the Competitive Balance Tax has accumulated roughly

285 million dollars, with 254 million dollars being contributed by the New York Yankees

(Delgado, 2013). New York paid 28 million dollars in luxury tax fees to Major League Baseball in

2013, which in comparison is roughly 25 percent more than the entire Actual Club Salary of the

Houston Astros (ESPN, 2013). The tax threshold set for 2014 by the 2012-2016 Basic Agreement

is 189 million dollars, which will most likely be surpassed by the New York Yankees for the 12th

year, and the Los Angeles Dodgers for the second straight year (2012-2016 Basic Agreement,

2011). The following graph shows the amount of money attained by year and by team since the

Competitive Balance Tax’s inception in 2003.

(Delgado, 2013)

Because of the tax, many teams spend either at or just below the threshold, and repeat

offenders such as New York and Los Angeles attempt to spend just below the threshold during


one contract year in order to reset their tax rate back to 17.5 percent as it applies to the first

season of violation. Small market teams do not benefit from the money collected from the tax,

thus the margin between high-revenue clubs and low-revenue clubs is only lessened via the

funds distributed through the revenue sharing program. In contrast, the NBA also enforces a

luxury tax, alongside a soft salary cap, that is redistributed amongst poorer teams in the league.

In comparison to the MLB, the NBA’s soft salary cap sets a limit on team salaries each

year, but allows teams to surpass the limit under certain exceptions, such as resigning a

returning player. The NFL and NHL both implement a hard salary cap, which limits team

spending on an absolute basis, and eliminates the need for a luxury tax. These leagues and their

policies enacted for the purpose of attaining competitive balance influence Major League

Baseball by setting comparable standards for the MLB to compare and contrast the luxury tax

with (ESPN, 2013).

Media market plays a major role in influencing the Competitive Balance Tax, large

markets such as New York, Boston, and Los Angeles produce high annual revenues, whereas

smaller markets such as Oakland and Houston generate low team salaries due to their yearly

revenues. The average salary of the last 10 World Series winners has been 120,360,837 million

dollars, a threshold that 23 of the clubs in the league were below in 2013 (ESPN, 2013). The

New York Yankees have missed the playoffs only twice in the last 19 seasons, and the $471

million they have spent during the 2013-2014 offseason alone is enough to fund the current

Houston Astros roster for over 21 years (ESPN, 2013).

Because the Competitive Balance Tax places no limit on team or individual salaries,

many players are enjoying the high salaries resulting from large market teams who are willing


to outbid the competition for their services. But just as the gap between team salaries of large

and small market teams is increasing, so also is a discrepancy developing in the individual

salaries of comparable players of clubs from different markets. For instance, Evan Longoria of

the Tampa Bay Rays and Alex Rodriguez of the New York Yankees are two All Star 3rd Baseman

from the American League East (MLB, 2014). The best advanced statistic used by analysts to

evaluate the overall value of a player to a team is the Wins Above Replacement [WAR] stat,

which compares the contribution of the player both offensively and defensively to that of an

average performing replacement. Over the past five years, Alex Rodriguez has had an average

annual salary of $31 million, and an average WAR of 2.96. In contrast, Evan Longoria, who plays

the same position, hits in the same spot in the order, and plays in the same league and division

as Rodriguez, has made an average of $2.8 million over the last five years, and boasted an

average WAR of 6.3 over the same span (Baseball-Reference, 2014). Because of the lack of

expendable income of small market teams, some players are underpaid based on performance

relative to those who enjoy the benefits of the Competitive Balance Tax.

Differing Viewpoints

In terms of attaining competitive balance in Major League Baseball, there are two

dominant views in regards to the implementation of the luxury tax. The goal of both views is to

attain competitive balance amongst the clubs in Major League Baseball, and both methods

attempt to limit the spending of large market teams. However, where the views differ is

through the means by which this ends is attained, one aims to maintain the current policy of

taxing teams that spend over a certain amount, the other aims to completely prevent spending

over a certain amount by enforcing a strict limit on how much a team can spend each year.


The first view is held by the Major League Baseball Players Association, as well as some

owners of large market teams generally, such as Hank and Hal Steinbrenner, the current

owners of the New York Yankees, or Magic Johnson and Frank McCourt, the current owners of

the Los Angeles Dodgers (MLBPA, 2014). Their view is that the luxury tax detailed in Article XXIII

of the current Basic Agreement has sufficiently established competitive balance in the MLB.

According to proponents of the Competitive Balance Tax, Major League Baseball has created a

greater parity of league champions each year than its NFL and NBA counterparts, who utilize

salary caps in an attempt to create the same effect. From 2001-2011, the MLB produced nine

different world champions, 14 different World Series teams, and only five teams that were

unable to reach the playoffs throughout the decade. In contrast, the NFL has produced seven

different champions, 14 Super Bowl contenders, and three non-playoff qualifiers. The NBA has

produced five unique champions, ten different finalists, and zero non-playoff teams (Perry,

2013). The players union strongly supports the benefits the luxury tax provides players, which

include no limit on personal salaries and a portion of the money acquired from the tax being

contributed to player funds (2012-2016 Basic Agreement, 2011). Large market club owners

favor the current policy because, theoretically, unlimited team spending produces greater team

results, and therefore profits and incentives for owners, than the alternative method of

implementing a salary cap. Supporters of the tax also argue that the main reason clubs push to

implement a salary cap is not to actually attain competitive balance, but to instead lower team

salaries and thus only increase profits for owners. They argue that if a salary cap were to be

implemented, the main beneficiaries would be owners, not the league, and exciting annual


offseason transactions with big-name players would all but be eliminated with a limit on team

spending (Perry, 2013).

The contrasting view is that the Competitive Balance Tax simply is failing to succeed in

creating competitive balance in Major League Baseball, and that a salary cap must be

implemented if the majority of teams in the league, who are beneath the average Actual Club

Salary of the past ten world series champions, are going to have a consistent chance to

compete for a championship each year. This view is held by the majority of clubs in the MLB.

According to Frank Deford of Sports Illustrated, the only way for “geographical losers” to

compete with rich clubs is “to be both wise and lucky when drafting amateur players” (Deford,

2010). In 2008, the Tampa Bay Rays, with a salary that was 20 percent that of New York and a

roster filled with talent acquired from the organization’s farm system, won the AL East and

topped the Yankees. The following offseason, the Yankees acquired the top free agent hitter

and top two free agent pitchers, spent $423 million [Enough to fund the Rays’ roster for nearly

ten years], and secured the 2009 pennant (Deford, 2010). A hard salary cap would set a firm

limit on team spending each year. And, in addition to currently active revenue sharing

programs, a cap would significantly diminish the margin between the team salaries of the large

market and small market teams. This, in turn, would create a greater parity in the market-size

of World Series champions in Major League Baseball, and increase the excitement of offseason

trading and signing due to the increase in teams that would be able to afford and compete to

sign top players (Brewer, 2013). A limit on team spending would increase team revenues, which

could be used to improve stadiums, advertising, and decrease ticket prices, thus increasing

ticket sales (Perry, 2013). If these effects were to take place, not only would a better


competitive balance be created in Major League Baseball, but the game as a whole would

benefit from the effects of increased team revenues.

Policy Recommendation

The Competitive Balance Tax should be eliminated from Major League Baseball and

replaced with a hard salary cap. It is important to implement a hard salary cap [similar to those

utilized by the NFL and NHL], not a soft salary cap [similar to that of the NBA], due to the soft

salary cap’s inability to effectively keep teams under the spending limit due to exceptions that

allow teams to spend over the predetermined threshold. Only five teams during the 2013-2014

season will spend at or below the NBA’s designated salary cap (ESPN, 2014). Major League

Baseball should instead enact a hard salary cap at the same threshold the Competitive Balance

Tax begins to fine clubs for their spending. For instance, if a salary cap were to be implemented

for the 2014 season, the cap would be set at $189 million, the amount the players and league

determined to be ‘excessive’ in the most recent Collective Bargaining Agreement (2012-2016

Basic Agreement, 2011). Because there would still be a significant margin between small

market club payrolls and large market payrolls, the MLB should also retain its implementation

of revenue sharing at a mark of 34 percent.

A hard salary cap would more effectively balance and limit spending, and thus create a

better competitive balance. It would allow teams from medium and small markets to also

compete for the services of top-tier free agents, which would cause a greater parity in

successful teams each year, similar to the variety seen from year-to-year in the NFL (Brewer,

2013). A hard cap would also increase team revenues, which would result in improved

stadiums, marketing, and ticket sales, all of which benefit the league and its audience as a


whole (Perry, 2013). By maintaining revenue sharing, poorer teams would receive money they

otherwise could not earn, and which that money they could sign better players, improve their

facilities or marketing, and increase their revenues to produce more competitive teams season

by season.

Politically speaking, a hard salary cap would be difficult to incorporate with the presence

of the Major League Baseball Players Association. The MLB players union is the most strongly

organized of any professional sports league’s union, and the decrease of player salaries that

would occur with a salary cap could possibly lead to a lockout similar to those that recently

occurred with the NBA in 2011 and the NHL in 2012 (Staudohar, 2002). However, players in

medium to small markets [which accounts for more than half of the league’s clubs] would

benefit financially from a salary cap, and if Commissioner Selig and the MLB added increased

player benefits from the additional revenue created by the cap, a compromise could be reached

and a salary cap could be enforced.

Economically speaking, because Major League Baseball is an independent and self-

sufficient organization, the addition of a salary cap would not result in a major economic

impact. However, a strict limit on spending would cause increased team revenues, which in turn

could lead to decreased ticket prices to MLB games, an increase in ticket sales, and

improvements to team facilities (Perry, 2013).

The benefits and advancements that a salary cap would provide Major League Baseball

should outweigh the needs of players that are seeking higher personal payrolls. A salary cap

would bring more fans to games, create more exciting offseason transactions through intense


bidding wars for top players, increase team revenues and improve team facilities, and provide a

much fairer playing field for all teams to compete upon.


References

Ajilore, O., Hendrickson, J. (2007). The impact of the luxury tax on competitive balance in

baseball. Retrieved from

http://college.holycross.edu/RePEc/spe/AjiloreHendrickson_LuxuryTax.pdf

Baseball-Reference. (2014). Team salaries. Retrieved from

http://www.baseball-reference.com/players/r/rodrial01.shtml

Brewer, J. (2013). Baseball needs a salary cap if it wants NFL-style parity. Retrieved from

http://www.bizjournals.com/bizjournals/how-to/growth-strategies/2013/11/brewer-

small-market-teams.html?page=all

Chass, M. (2002). Players offer their view of a contract they’d like. Retrieved fromhttp://ic.galegroup.com/ic/ovic/NewsDetailsPage/NewsDetailsWindow?

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ESPN. (2014). MLB team salaries. Retrieved from

http://espn.go.com/mlb/team/salaries/_/name/nyy/new-york-yankees

Major League Baseball. (2014). Schedule. Retrieved from


http://mlb.mlb.com/mlb/schedule/ps.jsp?tcid=mm_mlb_schedule

Major League Baseball Players Association. (2014). About. Retrieved from

http://mlbplayers.mlb.com/pa/pdf/cba_english.pdf

Perry, D. (2013). No, baseball (still) doesn’t need a salary cap. Retrieved from

http://www.cbssports.com/mlb/eye-on-baseball/24350073/no-baseball-still-doesnt-

need-a-salary-cap

Staudohar, P. (2002). Baseball negotiations: a new agreement. Retrieved from

http://www.bls.gov/opub/mlr/2002/12/art2full.pdf

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SENIOR PROJECT ROUGH DRAFT