Although Major League Baseball does not have a strict “salary cap”, like the NFL or NBA, it does have a system in place to even the playing field between the larger market/spending clubs and the small market clubs.
Teams are subject to a Competitive Balance Tax or “Luxury Tax” if they spend over a predetermined dollar amount for their player’s payroll for one championship season. Teams that “overspend” are penalized in the form of a tax payment they must pay to the commissioner’s office, as well as potential draft pick loss in the following year’s MLB Draft.
History
Major League Baseball created the Competitive Balance Tax in 1997 to achieve exactly what it’s named for, equalizing competition across the league. In the early 1990s, the gap between high and low payroll teams had increased so much that small payroll teams voiced their concerns about their ability to compete with more wealthy clubs when signing free agents. Large payroll teams did not want to impose a strict salary cap, fearing the massive pay cuts that would be required would substantially hinder the construction of their clubs.
What resulted was the first “luxury tax”, in which the top 5 spending teams in the league would pay 34% per dollar spent over the average payroll of the 5th and 6th payroll teams. This system lasted through the 1999 season before being abolished, then replaced in the 2002 Collective Bargaining Agreement.
The 2002 agreement created the system that is in place currently. The league sets a salary threshold that if a team spends more than the set amount, they will be taxed on every additional dollar. See below for the current and prior four season’s competitive tax thresholds.
Recent Competitive Balance Tax Thresholds:
2017 – $195 Million
2018 – $197 Million
2019 – $206 Million
2020 – $208 Million
2021 – $210 Million
2022 – $230 Million
Components
Tax rates are dependent on how much money a club spends over the competitive balance threshold and if they are doing so more than one season in a row. Due to the new CBA in 2022, the luxury tax contains multiple tiers of thresholds and tax rates.
For example, a club that spends over the first threshold between $230m and $250m for the first time will be taxed 20% on the amount over they are. If they spend the same amount over for two consecutive seasons, they will be taxed 30%. If a team spends the same amount over for three consecutive seasons, they will be taxed 50%.
As teams continue to push past higher payroll thresholds, the tax rates increase for each consecutive season and overage amount. See here for a full list of each threshold and tax amount.
Once a club spends below the competitive balance threshold for a season their penalty status resets. For example, if a club spends above the first threshold in season 1, then below in season 2, then above again in season 3, they will pay 20% in both seasons 1 & 3, because they reset during season 2.
Summary
The Competitive Balance Tax or “Luxury Tax” aims to create a more level playing field, financially speaking, for all major league baseball clubs. It provides deterrents for clubs that have seemingly endless money to spend on players. This allows clubs in smaller media markets or less cash-rich teams to sign major free agents, as well as extend homegrown superstars.
Related Links:
http://m.mlb.com/glossary/transactions/competitive-balance-tax
Comments