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by TFIR
McCullough: Why are teams so afraid of the competitive balance tax?
By Andy McCullough 4h ago 32
The three letters resurface each winter, when the owners of contenders pocket their wallets, and again each summer, when executives contemplate calculus at the trade deadline. The letters were invoked when the Red Sox dealt away Mookie Betts and when the Dodgers traded Adrián González and Yasiel Puig. They came up once more earlier this month, after the Mets acquired Francisco Lindor and Carlos Carrasco: Would the three letters inhibit further spending? Were the Mets wary of the competitive balance tax, the dreaded CBT?
“Well, it’s a significant demarcation,” Mets president Sandy Alderson said. “I wouldn’t say that it’s a line that cannot be passed, but it’s definitely a significant consideration when you get to that level.”
By instructing Alderson to mind the luxury-tax threshold, which will increase to $210 million for the 2021 season, new Mets owner Steve Cohen has conformed with his 29 colleagues in baseball’s ownership class. The competitive balance tax operates as baseball’s de facto salary cap, which is one factor to explain why top free agents like J.T. Realmuto and Trevor Bauer remain unsigned with the scheduled start of spring training less than a month away.
A thaw may be coming: DJ LeMahieu returned to the Yankees last week, and George Springer has just become this winter’s first nine-figure player. But even the construction of LeMahieu’s contract and the nature of Springer’s free agency demonstrated the deference teams pay to the CBT.
The Yankees stretched LeMahieu’s $90 million package across six seasons to dilute the contract’s average annual value, which is the metric Major League Baseball uses to calculate the yearly luxury-tax payroll. And as the Mets haggled with Springer, the team weighed how a long-term deal with the free-agent center fielder would complicate extensions for pending free agents like Lindor and Michael Conforto. Toronto won the bidding by offering six years and $150 million — unlike the Mets, the Blue Jays were not close to hitting the $210 million threshold in 2021.
Grappling with the luxury tax is not a phenomenon unique to New York. The entire sport quakes before it. Only three teams — the Yankees, Astros and Cubs — were charged the competitive balance tax for 2020, according to people with knowledge of the situation. All three teams hope to avoid it in 2021. The Cubs are engaged in a teardown. The Astros let Springer walk to Canada. The Yankees, who are actually entertaining the concept of winning the World Series this season, intend to hew to the line for the entirety of the year.
That fits a pattern. When teams do spend enough to incur the tax, they soon scurry away from it, even as the number rises each season — from $195 million in 2017, to $197 million in 2018, to $206 million in 2019 and $208 million in 2020. The Red Sox, Yankees and Cubs paid the tax in 2019, according to the Los Angeles Times. The Associated Press identified the Red Sox and the Nationals as the only teams to surpass the limit in 2018.
This behavior is a feature, not a bug, of the current collective bargaining agreement, which expires after this season. A luxury tax has existed in baseball in some form or fashion since 1997, save for a tax-free interregnum from 2000-2002. The most recent iteration features progressively escalating penalties: First-time offenders pay a 20-percent tax, two-time offenders pay a 30-percent tax and three-time offenders pay a 50-percent tax.
The penalties sound prohibitive. But the tax does not apply to the entire payroll — it only applies to the difference between the team’s luxury-tax figure and the threshold. Say a team finishes the 2021 season with a $211 million payroll. Based on the CBA, the franchise would owe $200,000 in taxes. Place that sum within the context of the rising franchise values within the sport. For reference: $1,000,000,000 features 5,000 increments of $200,000.
As The Athletic‘s Jayson Stark outlined last year, the CBA contains further impediments to spending in the form of additional surcharge thresholds, the first at $230 million and the second at $250 million for 2021. A third-time offender, in theory, would pay a 95 percent tax for surpassing that second threshold. Any team that exceeds the second surcharge threshold also suffers in the draft, with its first pick falling 10 spots.
These payroll numbers, of course, are mostly fantasia. Just four teams spent more than $200 million in 2019, the last season in which players received their full salaries, according to Spotrac. After the Red Sox, Yankees, Dodgers and Cubs, the Giants clocked in fifth place at $178.6 million. The overwhelming majority of baseball teams have determined that it is not worthwhile to even flirt with the luxury tax, let alone pay it.
The current stagnation stems from a confluence of factors. When paired with the aftershocks of the 2020 season, the ambiguity pertaining to this coming year has made it challenging for executives to craft budgets and unwieldy for business departments to project future revenue. The sport also offers fewer incentives for teams chasing greatness. With the prospect of further playoff expansion on the horizon, the value of a division title continues to decrease. If 88 wins offers a similar shot at a title as 92 wins, why pay the extra freight?
Even at the upper end of the spectrum, for the big-market clubs willing to make nine-figure commitments to players, the pursuit of an individual title means less than the ability to pursue titles year after year. You hear the phrase “opportunity cost” so often, you start to forget what the actual opportunity is. Sustainability is king, and flexibility rides shotgun. Consider the recent examples of the Red Sox and the Dodgers.
After Guggenheim Baseball Management purchased the Dodgers in 2012, the team became the sport’s spending kings, leading baseball in luxury-tax payroll each season from 2013 to 2017, according to Cot’s Contracts. For five years, owner Mark Walter paid the tax, while the baseball operations department assembled a player-development machine on the farm system. The days of blasting past the threshold ended in the offseason heading into 2018, as the organization grew tired of the escalating penalties. The team traded González, along with Brandon McCarthy and Scott Kazmir, to Atlanta to reset its CBT payroll. A year later, Puig and Alex Wood went to Cincinnati, in part, for similar reasons. The Dodgers stayed under the line.
“The CBT is an element that does add expense, for sure,” Dodgers president Stan Kasten told The Athletic. “If we’re close, we’re going to pay attention to it. There are years where we blow right past it, and it’s not much of a factor. But every dollar is an extra dollar out the door that we need to try to recoup somehow. And a better business model is better from a lot of standpoints, including accessing financing, accessing debt, for all kinds of purposes.”
As belts tightened in Los Angeles, the Red Sox dropped $110 million on J.D. Martinez, barreled more than $40 million past the threshold and basked in a championship. The title came at the cost of nearly $12 million in taxes, plus their first selection in the draft did not come until the 43rd pick. It seemed like a reasonable price for a flag that flies forever. “Boston should be happy to pay this tax bill,” the Associated Press wrote.
And yet a season later, after the team lavished $68 million on Nathan Eovaldi and invested $145 million into an extension with Chris Sale, the Red Sox missed the playoffs and elected to regroup. After negotiations about an extension with Mookie Betts stalled, Boston listened to trade offers. The team intended to reduce its CBT figure, so they included former Cy Young Award winner David Price in the discussions. To get under the tax, the Red Sox needed to find a suitor with the flexibility to add significant salaries, a team with a willingness to spend, but capable of doing so while avoiding those three letters.
Boston sent Betts and Price to the Dodgers. It is an emblematic story for this era, a cautionary tale that reinforces the impulses of executives and owners to practice caution. It is as simple as CBT.
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