Fixing Major League Baseball: Is The Competitive Balance Tax Effective?

We've heard a lot about the tax over the years. Let's see if it works.

Major League Baseball came exceptionally close to a work stoppage before the current Collective Bargaining Agreement was agreed to with the MLB Players’ Association. In the not so distant past, the last CBA was set to expire on Dec. 1, 2016, and players and owners didn’t reach a preliminary agreement until the day before that deadline. In all likelihood, the league and players were within hours of a lockout but thankfully, we will never have to know.

The current Major League Baseball CBA expires at 11:59 pm on November 30, 2021, and thus far, the league is well on its way to repeating history. MLB’s labor situation is in a precarious position given the impending expiration date. Much has been written about systemic issues plaguing the salary arbitration system such as the stories of Trevor Bauer, Marcus Stroman, and Dellin Betances claiming they were slandered by their respective teams in arbitration hearings, the prevalence of service time manipulation with respect to young players such as Kris Bryant, as well as the long-term financial viability of a sport with limited spending restrictions. Each of these issues is likely to come to a head after next season when the 2017-2021 CBA expires, and the league and players will have to negotiate a new agreement. While tension has risen regarding each of these topics among players, media, and ownership, solutions exist to each of these problems.

In this article series, we will work to address all of these topics. However, in this article, we will primarily focus on the third topic: the long-term financial viability of a sport with limited spending restrictions. In other words:

Does Major League Baseball need a salary cap?

To answer that question, we have to briefly discuss some labor law, then we’ll first have to examine whether MLB’s current system is effective.


Collective Bargaining History


In 1890, Congress passed the Sherman Anti-Trust Act, which prohibits any “contract . . . or conspiracy, in restraint of trade or commerce.” Basically, the government doesn’t allow any company or industry to implement anything that would restrict trade, with the government’s ultimate goal being reducing monopolies. To determine what constitutes a violation of this section, the court takes a balancing approach by comparing how reasonable any particular restraint on trade is against the legitimate business purpose of the restraint. The court will also look at whether the restraint is pro or anti-competitive.

Let’s work through an example: the first-year player’s draft. On its face, the draft violates the Sherman Act because it suppresses player salaries and restricts the ability of draft-eligible players to freely choose their employer, thus restraining trade. Using a balancing approach, we can see there are pro-competitive aspects of the draft, including the ultimate competitive fairness of the league, but is that outweighed by the restrictions we just mentioned? That is what the court looks at, but the league and players have actually taken that question out of their hands, as we’ll discuss below.

Through the Clayton Act and the National Labor Relations Act in 1914 and 1935, the United States encouraged self-organization and representation in unions and in the collective bargaining process as a byproduct. There are positives and negatives to collective bargaining. When a players’ association organizes, they open themselves up to mechanisms such as a salary cap, Competitive Balance Tax (CBT), or other cost limiting techniques. In exchange, they receive perks such as uniform contracts, a formal grievance process, and savings and benefits plans.

There are two big points I want you to take away from this: the first is that there are positives and negatives to unionization; you may hear terms like “decertify the union” thrown around in the media if things get dicey, but it’s important to understand the implications of that. If the time comes, I’ll put out an article in more depth on the topic. Second, is perhaps the most important aspect of collective bargaining, known as a “nonstatutory labor exemption”. This means that the items agreed upon are safe from claims under the Sherman Act, and this is how we have an MLB draft. The players and league agreed to the draft in the CBA, and thus there is no lingering question of its legality.

The NSLE is not terribly relevant to our discussion, but I want everyone to understand the legal implications of a CBA: once it’s agreed to, it’s legally binding, with few exceptions, until a new CBA is signed. This is why the collective bargaining process is so vital and why so much tension surrounds the negotiations.



Salary Cap and Competitive Balance Tax


For most of the 20th century, none of the major North American sports had a salary cap, defined as an upper limit on the amount that employees in a particular company or industry can be paid. It is not enough for a salary cap to be implemented solely. Typically, a salary cap accompanied by a salary floor, essentially the lower limit that employees can be paid, thereby creating a range of acceptable amounts that teams may spend on salary.

Although they abolished it after one season, the NBA actually had a salary cap in the mid-1940s. It remained absent until 1983 when a salary cap was added to the CBA in an attempt to level the playing field by creating equality in spending power among teams. The NFL followed suit roughly ten years later, adding a cap in 1994. Major League Baseball’s owners tried to implement a salary cap around the same time, which lead to the 1994 MLB strike, as players were wholly opposed to the notion, but they settled on a CBT. A CBT, which we’ll discuss further below, penalizes a team for each dollar they exceed a specific salary figure by.

Upon first glance, the NBA’s system and MLB’s are similar. The NBA has a cap but you can exceed it through any number of exceptions, to the point where every single NBA team actually exceeded the cap, but only four NBA teams (Portland, Miami, Oklahoma City, and Minnesota) exceeded the luxury tax in the most recent season. In MLB, only four teams (Red Sox, Yankees, Cubs, and Dodgers) exceeded the $206 million threshold ($208M in 2020) and had to pay tax. However, the charts below illustrate a bit of the difference:

As you can see, in MLB, the top spender, Boston, spent 65.4% more than the average team, whereas the lowest spender, Tampa Bay, was 53.7% below the average mark. Contrast this with the NBA, whose top spender, Portland, spent 9.5% above the average and lowest spender, New York (shocking, I know), spent just 12.5% below the average. Additionally, whereas 93% and 81% of NBA and NHL teams, respectively, are within 10% of league average payroll, only 20% of MLB teams are similarly close to league average.

So we can see that MLB’s CBT does not create the same spending distribution that the NBA’s does, nor does it match the spending distribution of the NHL. But is it a salary cap or not?

What is clear is that the CBT has been treated as a salary cap by many teams in years past. This past September, Red Sox owner John Henry said “This [coming] year, we need to be under the CBT.” He tried to walk back those comments in January, saying that the Red sox “are are focused on competitiveness over the next 5 years over and above resetting [the CBT]“, but their subsequent trade of Mookie Betts and David Price suggests otherwise. The Red Sox’ intentions were made even more clear yesterday, as they posted a meme celebrating getting under the luxury tax. The players are growing ever more aware of it too, with Anthony Rizzo as a prime example, deeply frustrated at times with their team’s financial choices.

Brian Cashman, the Yankees’ General Manager, had a different approach, stating that the Yankees didn’t want to keep paying into the revenue-sharing system to give money to their opponents. That claim is questionable because the tax only goes to other teams after first, a $13 million allocation to fund player benefits, and then a 50% reduction to fund player IRAs. In 2018, this resulted in just approximately $668,594 in total in revenue sharing.

Not per team.


To be fair though, 2018 was the lowest luxury tax spending year since 2003 and the amount of tax paid into the revenue sharing system was closer to $7 million in 2019. Regardless though, higher payroll teams are clearly treating the CBT as if it’s a cap.


Is the Competitive Balance Tax Effective?


Just because it’s treated as a salary cap does not mean it is one, largely because, as we’ll discuss in a later article in this series, a salary cap system is not merely a matter of setting a high-end bar on spending. It’s a complex system that includes not only a cap, but a salary floor, and a consistent sharing of revenues between players and owners. But Cashman’s quote does reinforce the notion that the top spending teams are trying to get under the CBT, and if it is limiting payroll by the top spending teams, it’s accomplishing its goals right?

Well, what are the goals of a salary cap? The answer to that is fourfold:

  • First, to prevent any one team from gaining a significant competitive advantage due to financial superiority;
  • Second, to allow smaller franchises to compete and grow their fan bases;
  • Third, to ensure the long-term viability of the sport by ensuring that teams don’t spend recklessly on player contracts; and
  • Fourth, to grow the game as a whole by ensuring a wide range of competitive franchises that are potentially interesting to casual fans.

These factors need not all be at play for a salary cap system to be deemed effective. Much like the courts when reviewing potential violations of the Sherman Act, we’ll need to engage in a balancing test.

First, does the Competitive Balance Tax prevent any one team from gaining a significant competitive advantage due to financial superiority? The quick answer is no. The long answer, as evidenced by the chart above, is no. But that chart just shows payroll and is just one year, what about year over year correlation between payroll and wins? Craig Edwards from Fangraphs addresses that topic in an article from 2018.

Several teams consistently outspend the others and win more as a result, creating massive financial imbalance. Are some teams, like Tampa Bay, able to buck this trend and perform well with low payrolls? Sure. But they’re the exception that proves the rule.

Second, does the CBT allow smaller franchises to compete and grow their fan bases? Kind of. The current system of rebuilding allows small-market franchises, such as the Kansas City Royals, the opportunity to compete if they’re willing to spend five to seven years losing so they can acquire and develop high-end prospect talent.

After winning just 43% of games between 2007 and 2012, the Royals managed a record over .500 from 2013-2015, culminating in their 2015 World Series title. They tried to run it back in 2016, but the team underperformed, finishing 3rd in the AL Central, but they had all the talent to challenge for another championship. However, we saw that success is not sustainable in the long-term without extensive financial resources because those high-end prospects eventually need to get paid. After 2016, Wade Davis was dealt to the Cubs. A year later, the team finished with just 80 wins and Lorenzo Cain and Eric Hosmer left for the Brewers and Padres. In 2018, they traded Mike Moustakas and Kelvin Herrera, and just like that, the Royals championship core was gone.

We’re getting into a very complicated topic: why teams like the Pirates and Royals are never among the league leaders in payroll. Are the Red Sox, Yankees, and Dodgers just richer than the Royals and thus more able to pay players? Well, those teams do generate more revenue, but if that were the decisive factor, the Knicks would consistently outspend the Portland Trailblazers, who are undoubtedly in a much smaller market. But that’s not the case and there is no clear separation in the other leagues between big and small-market teams. MLB should be the same because it has a revenue-sharing system designed to spread money around, much as the other leagues do. So why do the Pirates and Royals, for example, never appear near the league leaders in payroll?

The answer, in my view, is because they don’t have to. Even with the increased cash flow from the revenue-sharing system, the absence of a salary floor to ensure minimum acceptable payroll figures means teams like Pittsburgh and Kansas City are under no obligation or pressure to spend more than they have to. Sometimes their payroll won’t be bottom five, and we’ve seen such teams spend more when they see their competitive window open. However, the absence of outside influence to increase their spending will perpetually preclude them from not only building winners by paying high-priced free agents, but also from keeping their young players around when they command free-market prices. So while the CBT does allow those smaller franchises to compete, it in no way encourages them to do so.

Third, does the CBT ensure the long-term viability of the sport by ensuring teams don’t spend recklessly on player contracts? To address this, the league implemented something called the Debt Service Rules, which we’ll discuss further in a later article. However, there’s little evidence to date that the rules are properly enforced. That said, if teams at the top are curbing their payroll, we can reasonably say that it is keeping each team’s spending in check.

Fourth, does the CBT grow the game by ensuring a wide range of competitive franchises that are potentially interesting to casual fans? This relates very closely to the second point but speaks more to the casual fan. If we look at the last five years and the spending and relative success of each club, is there a reason for the casual fan to know anything about the Royals, Marlins, Mariners, Tigers, Orioles, Pirates, or Rangers? Granted, I ruled out just 6 of 30, leaving 80% of teams that are potentially competitive and viable for casual fan interest. But the fact that not every team has an equal shot at it every year could be somewhat to blame for the 16% decline in MLB attendance from 2007-2019 (obviously, there is a 100% decline in fan attendance in 2020). There are obviously a litany of other factors, but I’m inclined to believe this is one of them. While the hardcore fan knows that each of those teams has exciting young prospects who could turn those teams around in the next few years, the casual fan sees teams mired in mediocrity.


Conclusion and Lingering Questions


This brings us back to our question- is MLB’s salary cap system effective? While it does work to reign in spending by the more aggressive clubs, it does nothing to prevent teams from asserting financial superiority to gain a competitive advantage, does little to encourage long-term competitive attitudes by smaller-market teams, and in doing so, risks losing the appeal of the casual fan. Therefore, I would argue the current system does not work.

If it’s not working, should it be replaced? What should it be replaced with? What do the other leagues do? All of these questions, and more, will be answered in time, starting next week with Part II: Does MLB Need a Salary Cap?

Photo courtesy of Keith Allison (https://www.flickr.com/photos/keithallison/) | Adapted by Justin Paradis (@freshmeatcomm on Twitter)

Dave Cherman

Across the Seams Manager, also a former player and umpire and New York-based lawyer who spends his free time studying advanced statistics and obsessing over fantasy trades. Will debate with you about most anything.

2 responses to “Fixing Major League Baseball: Is The Competitive Balance Tax Effective?”

  1. Nathan says:

    Great read! Lots of interesting details I wasn’t aware of. I had never thought about the draft technically being in hazy legal territory for example.

    I think it would be cool to evaluate MLB’s financial structure not only in relation to North American sports leagues like the NBA and NHL, but the European soccer leagues like the EPL. Some factors over there are: 1) they don’t have any salary cap, 2) are mostly dominated by the same half-dozen teams, 3) do have concerns about fan support for the smaller teams, 4) teams going bankrupt is much more common, 5) there is a global market for talent (unlike baseball where the US has a monopoly on the highest-profile league) so teams need to spend to acquire top players and 6) of course promotion and relegation affects everything. Obviously there are positives and negatives to that system but I think it helps contextualize the MLB discussion, since they would no longer be “that one league stubbornly holding out from a salary cap” but would be one of several leagues with no cap.

    • Dave Cherman says:

      You’re jumping the gun a bit! Part two examines the North American esports system and the European football leagues to look at why they don’t have caps.

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