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MLB's Luxury Tax Became A Salary Cap Because Of Decades Of Failures

There it goes.
Photo: Mitchell Leff (Getty Images)

Major League Baseball’s luxury tax was introduced as a compromise during collective bargaining in the late 1990s as a way to avoid implementing a salary cap, which had been one of the major points of conflict that led to the 1994 strike by the Major League Baseball Players Association. In the years of strained labor peace since then, baseball’s front offices have changed their approach to the cap. Today, for all intents and purposes, the tax doubles as a salary cap. If labor war comes, that shift will be a big reason why.

The luxury tax works as a soft cap, with teams able to go over it provided they feel doing so is worth paying the penalties. The number of teams willing to do so, as last offseason and this one have highlighted, is dwindling towards zero. The richest team in baseball is the Yankees, and they seem oddly unenthused at the prospect of adding Manny Machado, a 26-year-old superstar who wants to play in the Bronx. The similarly ultra-rich Dodgers have spent their offseason shuffling around the depth that brought them to consecutive World Series in an attempt to shed salary. They’re not interested in Machado, either. Neither team has been connected to Bryce Harper, who is just as good, just as young, and just as readily available.

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To understand how the luxury tax went from a compromise to something very like the salary cap it was supposed to prevent, we have to go back to the 1980s and 1990s. To understand what has to be done in order to undo the damage that this new understanding of the luxury tax has done to the mechanism of free agency, we’ll need to imagine a future that’s different from the present in some important ways.

In 1985, the MLBPA went on strike. Two days later, they were back at work. The players were split on whether they actually wanted to strike at all, and it showed. Veterans did not see the point in striking over one of the issues at hand, which was increasing the years of service time it took to reach arbitration from two years to three; younger players were not thrilled that the vets had already forgotten what it was like to be paid well below their market value. But, according to John Helyar’s Lords of the Realm, the strike ended as quickly as it did because of then-commissioner Peter Ueberroth’s obsession with being hailed as a leader and doer. Ueberroth sought to lead/do by threatening to ruin the entire arbitration process and everyone involved if the stoppage wasn’t solved immediately, which gave the MLBPA the out it needed to end a strike they weren’t unified behind. Ownership compromised, too, at least to a point.

The owners gave up on every proposal they had put forward, which included a salary cap, save one: they secured that jump from two to three years of service time to begin arbitration eligibility. That one shift changed everything, as it allowed teams to spend the next three years colluding against free agents. Teams knew they had a sufficiently deep pool of inexpensive pre-arbitration players that they could either eschew free agents with altogether or get them to accept low-ball offers. This part probably sounds familiar.

The 1985 staredown was the first time that MLB’s owners decided to attack something other than the existence of free agency itself since the practice’s inception a decade before. Ownership had finally accepted that free agency existed, and turned instead to figuring out how to scale it back. By creating less of a need for free agents—and, of course, colluding against the free agents on the market—MLB succeeded in reducing player salaries at a time when the sport was seeing record revenues thanks to television deals. League revenues had tripled since the beginning of the decade, but that wasn’t enough for the owners. This part probably sounds familiar, too.

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It went on like this for a while. The 1990 season began with a lockout; ownership was upset that players were upset about being colluded against. Led by Brewers owner and not-yet-commissioner Bud Selig, owners demanded concessions from the union—pay-for-performance and, again, a salary cap—while insisting on cuts to both arbitration and free agency. None of that worked, and there was even more anger on both sides of the negotiating table when the two sides met again in ‘94. Ownership unsuccessfully demanded a salary cap, again. Selig was acting commissioner at that point.

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In 1997, the salary cap came up again, but this time MLBPA proposed a concession: a “competitive balance tax,” which the union offered in hopes of ending salary cap talk forever. That initial luxury tax was basic and hit only the five top-spending teams, but it eventually penalized any team that spent over a certain threshold. The threshold did not grow and has not grown alongside baseball’s ever-growing revenues. That was a problem, and it just kept getting worse.

In 2003, the first season under the luxury tax model in use today, the ceiling was $117 million. Any team going over that figure would be taxed a percentage on only the dollars over that limit, with that percentage going up for repeat offenders. In 2019, that figure is $206 million, with a second, higher figure in place that, if passed, would trigger a 10-slot drop in a team’s draft position. None of this is as much of a problem as it might seem: the Red Sox were over that second barrier in 2018, won a World Series championship, and all it cost them was draft position and under $12 million in penalties. Maybe the new Moneyball is spending money!

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More important than pointing out the insignificant punishment, though, is that jump from $117 million to $206 million over the course of 16 years. MLB’s revenues grew from $3.58 billion in 2003 to 2018’s record $10.3 billion, a 188 percent jump during that period. The luxury tax ceiling, however, grew by just 68 percent in that stretch. If teams are avoiding going over the luxury tax and luxury tax growth is well below revenue growth, then your luxury cap is, at best, a soft salary cap.

And teams are avoiding going over the tax: just eight clubs have ever even paid the competitive balance tax since it changed to the 2003 model; in 2018, only the Red Sox and Nationals did. There was still incentive to spend heavily, even if it was below the tax, during most of that period, but that’s because teams like the Yankees and Dodgers (and the Red Sox) were, if not ignoring the tax outright, not overly concerned with paying it. Now, though, with the Yankees publicly saying they don’t want to go over the luxury tax for obviously bullshit reasons they hope you’re not smart enough to understand, and the Dodgers putting together a five-year “let’s avoid the luxury tax” PowerPoint for investors, there’s less incentive for other clubs to go big on free agency. If teams know that they aren’t competing against the heavyweights, they can compete with each other at a lower level. The three biggest spenders in the game are already essentially out on Bryce Harper and Manny Machado, two of them because they’ve told you with their actions (and sometimes their words), and the Red Sox because they already crossed the brand new penalty marker once and are less than a Bryce Harper contract away from doing so again.

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The luxury tax is an arbitrary anchor point, and if the Yankees and Co. are defining “Yankees money” as a level below that tax threshold, then the rest of the league is going to follow suit. This is just business, but it also fits baseball’s personal kayfabe, in which no team can compete financially with the Yankees. Look no further than what Ken Rosenthal reported earlier this month for evidence of this scaling backward:

Teams say they are smarter. Players believe the clubs are squeezing too hard. As of Wednesday, all but three clubs were under the $206 million luxury-tax threshold, according to unofficial figures. Nineteen were at least $50 million under, 17 were at least $75 million under and nine were at least under $100 million under.

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When you combine teams at the top of the revenue pile being unwilling to push the financial boundaries of the game with Neil deMause’s observation that owners are putting business ahead of everything else in baseball, you are left with 17 teams that are at least $75 million under the luxury tax. That $75 million per season could get a team—any team—both Machado and Harper, even at the highest reported rates they’ve sought. And yet it’s still unclear if either will sign before March, never mind before spring training kicks off in February. Even if it’s unspoken, it’s clear what is happening here—in a sport without a salary cap, virtually every team is acting like it’s capped out.

Peter Ueberroth told the owners back in 1985 that losing games would make them more money than spending money to win games, and, as deMause pointed out, that’s the unfortunate truth of the matter. Because of how MLB’s revenues work, teams don’t need to be good or even interesting to rake in cash; a bunch of owners surely wish they could do what Jeffrey Loria did to the Marlins, only, you know, more subtle-like.

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How can teams do this while still putting on watchable baseball for 29 fan bases? (The Orioles do not count.) That’s where our trip back to ‘85 comes in: there are so many pre-arb players, good ones, that baseball can hold down salaries and pocket more and more revenue by simply choosing them over free agents. Some free agents still hold out as long as possible to get the best deal they can in a bad situation; others, like Yasmani Grandal, grudgingly gave in and took a one-year salary that he could stomach in the hopes 2020 will be better. You also have players like Nick Markakis doing ownership’s work for them, reciting the old “it’s a kid’s game, I’m lucky to be paid at all!” lines after accepting an absurdly below-market deal of $6 million. Don’t be like Nick Markakis, kids: he plays in a $10 billion industry for adults, and he just let his bosses take money out of his pocket.

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For reasons having to do with labor law and simple business best practices, owners couldn’t attack free agency directly back in the 1980s and ’90s, which led them to focus elsewhere. But the goal never changed: it is now, and has always been, bringing down player salaries any way they can. The MLBPA is likely going to have to think along similar lines: it’s too easy to argue that free agency is a bad deal for teams, so what has to be done is to make it a better one.

A higher minimum salary for players would be one step in that direction. To go back to our previous comparative time period, the minimum salary in 2003 was $300,000, and in 2018 it was $545,000, an 82 percent increase; as you probably already pieced together, that’s nowhere near the rate of revenue growth over the same years. If the minimum had followed revenue growth, then in 2019 it would sit over $850,000, a difference from 2018’s actual minimum larger than the one separating 2003’s from 2018’s. Similarly, something has to be done about that third year of service time before arbitration, as well as the scourge of service-time manipulation: the punishment for manipulating service time to steal an extra pre-arbitration year can’t just be “Kris Bryant won’t re-sign with you in seven years.” That’s obviously ineffective, and the price for conceding that third year of arbitration has proven to be far too high for the union. MLBPA lawyer Gene Orza knew it back in 1985, and he’s been proven correct again and again.

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Cutting down on the time to reach arbitration eligibility and raising the minimum salary could help restore the value of baseball’s free agents by changing the game’s broader financial equation. These might be the areas where the MLBPA needs to focus their energies in 2021’s collective bargaining. Free agency, just as it was for ownership decades ago, might be a lost cause in a head-on fight where even a soft salary cap exists. But there is plenty of room, and plenty of reason, to fight elsewhere.


Marc Normandin is the former MLB Editor of SB Nation, and currently writes a newsletter on baseball’s labor issues and more for Patreon subscribers. His baseball writing has appeared at Sports Illustrated, ESPN, Sports on Earth, and Baseball Prospectus.

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