It’s called the Competitive Balance Tax. But does it actually do anything to encourage competition?
That question hovers after MLB owners, who locked out players in December, broke off negotiations with the MLB Players Association Tuesday afternoon and announced the cancellation of the first two series of the regular season. To no one’s surprise, the Competitive Balance Tax — also known as the CBT and the luxury tax — was a fault line that erupted and divided the sides.
The luxury tax has become a defining feature in the team-building landscape, with its lethargic growth rate in recent years (especially relative to team revenues) leaving a number of teams contorting to lower payrolls below the threshold — and well below what their revenues would permit.
In 2021, the threshold for penalties of $210 million had a huge impact on how a handful of clubs built their rosters. Two teams (the Dodgers and Padres) spent beyond the threshold. Five teams spent more than $206 million (as calculated for luxury-tax purposes) but less than $210 million. The Yankees’ salary dump of Adam Ottavino illustrated how the threshold operated for some teams as a de facto cap.
Owners see that behavior as leveling the playing field, preventing runaway spending by bigger-market teams and encouraging smaller-market teams to feel they can compete in the free agent market. Teams such as the Padres and Brewers have been able to compete for top free agent talent, arguably emboldened by the restraint of traditional financial powerhouses.
“The last five years have been very difficult years from a revenue perspective for the industry because of the pandemic,” MLB commissioner Rob Manfred told reporters (glossing over the sport’s dramatically revenue increases in the first three years of the agreement; the substantial baseball-related profits in 2021 reported by Liberty Media, the publicly traded parent company of Atlanta’s baseball team; and a host of media deals that will bring MLB hundreds of millions of dollars in additional revenue starting in 2022). “We have a payroll disparity problem. To weaken the only mechanism in the agreement that’s designed to promote some semblance of competitive balance is something that I just don’t think the club group is prepared to do right now.”
Players, however, see the tax as providing cover for teams to concern themselves more with cost control than competition. Last season, for instance, would the Phillies ($209.4 million) have added the talent to leapfrog Atlanta in the NL East if they hadn’t been focused on keeping their year-end payroll below $210 million? Would the Yankees ($208.4 million) have hosted the Wild Card Game against the Red Sox had they been willing to spend?
Might the Red Sox ($207.4 million) have been better positioned against the Astros had they bolstered their bullpen in the offseason or midseason rather than limiting their trade-deadline acquisitions to Hansel Robles and Austin Davis?
The luxury-tax rules changed with the 2017-21 CBA. The penalties increased, with higher tax rates: 20 percent for first-time payees, 30 percent for a second straight year, and 50 percent for three straight years. Additional taxes were attached to spending that went $20 million and $40 million beyond the threshold.
On top of that, spending past the threshold meant the loss of revenue-sharing rebates worth up to tens of millions of dollars. Those teams spending beyond the threshold also faced potential penalties involving draft picks and international amateur bonuses.
Finally, and perhaps most significantly, the rate of growth in the luxury-tax threshold stagnated for the second straight CBA. The final year of the 2007-11 CBA featured a $178 million threshold, up 30 percent from the final year of the 2003-06 CBA. The 2012-16 CBA bumped that to just $189 million (6 percent), and the 2017-21 CBA moved the line to $210 million — a still-modest increase of 11 percent.
The result was an industry that increasingly treated the threshold as a cap. No team spent beyond the threshold for three straight years. Many large-revenue teams stayed below it over the entire five-year cycle of the expired CBA.
Did that behavior actually encourage the stated goal of competitive balance? Or is that terminology disingenuous?
The five-year period of increased penalties featured the least competitive balance the game had seen in decades. From 2012-16 — under the less onerous luxury-tax rules, and in the first five years with a 10-team playoff pool — 21 different teams reached the playoffs at least once and 18 won division titles. Eight different teams reached the World Series, and four won it.
From 2017-21, under the more punitive rules, 21 different teams reached the playoffs at least once, but three of those (the Blue Jays, Reds, and Marlins) did so only because of the expansion to a 16-team playoff field in the compressed 2020 season. (The Padres also made the playoffs for the only time during the just-concluded CBA in 2020, but they did so as one of the top teams in the majors.)
Just 15 franchises won divisions in the five-year period. Six reached the World Series — the fewest in any five-year period this century.
Perhaps most dramatically, the game featured a canyon-sized gap between the best and worst teams. There were 13 teams that hit 100-win totals and 11 that reached triple-digit losses — and more teams likely would have fallen into both categories had there been a full 2020 season.
There is scant evidence that the more punitive enforcement of the luxury tax contributed to competitive balance. The clearest impact of the mechanism was to control spending by one-quarter to one-third of the teams, particularly among the three — the Dodgers, Yankees, and Red Sox — that historically drive bidding the most.
Of the nine teams (12 if you include the Blue Jays, Reds, and Marlins) that did not reach the playoffs over the last five years, only one — the Tigers — spent past the luxury-tax threshold at any point during the just-concluded CBA. (The Tigers’ overage came in the first year of the CBA, before they kicked off a full-scale gut-and-renovate rebuild). Of the nine franchises that paid the luxury tax during the just-completed CBA cycle, all but the Tigers reached the playoffs at least once.
MLB owners love the cost control afforded by the cap-like threshold and have sought not only to maintain the harder cap but to make it even less permeable. MLB proposed modest increases in the rates (beginning at $214 million in 2022 and increasing to $220 million by 2026) and increased penalties for spending past the threshold. In their final offer before canceling games, MLB increased its offer slightly, offering a $220 million threshold from 2022-24 and then rising to $224 million in 2025 and peaking at $230 million in 2026.
“It’s important to look at the pattern of increases in the CBT thresholds over the last several agreements,” said Manfred. “I think the proposal that we made is right in line with the type of increases we’ve seen in the past.”
But players now understand the degree to which the luxury tax has emerged as a sledgehammer to flatten payrolls, and the degree to which, in the most recent CBA, team behavior was shaped by the threshold.
“We’re seeing it act as a salary cap,” said Mets pitcher Max Scherzer, noting that the luxury tax was the only possible explanation for the small-market Padres carrying a larger payroll than the threshold-ducking Yankees in 2021.
As such, players proposed a more significant increase to the tax line, starting at $238 million in 2022 and rising to $263 million by 2026.
The gap was considerable — evidently too great for the sides to bridge by Tuesday afternoon in Florida. And so, in the end, the Competitive Balance Tax may have finally lived up to its name — not in restoring competitiveness between teams, but instead by claiming a tax on 2022 competitions in the form of (at least) MLB’s cancellation of the first two series of the season.