As the 30 major league teams convene in San Diego for baseball’s Winter Meetings, the Red Sox will not be mentioned in the breathless speculation surrounding Gerrit Cole or Stephen Strasburg or Anthony Rendon. Instead, the primary conversation hovering over Boston’s delegation is whether the team will trade one of its high-priced pitchers or do the seemingly unfathomable by dealing its best player, Mookie Betts, one year in advance of his free agency.
How on earth could the Red Sox be in this spot? It’s a fair question that boils down to two words: Luxury tax.
For years, the “Competitive Balance Tax” (CBT) threshold was relevant chiefly for the Yankees (who shrugged off their annual tax bills) and Red Sox, both of whom mostly accepted it as the cost of doing business. But in recent offseasons, it’s become an industry-wide talking point described by numerous large-market teams as a desired payroll ceiling.
On the one hand, Major League Baseball sees a mechanism that has served its intended purpose of achieving competitive balance, allowing mid- and small-market teams such as the Brewers (Lorenzo Cain, Yasmani Grandal) and Padres (Eric Hosmer, Manny Machado) to land key free agents. MLB Players Association officials, players, and agents counter that the luxury tax is a convenient excuse for teams to limit spending on free agents while pocketing profits.
In many ways, the luxury tax has become a defining fault line in the game’s increasingly contentious labor environment as well as a central consideration in roster construction, including decisions on bidding for free agents and which stars large-market teams will consider trading.
How did the luxury tax become so important?
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In 1994, owners insisted the sport needed a salary cap to curb free agent spending. The union had no interest in such a concept. With the CBA expired and fear of the unilateral implementation of a cap, the players went on strike that August, a move that led to the cancellation of the remainder of the season.
As long as a cap was in play, no progress in negotiations was possible. As the work stoppage dragged on for months, the idea of a competitive balance tax emerged as having the potential to create middle ground — a framework in which both sides could argue about the specific rates and thresholds that would result in teams being penalized for spending.
The strike ended when then-federal judge (and current Supreme Court justice) Sonia Sotomayor issued an injunction restoring the terms of the 1990-93 CBA, but the negotiations on a new agreement weren’t done. Over the next 20 months, as the sides tried to strike a deal, the luxury tax became the vehicle for breaking the labor logjam.
MLB came to accept that the tax could fulfill its intention to create a “drag” on salaries without creating a cap. At the negotiating table, the union heard owners commit to the idea that teams would, in fact, pay the tax — perhaps slowing but certainly not stopping big-market teams from flexing financial muscle.
“When we were talking about salary cap vs. no salary cap and in fact unrestricted free agency, we’re talking past each other,” said Gene Orza, the MLBPA’s associate general counsel in those negotiations. “We’re on the same planet [when talking about the luxury tax].”
In its first form, the five teams with the highest payrolls were required to pay a tax based on the gap between their spending and that of the sixth-highest payroll.
There was considerable back-and-forth about the tax rates. Initial ownership proposals for a tax in excess of 50 percent was deemed a non-starter by the union, a level at which teams simply wouldn’t spend.
“We didn’t go on strike  days to avoid a salary cap only to get one in a different form,” said Orza.
Eventually, the rate was set at 34 percent for all spending beyond the halfway point between the fifth- and sixth-highest spending clubs. In 2002, with the shadow of another strike looming, the two sides reached agreement on a luxury tax that would take a different form – a reflection of what was, arguably, a different purpose. Teams had become acutely concerned about the Yankees’ emergence as a financial behemoth who landed seemingly every free agent.
“The concept of a luxury tax was never envisioned to trample the rights of free agency,’’ said agent Scott Boras. “It was never envisioned that the language of Major League Baseball would be in effect collusive language. The purpose of the luxury tax was actually driven home to impact only one team in baseball, one owner.”
Rather than just having the five biggest spenders get hit with a bill, the new CBA outlined annual thresholds that triggered penalties — a 17.5 percent tax on anything above the threshold the first time a team went over, a 30 percent tax for a second-time overage, and a 40 percent bill for a third infraction.
In the next two CBAs — which covered the 2003-06 and 2007-11 seasons — the impact of the luxury tax was narrow. The Yankees went past the CBT threshold — which jumped over those nine seasons from $117 million to $178 million — in all nine seasons; they spent past the threshold by millions of dollars every year and shrugged when the bill came. The Red Sox spent — usually modestly — past the threshold six times. The only other teams to get taxed in those periods were the Dodgers (once, in 2004) and Tigers (once, in 2008).
During those two CBAs, the tax rates remained largely unchanged while the thresholds increased at least $7 million almost every year. In the 2012-16 CBA, the annual rise of the CBT thresholds stalled — going up only once, from $178 million in 2012-13 to $189 million in 2014-16 — but with tax rates remaining relatively low and revenues exploding, a growing pool of teams proved willing to pay it. Free agent values soared as four teams went past the threshold in 2015 and a record six teams did so in 2016.
And then the music stopped — or at least changed.
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There wasn’t industry-wide conversation about the luxury tax before the negotiation of the current labor agreement. That’s changed, in a way that drew several raised eyebrows during the offseasons of 2017-18 and 2018-19, when top free agents encountered limited (though eventually lucrative) markets, while many mid-tier free agents heard crickets.
“Certainly since our last agreement, [the luxury tax] seems like it’s come up more and more,” said Cardinals pitcher Andrew Miller, a member of the MLBPA Executive Board. “We as players look for reasons why the market isn’t functioning in the way we want it to or expect it to. When you’re looking at sheer dollars, that’s one of the first places everyone is going to look to figure out why things are happening the way they are.”
And certainly a case can be made that the approach to the luxury tax has changed because the rules changed in the 2017-21 CBA. The current CBA features modest growth in the tax threshold — from $195 million in 2017 to $210 million in 2021. In an effort to rein in runaway spenders, it introduced additional layers of penalties for spending $20 million and $40 million above the threshold. It also produced potential draft pick and international amateur spending penalties.
Finally, and perhaps most underappreciated, the new CBA created the possibility that major revenue-sharing payers such as the Red Sox, Yankees, and Dodgers could forfeit tens of millions of dollars in revenue-sharing rebates if they fail to get under the luxury tax threshold at least every third year.
The introduction of several disincentives to spend beyond the luxury tax threshold has now resulted in teams paying far greater attention to the limit.
“The [impact on] free agency went from a 10-pound weight on the barbell to 200 pounds,” said Boras. “It just dramatically increased.”
Still, there can be tremendous payoff for spending past the luxury tax threshold.
The 2018 Red Sox paid a $12 million tax bill for going more than $40 million past the CBT line, but doing so yielded a championship. The Cubs paid the luxury tax in 2016 to go on a free agent binge that helped them to their first title in 108 years.
“Clubs that are going over the luxury tax are getting rewarded with winning,” Boras said. “Yet that is not talked about or viewed as a positive.”
As one MLB official notes, players are still receiving 54 percent of the sport’s revenues – in line with past distribution of baseball’s financial pool. The luxury tax threshold also has allowed smaller-market teams to benefit from restraint shown by teams such as the Yankees and Red Sox.
Baseball’s system is still likely the least restrictive of the four major sports. The NFL and NHL feature salary caps; the NBA employs a luxury tax that is several times higher than that in MLB. Moreover, at least two teams have paid the luxury tax in seven straight years, including three (the Red Sox, Yankees, and Cubs) in 2019.
Yet NBA teams have shown a willingness to pay that tax in recent years to levels that MLB teams have not, leading to distrust between the players and owners, and questions about whether profit or winning serves as the primary motivation of teams.
Against that backdrop, the Red Sox face their momentous roster decisions. At what cost are they willing to keep their high-priced starting pitchers and/or Betts? What would motivate the club to move them?
Currently, even without a fifth starter or second baseman or bench, the team projects to be a bit more than $20 million beyond the luxury tax threshold — with perhaps another $15 million to $20 million in financial costs (luxury taxes and lost revenue sharing money) next year should the team stay at that level. Betts is an incredibly valuable player at his projected salary of $27 million to $30 million. Does that still hold true if, by not trading him, the Sox will have to pay $40 million to $50 million in his salary plus corresponding penalties — particularly as skepticism grows about the ability to keep him beyond 2020?
It’s an indication of how the luxury tax, a mechanism that once gave the sport a path forward, now more often is cited as the reason teams arrive at decision-making crossroads.