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October 30, 2006

The Ledger Domain

The New Collective Bargaining Agreement - Revenue Sharing

by Maury Brown

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Wonders never cease. Almost two months before the December 19th deadline, management and the Players' Association hammered out a new collective bargaining agreement that will run for five years, expiring on December 11, 2011. Without acrimony, and without any threats of a lockout or strike. At the end of this new agreement we will have seen 16 years of labor peace. Hallelujah.

The CBA hasn't been ratified yet, and what has been released about it doesn't show the details that the final version will. Still, researching and interviewing several sources that have seen the details has painted a pretty clear picture.

The word has been that the new deal is not much different than the agreement that ran from 2002-2006. This is true to some extent, but there are a number of tweaks in place from the prior CBA that work to further define the cornerstones of the last agreement, with revenue-sharing front and center. Granted, what we're about to delve into isn't exactly light reading. Even those that I have spoken with that have either worked on the deal or reviewed the details admit, there's some complexity to the deal. Never mind that, you're smart, and you get it. You're interested in this because, after all, these adjustments are here for the next five years, and they're designed to allow each of the 30 clubs a better chance to be competitive. Let's roll up our sleeves and take a look.

Revenue-Sharing

Revenue-sharing will remain in place in the new agreement. The system that funnels monies from the high revenue-making clubs to the lower revenue-making clubs will go through a number of changes designed to address some of its previous shortcomings, and intended to make it more equitable.

The total net transferred revenues will remain at the same level as they did for 2006, at $326 million, with the net amount changing depending on how revenues increase and changes in disparity. It's the "how" that has changed.

First off, we're going to talk "pool" here. In a "straight pool," each team contributes equal percentages, and receives equally from this pool of cash, with the higher-revenue clubs contributing more dollars. In a "split pool," a percentage is distributed among the clubs in the bottom half of the local revenue pool in proportion to its distance from the mean.

How do these work together? The revenue sharing system in the 2002-2006 agreement had a "straight-pool" component in which 34% of each team's current year net local revenue was taken. In addition, clubs were also hit with a "split-pool" component based on the trailing three-year average of revenues. The two pieces together were then added to monies which make up a central fund component. This piece-called Central Revenue in the CBA-is made up of revenues pulled from, but not limited to, the Major League Central Fund, the Office of the Commissioner, Major League Baseball Properties, Inc., Baseball Television, Inc., Major League Baseball Enterprises, Major League Baseball Advanced Media, Inc., the Copyright Arbitration Royalty Panel, superstation agreements, the All-Star Game, and national marketing and licensing.

Of the $310 million that got redistributed from the higher revenue-making clubs to the lower revenue-making clubs last year, just over 70 percent of the total revenue sharing was through the 34% of net local revenues and straight-pool mechanism, with the rest through the central fund and the split-pool mechanism.

So, understanding where we were, what changes will the new deal propose?

The problem with the prior straight-pool system is that the marginal tax rate for the clubs has been different. In the old system, there was an inversion for the marginal tax rates, where the lower revenue-making clubs were paying a rate higher than the higher revenue-making clubs. You had a marginal rate of 40% for high revenue-making clubs, and 48% for the low revenue makers. In other words, the system was unfairly weighted. In the new revenue sharing system, a single marginal rate of 31% is applied across the board.

Andrew Zimbalist, who worked with the parties on revenue sharing for the new collective bargaining agreement, noted that "what the new adjustments to the revenue sharing system will do is to undo that inversion between the lower and higher revenue-making clubs, and get everybody at the same marginal rate."

Since MLB wants to distribute $326 million from the upper revenue makers to the low revenue makers, the lowering of the marginal rate keeps you from getting to that total amount. To make up the difference, the percentage pulled from a variation on the split-pool (plus the central fund component) is increased between 8%-10%. No, MLB is not yet like the NFL in terms of centralized revenues for revenue sharing purposes, but this is a step in the right direction.

In this new variation on the split-pool, it is still paid for by the richest clubs in the league, but instead of having their percentage of the pot re-evaluated every year, the clubs have a fixed contribution (8%, 12%, 18%, what have you). The total pot gets bigger or smaller as the league as a whole improves or declines, but that amount that the richest clubs pay in doesn't change as a result of changes in local revenue. So, sell out more games, and you get to keep more money.

Under this new system, you have the same fixed contribution expectation no matter how much or little you make (as long as nothing dramatic like a new stadium arrives and drastically changes your economic situation). This will allow clubs to project their revenues much more easily, as you're going to know that short of some major new development, you're going to get dinged with the same rate.

So, to cut to the chase, what's the bottom line?

Well, if you're a club, and you're better at growing your revenues than the league, then the tax hurts less. On the other hand, if you're sucking wind compared to the other clubs in terms of revenue growth, then the tax eats up a larger percentage of your revenue. It's a chance for you to not only keep up with the Joneses, but it incentivizes you to work to kick their rears in the revenue growth department.

Yes, you still will have to pay a 31% tax on marginal income, but if you're outpacing the league in revenue growth, then your split-pool contribution should become less and less of a factor. Yes, your straight pool tax goes up, but it goes up by a lot less than it did before. Plus, under the previous system you'd get hit with more taxes for making more money on your split-pool component.

What these changes from the prior revenue sharing plan to the new should do is establish healthier incentives to encourage clubs that are receiving revenue sharing to spend them on growing revenue. As part of growing revenues, you would place hiring better players to increase your winning percentage at the top of your list. With clubs investing in themselves this way, you should theoretically promote competitive balance. At least, that's the plan. With this many moving parts, there are bound to be places where unintended consequences will arise.

As I said at the beginning, the ratified version of the CBA hasn't been delivered as yet. The devil is in the details, and with that, we should have a better idea about what is good and not so good in the new revenue sharing system.

Maury Brown is an author of Baseball Prospectus. 
Click here to see Maury's other articles. You can contact Maury by clicking here

Related Content:  Revenue Sharing,  Revenue,  Marginal Revenue

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