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November 6, 2006

The Ledger Domain

A Look at the New Collective Bargaining Agreement: Luxury Tax, and Minimum Payroll

by Maury Brown

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In my first installment on the new CBA, we looked at changes to revenue sharing between the 2002-2006 Basic Agreement and the new agreement, which will run from 2007-2011. As noted in that article, the changes in the new agreement are designed to make the revenue-sharing system more equitable, and place incentives in place for the lower-revenue-making clubs to grow revenues. The hope is that clubs will see that fielding a competitive team is the best way to grow those revenues, which in turn improves competitive balance. To add to my first installment, Kevin Goldstein looked at the CBA and the Rule 4 draft, and Neil deMause looked at the new CBA and determined that the new revenue-sharing rules should spread the wealth, but not the talent.

Today, I'll look at two more pieces of the CBA puzzle that are designed in place to bolster better competitive balance. As I previously noted, this look at the CBA comes without a ratified CBA in hand. You can guarantee that BP will be going over the finalized agreement with a fine-tooth comb, once it is made public.

Competitive Balance Tax (Luxury Tax)

The Competitive Balance Tax (or as it's more commonly known as, the "Luxury Tax") remains in place in the new agreement, with both the thresholds themselves and the tax rate paid for exceeding those thresholds adjusted. There had been pressure for management to come to an agreement on the new labor deal before the December 19th deadline, as the Luxury Tax was set to expire at that time. If that had occurred, the tax would not have been in place for 2007. By reaching the new agreement, management guaranteed that the Luxury Tax would remain in place for the duration of the new agreement.

As a brief primer on how the tax works, thresholds for total team payroll are set within the agreement. When a club exceeds the threshold, they are taxed on the amount over this "soft cap." If the system holds true from the prior agreement to the new, payrolls are defined to include salaries plus earned bonuses for all players on the 40-man roster, plus a fixed amount per team in benefits and related expenses. All multiyear contracts are valued at their average annual value (sometimes referred to as AAV), regardless of the contract's actual payout in a specific year. The monies collected through this tax are then disbursed, and if the details on how those monies are disbursed remain the same as they were in the prior agreement, the Luxury Tax money will be used for player benefits, the industry growth fund, or player development in countries lacking organized high school baseball.

The threshold for the 2006 season was $136.5 million, and will jump to $148 million in 2007, $155 million in 2008, $162 million in 2009, $170 million in 2010, and $178 million in 2011. That's approximately a 5% increase per year, but the jump from 2006 to 2007 represents $11.5 million or an 11% increase from the old agreement to the new. This has to be seen as a negotiating victory for the players, as owners were expected to try to keep the rate down, thus suppressing salary growth, while the union would like the tax removed, or if not removed, have the thresholds set as high as possible to allow individual salaries to increase. The sizeable increase in the percentage from the last year of the prior agreement to the new agreement makes it appear that the Players' Association came out on top on this particular issue.

As for the rates of the tax, they will start at 22% for clubs over the threshold the first time, 30% for clubs over the threshold the second time, 40% for clubs over the threshold the third time, and then repeated at the 40% rate for the remainder of the agreement. The Yankees and the Red Sox are reported to be the only clubs to break the threshold in 2006 (official payroll numbers have not yet been officially released), and will therefore mean that the Yankees will have to pay the 40% rate this year. Under the new agreement, that 40% rate would then be applied again to the Yankees should they break the threshold in 2007.

The union had tried to negotiate re-setting the system so that all clubs started with a clean slate. In other words, if you had broken through the threshold in 2006, you would not be made to pay an increased tax rate if you went through the threshold in 2007. This would have benefited the Yankees almost exclusively, and it's easy to understand why the union backed the reset: When the Yankees escalate total team payroll, the other clubs have followed suit in attempts to compete for free agents.

Will clubs be able to pocket revenue sharing?

With revenue sharing adjusted, the question becomes, will clubs that receive revenue-sharing cash be forced to use those monies on their MLB player payroll? The new agreement strengthens language that will allow a club or the Players Association to more easily file a grievance in instances where they feel owners are pocketing revenue-sharing dollars. Revenue-sharing recipients are obligated by the agreement to improve their on-field performance, but how a club "improves" itself means different things to different clubs. What the MLBPA would like to see is investment by the recipients in their major league player payroll, which would improve salaries across the board. But some clubs may need to invest in scouting, which may pay dividends in the future. The same could be said if a club invests in other facets of player development.

Which is "an effort to improve its performance on the field" as defined in the last agreement? The answer is both. It's those clubs that are purposely skirting around reinvesting revenue-sharing dollars that are at the heart of the complaints being advanced by both the MLBPA and some high-revenue-making clubs.

While it may be easier for the Players Association to file a grievance, it will be difficult to prove that the monies a club receives are not getting pocketed. A salary floor would ensure investment at the major league player payroll level, but that did not make its way into the final agreement.

Minimum Salary

An issue that was never in question was whether there would be an increase in the minimum salary within the new agreement. Minimum salaries for Major League players will increase from the current $327,000 to $380,000 in 2007, $390,000 in 2008, and $400,000 in 2009, with cost of living adjustments (COLA) to 2011.

The jump to $380,000 shows a 22% increase from the minimum salary for 2006. With the sizeable increase, one wonders if the value of low-level talent will be lessened in favor of players that may sit more toward the middle. With that, salaries for the low-to-mid-tier talent will see their value increase, possibly setting the salary bar higher in that range.

Some clubs will feel the increase in minimum salary more than others. As an example, seventeen of the players on twenty-five man roster at the beginning of the season for the Marlins were minimum-salary players. Their expected compensation for 2006 totaled $5,559,000. If the new minimum salary were in place then, the Marlins would have instead spent $6,460,000, a difference of $901,000. That may not look like much, but it represents 6% of what was then the total payroll for the Marlins.

Conclusions from the two installments on the CBA

The early consensus seems to point to clubs spending more in the upcoming free agency period than in years past. To name a few, clubs such as the Angels, Blue Jays, Mets, Yankees, and Dodgers have said that they will not hesitate to make big moves if opportunity presents itself.

The raising of the Luxury Tax thresholds is a win for the upper-revenue-making clubs. Whether the 11% threshold increase from 2006 to 2007 creates an atmosphere in which the lower quartile of clubs feel that they can't compete will have to be played out against the other components in the revenue-sharing system. Do the adjustments to the straight-pool and split-pool create an environment where clubs such as the Twins, A's, Reds, and Brewers can compete? Are the clubs at the lower end of the revenue-making scale willing to invest based on the tweaks to the new system? Some clubs most likely won't. As an example, the Pirates have made comments that say that the new system doesn't go far enough, while other clubs, such as the Yankees and Red Sox, must feel like it goes too far. This battle will likely always rage on--the outliers will always clamor for more or for less. It's whether the majority of clubs will see that growing revenue has its advantages in the new system. If that's the case, in theory the new Basic Agreement will be a better system for the health of MLB clubs as a whole than the agreement prior. Given the comments by many of the owners and the players and representatives from the Players' Association, this seems to be the overwhelming consensus.

You can be sure that once BP has the final version of the new Basic Agreement in-hand that we'll be providing some numbers to see whether the new deal is a better deal, or if there are still holes in the system.

As an aside, by the end of this agreement, the chances are we will see not only a new Commissioner of MLB, but a new Executive Director of the MLBPA. If that is the case, let's hope that we see this continued labor peace in the future. For now, we have five more years of labor peace to look forward to. That, in and of itself, should allow the game to continue to grow revenue over the life of this new agreement.

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:  CBA,  Revenue Sharing,  A's,  Revenue,  Players Association,  Luxury Tax

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