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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

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.