The Luxury Tax & Revenue Sharing in MLB

Charlie Klein

Annually at 4:00 Eastern Standard Time on July 31 all 30 teams in Major League Baseball decide whether or not they are in contention. More than almost any other day in baseball July 31st casts teams into two entirely distinct piles: competitive and non-competitive. And yet what gets lost in all of the sound and fury of trade speculation is that many teams have been non-competitive since pitchers and catchers reported to Arizona or Florida in February.

While New York Yankees radio man John Sterling frequently states that one cannot predict baseball, I could have told you with absolute certainty at the start of the season that teams like the Washington Nationals, Kansas City Royals, and the Oakland Athletics were not going to win the World Series this season. Baseball itself is a sport that is predicated on tradition and probability. More than in any other sport patterns and trends are followed with the zeal of an Evangelical Priest who thinks he has met Jesus. In essence, it is the rule and not the exception that baseball is for the most part predictable.

What is the source of this predictability? The fact that Major League Baseball has been unable to create a level playing field for all of its 30 teams. In 1999 MLB created a self-described 'Blue Ribbon' panel to investigate the revenue inequalities between the teams. The committee discovered to no one's surprise that there was a steep difference between the top teams and the lower level clubs.

"Large and growing revenue disparities exist and are causing problems of chronic competitive imbalance. Year after year, too many clubs know in spring training that they have no realistic prospect of reaching postseason play."

And the numbers from the era preceding 1999 bear that out. In terms of revenues, due to faster growth rates on already larger revenues, by 1999 the top seven teams averaged more than double the revenues of the bottom 14 teams. Where the disparity is greatest is under the category of competitive balance. During the last five seasons of the late 1990s, none of the teams in the bottom 14 of payroll spending won one of 158 postseason games played. Every World Series was won by a team with one of the top seven payrolls.

Many within the baseball community championed the efforts made by MLB from 2002-2006 where some semblance of revenue sharing was imposed on teams who spent over the amount decided upon by MLB. According to a report in 2005 done by the Wall Street Journal the Toronto Blue Jays, Tampa Bay Rays, Kansas City Royals, and Florida Marlins each received $30 million or more. Some of those teams controversially decided to keep that money to enhance their own profits instead of investing the money in player salary. Forbes reported that the Royals revenues from 2002-2006 doubled to $32 million, while their player costs only increased six percent. Similarly, the Florida Marlins reportedly received more than $60 million in revenue sharing, according to The Hardball Times, but the team had an opening day payroll of $45.5 million. The system was still imperfect.

When 'Proud to be Your Bud' Selig and the delightful Donald Fehr sat down in 2006 to draw out a new collective bargaining agreement, the issues of revenue sharing and the luxury tax were major sticking points on a new deal. When, at long last, a deal was struck, the song remained the same. The biggest change was now all teams would be taxed at a 31 percent rate. Under the new deal, larger-revenue clubs agreed to continue to transfer $326 million in local revenue to smaller revenue-generating franchises.

To be fair, those who find themselves in affirmation of the efforts made by MLB to 'share the wealth' point to the fact that there has been no repeat World Series winner since 2000. Those same advocates would also point to the 2008 Tampa Bay Rays who for the first time in its franchise history won the American League pennant and the 2001 Arizona Diamondbacks who defeated the highest revenue generating team in the New York Yankees to win the World Series. "See," they say, "The little guy can make it with smarts and a little bit of luck!"

Yet the fact remains that big market teams will always have a leg up on their competition. It's all based on simple numbers. Baseball Economist author J.C. Bradbury concedes that there is some big market advantage: his regression analysis finds that every additional 1.58 million residents in a market generate an extra win per season. In the book Bradbury uses the biggest market (New York Yankees) against the smallest (Milwaukee Brewers), and size alone would project a New York team winning 10.6 more games in ten seasons. And yet from 1995-2004 the Yankees won 26.3 more games on average. Thus Bradbury concludes that city size only accounts for 40 percent of the difference in wins. He argues that the other 60 percent come from the skill or lack thereof a team's front office.

Other studies have shown that lower payroll teams have a much lower chance of winning their divisions. Washington University's Olin Business School professor Michael Lewis, writing in the New York Times noted that below-average-payroll teams have won their divisions less than ten percent of the time in the past two decades.

There is also a major misconception about the manner in which the luxury tax is used. The money from the tax is not distributed to smaller market teams to promote competitive balance. Instead, the money is transferred to an "Industry Growth Fund" that MLB utilises for player benefits and to globally promote the growth of baseball. The money that is used comes from the MLB revenue sharing program, which is entirely separate from the luxury tax.

In the end the revenue sharing regimen instilled by the 2006 CBA does not do enough to ensure real competitive balance in the areas that matter. The program does not address the inability of smaller market teams to keep or sign star players. It does not deal with the fact that bigger market teams can build new stadiums that will generate higher revenues that will never find their way to the pockets of smaller market teams. Most importantly, it has not leveled the playing field in terms of competition within any division in baseball. The poor are still poor, and the richer are getting richer by the day. Until MLB is able to instill a salary cap, this inequality will go on eternally. And I do not expect the Player's Union to accept any new CBA in 2011 that will create a salray cap.

After all, it is no mistake that the phrase 'any given Sunday' refers to the only league in the world with a functional revenue sharing system.