Dodgers: Understanding the MLB Luxury Tax System

LOS ANGELES, CA - JANUARY 07: Dodgers president of baseball operations Andrew Friedman introduces Pitcher Kenta Maeda to the Los Angeles Dodgers at Dodger Stadium on January 7, 2016 in Los Angeles, California. (Photo by Joe Scarnici/Getty Images)
LOS ANGELES, CA - JANUARY 07: Dodgers president of baseball operations Andrew Friedman introduces Pitcher Kenta Maeda to the Los Angeles Dodgers at Dodger Stadium on January 7, 2016 in Los Angeles, California. (Photo by Joe Scarnici/Getty Images) /

It’s become all the rage in Major League Baseball. It’s what drives good teams. It’s what drives average teams. It’s what drives really bad teams.

No matter your team’s current competitive situation, the Competitive Balance Tax has been driving your team’s front office for years, and that’s not going away anytime soon (read: never).

The Dodgers have been fighting this tax for years. According to Cot’s Baseball Contracts, they have led the Majors in salary in each of the past four seasons – and they were second in 2013. In fact, only once since the turn of the century have the Dodgers been outside the top 10 in salary.

Even Frank McCourt couldn’t keep the team from ranking at or near the top of the salary scale during his abbreviated and tenuous ownership days.

Gone away are the days when George Steinbrenner could buy himself a couple of World Series trophies. Here to stay are the days of hoarding draft picks and building from within, or buying on the cheap and hoping for the best.

What is the tax?

So, what exactly is the competitive balance tax, and how has it been shaping and molding all 30 teams for the past decade? You can read the definition, history and a brief Dodger example of the tax here, or you can read on and learn about it in layman’s terms.

Technically, baseball does not have a salary cap. Each year, a salary “threshold” is set, according to the Collective Bargaining Agreement, and teams that exceed that year’s set limit must pay a tax.

Monies collected under the MLB luxury tax are apportioned as follows: The first $5 million is held in reserve to pay for possible luxury tax refunds. Once it is clear that there are no refunds to be issued, this money is then earmarked for the Industry Growth Fund (IGF), with 50 percent of the remaining money to be used to fund player benefits, 25 percent used to fund baseball programs in developing countries with no high-school baseball, and 25 percent put into the IGF. According to the CBA, affected teams must send a check to the commissioner’s office by Jan. 31.

Teams are finding that the CBT, or “luxury tax,” can disrupt their plans for several years into the future. Beginning in 2018, a second, lesser-known part of the tax goes into effect. Teams that are $40 million or more over the threshold will have their highest draft pick moved back ten places unless it is in the top six. In that case, the team will have its second-highest selection moved back ten places instead.

The first tax agreement came out of the eventual 1994 strike settlement. From 1997-1999, only the top five teams in payroll had to pay a complicated 34 percent fine on every dollar they spent over the halfway point between the fifth and sixth highest-salaried teams.

Today, any team that exceeds the threshold, which changes annually, will pay a tax depending on how much they go over the threshold and how many consecutive years they’ve gone over.

What about the Dodgers?

The Dodgers, for example, have gone over the tax threshold in each of the past five seasons. Therefore, as fifth-time payors, they have been hit with a 50 percent tax bill on the amount they went over the threshold in 2017, which was set at $195 million.

In 2013, as first-time payors, the Dodgers paid a 17.5 percent tax on every dollar they spent over the $178 million threshold; as second-time payors in 2014, they paid 30 percent on what they spent over $189 million; as third-time payors in 2015, they paid 40 percent on what they spent over $189 million; as fourth-time payors in 2016, they paid 50 percent on what they spent over $189 million.

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Teams also must pay a 12 percent surtax for payrolls exceeding the threshold by $20 million and 42.5% (first time) or 45% (second or more consecutive times) on payrolls exceeding the threshold by $40 million.

Taking all that into account, it’s no wonder the Dodgers have paid a total of $149,580,371 in taxes over the past five seasons.

What about the future?

With the 2018 off-season shaping up as one of the wildest free-agent spending sprees ever, teams have been shedding salary to get under the threshold in preparation.

Currently, not one team is over next season’s $197 million CBT threshold, which will increase to $206 million in 2019, $208 million in 2020, and $210 million in 2021, the final year of the current Collective Bargaining Agreement. (You can see every team’s salary back to 1998 here.)

One thing many people don’t understand is that there is more to a team’s salary than the 25 guys who suit up every night. Every player on the 40-man roster counts as part of a team’s salary.

Too, teams must pay player benefits, which include health benefits, as well as pension benefits for those who have played a minimum of 43 days on a Major League roster.

Most teams are also paying portions of salaries of players they have traded to other teams. For example, the Dodgers have been paying the Padres $3.5 million per year of Matt Kemp’s salary after they traded him to San Diego after the 2014 season. That counts toward their total team salary.

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It only takes one year of dipping below the threshold for a team’s tax percentage to be reset to first-time offender levels. If the Dodgers, or any team, can stay under the threshold for the entire 2018 season, they can spend lavishly next off-season and only be taxed at the 20 percent level.

At that point, it would seem, the sky’s once again the limit.