MLB COMPETITIVE BALANCE AT A BREAKING POINT

• Posted on 8 January 2024
• By Carl Lemelin
• 0

The Dodgers' historic signing of superstar Shohei Ohtani has highlighted a competitive balance problem that MLB has yet to properly address.

This off-season, more than any other before, has shown how ineffective MLB’s current Competitive Balance Tax (CBT) – i.e. Luxury Tax – really is. We already knew big market owners didn’t care about paying a luxury tax – even a hefty one – if it meant fielding a World Series contender, but the Dodgers’ two blockbuster free agent signings last month have made a mockery of the CBT and what it stands for!

Before getting into the specifics of the CBT and how to fix it, let’s go back to its origins – the why and how it came about.

PROTECTING SMALL MARKET FRANCHISES

Major North American sports thrive on cross-continent coverage. That’s what puts them on the map as legitimately “major”. The NFL, NBA, NHL, and MLB now all boast 30 or more member franchises.

Big markets like New York, Chicago, Los Angeles, and a few others represent only a fraction of those leagues, yet left unchecked, owners of these big metropolitan area teams would spend seemingly unlimited amounts of money on their player payrolls. They run their franchise like prestigious collector’s item for which they want to upgrade the value.

On the other hand, smaller market owners must run their franchise like a any other business. Operations must generate a profit. For them, there is little-to-no tolerance for a deficit.

These are acceptable philosophical differences in business approaches in the real world. But in the realm of professional sports, the dichotomy, if unchecked, is a recipe for disaster.

That’s why, coming out of the 1994 player’s strike – which Montreal Expos’ fans blame for their team’s eventual move to Washington – MLB insisted on a mechanism that would be somewhat restrictive of owners’ spending on player salaries. The first version of the CBT came into effect in 1997.

The Player’s Association had insisted it would never agree to a hard salary cap – like all three other major leagues had already adopted. So, MLB elected to put the onus on its owners to police skyrocketing player salaries by taxing the richest among them past a certain threshold of payroll spending and redistributing the wealth to the poorer franchises.

In principle, I prefer this way of ensuring competitive balance, because sports are entertainment, and the players ARE the show. They should be able to make as much as an owner is willing to pay for their services.

However, since small market viability relies on these fan bases having a glimmer of hope of competing with the big boys, the owners have the responsibility to police payroll spending among themselves.

The CBT has since evolved to its current structure, which has stood since the 2002 season.

CBT 101

The MLB Luxury Tax states that the top spending teams must pay a tax if they spend over a pre-determined threshold for player salaries.

Funds obtained from these taxes are to be redistributed – according to parameters defined in the CBA (Collective Bargaining Agreement) – to the teams that spend the least on their payroll. This is meant to discourage excessive spending at the top of the food chain and encourage small market team to spend more.

Furthermore, teams that surpass the threshold in consecutive years are taxed at higher rates: 30% of the overage the first year, 40% the second consecutive year, and 50% for a third straight year of overspending. To further encourage big spenders to harness their yearly splurges, if a taxed team falls under the threshold the next year, the escalating rate is reset to 30%.

MLB has pre-set the new spending threshold for CBT purposes with the ratification of the last CBA (2022-2026). 2024’s number is set at $237M. As a reference, the 2023 CTB threshold was $233M, and $230M for 2022.

Last year saw a record $209M in tax pool money paid by 8 offenders. With such an amount to be handed out to the less fortunate, one could be forgiven for not understanding why there is still such a cavernous gap between the haves and have-nots in baseball.

THE DODGERS: A CASE STUDY IN CBT INEPTITUDE

If the CBT’s purpose is to reign in super spenders and reduce the gap in payrolls across the Big Leagues, I have one very puzzling question for the Commish: after having just spent over one BILLION dollars on two Japanese superstars (two-way MVP Shohei Ohtani and starting pitcher Yoshinobu Yamamoto), how can the Dodgers’ estimated CBT bill for 2024 be a paltry $761,524 (as per Spotrac.com)?

After digging into it a little, the first thing you realize is that, although the basic structure of the CBT as publicly presented seems like a viable asset equalizer, some little-known CBA clauses have rendered it highly ineffective in practice.

What you need to know is that for accounting purposes the CBA distinguishes between the players’ actual salary – their AAV (Average Annual Value) – and their Luxury Tax salary.

What’s the difference?

The CBA allows for a player’s salary to be differed, if agreed upon by both parties. For example, Shohei’s AAV is $70M ($700M for 10 years), but he offered to get paid only $2M per year for the duration of the contract and have the rest of the owed money ($680M) paid out over the following 10 years, meaning he will get paid by the Dodgers until 2043.

Accounting gymnastics have figured out that – according to many economic factors – if the contract were to be paid out normally, it would have been worth a $46M AAV. That magical result thus becomes Ohtani’s Luxury Tax salary.

Some casual baseball fans may not realize that the Dodgers also used this CBA loophole when they signed Mookie Betts and Freddie Freeman to huge contracts over the past few years. That’s right, two more perennial MVP candidates have their AAV’s considerably reduced for CBT accounting, so they can all fit on the same powerhouse roster.

SO, WHAT’S THE FIX?

Obviously, for the MLB Board of Governors to get together and adopt the CBT back in 1997, they were fully aware of the need to save their small market franchises by adopting a system with some form of wealth redistribution.

However, the Dodgers are living proof that under its current constitution, the CBT is failing miserably to achieve its intended objective. I believe the crux of the matter is the lack of a long-term vision on the part of big market ownership.

Owners are fervent capitalists naturally, so they reluctantly agreed to a seemingly socialist principle.

Another word that describes MLB owners is “ultra-competitive”. That’s why they insisted on including that counterproductive clause – allowing differed payments and an adjusted Luxury Tax payroll number – during CBA talks.

“We’ll accept to be taxed for overspending, but in return, give us an out clause in case we see an opportunity to build a powerhouse”, is what this sounds like to me. Big market owners are like children who only see what’s right in front of them: WIN NOW!

Apart from the differed payments loophole, the other widely unknown fact about the CBT is that the redistribution of tax money doesn’t solely go to smaller market franchises. In fact, half of it first goes to fund player compensation as per the MLB Players Benefits Plan Agreements. Why would MLB use dollars from a competitive balance fund to pay for player benefits?

In light of these blatant weaknesses of the CBT, the fix is plain to see. The “Luxury Tax Salary” must be eliminated, and the true AAV of each player’s contract should be the only number to count towards a team’s CBT payroll.

To add even more weight behind the wealth redistribution system, I would even suggest scrapping the gradual 30-40-50% tax for consecutive years of overspending and simply always make it a flat 40% tax, any year a team surpasses the tax threshold.

Furthermore, 100% of the money pooled in taxes should be used to compensate smaller market teams, who in turn should be given a spending floor according to the amount received. Because some of the talent inequity issues are also due to some stingy ownership in leaner markets. MLB can easily find some other revenue stream to fund the player’s benefits program.

A pro sports league is only as strong as its weakest link. Struggling franchises – at the box office and in the standings – hurt the competitive integrity of the sport. Eventually, as the disparity increases and fan interest wanes, this can only have negative effects on every owner’s bottom line.

Everyone mind’s eye – outside Dodger Nation, of course – saw a collective rolling of the eyes when Ohtani and Yamamoto both ended up signing to play in LA-LA Land, especially in places like Pittsburgh, Kansas City, Tampa Bay, Milwaukee, and other markets who know their team could never aspire to pull off such a coup.

Owners and players alike have an insatiable appetite for money and winning, which always tends to work in favor of MLB’s big markets – not to mention the geographical attraction some of those cities present. Even though franchises like the Tampa Bay Rays, Milwaukee Brewers, and Cleveland Guardians have proven you can succeed without overspending on payroll, recent studies have revealed a clear correlation between the amount spent on player personnel and winning ball games.

Smart businessmen realize that a short-term loss in profit margins due to a spending spree is a sustainable business model in pro sports because consistent winning with star players brings the franchise the prestige that helps build up its market value.  

However, MLB brass must now realize that a healthy competitive balance is crucial to their sport’s long-term health and thus use every tool in their box to ensure its integrity. By refusing to go all-out with the CBT, it is sending the wrong message to a large proportion of its target audience.

Unfortunately, with this off-season’s events, I’m convinced that the message is now heard loud and clear. Owners and players must all compromise and reverse competitive imbalance in the next CBA, at the peril of fans losing interest, MLB losing franchises, and players losing jobs.