REPORT: Chicago Cubs Set to Pay Luxury Tax for the First Time - What Happens Next?

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REPORT: Chicago Cubs Set to Pay Luxury Tax for the First Time – What Happens Next?

Chicago Cubs

pile-of-moneyIn the deepest throes of the rebuilding process, there was a not insignificant portion of the Chicago Cubs fan base that feared the entire thing was a scam, designed to save the new owners money while squeezing the golden goose for all she was worth. For my part, I saw the extremely limited spending as both incidental to the rebuilding process and an acknowledgment of very real spending limitations tied to the original sale of the team. As the rebuild moved into a competitive phase, however, and the Cubs better capitalized on the value of their various properties, I felt revenues would climb, and the Cubs’ ability to spend would climb alongside them.

So that you don’t think I’m simply patting myself on the back here, I offer all of that as a set up to something about which I was wrong. My greatest hope was that, by the time the rebuild was complete and the team’s optimized revenue streams were in place, the Cubs could field a payroll that tickled the edge of MLB’s luxury tax cap. I wasn’t going to be greedy. I didn’t need to see the Cubs become the Dodgers or the Yankees. But, given the market advantages of being in Chicago, on the north side, and with the fan base the team has, being among that upper echelon of spenders on payroll seemed an appropriate thing.

I just didn’t expect this to come for another few years. On that point, I am delighted to have been erroneously conservative.

According to the Associated Press (via Sportsnet), the Chicago Cubs exceeded the $189 million luxury tax payroll level in 2016, and will thus be paying about $3 million in luxury tax to the league. Given how successful – and undoubtedly profitable! – the 2016 season was, I’m sure the Cubs are all too happy to be paying the tax.

And, given the long – and undoubtedly worthwhile! – wait before and during the rebuild, I’m sure Cubs fans are all too happy to see the organization boasting a payroll at luxury tax levels.

Really, that’s your headline news for this post: the Cubs spent very aggressively in 2016 (and, in reality, they spent in the two offseasons that preceded it). They were committed to adding to a young, cost-controlled core with whatever free agents and trade additions could help the team win right now, and paid the literal price for it.

If you’re not into super nerdy details and financial considerations, you can depart this post now. If you’re curious about the luxury tax implications here for the Cubs going forward, however, please read on.

Something important to keep in mind about the luxury tax payroll level: it’s not quite the same thing as the actual payroll that a team paid out in a given year. Instead, “payroll” for luxury tax purposes is the average annual value (“AAV”) of all contracts for 40-man players (including bonuses, incentives, and guaranteed money tied to options), as well as things like health and pension benefits, payroll taxes and expenses, travel expenses, meal expenses, etc.

On the outside, you are never, ever going to be able to calculate this luxury tax payroll number perfectly. We can come close, but even just getting the contract portion correct is difficult enough on the outside. Once you get that portion down, the best proxy I can give you for all the other stuff is to say “add about $20 million.” That’s a rough guide, but in my anecdotal experience, it’s a decent and conservative estimate, given that the actual figure usually appears to be around $15 to $20 million. It’s also a very large number, and it’s one that people constantly forget when trying to add up contracts and figure out where a team stands on payroll, because it’s not like you’re seeing another $20 million player out on the field.

OK, so, having a better understanding of just what luxury tax payroll is, why do we care?

In terms of paying the luxury tax, itself, the considerations here – from a fan perspective – are almost non-existent. If the Cubs’ revenues continue to grow and support a large payroll as well as luxury tax payments, well, groovy.

Instead, in terms of the consequences fans are more likely to notice, the new Collective Bargaining Agreement has a number of penalties tied to being over the threshold. Those changes are being phased in for 2017, and take full effect in 2018. We don’t have the full language of the CBA just yet, so it’s possible that these penalties will not apply to 2017 payrolls … but it’s also possible that some might. Until we can evaluate the full CBA, we can only speak generally.

Teams over the luxury tax threshold are treated differently when it comes to draft pick compensation for free agents. Under the new CBA, when signing a qualified free agent, a large market team like the Cubs would normally lose its second pick in the upcoming draft and $500,000 of international free agency bonus pool money. But if they were over the luxury tax limit that season? They they lose their second pick AND their fifth pick AND $1 million of IFA bonus pool money.

Furthermore, although a large market team like the Cubs would normally receive a compensatory draft pick after the second round for losing a qualified free agent, that drops to after the fourth round if the team is over the luxury tax threshold.

If that kicks in for 2017, it’s not hard to see a very immediate potential impact to the Cubs, as they have several players set for free agency after this season who could conceivably be qualifying offer candidates (Jake Arrieta and Wade Davis chief among them).

(One other wrinkle that does not appear to take full effect until 2018: if you are $40 million or more over the luxury tax threshold, your first round draft pick is moved back 10 spots (unless it’s in the six highest picks (in which case, God have mercy on your frighteningly inefficient soul).)

This is all to say that, in an ideal world, the Cubs would be able to get back under the luxury tax threshold in 2017* – for which the luxury tax is set at $195 million, or $6 million higher than 2016. Are they in a position to do it?

There’s still a long way to go in the offseason, and payroll can change dramatically throughout a given season. Furthermore, as I mentioned, some of the relevant payroll expenses will always be opaque to us. But, as I sit here today, I can at least offer a peek at where things stand for the Cubs, in terms of the changes in their payroll heading into 2017.

The Cubs were about $17 million over the $189 million limit for 2016, or about $206 million in luxury tax payroll (that’s based on a 17.5% tax rate for the overage, and then using the AP’s reported $2.96 million tax bill the Cubs received). To be under the 2017 luxury tax limit, then, the Cubs need to drop about $11 million in payroll for luxury tax purposes.

Coming off the books this offseason (only players earning at least $1 million considered here, listed together with AAV value): Edwin Jackson ($13M), Dexter Fowler ($13M), Jason Hammel ($10M), Aroldis Chapman (about $5M), Travis Wood ($6.175M), Trevor Cahill ($4.25M), Jorge Soler ($3.333M), David Ross ($2.5M), Clayton Richard ($2M), Gerardo Concepcion ($1.2 million), Adam Warren (about $1M), Joe Smith (about $1M), and Brendan Ryan ($1M).

That’s about $63.458 million dollars coming off of payroll for luxury tax purposes. The Cubs would need to shave about $11 million in order to get under the luxury tax threshold for 2017, which means they could add about $52 million in new AAV this offseason without an issue.

Remember: because AAV is all that counts for luxury tax purposes, it doesn’t matter whether a player’s contract pays him more or less in 2017 than in 2016. The only changes that matter are departing free agents, arbitration raises, new contracts, and traded contracts.

Added so far this offseason (together with AAV value): Wade Davis ($10M), Jon Jay ($8M), Koji Uehara ($6M), and Brian Duensing ($2M). That’s a mere $26 million, only about half of what the Cubs could add this offseason and stay under the luxury tax threshold. But we also have to consider arbitration raises due – Jake Arrieta is projected to add about $6 million in salary, Hector Rondon about $1.5 million, Pedro Strop about $1 million, and Justin Grimm about $500K. So, very roughly, that’s another $8 million in added salary.

So, then, the Cubs could add a decent AAV contract from here and still project to be under the luxury tax threshold for 2017.

But there are two huge HOWEVAs: (1) that doesn’t include any in-season trades the Cubs might want to make, and, as a clear playoff contender, it’s a safe bet that they’ll be looking to add; and (2) longer-term additions mean you have to also consider the luxury tax implications in 2018 and beyond.

I wouldn’t expect the Cubs to make a significant new financial commitment this offseason for those two reasons, and also because the only real need I see for the Cubs is a back-end depth starting pitcher (not much AAV there) or a cost-controlled long-term starting pitcher (again, not much AAV there). I would, however, expect the Cubs to have a great deal of flexibility to spend after 2017 and 2018, even as the luxury tax level will have to linger as a peripheral consideration, especially as salaries for the Cubs’ young core rise in arbitration.

*(Another important note: as I said above, it’s still not quite clear which luxury tax-related penalties will kick in for 2017, and which will be held off until 2018. It’s possible that there really isn’t a need to get under the luxury tax threshold until 2018, at which time the Cubs will have seen a huge number of free agent contracts come off the books, and the luxury tax threshold increases to $197 million. Things get really interesting from there, though, as the luxury tax threshold jumps all the way to $206 million for 2019, at which time the Cubs could have several stars in arbitration, and the free agent market is going to be extremely attractive. All the more reason for the Cubs to try to lock up a youngster or two to a pre-arbitration extension, which will offer AAV certainty when planning in the years to come.)

Author: Brett Taylor

Brett Taylor is the Editor and Lead Cubs Writer at Bleacher Nation, and you can find him on Twitter at @BleacherNation and @Brett_A_Taylor.