NEWSLETTER
Given that rumors are swirling about the Cubs’ inability to ink a substantial contract this offseason without moving a lot of salary (rumors that are very close to being publicly adopted by the front office), I thought it would be worth adding a little context to the financial considerations associated with blowing out your payroll in a huge way.
In MLB, under the current CBA, there is no hard salary cap. A club is free to spend as much (or as little) on payroll as its win-chasing heart desires. There is, however, a level above which you will be subject to a payroll tax – the Competitive Balance Tax, or “luxury tax,” as we all colloquially call it. The luxury tax uses a tiered system, where, in 2019, teams will pay a 20% tax on the overage up to $226 million. From there, in the second tier, you’re paying a 32% on the overage from $226 million to $246 million. Then, for the final and top tier, you’re paying a 62.5% tax on any overage over $246 million in payroll.
Note: a team’s payroll for luxury tax purposes is calculated based on the average annual value of all guaranteed money contracts on the books, plus bonuses, benefits, etc. for the 40-man roster.
As we recently calculated, the Cubs’ current projected payroll for 2019, when accounting for everything, is about $226 million. let’s say, for the sake of discussion, that the Cubs did nothing else, made no significant in-season moves, and wound up with precisely a $226 million payroll in 2019 for luxury tax purposes. How much would they owe in luxury tax? Well, that one’s easy enough: it’s a 20% tax on the overage from $206 million to $226 million, so 20% of $20 million is $4 million. Boom. There’s your tax bill.
That sure isn’t much, is it? $4 million out of a total payroll cost of $230 million is just 1.7% of the total cost. Look, $4 million is not nothing, but it’s a mediocre reliever. In this context, it’s close to a rounding error.
Once you’re over the first luxury tax tier, and you’ve incurred some draft pick related consequences in the following year’s free agency (i.e., worse compensation if a qualified free agent leaves, greater cost to sign a qualified free agent), you might as well go all the way up to that $226 million mark. The “extra” cost is really just a whole lot of nothing to any club that can afford to spend at that level anyway.
But what about when you get much farther over the start of the second tier? Surely at that level, the money really starts to rack up, right?
Well, let’s do a little math.
Imagine the Cubs decided they were going to make only ONE other move this offseason: signing Bryce Harper to a monster 10-year, $340 million contract. The average annual value of that deal is $34 million, and that’s what would be added to the Cubs’ $226 million 2019 payroll estimate. We’ll again assume no significant in-season trades just to keep things in context.
That would leave the Cubs’ 2019 payroll for luxury tax purposes at a whopping $260 million. That’s a lot! And it’s over the top tier of the luxury tax, so here comes the whammy! … well …
First tier: 20% of $20 million = $4 million
Second tier: 32% of $20 million = $6.4 million
Third tier (Cubs over by $14 million): 62.5% of $14 million = $8.75 million
Total luxury tax owed on a $260 million 2019 payroll: $19.15 million
… I don’t know. Is that a whammy? In that total layout of $279.15 million, the $19.15 in luxury tax is just 6.9%. That’s like sales tax, man. It just doesn’t seem like a lot in relative terms.
To be sure, nineteen million bucks is a WHOLE lot of money in absolute terms (you don’t even want to know what I would do for nineteen million bucks or how I’d get all that honey out of there). But when it’s the added cost for being able to aggressively supplement your roster in a competitive window? Again, that’s barely the cost of an average positional starter in free agency. Why should that amount be the difference between handcuffs and no handcuffs?
I won’t leave that question dangling out there entirely rhetorically, because there could be an actual answer. For one, maybe revenue projections for 2019 simply don’t justify a $279.15 million total luxury tax payroll. We won’t even be able to take an intelligent guess on that front for over a year, so we’ll just have to leave it as “I doubt it, but hey, maybe that’s a reasonable explanation for not going nuts.”
Another possible explanation? The front office deplores the idea of seeing its top draft pick in 2020 bumped back 10 spots, which is what happens when you go over the top tier of the luxury tax. Of course, the flip side to that is, if you reasonably expect the Cubs’ top pick to be somewhere in the 25 to 30 range, is the drop of 10 spots really *that* big of a difference? It’s not nothing, but should it be *THE* singular reason not to spend aggressively at this rare point in time for the Cubs?
In the end, there are plausible reasons for pumping the spending brakes here, and some of it could be tied to long-term financial commitments, and not just the luxury tax in 2019. So I don’t want to oversimplify things. But I thought it was important to get some exemplary dollars and cents here into this discussion so that everyone is considering things from the same starting point.
Putting things another way, as applied to all Major League Baseball teams:
- Spending a ton of money on payroll, in general? Yeah, it’s definitely fair to consider that carefully in relationship to revenue.
- Drawing hard lines at the various luxury tax tiers for solely financial reasons? Eh, I’m not so sure about that one.
