What is the MLB Luxury Tax?

The latest news from the MLB's off-season was the 12-year $315 million deal Carlos Correa made with the New York Mets on the same day the San Francisco Giants released they were not announcing the Correa deal because of concerns over Correa's physical examination. The deal with Carlos Correa and the Mets puts the club's payroll at $495 million. That price tag includes payroll and the luxury tax amount. Luxury tax is the commonly used phrase for the MLB's Competitive Balance Tax ("CBT"), which places a tax on every dollar a club spends during a year above a predetermined payroll threshold—for 2023, the threshold is $233 million. The Mets' expected payroll for 2023 without the luxury tax is about $384 million, thus the club will pay an additional $111 million in luxury tax.

Clubs are subject to an increased tax rate for each consecutive year they exceed the payroll threshold. First-time offenders pay a 20 percent tax. Then clubs exceeding the threshold for a second consecutive year pay a 30 percent tax, and for a third or more consecutive year, clubs pay a 50 percent tax.

Additionally, clubs have to pay a surcharge depending on the amount the club's payroll exceeds the threshold. The surcharge is determined using additional thresholds set at $20 million, $40 million, and $60 million above the base threshold. The surcharge increases the tax owed regarding the consecutive years a club exceeds the base threshold, so a first-time offender with a payroll exceeding the base threshold by $20-$40 million has their luxury tax increased from 20 percent to 32 percent—for a second consecutive year, it's raised to 42 percent and 62 percent for the third year.

The last level of surcharge is $60 million above the threshold. This level is now dubbed the "Cohen Tax" and gets its namesake unsurprisingly from the Mets owner, Steve Cohen, because of his well-known lustrous spending even before this offseason. Under the Cohen Tax, when a club exceeds a payroll of $60 million above the base threshold, it pays 80 percent the first year, then 90 percent for the second, and 110 percent by the third year.

Is the Luxury Tax Actually Holding Owners Back from Large Spending?

The luxury tax's purpose is to maintain a competitive balance among the MLB clubs. Typically, sports leagues implement a salary cap—a limit to how much a team may spend on its payroll each year—to promote competitiveness and prevent large market teams from gaining too much control, however, baseball is the only major professional sport in the United States that does not have a salary cap.

Thus, the question is if the MLB should establish a salary cap as opposed to a luxury tax. It is clear MLB clubs have no intention to stay below the base CBT threshold, likely because an extra $20-$50 million is pocket change for most clubs, especially if the owner has a net worth in the billions of dollars like Steve Cohen.

The San Diego Padres and Philadelphia Phillies are new clubs that have jumped into the spending field these past couple off-seasons alongside common culprits like the New York Yankees and Los Angeles Dodgers. One thing this offseason has shown is clubs are more willing to pay unprecedented salaries to get the players they want. This means that if you are a billionaire who wants to own an MLB ball club, you can likely go buy whatever player you want—the luxury tax is not stopping you.

This may be good or bad for baseball. At first, it might seem like a billionaire owner going out and buying whatever players they can to build a team of all-stars will make the game more exciting. Unfortunately, the likely outcome is the only team baseball fans will see competing for the World Series are those that call major cities their home. That is already the case now, as it's uncommon to tune into the MLB playoffs and not see the Atlanta Braves, Dodgers, Yankees, or Astros. The days of the Big Red Machine in Cincinnati and Randy Johnson leading the Arizona Diamondbacks to a World Series title are quickly fading away.

A salary cap may stop team owners from building teams of all the best players on the market and raising the value of contracts, leaving the rest of the clubs who cannot afford those contracts out of luck and out of the competition. But, will a salary cap stop clubs if a luxury tax does not scare them?

The salary cap is effective in leagues such as the NFL because it does not limit punishments for exceeding the salary cap to monetary sanctions. The NFL punishes its teams that exceed the salary cap by taking away draft picks, or canceling contracts and rejecting trades that put a team over the cap. Those punishments encourage teams to make cap space at the beginning of each year.

A luxury tax is solely monetary, with an additional punishment for a club that exceeds the threshold by $40 million or more. In such a case, that club has its highest draft pick moved back 10 places, but that is not much of a punishment because the MLB draft is not like the NFL or NBA draft. It can take many years for a team to see their draft pick at the major league level, and many draft picks are used as trade pieces. What is successful in one sport may not be successful in another, so even if the MLB were to implement a system of stricter punishments for clubs exceeding the CBT threshold, the nature of the game of baseball may make those attempts futile.

The Large Market Monopoly in Major League Baseball

Large market clubs like the Mets are forming a monopoly that controls the player market. The willingness to spend hundreds of millions of dollars above the luxury tax, which removes all the top talent in free agency, is exclusionary conduct that may create an anti-competitive effect within baseball. Small market teams such as the Cincinnati Reds, whose owner's net worth is a mere $400 million, cannot compete with large market teams—frankly, they stand no chance and the historically poor season the Reds had in 2022 indicates that anti-competitiveness. Purchase power has led to unmatched player market domination.

Howbeit, an allegation of monopoly formation falls under U.S. antitrust law, which the MLB is the only professional sports league to boast an exemption from.

Origin of the MLB Antitrust Exemption

In 1922, the United States Supreme Court issued an opinion in Federal Baseball Club of Baltimore v. National League of Professional Baseball Clubs.[1] The opinion, written by Justice Oliver Wendell Holmes, concluded that the business of baseball was just a game and not interstate commerce, thus it was exempt from the regulations of the Sherman Antitrust Act.[2]

Then, the Supreme Court reaffirmed the exemption in 1953 with the decision of Toolson v. New York Yankees, Inc.[3], and again in the opinion of Flood v. Kuhn in 1972.[4] The Flood opinion determined that the MLB's antitrust exemption is entitled to the benefit of stare decisis—established precedent.[5]

It May Be Time to Lift the MLB Antitrust Exemption

For the benefit of America's pastime, MLB clubs ought to be subject to antitrust laws. The MLB has very little intimidation when it comes to suppressing clubs that ignore what it means to have a competitive sport and instead buy their way to forming baseball's version of the Miami Heat's Big Three.

The antitrust exemption does not have to be lifted for all aspects of the business of baseball, as some features of the sport benefit from the exemption, such as the minor league system. MLB Commissioner Bob Manfred sent the U.S. Senate Judiciary Committee a letter outlining the negative impact subjecting the MLB to antitrust laws would have on minor league players. However, Commissioner Manfred has not been consistent with his support of the exemption. During the 2022 All-Star break, Manfred stated he could not "think of a place where the exemption is really meaningful, other than franchise relocation." Therefore, the relevancy of the MLB antitrust exemption is more case by case than broad protection.

The bottom line is that the game of baseball is being threatened by big pockets. That is not to say players should deserve less, but select MLB clubs are rising above others with their spending in ways never seen before. That trend is pointing more and more toward monopolistic control that may not be stopped by simply adding a salary cap.

Jared Yaggie is a 2L at the University of Cincinnati College of Law. You can connect with him via LinkedIn or on Twitter @JaredYaggie.

Sources:

[1] Federal Baseball Club v. National League, 259 U.S. 200 (1922).

[2] Id. at 208.

[3] Toolson v. New York Yankees, Inc., 346 U.S. 356 (1953).

[4] Flood v. Kuhn, 407 U.S. 258 (1972).

[5] Id. at 269-285.