Luxury tax (sports)

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Luxury tax rules by sport
League Payroll rules
Major League Baseball Luxury tax
National Basketball Association Soft salary cap + luxury tax
National Football League Hard salary cap
National Hockey League Hard salary cap
Major League Soccer Hard salary cap

A luxury tax in professional sports is a surcharge put on the aggregate payroll of a team to the extent to which it exceeds a predetermined guideline level set by the league. The ostensible purpose of this "tax" is to prevent teams in major markets with high incomes from signing almost all of the more talented players and hence destroying the competitive balance necessary for a sport to maintain fan interest. The money derived from the "tax" is either divided among the teams that play in the smaller markets, presumably to allow them to have more revenue to devote toward the contracts of high-quality players,[1] or in the case of Major League Baseball, used by the league for other pre-defined purposes.

In North America, Major League Baseball has implemented the luxury tax system. The National Basketball Association also has a luxury tax provision; its utility is somewhat limited by the fact that the league also has a salary cap provision. The "hard" salary cap of the National Football League and the National Hockey League has prevented any need for a luxury tax arrangement.[2]

Methods for limiting payroll[edit]

In the Big 4 North American sports leagues (Major League Baseball (MLB), National Basketball Association (NBA), National Football League (NFL), and National Hockey League (NHL)), there are three different methods employed to limit individual teams payroll: hard salary cap, soft salary cap with luxury tax, and luxury tax.

Hard salary cap[edit]

A hard salary cap is where the league sets a maximum amount of money allowed for player salaries, and no team can exceed that limit.

Soft salary cap[edit]

A soft salary cap has a set limit to player salaries, but there are several major exceptions that allow teams to exceed the salary cap. For example, in the case of the NBA, teams can exceed the salary cap when keeping players that are already on the team.

Luxury tax[edit]

A luxury tax system does not have a limit to how much money can be spent on player salaries. However, there is a tax levied on money spent above a threshold set by the Collective Bargaining Agreement (CBA) between the players union and the owners. For every dollar a team spends above the tax threshold, they must also pay some fraction to the league. This system is used to discourage teams from greatly exceeding the tax threshold, with the goal of ensuring parity between large and small market teams.

Luxury tax rules by league[edit]

Former Owner George Steinbrenner's New York Yankees have paid over $254 million in luxury tax since 2003 (as of December 2013).

Major League Baseball (MLB)[edit]

As explained by Fangraphs: "Technically called the 'Competitive Balance Tax', the Luxury Tax is the punishment that large market teams get for spending too much money. While MLB does not have a set salary cap, the luxury tax charges teams with high payrolls a considerable amount of money, giving teams ample reason to want to keep their payrolls below that level."[3]

The threshold level for the luxury tax will be $189MM in 2014 (up from $178MM from 2011-2013) and will remain at $189MM through 2016. From 2012 through 2016, teams who exceed the threshold for the first time must pay 17.5% of the amount they are over, 30% for the second consecutive year over, 40% for the third consecutive year over, and 50% for four or more consecutive years over the cap.[4]

Only five teams have ever exceeded the luxury tax threshold, the Boston Red Sox, the Los Angeles Angels of Anaheim, the Detroit Tigers, the Los Angeles Dodgers, and the New York Yankees. Only the Red Sox and Yankees have exceeded it more than once. Boston has exceeded it six times. New York has exceeded it eleven times, every year since it has been in existence. In aggregate, the Yankees have paid out some $254 MM, 95% of the total fines assessed.

The luxury tax is separate from revenue sharing, which is a system to balance out the income distribution between large and small market teams by dividing money from merchandise sales and media contracts. The money generated from the luxury tax is not distributed to the rest of the league, as is the case with the NBA, but rather is used for other purposes. The first $5 million is withheld to cover potential refunds, and is contributed to the Industry Growth Fund (IGF) if no refunds are forthcoming. The remaining money is divided as follows: 50% funds player benefits, 25% funds developing baseball in countries without high school baseball, and 25% goes to the IGF.[5]

Luxury tax paid per year by team (in millions of $)[6][7][8][9][10][11][12][13]
Team 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013
Luxury tax threshold 117 120.5 128 136.5 148 155 162 170 178 178 178
Yankees 11.8 26 34.1 26 23.88 26.9 25.69 18 13.8 18.9 29.1
Red Sox - 3.15 4.1 0.498 6.06 - - 1.49 3.4 - -
Angels - 0.927 - - - - - - - - -
Tigers - - - - - 1.3 - - - - -
Dodgers - - - - - - - - - - 9.9

National Basketball Association (NBA)[edit]

Main article: NBA salary cap

The NBA utilizes a soft salary cap, meaning there is a salary cap but there are a variety of exceptions that allow teams to exceed that cap. For example, teams can resign players already on the team to an amount up to the maximum salary allowed by the league for up to five years regardless of where their payroll is relative to the cap. This provision is known as the ""Larry Bird" exception, named after the former Boston Celtics great who was retained by that team until his retirement under the provisions of this rule. The result is that the majority of teams are over the cap at any given time.

In addition to the soft cap, the NBA utilizes a luxury tax system that is applied if the team payroll exceeds a separate threshold higher than the salary cap. If a team exceeds the luxury tax threshold, they must pay one dollar to the league for every dollar that they are over the limit. The resulting total is then distributed to the remaining teams that are under the tax threshold. However, the luxury tax penalty is only applied if the league average payroll exceeds a separate threshold.[14]

The effectiveness of the luxury tax system at limiting the growth of players salaries is in question. Although exceeding the luxury tax threshold costs the team twice as much money, it does not seem to limit teams' willingness to spend big money on players. As a result, since 2001 player salaries have jumped from $1.6 billion to $2.3 billion, and have outpaced league revenue growth by $110 million. At the start of the 2009-2010 season, 14 out of 30 NBA teams were above the tax threshold, with seven at least $10 million over.[15]

Luxury tax paid per year by team (in millions of $)[16][17][18][19][20]
Team 2002-03 2003-04 2004-05 2005-06 2006-07 2007-08 2008-09 2009-10
Luxury Tax Threshold 52.9 54.6 0 61.7 65.42 67.865 71.15 69.92
Knicks * 39.8 - 37.2 45.142 19.724 23.736 14.65
Trail Blazers * 28.8 - - - - 5.899 -
Mavericks * 25 - 17.3 7.205 19.613 23.612 17.79
Timberwolves * 17.6 - - 0.999 - - -
Kings * 9.7 - - - - - -
Lakers * 8.3 - - - 5.132 7.186 21.42
Nets * 7.3 - - - - - -
Sixers * 5.5 - - - - - -
Raptors * 4.1 - - - - - -
Pacers * 3.2 - 4.7 - - - -
Celtics * 1.6 - - - 8.218 8.295 14.98
Pistons * 0.8 - - - - - -
Magic * - - 7.8 - - - 1.99
Grizzlies * - - 3.7 - - - -
Spurs * - - 0.9 0.196 - - 8.853
Nuggets * - - - 2.022 13.572 - 5.19
Cavaliers * - - - - 14.009 13.707 14.8
Heat * - - - - 8.319 - 2.83
Suns * - - - - 3.867 4.918 5.01
Jazz * - - - - - - 12.629

Other leagues[edit]

The National Football League and the National Hockey League both have hard salary caps, making it unnecessary to utilize the luxury tax.

Several other leagues in the United States and abroad use salary caps, but the luxury tax is uncommon.

Footnotes[edit]

  1. ^ Dietl, H., Lang, M. and Werner, S. (2010): "The Effect of Luxury Taxes on Competitive Balance, Club Profits, and Social Welfare in Sports Leagues", forthcoming in International Journal of Sport Finance.
  2. ^ Andreff, Wladimir; Stefan Szymański (2006). Handbook on the economics of sport. Edward Elgar Publishing. p. 656. ISBN 978-1-84376-608-7. 
  3. ^ http://www.fangraphs.com/library/business/luxury-tax/
  4. ^ Luxury Tax" Fangraphs
  5. ^ "Luxury Tax in Major League Baseball", Wikipedia, 11 April 2011.
  6. ^ CHART OF THE DAY: The MLB Luxury Tax Should Really Be Called "The Yankees Tax"." Business Insiders April 6, 2011.
  7. ^ Yankees Assessed Luxury Tax." mlb.com 12/29/2009.
  8. ^ MLB players, owners announce 5-year deal." ESPN.com October 25, 2006.
  9. ^ New York Yankees cut the amount they spend on Major League Baseball luxury tax by over $7 million." NY Daily News December 22, 2010.
  10. ^ Breaking Down MLB's Luxury Tax: 2003-2007." The Biz of Baseball December 25, 2007.
  11. ^ Baseball Luxury Tax." Steve the Ump.
  12. ^ Report: Yanks hit with luxury tax:" ESPN December 14, 2012
  13. ^ Yankees, Dodgers hit with luxury tax penalties" sbnation.com September 11, 2013
  14. ^ NBA Salary Cap," Sports City, August 30, 2000.
  15. ^ Proposing a Solution for NBA's Ineffective Luxury Tax," AOL News January 25, 2010.
  16. ^ Knicks and Mavericks hit hardest by luxury tax," NBA.com Jul 8, 2009.
  17. ^ Knicks top list of eight teams that must pay luxury tax," ESPN.com Jul 9, 2008.
  18. ^ Knicks top list of teams to pay luxury tax," ESPN.com October 29, 2007.
  19. ^ A Brief History Of Luxury Tax," ShamSports.com 2009.
  20. ^ 11 NBA Teams Set to Pay Luxury Tax." AOL News Feb 19, 2010.