With the conclusion of the World Series, the Major League Baseball (MLB) offseason is officially underway. Despite this year’s Fall Classic containing two small-market, low revenue teams, the league and its owners have done a good job banging the drum that, to ensure fairness among every team in the league, a salary cap is necessary. This position is not shared by the Players’ Association, who maintain that a cap will only suppress their members’ earning power. This schism over a salary cap will almost assuredly lead to a work stoppage when MLB’s current labor agreement expires next month. But one thing you will be hearing about this winter is Major League Baseball’s quasi-salary cap already in existence. It’s called the luxury tax and it is relatively unknown, or at least misunderstood, by many baseball fans. It will likely be such a hot button topic this winter, one with ramifications that could even cause a shorter MLB season in 2027, I decided to focus on it for this issue’s edition of SYTYKB.
What is it?
The luxury tax, formally known as the Competitive Balance Tax (CBT), has for a long time been MLB’s solution to having their cake and eating it too. Because of their own greed in 1990s labor negotiations, the league and the owners lost out on the ability to create a real salary cap. Therefore, they created the CBT. This system works by taxing clubs every year that exceed a predetermined payroll threshold. Teams who go over the allotted amount are taxed on each dollar above the threshold, with the number of repeat offenses correlating with a higher tax rate. This payroll is determined by calculating the present day average annual value (AAV) of the entirety of a team’s 40-man roster. In 2026, this threshold was $244 million. Nine teams went above this threshold this past season, with seven making the playoffs. They are (in order from largest payroll to smallest): the Dodgers, Mets, Yankees, Phillies, Blue Jays, Red Sox, Cubs, Padres, Braves. These clubs all had to pay various penalties and surcharges as reflected in the chart below.
What are the exact penalties and surcharges?
Well, because of the impending lockout and renegotiated labor deal things will change. But from 2022 to 2026 the process went as follows: For the first year, teams are taxed 20% on their overages (the amount they go over the base luxury tax threshold), second year teams are taxed 40%, and third consecutive year teams are taxed at a hefty 50%. But that is not all. If a team goes over the luxury tax by an amount greater than $20 million and less than $40 million, it pays a 12% surcharge. If they go over by $40 million dollars to just under $60 million, they get taxed a 42.5% surcharge the first year, and 45% every year after that. And on top of that, the team sees its highest draft selection drop 10 spots (unless that pick falls in the top six overall, in which case the team’s second highest pick gets docked), perhaps an even greater burden than a financial penalty. Finally, if a team goes over the tax threshold by $60 million or more, they are subject to a 60% surcharge. Additionally, all teams who exceed the luxury tax lose their second and fifth round draft picks and $1 million in international bonus pool money (funds used to sign amateur free agents from every country other than the US and Canada) if they sign a player in free agency that has a qualifying offer attached.
Where does all this money go?
Again, this is something that will change when a new labor agreement is reached, but in the last collective bargaining agreement (2022-2026), the first $3.5 million was used to fund player benefits. Half of the remaining amount was used to fund players’ individual retirement accounts, while the other half was given to a discretionary fund controlled by the commissioner. This money was then supposed to be given to small market teams who were actively trying to increase attendance and other fan engagement.
The Takeaway
MLB may not have a firm salary cap, but the harsh penalties do create fairly significant consequences for teams going over the luxury tax. Some teams do go over the threshold, but baseball has shown us that a team cannot win with money alone (take it from me, a fan of the New York Mets). Since the turn of the century, Major League Baseball has seen the most parody out of any of the four major sports leagues, even without a salary cap. This season saw the Milwaukee Brewers defeat the Tampa Bay Rays in the World Series matchup that pitted two teams with low payrolls, but top-level player development and analytics departments. This all may be a moot point because with the impending labor negotiations, the CBT system is sure to change. But for now, perhaps no salary cap is not so bad for baseball after all.
