How do MLB Luxury Taxes Work?
Monopoly Board (Monopoly Land)
As MLB fans know, front offices are constantly thinking about the luxury tax number, the soft cap of how much a team can spend on their roster, and if they should reset it. Today, I’ll break down the Collective Balance Tax (CBT) rules into three parts: the thresholds of the CBT in the last few years and the 2024 number, the CBT % for consecutive years and why resetting the CBT is important, and the progressive tax and different luxury tax % based on the team’s bracket.
Year by year threshold for CBT
In 2021, the Dodgers and the Padres were the only clubs to go over the $210M CBT number, that is, they spent more than $210M on their rosters. In 2022, six teams went over the $230M number, but only two teams had a tax bill over $5M, the Mets and the Dodgers. Finally in 2023, nine clubs went over the $233M soft cap according to Spotrac, with the Mets paying over $110M in luxury taxes! For 2024, the CBT threshold number is $237M, with six clubs currently projected to go over that number.
2021: $210 million
2022: $230 million
2023: $233 million
2024: $237 million
2025: $241 million
2026: $244 million
The CBT % for Consecutive Years
First year: 20% tax on all overages
Second consecutive year: 30%
Third consecutive year or more: 50%
It goes without saying that resetting your CBT every few years to avoid a 50% tax is an important strategic option. To reset your CBT, you need to remain under the spending cap for one full year. The Red Sox have recently utilized this reset, by barely staying under the $233M number for 2023. Presumably, Boston can now afford to go a few million over the threshold if need be, since they are back down to the 20% figure on overages. The Padres also found themselves in the 50% bracket on overages in 2023, and have announced they will reset the CBT this season in 2024, by staying under $237M. Comparatively, the Dodgers are also paying the 50%, but seemingly have no issue with continuing to do so going forward. The Mets were over in 2022 and 2023, with a projected $279M number for next season, so there’s no way they stay under for 2024.
2024 Project CBT payroll (Spotrac)
The Progressive Tax Brackets Explained
$20 million - $40 million: 12% surcharge
$40 million - $60 million: 42.5 % surcharge for first year; 45 % for each consecutive year after that
$60 million + : 60 % surcharge
Clubs that are $40 million or more above the threshold shall have their highest selection in the next Rule 4 Draft moved back 10 places unless the pick falls in the top six. In that case, the team will have its second-highest selection moved back 10 places instead.
As you can see in the above brackets, any dollar from $257M to $277M in 2024 will be taxed a 12% surcharge (on top of the above number based on consecutive years over the threshold). Any dollar spent in the $277M- $297M range will be taxed at 42.5% in the 1st year, 45% after that, while anything over the $297M number is taxed at 60%. If you are an organization such as the Mets or Dodgers paying the 50% charge for 3+ years, while also potentially paying the 45% charge in the $277M -$297M range and the 60% number over $297M, these tax bills can get crazy quickly. Finally, there is the added element of having your highest draft pick moved back 10 spots. This is a huge disadvantage for a competitive team that already has a lower chance to get high draft picks (weighted lottery) given their record.
You can start to see why an organization like the Padres wants to reset everything to get back to the original tax numbers. By design, this does cost the organization a competitive window. For example, the Padres have to move Juan Soto to clear around $30M in salary and get close to that $200M figure. Word is San Diego ownership wants to stay close to this number, but at least they have $30M or so of payroll room to fill some obvious roster holes. The CBT tax has been effective in hampering some organizations and creating parity, while others seem unaffected by the taxes they’re paying (e.g. Dodgers and Mets). For the record, I would not be opposed to having teams paying a tax for the opposite reason, not having a high enough payroll. If they truly want to create parity, owners should have to make a minimum level of investment in talent annually to ensure there is at least some effort to be competitive. Even a figure like $80M would go a long way to push organizations like the A’s and the Pirates to add some pieces from the free agent market and less likely to trade their stars away as they enter arbitration and get expensive.
https://www.mlb.com/glossary/transactions/competitive-balance-tax
*Stats are as of 12/20/23