How teams are gaming the luxury tax threshold

[G-Snarls]

I find this topic very interesting. No doubt it will affect the next CBA.

 

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MLBTR, Steve Adams

 

What does Trevor Bauer have in common with Taijuan Walker, Hirokazu Sawamura, Darren O’Day and (just before you blurt out “he’s a right-handed pitcher, Steve, this is stupid”), Kevin Pillar and Brett Gardner? Yes, all six are Major League Baseball players. And all six signed free-agent contracts this winter. But the more interesting answer is that all six are recent examples of big-market clubs leveraging typically player-friendly contractual clauses to work in their advantage.

 

I’m talking about player options -- a clause we haven’t seen all that often in recent years. Or at least, a clause we haven’t seen in its most traditional form and called by its most traditional name. Player options, however, are staples in major free-agent contract negotiation. They’ve simply been rebranded, for lack of a better term as “opt-out clauses” and shifted to an even more player-friendly form that typically grants top-tier players the ability to turn down multiple years rather than just one.

 

Bauer’s three-year, $102MM contract is really just a one-year, $40MM contract with a pair of player options attached to the end of the deal. That multi-year opt-out structure has become more normal recently, but we’ve also seen several more traditional player options for a single year issued in the 2020-21 offseason.

 

There’s a common thread among the teams handing them out, too; Gardner, O’Day, Sawamura, Pillar and Walker all play for major-market teams that are generally averse to crossing the luxury-tax threshold. The Mets were certainly willing to do so for the right player (i.e. Bauer), but their recent contracts with Pillar and Walker suggest that they’re hoping to remain south of that number even as they continue shopping.

 

Here’s what I mean.

 

While we’ve broadly come to accept player options as player-friendly clauses, that’s really only true if the player option is valued at a price the player is likely to pick up. Walker’s deal, for instance, carries a $6MM player option with a $3MM buyout. It’s possible that his arm injuries resurface and he ultimately picks up that net $3MM for the 2023 season, but so long as he’s remotely healthy, it’s hard to imagine him picking up that net $3MM salary rather than again testing the market.

 

So why include it in the contract at all, then? Because player options are considered guaranteed money for luxury-tax purposes. And because they’re guaranteed money, they impact the average annual value of a contract.

 

While most will reference Walker’s contract as a two-year, $20MM deal with a player option, it’s actually a three-year, $23MM contract as far as the luxury tax is concerned. Were that option a club option, the contract would come with a $10MM luxury-tax hit; Walker is owed $10MM in 2021, $7MM in 2022 and at least the $3MM buyout of that option for 2023 -- hence the $10MM annual value and luxury-tax hit.

 

As it’s currently structured, however, Walker is technically guaranteed the full freight of that $6MM in 2023, even if he’s highly unlikely to exercise it. The luxury-tax hit drops to $7.666MM for the Mets, and Walker still gets his $20MM over two years even if/when he inevitably opts out.

 

It’s a similar story with O’Day and the Yankees. It’s commonly referenced as a one-year, $2.45MM deal with a player option, but O’Day almost certainly won’t be picking up a $1.4MM player option when it comes with a $700K buyout (again, barring injury). But the presence of that option adds $1.4MM in guaranteed money to O’Day’s $1.75MM salary in 2021, making the annual value/luxury hit $1.575MM rather than the $2.45MM it would be if his contract instead included a club option. We don’t know particulars on Gardner’s deal yet, but expect a similar setup.

 

Pillar’s contract is referenced as a one-year, $5MM contract with a player option despite it really being a two-year, $6.5MM deal that allows him to opt out after year one. He’s promised $3.6MM in 2021 and can take a $2.9MM player option without a buyout for 2022. If he declines, the Mets then possess a $6.4MM club option and $1.4MM buyout. It’s a complex structure, but its purpose is effectively to game the luxury-tax system. Pillar will earn either $5MM, $6.5MM or $10MM on the contract, but its luxury hit for the current season is just $3.25MM.

 

It’s borderline absurd to see the Yankees tinkering to save a few hundred thousand in luxury commitments or the Red Sox constructing an immensely complex deal to push Sawamura’s AAV from $1.5MM to $1MM, but both clubs are within $3-4MM of the luxury barrier. The MLBPA’s failure to further drive up the luxury tax in the previous round of collective bargaining talks has resulted in the game’s wealthiest teams playing the type of accounting tricks we might expect to see from front offices whose ownership groups give them one-third the financial latitude of the Yankees, Red Sox, Mets and Dodgers.

 

It should be noted, of course, that the Dodgers’ situation is at least a bit different. Ownership had no problem skyrocketing past the tax threshold in order to sign Bauer. The structuring of his contract was largely a mechanism designed to lessen the extent of the luxury damages rather than to avoid them entirely. By paying him $40MM+ in the contract’s first two years and then adding a third year at $17MM, they effectively paid him two-year money on a three-year term.

 

Barring a major injury or collapse, Bauer will opt out at the first (or perhaps more likely) second chance he gets, guaranteeing him either $40MM (with an opt-out next winter) or $85MM (with an opt out post-2022). But rather than actually being on the hook for a $40-42.5MM annual value that would’ve come with tax hits north of 75 percent, the Dodgers are “only” on the hook for a $34MM annual value.

 

If all of this -- and Tim’s luxury tax post on the site last week -- make your head spin, it probably should. It’s a needlessly complicated system that could’ve been avoided, or at least had its impact lessened, with better negotiating during the previous wave of CBA talks. With the current agreement expiring post-2021, it’s possible this is the last year we’ll see the luxury tax in this form. Hopefully that’s the case, but it’s sure to be one of the most fiercely contested issues.

[RobinThicc]

I think its hilarious how the players union essentially let there be a soft cap but didnt get a floor in return.

 

So poorly run.

[connorp]

I think its hilarious how the players union essentially let there be a soft cap but didnt get a floor in return.

 

So poorly run.

 

Not sure the PA let’s there be a soft cap. That’s what they would clearly prefer, no? If there was a hard cap you’d want a floor I guess

[RobinThicc]

Not sure the PA let’s there be a soft cap. That’s what they would clearly prefer, no? If there was a hard cap you’d want a floor I guess

 

The luxury tax being a thing pretty much acts as a soft cap. You can blow past ilthe threshold if you want, but theres still an incentive not to.

[Jays24]

The luxury tax being a thing pretty much acts as a soft cap. You can blow past ilthe threshold if you want, but theres still an incentive not to.

 

But how many teams does the luxury tax even apply to? Whole system is a joke when you compare the wide range of total salary from the Dodgers to the Rays/Marlins.

[connorp]

The luxury tax being a thing pretty much acts as a soft cap. You can blow past ilthe threshold if you want, but theres still an incentive not to.

 

Yeah but a hard cap puts a lot of pressure downwards on paying the super elite players and also other contracts in trying to fill your team out. There’s benefits to both but the current system is better for the players

[Spanky99]

But how many teams does the luxury tax even apply to? Whole system is a joke when you compare the wide range of total salary from the Dodgers to the Rays/Marlins.

 

That's why a floor needs to be implemented. IMO.

[connorp]

But how many teams does the luxury tax even apply to? Whole system is a joke when you compare the wide range of total salary from the Dodgers to the Rays/Marlins.

 

Yeah if you go to a hard cap, the teams that will be pressing the ceiling are the big market teams. You’ll take them out of the market on players and that may be better for competitive balance but not for the players

[connorp]

That's why a floor needs to be implemented. IMO.

 

There should be a floor, agree on that but players didn’t make a concession allowing a soft cap was what was in dispute

[Spanky99]

There should be a floor, agree on that but players didn’t make a concession allowing a soft cap was what was in dispute

 

Gotcha.

[Grant77]

Players like Troy Tulowitzki become a hot commodity if they implement a salary floor.

[RobinThicc]

Yeah but a hard cap puts a lot of pressure downwards on paying the super elite players and also other contracts in trying to fill your team out. There’s benefits to both but the current system is better for the players

No doubt the current system is better than a hard cap, but the pa essentially there be a soft cap, hence teams signing contracts like Bauers, Walkers, Wilsons, without getting a floor.

 

Any type of salary cap should come with a floor.