How does the Luxury Tax work in MLB?

Answer 1

MLB's current collective bargaining agreement sets a 'payroll threshold' each season that is somewhat similar to a salary cap. For the 2007 season, this threshold has been set at $148 million ($155 million in 2008). Should the average annual value of a team's total salary contracts surpass this threshold in any year, they pay a 'tax' on the amount over the threshold. The tax is graduated such that a team pays a progressively higher percentage every year it exceeds the threshold, to a maximum of 40%. As an example, when Roger Clemens signed with the Yankees this season, his salary was reported at $18.5 million. But since the Yankees have already exceeded the payroll threshold several times, they were forced to pay the maximum luxury tax on his salary of 40%. Applied to Clemens' salary, the tax comes to $7.4 million. So in actuality, Clemens is costing the Yankees $25.9 million this season. The Luxury Tax is also called the 'Competitive Balance Tax'. Ironically, the money from the tax isn't distributed to smaller market teams to promote competitive balance. Instead, it goes into an 'Industry Growth Fund' that MLB uses for player benefits and to promote the growth of Baseball around the world. Money is distributed to smaller revenue teams, but that money comes from MLB's revenue sharing program, which is entirely separate and independent of the luxury tax.