The Luxury Tax Proposal for Major League Baseball: A Partial Equilibrium Analysis
Elizabeth Gustafson and Lawrence Hadley
The longest strike in major league baseball ( MLB) began in August 1994. The owners' main objective was to control growing players' salaries by placing a floor and ceiling on team payrolls. The players wanted to avoid administered limits on salaries and to retain the two key provisions of the existing contract: salary arbitration and free agency. The owners' offer to guarantee players 50% of total MLB revenue was not sufficient to convince players to agree to limits on team payrolls.
Most recently, both sides have agreed in principle on a luxury payroll tax. MLB would impose a tax on all teams whose payrolls exceed the average MLB payroll by a defined percent. The areas of disagreement are the tax rate and the defined percent. As of March 1995, the owners had proposed a 40% tax rate on the portion of any team's payroll exceeding the mean MLB payroll by 15%. Based on an estimated mean payroll of $40.7 million in 1994, this tax would take effect for all payroll dollars exceeding $46.8 million. The players have proposed a 25% tax rate which would take effect for payroll dollars above $54 million. This defines the tax bracket at 32.7% above the MLB mean payroll for 1994.
Despite their conceptual agreement on a luxury tax, both sides are still far apart. Indeed, neither side has really abandoned its original objective. If the tax bracket is low and the tax rate high (as proposed by the owners), the luxury tax acts as a quasi-cap on team payrolls. If the tax bracket is high and the tax rate low (as proposed by the players), the tax has only a negligible impact on the players' labor market.
The purpose of this chapter is an economic analysis of the luxury tax. We use a supply and demand model of MLB's labor market to examine the expected impacts of this tax on players' salaries and on competitive balance in MLB.