A Minor CBA Change Could Create Contract Wrinkles

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If you weren’t looking for it, you’d miss it. Buried in a blow-by-blow account from The Athletic’s Matt Gelb of how the Phillies ended up signing Kyle Schwarber, FanGraphs newsletter writer Jeffrey Bellone spotted something interesting:

“However, under the new CBA, a traded contract is recalculated to reflect the remaining actual dollars. That means contracts that are backloaded will be harder to trade (if the acquiring team is concerned about the luxury tax threshold).”

This change was an afterthought in the piece, an offhand justification the Phillies made for not acquiring Kevin Kiermaier. His remaining average salary outstrips the average annual value of his deal, which means that under the terms of the new CBA, he’d carry a higher tax hit than he would have in the old regime. The ownership group’s desire to abide by the sport’s soft salary cap made Kiermaier’s salary an untenable addition.

With the benefit of hindsight, it seems that ownership didn’t actually care about the dollars very much, given that they signed Nick Castellanos and ticked over the first CBT threshold anyway. And given that the tax rate is 20%, the difference in Kiermaier’s tax hit under the old and new agreements is a hair under $6 million; the total monetary difference would have been roughly $1 million in assessed tax. That’s a vanishingly small difference on a $230 million payroll.

I’ll level with you: I don’t think this is going to be an earth-shaking change to the economics of baseball. Only five teams look likely to pay any tax this year, with a few other in hailing distance of the barrier. The differences aren’t huge; $6 million a year isn’t quite a rounding error, but it’s hardly a life-and-death number. Remember: teams are not actually paying Kiermaier $6 million more than they would have before. Salary is salary. This is merely an accounting game that affects teams who pay at least some amount of tax.

Still, we analysts love financial tomfoolery, so let’s consider a few contracts that are interestingly shaped now that trades can trigger the re-calculation of tax numbers. First, a quick disclaimer: I haven’t seen the exact text of the new agreement. It’s unclear how the Rays’ CBT number would be affected by trading Kiermaier; I’m assuming no effect, but if that isn’t the case, that obviously changes the calculus. It’s not clear how signing bonuses will be handled, either; it appears that it would be spread evenly across each year, but again, I’m working from the outside.

With all that said: we should probably call this the Eric Hosmer rule. To explain why, let’s start generalizing. Baseball contracts mostly take two forms: flat payouts or back-loaded. A flat dollar-per-year payout is easy for accounting; when the Braves extended Matt Olson, for example, they agreed to pay him $22 million in each of the six free agency years they bought out. Manny Machado is getting $30 million in cash every year of his deal. Zack Wheeler’s deal isn’t quite so flat, but he’s making an average of $23.3 million in the first three years of his deal and an average of $24 million in the last two years, more or less a flat number. The new CBT rules aren’t interesting for these types of contracts.

All three of those examples cover players who were free agents (or near-free agents used for illustration in Olson’s case). The other common contract shape is the pre–free-agency extension, which almost always escalates over time. Wander Franco’s blockbuster extension has an average annual value of $16.5 million, but he’s making $2 million in 2023 and $25 million in 2032 because the annual payouts roughly mimic what he could expect to make if he hadn’t signed an extension. His lowest salaries are in the years that would have been pre-arbitration years before signing the extension, followed by an arb-mimicking increase in salaries and a final high annual salary for the free-agency years the contract buys out. The new CBT rules make trading for players with these contracts more costly from a tax standpoint, as recalculating the average annual value later in the contract will always result in an increase.

Hosmer’s deal doesn’t fall into either of these categories. He signed an eight-year, $144 million deal with the Padres, which works out to $18 million per year. The shape of the contract was novel: $21 million in each of the first five years, followed by an opt out, followed by $13 million in salary for each of the last three years.

Hosmer almost certainly won’t opt out, because replacement-level first basemen don’t get eight-figure salaries. He’s been rumored as a trade candidate for years now; the Padres are running a payroll near the tax line, which means that paying less on Hosmer’s contract and in tax are both incentives for them to move him.

Under these new rules, an acquiring team would be on the hook for $5 million less in tax hit if San Diego traded him after this season. If the Padres were willing to chip in some of the salary Hosmer is owed, his new club might incur a seven-figure tax charge, or roughly half what the Padres are on the hook for at the moment.

Is that a big deal? Not in the current landscape, where none of the teams who care about their total CBT payrolls would be interested in rostering Hosmer. That doesn’t mean the same will be true next year, though. Hosmer could get better. An incumbent lefty first baseman could get hurt or decline precipitously, leaving an obvious positional fit. Some team that’s not currently in range of the tax line could add a pile of contracts to its payroll while somehow maintaining a hole at first base. That’s a far-fetched scenario, but certainly not impossible.

In those instances, this new method of salary calculation could be a meaningful tailwind in trade talks. In lowered tax numbers, $15 million — $5 million each year for three years — is hardly a king’s ransom. But for a team that expected to exceed the threshold in each of the three years, that’s $3 million in lowered tax payments, which is more than zero, and every little bit counts when you’re trying to move an underwater contract.

While Hosmer’s situation is the most obvious current implication of this new wrinkle, I can think of one obvious move teams should be making to get the most out of the byzantine workings of the system. When you’re signing someone like Machado, why make the payouts level in each year? Instead, the new natural shape is for a mostly flat contract with a sharply lower last year. Instead of ten years at $30 million each, what about $33 million for the first eight, $20 million for year nine, and $16 million for the last year? The numbers are the same, especially if you ignore Machado’s opt-out; I’m going to do just that, since I’m using his contract as an illustration anyway.

The way things were in the old system, trading an aging veteran almost always meant one of two things: trading them to a team that was near the tax threshold and eating almost all of the money left on their deal, or attaching prospects to send the contract off to a non-contender willing to take on the salary. If veteran contracts can essentially scale down upon a trade — assuming the average annual value of the last few years rather than the deal as a whole — then tax-adjacent teams would make more sense as a landing destination. And imagine the bonanza if two teams both afraid of paying the big bad tax could exchange veterans at the end of their contracts. If two teams exchanged identical versions of the Machado contract I just made up, they could each save $14 million in tax calculations.

Does the fine print of the rule actually allow these silly shenanigans? I have no idea! Maybe the trading team has to assume the difference in cap numbers, which would instead incentivize contracts that increase over time. Maybe there are mechanisms in place to handle the loopholes I’m hunting here. But there should be something teams can do that will allow them to spend more without triggering tax payments, and I’m excited to see who figures it out first.

Ben is a writer at FanGraphs. He can be found on Twitter @_Ben_Clemens.

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1 year ago

MLB wants teams to reduce their longer term debt loads.
Discentivizing backloaded contracts and Bobby Bonilla deals helps.

They may very well want teams to go with aging curve contracts…
…or just discentivize very long ones.