The Impact of Payroll Tax on the Pursuit of Giancarlo Stanton

“I know all teams have plenty of money.”

—Giancarlo Stanton

This season’s National League MVP, Giancarlo Stanton, recently addressed rumors that Miami might trade him, noting that the club could immediately become a postseason contender with the addition of pitching. His suggestion that all teams have plenty of money certainly appears to be a response to speculation that the Marlins intend to slash payroll a few months after having been purchased for more than a billion dollars.

It also stands to reason that he was commenting upon the fact any club could theoretically afford to acquire Stanton and the $295 million remaining on his contract. In one sense, he’s probably right. Revenues in baseball are at an all-time high. For a number of reasons, however, there’s not a direct correlation in baseball between revenues and spending.

One main reason is the competitive-balance tax, formerly known as the luxury tax. The cap for the tax has increased at only about half the rate of MLB payrolls. Accordingly, more teams find themselves up against a tax that was made more painful in the last CBA. Those taxes have pretty drastic effects on the trade market for Giancarlo Stanton, putting some teams out of the bidding and making the cost for others high enough that a competitive offer might be unreasonable.

Two years ago, Nathaniel Grow wrote an excellent piece about the implications of the luxury tax this century, showing how many teams used the tax as a cap, which has driven down spending relative to revenue over the last decade. In the last few years, the tax threshold has grown at a very slow rate, such that, by the end of the current CBA, teams with an average payroll will find themselves just a single major free-agent signing away from transcending it. The graph below depicts both average team payrolls and the tax threshold since 2003.

Over the last 15 years, payroll has grown at a pace 50% faster than that of the competitive-balance tax amount. However, the chart above actually overstates the rate at which the competitive-balance threshold has grown. From 2003 until the beginning of the previous CBA in 2011, the luxury tax grew at a rate pretty close to MLB payrolls, even if it did depress salaries compared to revenue. Beginning with the CBA that started in 2011 and the new CBA, which goes through 2021, the competitive-balance tax has seen barely any growth, especially when it comes to payroll.

Below are the numbers starting with 2011 instead of 2003. I’ve projected a leaguewide salary increase of 5% annually from 2018 to -21. (Which is actually conservative: between 2011 and -17, it was 6.7%.) As you can see, payrolls are advancing upon the tax threshold quickly.

The tax amount has not kept up with payroll and could really hinder spending into the future, decreasing the numbers of bidders in free agency, where players make nearly all of their money. But the effect isn’t limited to free agency. Let’s take a look at a concrete example by examining how much teams would have to pay to trade for Giancarlo Stanton.

First, let’s estimate how much Stanton would cost over the next four years to a team that’s below the tax amount. We’ll use four years as an example, as that’s how long the current CBA will last. If Stanton were to stay on the Marlins or get traded to a team with a lot of payroll room, like the Astros, Cardinals,or Phillies, this is what Stanton would cost and how much the those teams would receive in value. (I’ve used Stanton’s Steamer projection for 2018 to estimate his value and applied a generic aging curve.)

The cost to the aforementioned clubs would be $106.0 million over the next four years — which is to say, identical to the actual amount of Stanton’s contract over that period.

Now let’s take a look at a club that currently possesses a higher payroll — in this case, the Giants. The Giants are a team currently situated right at the tax threshold. If they trade for Stanton, however, it appears as though they’d try to shed payroll elsewhere to avoid paying as much of a penalty. They are a multi-year payor of the competitive-balance tax, meaning they are assessed a 50% tax on the amount by which they exceed the cap.

The Giants could try and  shed some payroll to reduce their tax, but they would then be making the team actively worse when they are trying desperately to contend. For the sake of this exercise, let’s assume the Giants stay around $20 million over the tax amount every year they have Stanton.

As you can see, the actual cost of employing Stanton would be greater for the Giants than the other teams mentioned above. Over the next four years, they’d pay $146.0 million, a figure that includes their competitive-balance tax figures. That’s $40 million more than the Cardinals or Marlins. It’s another $10 million of average annual value.

If we assume that the next CBA resembles the current one and that the Giants stay about $20 million over the tax cap, we are no longer talking about a contract with 10 years and $295 million remaining. The Giants would then be paying out $395 million over those 10 years. A lot can happen over the course of 10 years, of course. It’s possible that the Giants might be able to transform their current veteran-heavy roster to a younger, cheaper one. But that doesn’t look anything like the near future in San Francisco.

We could also acknowledge that it isn’t just Stanton’s contract that causes the team to go over the taxable payroll amount — that all contracts contribute to it — but over the next few years, those contracts are already on the books. San Francisco already has $109 million on the books for 2020, for example, and that’s without accounting for Madison Bumgarner, who will be a free agent after 2019. If the team wants to contend, with or without Stanton, they’re going to have to spend some amount of money.

Now let’s examine the Red Sox. Boston got under the tax amount last season so they’re in the 20% tax bracket this season, followed by 30% for a second year, and 50% for a third year. However, they’re already over the tax amount for the 2018 campaign — and, with Chris Sale’s options and arbitration raises for important players like Mookie Betts and Xander Bogaerts, they’re looking at $150-plus million already for 2019.

Let’s say they’ll enter the 2018 season in excess of the cap by $30 million and then $20 million over the seasons beginning in 2019.

Because the Red Sox were able to get under the tax last season, their liability is slightly less than the Giants’. Of course, the numbers I’ve chosen here assume that the Red Sox don’t make substantial increases in spending that would potentially increase their tax payments. As Betts, Bogaerts, and Bradley head toward free agency, the organization can hope that Andrew Benintendi and Rafael Devers make up the production, but the team might feel the need to sign Betts to a massive contract, as well.

Boston was recently hit hard with international signing penalties and aren’t expected to pick near the top of the draft anytime soon, which makes building from within difficult. Stanton still seems likely to produce surplus value in his first four years, but those last six might be a different story. If he ages poorly, the competitive-balance tax would make it even more difficult for Boston to get some kind of value from Stanton, without considering the prospect cost as well.

The last model we’ll consider includes clubs with Dodgers- and Yankees-type spending habits. We know the Yankees likely aren’t a fit for Stanton already because of their competitive-balance tax situation. They have an opportunity to go under the tax threshold in 2018, and it appears as thought they’ll take it, saving around $20 million in 2019 and 2020. Those figures don’t even consider the savings from a lower payroll in 2018 after a playoff run that should boost revenue next season. The Yankees might spend $30 million less next season and make $30 million more if they get an attendance boost. For the sake of this post, let’s pretend the Yankees were to continue doing Yankees-type spending.

The Dodgers, for their part, have been far in excess of the tax amount for the last few years. While their payroll has been trending down a bit and they do have a bunch of expiring contracts, adding Stanton would put them well over again this year, and likely into the future.

Once a team is $40 million over the tax threshold, there’s nearly a dollar-for-dollar tax on payroll, up from the 50% for three-time payors for the first $20 million over or the 62% with 12% surtax on the amount between $20 million and $40 million. For our purposes below, let’s assume the Yankees and the Dodgers would stay right around $40 million above the threshold, not wanting to incur the mega-tax that also includes a penalty of dropping 10 spots for the first pick in the next draft. Once again we’ll assume the team without Stanton would not have spent Stanton’s salary money elsewhere, making Stanton a special, one-time, push-you-over-the-top type acquisition.

This what the outlay to Stanton looks like in the first four years of the deal, noting that for tax purposes, Stanton’s deal is an even $25 million over the life of the contract.

Here we find an ever greater expense than in any of the scenarios above. For the Dodgers or Yankees, Stanton would cost roughly $60 million more over four years. At that price, the incentive for either club becomes much lower.

Giancarlo Stanton is going to cost the high-payroll team nearly free-agent prices in the good years of his contract, a period during which a team expects to receive some surplus value. The above situations are hypothetical, of course. One or more of these teams could move payroll around a number of different ways. Nevertheless, these scenarios should illustrate the different type of costs with which teams are dealing when they try to make a trade for a player like Stanton or are about to sign a major free agent to a big contract. It doesn’t hurt those teams until the cost reaches the very top in terms of payroll, but that top is moving increasingly down when you compare it with the average payroll throughout the game.

The irony of the present situation is that the competitive-balance tax, in theory, hurts the big teams by making them spend more than the rest of the league for the same talent. Here, though, it’s the lower-revenue Marlins who are hurt by having their potential suitors either evaporate — like the Yankees — or deal with considerably higher acquisition cost, like the Dodgers, Giants, and Red Sox, where teams have to adjust what they are willing to give up based on the cost. In the Giants’ case, it means moving other assets that might contribute, making the team worse in order to avoid paying as much in tax. As Stanton says, everybody has a lot of money, but the cost to acquire Stanton isn’t the same for every team due to the competitive-balance tax in the new CBA. Offers are going to reflect those differences.