It’s official name is the "competitive balance tax," but it is more commonly referred to as the "luxury tax." That is the payroll level above which a Major League Baseball club must pay a 17.5 percent penalty on the amount above the threshold, if they were not above the limit in the previous season. That is the tax rate that the Detroit Tigers would have to pay on the overage, if their actual club payroll were to exceed the luxury tax threshold for the 2015 season.
The luxury tax threshold is at $189 million for the 2015 season. However, the real limit is about $11 million lower than that, because the club’s share of player benefits -- a total not typically calculated into commonly shared payroll figures -- is added to the total payroll. So the tax triggers at about $ 178 million in salaries and bonuses.
We have estimated that the Tigers’ payroll for 2015 would be approximately $170.6 million. This involves a couple of assumptions: they will (1) exercise the club options on Alex Avila and Joakim Soria, (2) re-sign Victor Martinez for $16 million, and (3) fill out the roster with nine players earning the league minimum salary. That is without replacing or signing Max Scherzer or Torii Hunter, and without addressing any needs in center field or the bullpen.
That figure of $170.6 million is not the actual number that will be used by Major League Baseball to determine whether the Tigers will have to pay a luxury tax in 2015. The MLB calculation uses the average annual value (AAV) of the current contracts for each of the players on the roster, including those optioned to the minor leagues. You also have to figure in bonuses that may not be known until after each season is completed.
For Detroit, the four highest paid guaranteed contracts add up to $82.8 million in 2015 salaries that will be paid to the four players: Justin Verlander, Miguel Cabrera, Ian Kinsler, and Anibal Sanchez. But Verlander’s contract includes two seasons from his old contract at $20 million per season that were wrapped into his next contract, which pays him $28 million per season going forward. Miguel Cabrera will be in the last year of his current contract with an AAV of $19 million. He starts a new contract with an AAV of $31 million in 2016, according to Cot's contracts. How the AAV is calculated has a large impact on the luxury tax implications.
The actual salaries paid to minor league players is relatively small, as those players earn only a few thousand dollars per month, if they’re lucky. There are very few guaranteed major league contracts remaining among minor league players, since the latest collective bargaining agreement (CBA) put an end to them for newly drafted players.
The net result of all this is that the Detroit Tigers’ payroll for luxury tax purposes is about $163 million for 2015, leaving them approximately $15 million to spend on fixing up the bullpen and the outfield before they get hit with a luxury tax. If they don’t sign Victor Martinez, that number increases to about $31 million. This assumes that Cabrera's old contract is used for AAV.
It’s not the end of the world to exceed the luxury tax threshold, although it’s something the Tigers surely would like to avoid. As a first time "offender" they would pay a relatively modest tax. The New York Yankees, for instance, pay a 50 percent tax on every added salary because they have exceeded the threshold for the past several years. For example, if the Tigers were to exceed the limit by $10 million, they would pay a $1.75 million penalty. The Yankees are in a position where every extra dollar spent on player salaries will cost them a buck and a half because of the tax.
The 2016 season will be the final season for the current CBA and the final season that Major League Baseball will have the current luxury tax scheme in place. There is a specific sunset clause in the agreement that clearly states the next CBA will not have a competitive balance tax.
The Tigers could be much more concerned about the tax for the 2016 season. Miguel Cabrera will be the most expensive player and will be under a new contract that begins in 2016. It’s too soon to tell whether they will be able to extend such players as David Price and Rick Porcello, and how much they will add to the payroll if they are extended. Joe Nathan and Joakim Soria could be free agents also.
Decisions that are made this off season will have an impact on the payroll numbers for the 2016 season as well as this coming season. They will have to be careful when adding payroll for the 2016 season. But for the time being, the club should have enough of wiggle room to sign Martinez, exercise the options on Soria and Avila, and patch up the bullpen and the outfield.