| League | Payroll rules |
|---|---|
| Major League Baseball | Luxury tax |
| National Basketball Association | Soft salary cap + luxury tax |
| National Football League | Hard salary cap |
| National Hockey League | Hard salary cap |
A luxury tax in professional sports is a surcharge put on the aggregate payroll of a team to the extent to which it exceeds a predetermined guideline level set by the league. The ostensible purpose of this "tax" is to prevent teams in major markets with high incomes from signing almost all of the more talented players and hence destroying the competitive balance necessary for a sport to maintain fan interest. The money derived from the "tax" is either divided among the teams that play in the smaller markets, presumably to allow them to have more revenue to devote toward the contracts of high-quality players[1] , or in the case of Major League Baseball, used by the league for other pre-defined purposes.
In North America, Major League Baseball has implemented the luxury tax system. The National Basketball Association also has a luxury tax provision; its utility is somewhat limited by the fact that the league also has a salary cap provision. The "hard" salary cap of the National Football League has prevented any need for a luxury tax arrangement.[2] The National Hockey League also has a hard salary cap.
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In the Big 4 North American sports leagues (Major League Baseball (MLB), National Basketball Association (NBA), National Football League (NFL), and National Hockey League (NHL)), there are three different methods employed to limit individual teams payroll: hard salary cap, soft salary cap with luxury tax, and luxury tax.
A hard salary cap is where the league sets a maximum amount of money allowed for player salaries, and no team can exceed that limit.
A soft salary cap has a set limit to player salaries, but there are several major exceptions that allow teams to exceed the salary cap. For example, in the case of the NBA, teams can exceed the salary cap when keeping players that are already on the team.
A luxury tax system does not have a limit to how much money can be spent on player salaries. However, there is a tax levied on money spent above a threshold set by the Collective Bargaining Agreement (CBA) between the players union and the owners. For every dollar a team spends above the tax threshold, they must also pay some fraction to the league. This system is used to discourage teams from greatly exceeding the tax threshold, with the goal of ensuring parity between large and small market teams.
Major League Baseball uses a luxury tax (also called a competitive balance tax) with no salary cap to discourage high payrolls. Teams whose overall payrolls (40-man roster) exceed a pre-determined threshold must pay a tax on the amount by which they exceed the threshold.
The per-year thresholds and tax rates are set out in the Collective Bargaining Agreement between the owners and the players union. In 2011, the tax threshold is set at $178 million, an increase from the $170 million cap in 2010. Teams who exceed the threshold for the first time must pay 22.5% of the amount they are over, teams who are over for the second time must pay 30%, and teams that have been over more than twice must pay 40%.[3]
The current luxury tax system was instituted in 2003 as a way to discourage big market teams from having a substantially higher payroll than the rest of the league. Only four teams have ever exceeded the luxury tax threshold, the Boston Red Sox, the Los Angeles Angels of Anaheim, the Detroit Tigers, and the New York Yankees. Only the Red Sox and Yankees have exceed it twice, with the Yankees having contributed 95% of the total contributions.
The luxury tax is separate from revenue sharing, which is a system to balance out the income distribution between large and small market teams by dividing money from merchandise sales and media contracts. The money generated from the luxury tax is not distributed to the rest of the league, as is the case with the NBA, but rather is used for other purposes. The first $5 million is withheld to cover potential refunds, and is contributed to the Industry Growth Fund (IGF) if no refunds are forthcoming. The remaining money is divided as follows: 50% funds player benefits, 25% funds developing baseball in countries without high school baseball, and 25% goes to the IGF.[4]
| Team | 2003 | 2004 | 2005 | 2006 | 2007 | 2008 | 2009 | 2010 |
|---|---|---|---|---|---|---|---|---|
| Luxury tax threshold | 117 | 120.5 | 128 | 136.5 | 148 | 155 | 162 | 170 |
| Yankees | 11.8 | 26 | 34.1 | 26 | 23.88 | 26.9 | 25.69 | 18 |
| Red Sox | - | 3.15 | 4.1 | 0.498 | 6.06 | - | - | 1.49 |
| Angels | - | 0.927 | - | - | - | - | - | - |
| Tigers | - | - | - | - | - | 1.3 | - | - |
The NBA utilizes a soft salary cap, meaning there is a salary cap but there are a variety of exceptions that allow teams to exceed that cap. For example, teams can resign players already on the team to an amount up to the maximum salary allowed by the league for up to six years regardless of where their payroll is relative to the cap. This provision is known as the ""Larry Bird" exception, named after the former Boston Celtics great who was retained by that team until his retirement under the provisions of this rule. The result is that the majority of teams are over the cap at any given time.
In addition to the soft cap, the NBA utilizes a luxury tax system that is applied if the team payroll exceeds a separate threshold higher than the salary cap. If a team exceeds the luxury tax threshold, they must pay one dollar to the league for every dollar that they are over the limit. The resulting total is then distributed to the remaining teams that are under the tax threshold. However, the luxury tax penalty is only applied if the league average payroll exceeds a separate threshold.[11]
The effectiveness of the luxury tax system at limiting the growth of players salaries is in question. Although exceeding the luxury tax threshold costs the team twice as much money, it does not seem to limit teams' willingness to spend big money on players. As a result, since 2001 player salaries have jumped from $1.6 billion to $2.3 billion, and have outpaced league revenue growth by $110 million. At the start of the 2009-2010 season, 14 out of 30 NBA teams were above the tax threshold, with seven at least $10 million over.[12]
| Team | 2002-03 | 2003-04 | 2004-05 | 2005-06 | 2006-07 | 2007-08 | 2008-09 | 2009-10 |
|---|---|---|---|---|---|---|---|---|
| Luxury Tax Threshold | 52.9 | 54.6 | 0 | 61.7 | 65.42 | 67.865 | 71.15 | 69.92 |
| Knicks | * | 39.8 | - | 37.2 | 45.142 | 19.724 | 23.736 | 14.65 |
| Trail Blazers | * | 28.8 | - | - | - | - | 5.899 | - |
| Mavericks | * | 25 | - | 17.3 | 7.205 | 19.613 | 23.612 | 17.79 |
| Timberwolves | * | 17.6 | - | - | 0.999 | - | - | - |
| Kings | * | 9.7 | - | - | - | - | - | - |
| Lakers | * | 8.3 | - | - | - | 5.132 | 7.186 | 21.42 |
| Nets | * | 7.3 | - | - | - | - | - | - |
| Sixers | * | 5.5 | - | - | - | - | - | - |
| Raptors | * | 4.1 | - | - | - | - | - | - |
| Pacers | * | 3.2 | - | 4.7 | - | - | - | - |
| Celtics | * | 1.6 | - | - | - | 8.218 | 8.295 | 14.98 |
| Pistons | * | 0.8 | - | - | - | - | - | - |
| Magic | * | - | - | 7.8 | - | - | - | 1.99 |
| Grizzlies | * | - | - | 3.7 | - | - | - | - |
| Spurs | * | - | - | 0.9 | 0.196 | - | - | 8.853 |
| Nuggets | * | - | - | - | 2.022 | 13.572 | - | 5.19 |
| Cavaliers | * | - | - | - | - | 14.009 | 13.707 | 14.8 |
| Heat | * | - | - | - | - | 8.319 | - | 2.83 |
| Suns | * | - | - | - | - | 3.867 | 4.918 | 5.01 |
| Jazz | * | - | - | - | - | - | - | 12.629 |
The National Football League and the National Hockey League both have hard salary caps and do not utilize the luxury tax. Several other leagues in the United States and abroad use salary caps, but the luxury tax is uncommon.