Does Baseball Need a Salary Cap?

NEIL DEMAUSE

Perhaps no two words in baseball generate as much controversy and emotion as “salary cap.” (“Designated hitter” might be a close second.) Depending on whom you ask, a salary cap would either save the game, destroy the players’ union, provide hope for small-market fans, pervert the free market, or create a tangle of red tape that would turn every trade deadline into a battle of wits among dueling “capologists.” Whenever owners and players have to negotiate a new collective bargaining agreement—the next tussle is scheduled for after the 2006 season—discussion of a cap is sure to follow. Mere mention of the c-word usually throws a giant wrench into labor talks and raises fans’ fears of another 1994.

The concept of a cap sounds simple enough. Every team, whether the Yankees or the Devil Rays, is given an annual salary budget, and no team is allowed to exceed it. But as actually practiced by pro sports leagues, salary caps come in a million flavors: hard caps and soft caps, franchise-player exemptions, and luxury taxes. Each tweak to the system runs headlong into the economics of unintended consequences.

Before we can determine whether a salary cap would fix baseball, we have to decide just what it is about baseball that we want to fix. Taxes and caps have been suggested to cure various ills, including payroll inflation, high ticket prices, and competitive imbalance. Let’s take them one at a time.

Reducing Player Salaries

As economists like to point out, if you want less of something, you should put a tax on it—and player salaries are no exception. Reduce the ability of the richest teams to bid up the price of players and salaries are sure to fall.

How this plays out depends on the type of tax in place. A salary cap—which should more properly be called a “payroll cap,” since it says nothing about individual player salaries, only overall team payrolls—is the simplest to envision. Once teams have reached the magic payroll number, they are forbidden to spend more. This reduces salaries in two ways: Teams that are over the cap are taken out of the bidding for free agents (or for pricey trade targets), giving available players fewer options and reducing bidding pressure, and teams that are just below the cap will resist blowing their budget on a single player. This is precisely why the players’ union has always fought bitterly and successfully against a hard cap.

Instead, baseball now has two modified cap-type mechanisms: the luxury tax and revenue sharing. The luxury tax, instituted in the 2002 collective bargaining agreement after a brief trial run in the late 1990s, is essentially a soft cap. Teams can bust their league-appointed budget, but at the cost of being taxed—“fined” might be a better word—for the excess amount. The tax starts at 22.5 percent and increases for repeat offenders. As a three-time recidivist, the Yankees paid a 40 percent tax on their excess spending in 2005. (Thanks to the oddities of collective bargaining, first-time violators received a bye in 2006.)

It’s easy to see how a 40 percent tax would be a drag on spending. Coughing up $20 million a year for a superstar player is one thing, but adding another $8 million in payments to the league could make the deal untenable. Imagine how you would react if you had to pay a 40 percent surcharge for every gallon of gas you bought over the first ten. Filling up would become a thing of the past.

The main reason the luxury tax hasn’t led to a crash in player salaries is that it very rarely comes into play. The tax threshold started at $117 million in 2003, rising in steps to $136.5 million in 2006. In its first three years, it was paid only six times, half of those by the Yankees. (The luxury tax, in fact, is widely known as the “screw the Yankees tax.”) This is why the players’ union didn’t consider it worth striking over: While putting the reins on George Steinbrenner’s checkbook may have been distasteful, it left the rest of the league free from constraints, and perhaps, with the Yankees brought down to earth a bit, more willing to spend. If the owners’ original proposal—a 50 percent tax on all spending over $84 million per team—had been enacted, it would have hit ten teams in 2005 and sent shock waves through baseball’s salary structure.

Baseball’s other main income-redistribution scheme is revenue sharing, which has existed in one form or another for decades (counting such ancient innovations as giving a portion of ticket receipts to the visiting team). In this general form, revenue sharing is a less obvious means of keeping down salaries, but it’s a means toward that end nonetheless. To see why, think about players as cost-conscious owners do—not as heroes to cheer from the grandstand but as business investments.

Let’s say you’re Texas Rangers owner Tom Hicks in the winter of 2000–2001, and you’re deciding whether to sign Alex Rodriguez to a record $25-million-a-year contract. Certainly, you’re going to look at A-Rod’s stats: just twenty-five years old with 189 home runs and a batting title under his belt. But when figuring out how much to pay him, you’ll also consider his value: How many more tickets will he sell; how much will he increase advertising revenue on your team’s broadcasts; how many more souvenir jerseys will fans buy; how much will he increase the value of the franchise? If the answer isn’t “more than $25 million a year,” then paying A-Rod that much would be foolish—unless you’re willing to lose money in pursuit of a World Series ring.

Add in revenue sharing and the picture changes greatly. The current system is complicated, but it can be summed up in a simple rule: Every team in the league, rich or poor, gets to keep about 60 cents on every new dollar it earns. For high-revenue teams, this percentage comes from having to write bigger checks to the league the more money they make; for the low-revenue ones, it’s in receiving smaller checks from the league as revenue increases.

Go back to Hicks’s dilemma. Now he doesn’t need to ensure that Rodriguez brings in $25 million a year to pay his own way. Rather, A-Rod needs to increase revenue by $41.7 million a year ($25 million = 60 percent of $41.7 million). Suddenly his potential dollar value to a team has plummeted. That’s even more true for teams at the bottom of the barrel, who are subject to a higher tax rate. (Chapter 5-2, “Is Alex Rodriguez Overpaid?” explores this topic in more detail.)

It’s easy to see, then, why the players’ union has fought bitterly against revenue sharing, considering it a thinly disguised way to transfer money from players’ pockets to owners’. It’s also easy to see why owners love it, Steinbrenner notwithstanding. But to see what revenue sharing means to fans, who presumably don’t care which millionaire is getting their hard-earned money, we need to look at the proposed effects of cutting player salaries.

Lowering Ticket Prices

The theory here is that reducing the amount of money teams spend on players will reduce the amount of income they need and thus allow them to lower ticket prices—or at least not increase them quite so fast.

If you’ve been skipping around in this book, here’s where you should go back and read Chapter 6-1 on the link between team payroll and ticket prices. In a nutshell, there is no such link. Or rather, while increased ticket prices do seem to drive up payroll, increased payroll decidedly doesn’t drive up ticket prices. So don’t expect your favorite team to offer cheaper seats just because they failed to sign Carlos Beltran.

Yet this isn’t entirely true. If the Yankees hadn’t been afraid of the luxury tax and had signed Beltran, they would have been a better team: Despite his disappointing 2005 season, Beltran was still markedly better than the likes of Bernie Williams and Tony Womack, who contributed next to nothing as the Yankees’ center fielders. This could in turn have increased demand for tickets—yes, even beyond the four million fans the Yankees drew in 2005—and allowed them to raise ticket prices. On the other hand, the distribution of talent is a zero-sum game: When Beltran didn’t sign with the Yankees, he did sign with the Mets, driving up demand for their tickets and thus their ability to raise prices. Such are the hazards of revenue redistribution. If it makes your team more competitive, you’ll be asked to pay for it at the box office.

Competitive Balance

Arguments about salary caps and revenue sharing always come down to competitive balance. When owners were pushing a cap in the run-up to the 2002 labor wars, they made sure to sell it as a means to restore, in Bud Selig’s famous words, the fans’ “hope and faith” that their team could have a shot at a pennant. “Perhaps 12 of 30 Major League teams have any possibility of reaching postseason play, and fewer still have a realistic hope of winning a pennant,” Padres owner John Moores wrote in the Wall Street Journal shortly after his team had, ironically, reached the World Series. “Unless baseball changes the way it does business, it risks seeing its fans drift away, tired of their teams’ futility.”

Of course, in any given year, most teams won’t come close to making the playoffs. A more significant measure is whether poor revenue potential is locking teams out of pennant races for years at a time. The numbers here are less clear: Since the expanded playoffs began in 1995, twenty-two of the thirty big-league teams have reached the postseason at least once; two of the remaining eight, the Phillies and Blue Jays, had just met in the final World Series under the old setup. Compare that to baseball’s “golden age,” when the Phillies once went thirty years without finishing higher than fourth while teams like the St. Louis Browns and Washington Senators rarely even sniffed a pennant race.

TABLE 6-3.1 Postseason Appearances and Average Team Revenue, 1995–2005

That said, the Yankees are one of two teams never to have missed the postseason under the current system (the Braves are the other). If we chart postseason appearances against average team revenue (see Table 6-3.1), we find that the two are correlated at a coefficient of determination (R-squared) of .51—which is to say that a little more than half of getting to the postseason is determined by team revenue.

Of course, there’s a problem here. High revenue may help lead to the postseason, but postseason appearances increase revenue as well. Not only are playoff tickets a lucrative item, but a winning team typically sees regular-season sales soar. Table 6-3.1 could as easily be telling us that half of team revenue can be explained by who gets to the postseason, which isn’t quite what we were after.

To avoid this dilemma, let’s instead compare postseason appearances not with revenue but with TV market size (Table 6-3.2). Beyond the obvious—you really don’t want to play in the tiniest markets, or in Canada—the correlation between market size and playoff appearances is extremely weak. What explains the Cardinals’ or the Indians’ success, or the Phillies’ lack of it? The correlation coefficient has dropped to a mere .11—market size accounts for 11 percent of the cause—meaning anyone who’s tempted to place bets on division winners based solely on TV market size is kidding himself.

TABLE 6-3.2 Playoff Appearances and Market Size, 1995–2005

Regardless of how big a problem you consider competitive balance to be, there’s still the question of how it would be affected by a salary cap. As we’ve seen, a hard cap is an effective way to stop high-revenue teams from spending as much money as they’d like—and even a “soft cap” like the luxury tax can help put on the brakes. But what if your team isn’t near the cap? You have no reason to spend more on players: If that new left fielder wasn’t worth $10 million a year to you before, you’re certainly not going to think he is now. In fact, you might now be willing to pay less for him. Since the big spenders over the cap are out of the running, there are fewer teams eligible to bid on his services, meaning you have a better shot at lowballing him on salary. Even if it lowers salaries across the board, a soft cap doesn’t eliminate the hierarchy of revenues. The teams that can afford to pay the most in luxury taxes will still have their pick of players.

There are only two ways, then, that a spending cap could conceivably improve baseball’s balance. One, if the big-spending teams were brought somewhat down to earth, it might increase the number of teams in contention and thus increase the number of teams willing to invest in high-priced talent to get them over the hump. It’s a bit early to tell if there’s any evidence of this happening since 2002, but if so, the impact is minimal. In any case, it would still do nothing to promote spending among second-division teams.

The other possibility is that if you depress salaries far enough, you eventually get to the point where no teams are priced out of the market for any player—even the Kansas City Royals could fit Barry Bonds into their budget at $100,000 a year. Of course, long before you arrived at that point, you’d have Don Fehr leading a picket line around your house while Gene Orza dropped tear-gas grenades down your chimney. It’s not exactly a workable solution to competitive-balance issues.

The usual union-friendly suggestion for forcing lower-echelon teams to spend on payroll is a “salary floor,” a minimum team payroll to match the maximum imposed by a cap. (The NBA and NHL currently have payroll floors in place.) While this would certainly encourage spending, it might not be the kind of spending you want. It’s arguably more effective for rebuilding baseball teams to throw money into scouting and player development in the short term, then invest in payroll only when they have players worth spending on. Any system that would encourage irrational spending sprees such as the Devil Rays’ run a few years ago on Greg Vaughn, Vinny Castilla, and their ilk wouldn’t be helping matters.

Outsiders’ Proposals

So much for the owners’ ideas. Can baseball outsiders do any better? There’s been no shortage of suggestions for better mousetraps. In 2002, Baseball Prospectus’s Doug Pappas suggested a simple progressive revenue-sharing rate, where teams would keep all their revenue up to 80 percent of the league average, then pay a graduated rate scaling up to 75 percent for revenue over double the league average. Most alternative suggestions, though, have focused on taxing market size rather than revenue. The idea here is that unlike revenue—a gauge of both market size and front-office savvy—market size is a measure of differing opportunity to make money. The Yankees will always have an advantage over the Devil Rays by virtue of being in New York, even if the Rays hire the ghost of Branch Rickey as general manager and the Yanks hire an entire front office of Syd Thrift clones.

One such revenue-sharing plan, devised by Baseball Prospectus’s Keith Woolner, would impose a “market size” tax on payroll, starting at zero for the smallest markets, then scaling up to about 9 percent for the top teams. On the subsidy side, the bottom 40 percent of teams would earn payments based on total wins and improvement in wins over the previous year, plus additional bonuses for making the playoffs or being one of the top teams among small-market clubs. In his book May the Best Team Win, sports economist Andrew Zimbalist proposed an even simpler system: Calculate a theoretical baseline revenue for each team based on how much they’d be expected to earn in a season with a .500 record, then tax them on that, regardless of their actual income.

Of course, these plans have their difficulties: Woolner’s is still a payroll tax and so would create a drag on payrolls. Zimbalist’s would be a nightmare to calibrate, as every new stadium or shift in metro population would move the “average season” baseline. And with untested systems like these, there’s always the risk of creating unforeseen negative effects, such as (under Woolner’s system) teams losing games intentionally to boost the next season’s “win improvement” numbers.

For that matter, there are plenty of ways to encourage competitive balance that have nothing to do with revenue. The player-compensation draft for free-agent losses—the one memorable for making Tom Seaver White Sox property—was one short-lived mechanism, as was the never-adopted suggestion that all foreign players be subject to the player draft, thus preventing wealthy teams from grabbing the best Latin American talent with big signing bonuses. For that matter, if “hope and faith” for every team is the goal, you could give a twenty-game head start in the standings to any team stuck in a below-average TV market. Or you could pick teams by lot and hand the trophy to the first name out of the hat. But at a certain point, this sort of “balance” defeats the purpose.

This is why as many fans hate the salary cap as yearn for it. The more complex the arrangement you devise to level the playing field, the more it feels like the winners are those who can game the system.

Ultimately, baseball requires as many losers as winners. Short of four or five World Series a year, some franchises are bound to go for generations without winning the big prize. “Hope and faith” is a nice idea and a great public relations slogan. But the cure shouldn’t be worse than the disease.