10 Reasons L.A. Dodgers Are—and Aren't—Making Baseball Consider a Salary Cap

Gil ImberAnalyst IINovember 28, 2012

10 Reasons L.A. Dodgers Are—and Aren't—Making Baseball Consider a Salary Cap

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    Of the top tier of North American professional sports leagues—hockey's NHL, football's NFL, basketball's NBA, soccer's MLS and baseball's MLB—only Major League Baseball does not employ a salary cap. In lieu of a bona fide cap, MLB implements a luxury tax, allowing teams to exceed a certain payroll threshold in exchange for a tax, payable to the league, which is imposed on the excess amount.

    For a sport in which the New York Yankees have long held the top slot of highest payroll expenditures—New York's AL club has spent more on players annually every season since 1999—the debate of whether baseball should institute a salary cap has devolved into a stale argument.

    Yet now that the Bronx Bombers may, for the first time this century, have their spending power surpassed by a powerhouse NL team, that tax vs. cap debate can be revisited.

    Is it time for a change?

    Or is the mere possibility of a changing of baseball business's top dog an illusion, a irrelevant fact that neither strengthens nor damages either position?

1. Correlation Between Money and Championships

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    When Major League Baseball instituted its luxury tax in 2003, the initial tax threshold was set at $117 million, which in its inaugural season only affected the New York Yankees, who paid $11.8 million in luxury tax for an over-the-limit payroll.

    Over the years, the Yankees and Red Sox have often occupied the one-two slots in MLB's list of highest team payrolls and, accordingly, these two teams are the only two to have paid luxury taxes in multiple seasons—the Yankees have paid every year since 2003 while the Red Sox have paid six times.

    Since 2003, the Yankees have won one World Series while the Red Sox won two, for a 3-of-10 (30 percent) success rate for MLB's two top spenders.

    Clearly, 3-of-10 for 2-of-30 teams is a disproportionate figure. On the other hand, the 25th-payroll-place Marlins won it all in 2003.

    World Series champions since 2003:

    Year World Series Champion Payroll Rank
    2003 Florida Marlins 25
    2004 Boston Red Sox 2
    2005 Chicago White Sox 13
    2006 St. Louis Cardinals 11
    2007 Boston Red Sox 2
    2008 Philadelphia Phillies 12
    2009 New York Yankees 1
    2010 San Francisco Giants 9
    2011 St. Louis Cardinals 12
    2012 San Francisco Giants 8

2. The Value of a Salary Cap

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    When a league considers whether to implement a hard salary cap, the primary motivating factor behind the discussion—by and large—is financial disparity throughout the league.

    By setting a maximum payroll and not allowing a team to surpass this amount, the league hopes to restore a sense of financially equality—or at least reduce disparity—with the intended consequence of increasing competitive balance throughout the league.

    In the NBA, where a salary cap is present with very limited, strict exemptions, past champions have featured several teams which have won two or more consecutive championships: the Los Angeles Lakers in 2008-09 and 2009-10, the Lakers from 1999-00 to 2001-02 and the Chicago Bulls from 1995-96 to 1997-98.

    Of these repeats and three-peats, the Lakers held the NBA's highest salary in 2009-10, but only ranked 12th in 2001-02. The Bulls' payroll ranked dead last during both the 1996-97 and 1997-98 seasons.

    It would appear the correlation between payroll and championships, as it exists in MLB, does not exist in professional basketball.

    Could this be due to a salary cap?

3. The Value of a Luxury Tax

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    Baseball's premise behind the luxury tax is fairly simple: By implementing a tax—which may theoretically be described as a soft cap—as opposed to a hard salary cap, baseball has attempted to allow large-market teams to thrive and cater their product to their customers while affording small-market teams the opportunity to improve as a result of the large-market team's tax payment.

    Researchers led by the University of Zurich Institute for Strategy and Business Economics' Helmet Dietl tested the theory in his 2009 working paper, "The Effect of Luxury Taxes on Competitive Balance, Club Profits and Social Welfare in Sports Leagues."

    The researchers concluded that MLB's luxury tax decreases talent disparity and increases social welfare throughout the league. Put bluntly, Dietl's team reasoned, "Luxury taxes are an important way to increase competitive balance in professional sports leagues."

    On the other hand, the researchers point out that their MLB sample size—driven primarily by one team (New York Yankees)—is fairly small and may have an unknown effect on their ability to accurately portray the amount of competitive inequality from team-to-team in professional baseball.

4. If You Want to Keep Salaries Down...Implement a Cap

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    Luxury taxes have correlated with an increase, rather than decrease in aggregate player salaries, resulting in an increase in aggregate payrolls.

    Researchers such as Dietl have stated that such an effect is independent of factors such as inflation, while demonstrating that aggregate increases are also associated with higher profits in the wake of a luxury tax implementation.

    This is because...

5. If You Want to Increase Aggregate or Overall Talent...Do Not Implement a Cap

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    Under the present MLB model, a lessening of competitive inequality between teams has resulted in greater aggregate talent, which itself has contributed to increased player salaries and higher aggregate payrolls.

    As such, the luxury tax allows teams such as the Yankees, Red Sox and potentially Dodgers to invest in exceptional talent, which effectively improves the average talent across the league as other teams—including small-market clubs at the base of the payroll list—ramp up efforts to improve their talent so as to better compete with the big-money clubs.

    A salary cap would prevent such a need for small market teams to close the talent disparity gap because this cap would effectively also cap big-market teams' talent levels, resulting in an MLB talent plateau.

    The end result would effectively be a less talented league.

6. If You Want to Stop out-of-Control Player Salaries...Implement the Cap!

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    Earning $30 million in 2012, Yankee Alex Rodriguez was the highest paid player in baseball last season, followed by the Angels' Vernon Wells and the Mets' Johan Santana.

    Paradoxically—yet by a similar token, completely logically—the Los Angeles Dodgers did not field a single player whose annual salary cracked the top 25 MLB salaries.

    Using Rodriguez as our starting point, Baseball Player Salaries—a website which judges a player's performance merit relative to his salary and percent of team payroll–and going through Wells, Santana, Prince Fielder and CC Sabathia—all players in the top 5, the website's algorithm has computed that not one of those players performed to financial expectation in 2012.

    As Jonah Hill's Peter Brand character noted in the 2011 film Moneyball, many players who receive high-profile contracts are being overpaid.

    Given this following quote—taken from my last slide—this conundrum is absolutely logical.

    Under the present MLB model, a lessening of competitive inequality between teams has resulted in greater aggregate talent, which itself has contributed to increased player salaries and higher aggregate payrolls.

    In other words, players who are paid higher salaries effectively retain their talent level when moving to a team with an already-high level of talent, accordingly encouraging other teams throughout baseball to improve their aggregate talent. Not only, however, does this make the entire league more talented, it sets a salary precedent for talented veteran players.

    When a non-elite (to be read: non-Yankees and non-Red Sox) team, such as the Dodgers, therefore executes an incredible payroll push or spending spree, this has the effect not only of increasing this third-party team's (e.g., Dodgers') aggregate talent and payroll, it inspires the remainder of the league to increase their talent by either paying the piper or by developing a quality farm system.*

    *The MLB league minimum increases from year-to-year—when compared to salaries in the tens of millions of dollars—are negligible.

7. If Moneyball Is the Name of the Game...Leave the Luxury Tax Alone

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    Because the luxury tax has been shown to increase aggregate league talent and allow small-market/low payroll teams to improve even if the small-market club itself does not increase payroll by a dramatic figure, many small-market clubs would be hurt, as opposed to benefiting, from a salary cap.

    Dietl's abstract states that in a luxury tax system, "the profits of small-market clubs only increase if the tax rate is not set inadequately high."

    This is to say the luxury tax system can work wonderfully for smaller teams—given a reasonable tax rate—because it allows the larger teams to spend fairly freely above the payroll threshold, and it has already been proven that small-market teams benefit more than simply financially from this luxury tax.

    A lower luxury tax, meanwhile, does not provoke smaller clubs to increase salary payments in the same way that a larger luxury tax does.

    A cap, on the other hand, does decrease overall salary payments, but does not necessarily benefit social welfare throughout the league.

8. If Equalizing Talent Is the Goal...It Depends What Team You're a Fan of

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    Unlike luxury taxes, those who unequivocally benefit the most from an inflexible salary cap include small-market and low-spending teams—for instance, the San Diego Padres, who spent a league-low $55.25 million on their 2012 payroll—would likely cheer the implementation of a salary cap.

    Teams like the New York Yankees predictably would not.

    Research demonstrates that while the implementation of a salary cap lowers aggregate talent levels, it also increases competitive balance (e.g., lowers talent disparity) among teams.

    Therefore, Padres or Astros fans looking to turn a losing record around will applaud a salary cap because less overall talent in the league equals a greater chance for a talent-low team to win.

9. If You're Financially Invested in Baseball...Keep the Luxury Tax as Is

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    When sports agent Scott Boras represents Robinson Cano in negotiations with the Yankees, he smiles at the thought of a luxury tax as opposed to a salary cap.

    Here's the shocker: So does Yankees GM Brian Cashman.

    Whereas player salaries do tend to spiral higher and higher with no strict salary cap, research has also shown that profits for larger-market clubs tend to increase under a tax, rather than cap, system.

    Under a luxury tax, social welfare—the fan experience—receives a boost, which in turn translates into increased ticket sales, television ratings and associated baseball spending, resulting in increased profits for teams, even though the richest of the rich subsidize smaller clubs after exceeding the payroll threshold.

    Simply put, large-market business booms under a luxury tax but may not be as prosperous under a cap.

10. In Conclusion

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    Logically, socially and in general, any time a non-elite team increases spending and gains elite status, the issue of luxury tax vs. salary cap will be present.

    The luxury tax scheme benefits large-market teams because it does not limit spending, increases profits, aggregate talent and social welfare. It harms large-market teams by producing a more balanced league.

    The luxury tax scheme benefits smaller-market teams because it increases talent, social welfare and competitive balance throughout the league. It harms small-market teams by inducing them to increase player salaries and, therefore, payroll.

    The tax scheme also may help or hurt smaller teams, depending on the height of this tax and level of threshold—an inadequately set tax rate will hurt smaller teams, while appropriately high luxury taxes will increase small-market profit.

    Meanwhile, the salary cap benefits large-market teams only if salary payments and spiraling player costs have reached undesirable levels (with elite teams, this rarely is the case). The salary cap may or may not result in increased profit; if fans prefer aggregate talent, profit will increase. If fans prefer competitive balance, welfare will decrease.

    Smaller teams benefit because salary caps increase competitive balance and decrease overall salary payments, although aggregate talent decreases with a salary cap.

    In the end, larger teams (higher spenders) generally will prefer the luxury tax, while smaller teams (lower payrolls) may support either proposal, depending on the rate and threshold of luxury taxation.