Dear Angels: Stop Sweating the Luxury Tax

At the start of every winter, amidst the regular season recaps, free agency previews, and the what-if stories that Angels reporters use to fill the lull between end of another disappointing season and the official start of the offseason, owner Arte Moreno is asked about the state of the organization and what he feels is in store for the future. Inevitably, the subject of MLB’s luxury tax limit comes up.

Moreno notes, in so many words, that his hands are effectively tied so far as budget goes. That staying under the Competitive Balance Tax (CBT) threshold isn’t just good business, it’s a matter of principle. That if they cross this arbitrary line, there’s no turning back. That only the “right player” is worth the fines, but just who that player is might be is to be determined. The specifics change from year to year, but his general message is basically the same: “I set an ultimatum, and I am sticking to it.”

It’s good to have a plan, and as plans go the “you’re free to spend up to $189 million to field a competitive roster” is not a terrible one. Every strategy has its drawbacks, but allowing a moderate amount of financial freedom would seem to have fewer than most. Simply handing the front office a blank check like the Dodgers have done can stifle creativity and foster excess—see also: every film sequel ever—while tightening purse strings like the A’s or Rays do often forces a front office to abandon its plans prematurely. The upper-middle of the spectrum is definitely the place to be, and it’s where the Angels have been more or less since Moreno bought the team in 2003.

This strategy has mostly worked well for the Angels over the years, but much less so of late. Moreno has stubbornly maintained his $189 million ceiling the last two seasons, seemingly unaware that circumstances have changed both within the organization and around the league. He posits that he doesn’t want to “hamstring” the team financially, but what he doesn’t seem to realize is that he already has1. The reality is that there’s never been a better time for the Angels to blow past the luxury tax, and the sooner Moreno and company realize it the better.

The Initial Luxury Tax Penalty Is Minimal

The first year a team exceeds the CBT, it is levied a 17.5 percent tax on the overages. This means that if a club finishes the year with a luxury tax payroll of $195 million, it is taxed only on the $6 million by which it went over the $189 million threshold, not the entire payroll. In this made-up scenario, the team in question would owe just $1.05 million in taxes, bringing its overall luxury tax payroll up to $196.05 million.

You’ll notice that I specified luxury tax payroll. Calculating the actual annual payroll involves simply summing all player salaries for a certain year. Mike Trout earned ~$6 million in 2015? Then add ~$6 million. Luxury tax payroll, however, makes things more complicated by taking the average annual value (AAV) of multi-year contracts into account. Mike Trout is earning ~$16 million in 2016? Fine, but the AAV of his six-year extension is $24 million, so that number is what we have to add to the luxury tax payroll for each year of the deal. This wrinkle in the calculation prevents teams from heavily back-loading contracts to purposely avoid the tax.

At the moment the Angels possess a 2016 luxury tax payroll of about $179 million, thanks in large part to hefty AAV numbers from Albert Pujols ($24M), Mike Trout ($24M), Josh Hamilton ($20M), Jered Weaver ($17M), and C.J. Wilson ($15.5M). That figure puts them roughly $10 million under the CBT threshold, and only a few million shy of where they finished the 2015 season.

If we presume that one of Alex Gordon, Yoenis Cespedes, or Justin Upton commands a $20 million/year contract from the Angels and that the rest of the roster remains static, the club would exceed the luxury tax by roughly $10 million in 2016. With a CBT payroll of roughly $199 million, the Angels would owe a measly $1.75 million in taxes at the end of the year. That’s a windfall for you or me, but for a team already well into nine figures in payroll, does that kind of money even register? If some supposedly scary taxes can’t even afford a single season of Cliff Pennington on the open market, maybe they’re not actually worth worrying about.

The Odds Of Exceeding The Tax Again Are Slim

Given the points above, I think even Arte Moreno would concede that exceeding the luxury tax for a single season really isn’t that big a deal. He already did it once—costing the Angels an additional $927K in 2004—so he should know. Where the real concern arises is when a team surpasses the limit in subsequent seasons, increasing the taxes levied to 30%, 40%, and 50%, respectively.

If this were the 2013 or 2014 offseason, I could see how signing another player to an eight-figure contract would worry ownership about going over the luxury tax in perpetuity. Jason Vargas and Jason Grilli were the only players of note hitting free agency, and the four or five biggest contracts on the team were all good through at least 2016. But now, with some $40 million allotted to Jered Weaver, C.J. Wilson, Joe Smith, and Fernando Salas coming off the books following the 2016 season, there’s a much higher probability that facing the tax penalty would be a one-time proposition.

Further increasing these odds are two compounding factors: 1) MLB is flush with cash like never before, and 2) it is just a season away from re-negotiating the Collective Bargaining Agreement with the MLBPA. With whispers of players not getting their fair share of the league’s record revenue, you can bet that the CBT threshold won’t remain static at $189 million for a fourth straight year. In 2003, the difference between the average team’s annual revenue ($130M) and the luxury tax threshold ($117M) was just $13 million. By 2014, that difference was $111 million. I’m not saying the limit will suddenly leap exponentially next winter to even things out perfectly, but it sure as hell isn’t staying under $200 million.

Conceivably, then, the Angels could sign one of Cespedes/Upton/Gordon this winter and still have $40+ million to play with next offseason before hitting the tax limit. Even if there isn’t quite that much money to spend with C/U/G in tow, the payroll come 2017 is certain to be well under whatever new CBT threshold is devised.

The Angels Already Have The “Right Player” 

Thinking about and categorizing activities in chronological order is a natural thing to do. Everything we do is governed by time, so our brains often interpret the most recent (or forthcoming) sequence of events as the most important one, even if that isn’t the case. When a team’s next move is the one that will take it over the luxury tax limit, then, it is only natural to view that move as the most critical—that it has to be for the “right player.” For some teams, that may even be true. For the Angels, it most definitely is not.

The Angels already made their move for the “right player” two years ago, when they convinced Mike Trout2 to sign a six-year, $144.5 million extension. Pretending that the next move is somehow more important than that deal, just because an arbitrary number might be eclipsed, is absurd. If the situation were reversed, so that extending Trout would push payroll past the threshold due to an existing contract for Cespedes/Upton/Gordon, there would be absolutely no “waffling” from Moreno about what to do with that money. He’d throw it all in and worry about the rest down the road.

That the sequence of events is flipped in reality shouldn’t change the decision-making process. So long as Trout is in Anaheim, every effort should be made to build the best team possible around him. Right now, that means doling out money for a big-name free agent and absorbing the negligible, temporary penalty that deal might entail.

___

1In years past, even when the Halos had the unique misfortune of paying players to either suit up for other teams—Gary Matthews, Vernon Wells—or just go away altogether—Scott Kazmir, Bobby Abreu, Joe Blanton—they always managed to have enough room to make the competitive moves they needed to make. That is no longer the case, thanks in large part Moreno attempting to wash his hands of Josh Hamilton and paying $63 million for the privilege.

2Hat tip to Mike Hyllwa for the epiphany.

Nate Aderhold

About Nate Aderhold

Nate Aderhold was a writer and managing editor at Halos Daily for three years until the folks at MWAH swept him off his feet. He got his start in the blogging world in 2012 as a contributing editor at MLB Daily Dish. He's pretty sure his Mike Trout shrine is bigger than yours.

Quantcast