The Major League Baseball (MLB) salary cap is a system that limits the amount of money that teams can spend on player salaries. The cap is set by the MLB commissioner’s office and is determined by a percentage of league revenues. Of the major sports leagues, the MLB salary cap system utilizes the most free market principles of them all and the one most similar to ironically, the free market sports leagues of European soccer.

The way the cap works is that each team has a set amount of money, known as the “luxury tax threshold,” that they are allowed to spend on player salaries. If a team exceeds this threshold, they must pay a “luxury tax” to the league. The luxury tax threshold for the 2022 season is $210.5 million.

There are several exemptions , including:

  1. The “average annual value” (AAV) of a long-term contract does not count against the cap until the player is actually paid the money.
  2. Teams can exceed the cap during the off-season to sign free agents, but the excess amount counts against the cap in the following season.
  3. There are also exemptions for teams that are rebuilding and have a low payroll, known as the “competitive balance tax” (CBT)

As the competitive balance tax is the most misunderstood, let’s start there.

MLB’s Competitive Balance Tax Explained

This MLB Competitive Balance Tax is a way to try to make sure that rich teams don’t spend too much money on players and become too dominant.

Every year, there’s a limit to how much money a team can spend on players’ salaries before they have to pay extra money to the league. This limit is called the “threshold.” The threshold is different for each year from 2022 to 2026:

  • 2022: $230 million
  • 2023: $233 million
  • 2024: $237 million
  • 2025: $241 million
  • 2026: $244 million

If a team spends more than the threshold on player salaries in a year, they have to pay a tax on the extra amount. The tax rate increases depending on how many consecutive years the team has exceeded the threshold.

For example, if a team goes over the threshold for the first time in 2022, they’ll have to pay a 20% tax on the extra money they spent on player salaries. But if they go over the threshold again in 2023, they’ll have to pay a 30% tax on the extra money. And if they go over the threshold for three or more consecutive years, they’ll have to pay a 50% tax on the extra money.

There’s also a “surtax” if a team spends a LOT more money than the threshold. If they spend between $20 million and $40 million more than the threshold, they have to pay a 12% surtax on top of the regular tax. If they spend between $40 million and $60 million more than the threshold, they have to pay a 42.5% surtax in the first year, and a 45% surtax for each consecutive year after that. And if they spend $60 million or more above the threshold, they have to pay a 60% surtax on top of the regular tax.

Finally, if a team goes over the threshold by a lot of money (more than $40 million), they might have to move back in the draft order when it’s time to choose new players for their team. They’ll have to move back 10 places in the draft order, unless their pick is in the top six, in which case they’ll have to move back 10 places with their second-highest pick instead.

The Major League Baseball (MLB) reserve clause was a provision in player contracts that effectively bound a player to a team for the entirety of his career. The reserve clause was established in the late 19th century and was in effect until the 1970s.

The reserve clause was challenged in court in the 1970s by players’ union, and in 1975, an arbitrator ruled that the reserve clause was invalid and that players had the right to become free agents after their contracts expired. This decision led to the creation of the modern system of free agency in baseball and greatly increased player mobility in the league.

The reserve clause was a significant factor in the power dynamic between teams and players during the period it was in effect, with teams having a significant advantage over players and limiting their earning potential and ability to negotiate contracts. The abolishment of the reserve clause was a significant step towards fair negotiations and a more balanced relationship between teams and players in the league.

Luxury Tax Established

The luxury tax system was first implemented in the 2002 season as a way to slow the increase in player salaries and promote parity among teams. The luxury tax threshold has increased over time as league revenues have grown. The threshold for the 2022 season is $210.5 million, which represents an increase from previous years.

In 2016, the MLB implemented the CBT, which is a tax on teams with high payrolls, with the goal of promoting parity among teams.

The CBT threshold is determined by the MLB commissioner’s office and is based on a percentage of league revenues. The current threshold is $210.5 million for the 2022 season. Teams whose payrolls exceed the threshold will have to pay a tax to the league, with the amount increasing depending on how far above the threshold the team’s payroll is. The money collected through the CBT is then distributed among the teams in the league in the form of revenue sharing.

The CBT has been in effect since the 2016 season. Its implementation was part of a larger effort by the league to promote parity among teams and prevent wealthy teams from dominating the league by outspending their competitors. However, it is still a topic of debate if the current system effectively promotes parity among teams.

The Collective Bargaining Agreement

The CBA, which is the agreement between the MLB and the players’ union, is renegotiated every few years and includes changes to the salary cap system. For example, the most recent CBA, signed in 2021, introduced a minimum salary for players, which is set to increase gradually until 2023.

The full CBA is extensive but some of the key features include:

  1. Salary structure: The CBA sets the structure for player salaries, including the minimum salary for players, which is set to increase gradually until 2023.
  2. Free agency: The CBA establishes the rules for free agency, including the length of service required for a player to be eligible for free agency and the process for a team to sign a free agent.
  3. Arbitration: The CBA establishes the rules for salary arbitration, which allows players with more than three years of service time to have their salary determined by an independent arbitrator.
  4. Revenue sharing: The CBA establishes the rules for the league’s revenue sharing program, which redistributes wealth from large market teams to small market teams.
  5. Luxury tax: The CBA establishes the rules for the luxury tax, which is a tax on teams with high payrolls, with the goal of promoting parity among teams.
  6. Competitive balance tax (CBT): The CBA establishes the rules for the Competitive Balance Tax (CBT) which is also a tax on teams with high payrolls, with the goal of promoting parity among teams.
  7. Drug Testing: The CBA establishes the rules for drug testing, including the substances that are banned and the penalties for players who test positive.
  8. Pension and benefits: The CBA establishes the rules for player pensions and benefits, including retirement benefits, health insurance, and other perks.

Revenue Sharing

In the quest for even more parity, Major League Baseball also created a revenue sharing program. The revenue sharing program is a system in which a portion of the league’s revenue is distributed among the teams to promote parity among them. The goal is to help small market teams to compete with large market teams by giving them more financial resources.

The revenue sharing program has several components:

  1. Central Fund: A portion of the league’s revenue, such as from national television contracts and sponsorships, is placed into a central fund and distributed among the teams.
  2. Local Revenue Sharing: Teams with larger local revenues, such as from ticket sales and local broadcasting rights, share a portion of that revenue with teams with smaller local revenues.
  3. Luxury Tax: Teams that exceed the luxury tax threshold, which is determined by the MLB commissioner’s office, pay a tax to the league. The money collected through the luxury tax is then distributed among the teams.
  4. Competitive balance tax (CBT): Teams whose payrolls exceed the CBT threshold pay a tax to the league. The money collected through the CBT is then distributed among the teams

The specifics of how the revenue is shared and distributed can change depending on the Collective Bargaining Agreement (CBA) between the league and the players’ union, which is renegotiated every few years.

The revenue sharing program is designed to promote parity among teams by redistributing wealth from large market teams to small market teams, but it’s still a topic of debate if it has been successful in achieving this goal.