August 16, 2002

Bridging the Gap

Revenue Sharing Both Sides Can Live With

by Doug Pappas

Even though a strike date has now been set, the MLBPA's decision to postpone setting a strike date earlier this week suggests that unlike in 1994, the owners and players are at least speaking the same language. The biggest, and probably only, stumbling block to an agreement is the parties' split over revenue sharing and the luxury tax.

The owners' current offer calls for all clubs to share 50% of their local revenues, and for high-payroll clubs to pay an additional "luxury tax" of 50% on the portion of payrolls over $98 million. The players oppose the luxury tax and have proposed revenue sharing at a level of 22.5%, with a higher percentage of the shared money going to the lower-revenue clubs.

If, as the owners insist, the combination of revenue sharing and a luxury tax is necessary to improve competitive balance, then a key question to ask is whether their proposal will actually improve competitive balance. It won't. A fundamental flaw in the owners' revenue sharing formula almost guarantees that if adopted, it would increase the number of teams that "can't compete."

That flaw is requiring all teams to share 50% of all their local revenue, from Dollar One. By creating a 50% marginal tax rate that applies equally to the Yankees and the Kansas City Royals, the owners' revenue sharing plan discourages both clubs from spending money to improve their teams. Discouraging the Yankees is part of the plan, of course, but anything that deters the Royals from reinvesting their revenue-sharing proceeds in better players will only worsen "competitive balance."

In fact, 50% revenue sharing have a greater deterrent effect on bad teams like the Royals and Devil Rays than on the Yankees or Red Sox. Any club would be reluctant to increase its payroll by $1 million unless it thought the move could increase local revenues by $2 million. This would be relatively easy for contenders, for whom a better team means higher attendance and a better chance of making the playoffs -- but for bad teams, spending an additional $5 million to improve from 67 to 75 wins is a terrible investment. Thus while sharing money with low-revenue teams may be a good idea, taxing them isn't.

There's a simple solution, though. By combining the principles underlying revenue sharing and the luxury tax into a single formula, the owners could share as much money as they wanted without the counterproductive side effect noted above. Such a formula might look like this:

1. Clubs keep all local revenue up to 80% of the MLB average.

2. Clubs share 25% of all local revenue between 80% and 120% of the MLB average.

3. Clubs share 50% of all local revenue between 120% and 160% of the MLB average.

4. Clubs share 75% of all local revenue above 160% of the MLB average.

5. As under the current formula, stadium expenses are deducted from local revenues before computing the amount to be shared.

6. The money in the shared-revenue pool is then divided according to the owners' "straight pool" formula, with each club receiving 1/30th of the total in the pool.

There's nothing magic about the tax rates or the thresholds, which can easily be adjusted to transfer as much money as the parties desire.

In 2001 the average team generated about $94 million in local revenue. 80% of this is roughly $75 million. Exempting the first $75 million of local revenue would have allowed the 11 lowest-revenue clubs (Anaheim, Cincinnati, Florida, Kansas City, Minnesota, Montreal, Oakland, Philadelphia, San Diego, Tampa Bay and Toronto) to receive revenue-sharing money without contributing to the pool. At the other extreme, the Yankees, whose local revenues of $217.8 million were almost $60 million higher than anyone else's, would have paid about 2-1/2 times as much as they actually did.

This system would also eliminate the biggest problem with the split-pool system favored by the players: the way it subsidizes teams which aren't trying to compete. Under the revenue-sharing formula adopted in the 1996 CBA, all clubs contribute 20% of their Net Local Revenue (defined as local revenues minus stadium expenses) into a common pool. 75% of this money is then divided equally among all 30 clubs. The remaining 25% is distributed among the clubs in the bottom half of the local revenue pool in proportion to its distance from the mean. As a result the Expos, who generated less than $10 million in local revenue, received a $28.5 million revenue-sharing subsidy in 2001. The combination of a progressive revenue-sharing formula and equal division of the proceeds would make it much harder for parasitic owners like Jeffrey Loria to survive off revenue-sharing money.

A revenue-sharing plan based on this formula should satisfy both sides' stated principal concerns. For the owners, more money would be distributed to smaller-market teams, under a system more likely to improve competitive balance. The players would be happy that the formula was based entirely on revenues, with no direct tax on player salaries. Perhaps an agreement along these lines would be easier to achieve than one in which the parties had to balance the combined effect of revenue sharing and a luxury tax.

Doug Pappas is an author of Baseball Prospectus. You can contact him by clicking here.