May 18, 2017

Flu-Like Symptoms

A Taxing Problem

by Rob Mains

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The Wall Street Journal op-ed section is not known for its fondness for taxes. So it wasn’t a surprise, at least in terms of the editorial board’s predilections, to see this headline earlier this month: “Tax Rates and Professional Losers: A new study says high taxes could cost your team a championship.”

I’ve included a link, but the article is behind the WSJ’s paywall, so I’ll summarize the argument for non-subscribers. The key paragraph:

Erik Hembre, an economist at the University of Illinois-Chicago, looked at the question: Do tax rates affect a team’s performance? He analyzed data in professional football, basketball, baseball and hockey between 1977 and 2014. Since the mid-1990s, he writes, “a ten percentage point increase in income tax rates is associated with between a 1.9-3.0 percentage point decrease in winning percentage.”

In other words, the higher your state taxes, the worse your professional sports teams.

Professional athletes make a lot of money. As a result, their income generally falls in the highest tax bracket in their state of residence. Let’s say someone is single and makes the major-league minimum of $535,000. Living in California, that person will pay $51,330 in state taxes. Someone making $1 million per year will pay $108,351. Someone making $10 million per year will pay over $1.3 million.

Every spring, USA Today runs a story about major-league salaries. This year, it reported an average salary of $4.47 million. That’s a mean figure, where a median would be more appropriate in my opinion, but let’s go with that. Here are the state taxes a single taxpayer with a $4.47 million salary will pay in the states in which Major League Baseball operates (I’m excluding Toronto):

There are limits to this analysis. I’ve put them all in a footnote for those of you who care.[1]

The implication is pretty clear. Taxpayers in Dallas, Houston, Miami, Seattle, and Tampa Bay with an income of $4.47 million pay no taxes. Taxpayers in Los Angeles, New York, Oakland, San Diego, and San Francisco pay over a half a million dollars.

Hembre’s study covered football, basketball, and hockey as well as baseball. He noted that, because there aren’t salary caps in baseball, the effect he found—players avoiding higher-tax locations—is less than in the other sports. But is there an effect at all?

You’ll notice that in the examples above, I talked about taxpayers rather than players. The reason is that professional athletes don’t get taxed the way you and I are. They are subject to what’s known as the “jock tax,” in which they’re taxed by states based on the time they spend there. Take an athlete playing for the Rangers, living in Texas. When he plays home games, he’s in his home state, where he isn’t taxed. When he plays in Houston, he’s in his home state, where he isn’t taxed. When he goes to Seattle to play the Mariners, he’s in a state with no state income taxes. So far, so good.

But the Rangers play nine games in Oakland and 10 in Anaheim, as well as two in San Diego this year. That’s 21 games in high-tax California. Because of the jock tax, our player is going to have to pay California state income taxes based on the time he spends there. I estimate that our “average” player making $4.47 million will wind up paying something in the neighborhood of $57,000[2] in California state income taxes even though he doesn’t live in California.

Add in the taxes for his games in New York, Minnesota, and Missouri, and ... well, all players pay state income taxes. So the effect that Hembre describes is watered down. Athletes get stuck paying some state taxes (and a lot of accounting fees) no matter where they live. Beyond that, teams, players, and their agents are aware of state taxes and can structure contracts to avoid them.

Max Scherzer’s contract with the Nationals, signed in January 2015, was billed as seven years, $210 million. But it really isn’t. He’ll make $15 million per year from 2015-2021, the life of the contract. That’s $105 million. Then he’ll make $15 million per year for seven years starting in 2022, another $105 million—after the contract ends. Why? Because Scherzer will be pushing 38 in 2022, and very possibly retired—to his home in Florida, where he will pay no income taxes. So while he’ll get hit with District of Columbia and road team state taxes over the first seven years of the deal, half the contract’s value will be paid to Scherzer, free of state taxes.

And, of course, this argument is predicated on the idea that athletes are seeking only to maximize their after-tax income. That’s not always the case. Players regularly sign contracts with home-town discounts. David Ortiz never earned more than $16 million per year from the Red Sox despite averaging over 3.0 WARP per year over the last seven years of his career, performance worth something in the $20-$25 million/year range. That’s because Ortiz wanted to stay in Boston, not that he was forced to take a below-market contract.

But here’s the killer: The numbers just don’t work out. I compiled winning percentages for all the teams during the 30-team era from 1998 to 2016. I compared them to the state tax estimates in the table above. If high taxes drive away better players, hurting the performance of the clubs in high-tax states, the correlation should be negative: higher taxes = lower winning percentages. It isn’t. It’s positive, +0.37. That’s a weak positive correlation, but a positive correlation nonetheless. Teams in higher-tax areas do better.

And if we look at World Series titles, it’s even more stark. Since 1998, teams in states with no income tax have won a grand total of one World Series—the Marlins in 2003. Teams playing in the two highest tax states, California and New York, have won four each. Missouri and Philadelphia are high-tax localities; they account for another four. Massachusetts and Illinois aren’t tax havens, and they’ve won five between them.

So, far from proving Hembre’s assertion, this analysis indicates the opposite is true: Teams in high-tax states do better than those in low-tax states. I’m pretty sure you’ll agree that there is no causality there, but you’ll also have to agree that there is no negative impact of high state taxes, at least as far as baseball teams’ performance goes.

So, go ahead, Mets, Giants, and Padres fans. You can curse your team’s luck, its ownership, its front office, its health, its dirt bikes. They’re all fair game for explaining the disappointment so far. Just don’t blame high state tax rates.

Rob Mains is an author of Baseball Prospectus. Follow @Cran_Boy
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