November 3, 2006

On the Margins

New Revenue-Sharing Rules Should Spread The Wealth, But Not The Talent

by Neil deMause

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When baseball announced its new five-year collective bargaining agreement last week, it was seen as a major step forward in the sport's often-ignominious history of labor relations. Not only had the two sides struck a deal two months before the last pact expired, but here you had Bud Selig and Don Fehr sitting side-by-side at the World Series, declaring their love for each other and for the current "golden era" of baseball profitability.

For anyone trying to analyze the new deal, though, the way it was announced was less revolutionary. All that MLB and the MLBPA signed last week was a "memorandum of understanding" sketching out the broad strokes of the deal--and what was released to the press was even less than that, effectively a summary of a summary. As a result, most of the reporting thus far has necessarily been a mix of incomplete facts, rumor, and guesswork. Maury Brown began to untangle the CBA's new revenue-sharing rules on Monday. My job today is to take a deeper look at some of the implications of the new system for how teams will actually be receiving--and spending--money.

First off, a quick recap of the rule changes, as we understand them so far. Under the old system, as Maury explained, revenue sharing consisted of two separate pieces: A "straight pool" that skimmed off 34% of every team's revenues and divided equally among all 30 teams, and a "split pool" that was levied only on the top-revenue teams and redistributed to the lowest-revenue ones. (This two-headed system was a compromise put into place during the last labor talks in 2002, when the owners wanted a straight-pool plan, and the players a split one.) The overall effect was that several hundred million dollars a year was shuffled around, mostly from the rich teams to the less-rich, but with the odd effect that teams at the top of the economic ladder actually got to keep a bit more of each dollar of new revenue (giving up 39%) than those at the bottom (who gave up 47%).

Under the new system, two things change. First off, the 34% straight-pool tax drops to 31%. Secondly, the split pool portion has been replaced by a new tax that starts with a target for how much money will be shared (based on the past two years' league revenues), then assigns a fixed percentage of that cost to each of the high-revenue teams, based roughly on what they've paid out in revenue-sharing in recent years.

If that isn't confusing enough--and judging from the number of times I just rewrote the preceding paragraph, it's already plenty confusing--there's an added twist. Under the old rules, all teams with below-average revenues got revenue-sharing payments based on how far they fell below the league median. According to someone who was briefed on the new plan, from now on everybody below the league median will get the same-sized checks, with the sole caveat that no team can get a revenue-sharing check that pushes it above the midpoint.

The effect of all this fancy fiscal footwork is actually pretty clever. The total amount of revenue to be redistributed in 2007 will be exactly the same as it was in 2006. Yet because the amount each high-revenue team puts into the split pool is unaffected by increasing revenues, as is the amount that each low-revenue team receives from it (at least, until they approach that magic median), teams' effective marginal tax rate--the amount of each new dollar of revenue they don't get to keep--drops from the old 39-to-47% range down to just the new straight-pool rate of 31%. (It actually comes to a couple of percentage points lower for low-revenue teams, and higher for high-revenue ones, because of the odd effects that increasing one team's revenues has on the total amount of cash that's thrown into the pool.) The hoped-for effect: If teams get to keep more of the revenue they generate, they'll have more incentive to invest in their product, lure new fans, and grow the pie for everybody.

For players, the news is even better. Assuming that owners behave as rational economic beings--and there's plenty of evidence that they behave more like Wilma Flintstone and Betty Rubble with charge cards, but we'll set that aside for a moment--a lower revenue-sharing rate means the monetary value of a free-agent signing goes up. If you think that signing a Barry Zito will bring in an additional $20 million in annual team revenues (thanks to extra ticket sales, increased value of your media contract, and appreciation in the value of your Barry Zito bobblehead collection), and your effective marginal tax rate is 40%, you'd consider it a profitable venture to sign him if you can do it for less than $12 million (60% of $20 million) a year. Cut the marginal rate to 31%, and Zito's value jumps to $13.8 million (69% of $20 million) a year. By percentage it doesn't seem like a lot, but a few commissions like that and your agent can buy himself a new Caribbean island.

Revenue sharing is supposed to do two things, though, and only one of them is to force the George Steinbrenners of the world to tithe a share of his riches in appreciation for the Royals and Devil Rays showing up to fill the opposing dugout, and spare him the indignity of having to hire out the Washington Generals. The other, in theory, is that revenue sharing helps level the playing field for talent, by giving the low-revenue teams more to spend. And it's here that the new CBA, like the old one, does little to help the situation.

The problem, once again, lies in the margins. A minute ago, I proposed a free-agent signing that would bring in $20 million a year in new revenue. As noted, the new plan does provide low-revenue teams with an incentive to get off their duffs and try to boost revenues--though with high-revenue teams' effective marginal rate dropping from 39% to around 33%, their incentive to spend is increased as well, albeit not as dramatically.

How much a team spends, though, is dependent not just on how much revenue it gets to keep, but on how much it can generate in the first place--and that calculation of how much new money a player can bring in is going to vary wildly from team to team. Even if an influx of talent would result in the Yankees and the Royals putting the same number of new fannies in the seats, those seats are worth two to three times as much in New York as in Kansas City, and that's before even accounting for the increased value of eyeballs attracted to the team's cable broadcasts.

This discrepancy in teams' marginal revenue potential goes a long way toward explaining why the top-revenue teams hog all the big names at free-agent time. It's not so much that the Yankees have more money than the Twins--without knowing their actual bank balances, I'd wager that banking mogul Carl Pohlad could outspend failed shipping magnate George Steinbrenner if they both busted open their piggy banks. It's that players are worth more to the Yankees than the Twins, solely by virtue of the fact that the Yankees play in such a high-marginal-revenue environment.

The new plan does very little to change this. Let's say a ten-win player will bring in $20 million a year more for the Yankees, against $10 million a year for the Royals. Under the old system, the Yanks should be willing to pay him $12.2 million a year (61% of $20 million that's left after revenue sharing), the Royals $5.3 million (53% of $10 million). Under the new system, the Yanks should be willing to pay $13.4 million a year, the Royals $7.1 million. While the gap is reduced slightly thanks to the tax rate changes, a player who was worth about twice as much to a high-revenue team under the old plan remains about twice as valuable under the new one.

There are ways that MLB could have better addressed this. For instance, instead of a flat revenue-sharing rate, they could have pegged the rate to a team's marginal revenue potential--in the example above, taxing the Yankees at an effective marginal rate of 60% and the Royals at 20% would make our hypothetical player worth $8 million a year to both teams. How to make the calculation of how much marginal revenue a player was worth to different teams would doubtless have been tricky to calculate, and controversial. But there are plenty of smart people who could have come up with such a formula--and in any case, the final verdict would have been less a matter of number-crunching than of sitting around a negotiating table and hashing out a compromise acceptable to all parties, just as the 30 teams apparently did in deciding on the fixed team rates under the new split-pool plan. In labor negotiations, "right" is a matter of consensus, not statistical accuracy.

Instead, baseball is left with what might be called the "Don't make Bud come in there rule": Teams are supposed to make every reasonable effort to compete, and not just sit back and collect revenue-sharing checks. (Not too obviously, anyway.) It's a typically old-school approach for the old-boys cabal: Don't sweat what the rules and regulations say; we'll handle our own.

We'll know more about the full effects of the new CBA once the lawyers actually finish putting the general agreements made at the negotiating table into hard-and-fast rules. (There have already been some reports of things that were agreed on by the negotiators, but scrapped once they couldn't be translated into legalese.) But if you're a Royals fan hoping that "overhaul of the revenue-sharing system" means your team will finally have an incentive to spend with the big boys, don't hold your breath. On the margins, where it counts, this looks a lot like the same old deal.

Neil deMause is an author of Baseball Prospectus. 
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