The Effect on Player Transfers of a Luxury Tax on Club Payrolls : The Case of Major League Baseball

The 1997 collective bargaining agreement between the Major League Baseball (MLB) owners and players' union introduced a luxury tax on club payrolls. The purpose of the tax was to restrain spending by the highest revenue producing clubs, thus enhancing completive balance. The 2003 collective bargaining agreement extended the tax (renamed the competitive balance tax) through the 2006 season, with modifications. MLB is criticized for its use of a tax rather than a hard payroll cap, such as is used in the NFL and NHL. Critics claim the tax is not sufficiently effective in restraining spending by high revenue clubs. Typically, measures of win dispersion are used to evaluate changes in competitive balance. However, the period of analysis in this study is insufficiently short. Changes in the distribution of talent can be observed in more detail by analyzing player mobility across clubs. An empirical model of player transfers in the context of a luxury tax developed and tested for both formulations of the tax in MLB. The results support the thesis that the tax is effective, and more so in its second formation with the 2003BA. Most striking is the decreased flow of the most productive talent toward the highest revenue clubs during the second collective bargaining period