Dodgers Pay $11.4m Luxury Tax, Do Not Care

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Last November, I looked at just how badly the Dodgers were going to blow past the luxury tax, guessing that it would be a little over $9 million. That was obviously at that moment in time — the team hadn’t signed Zack Greinke or Hyun-jin Ryu yet, and it’s incredibly difficult, if not impossible, to guess what sort of incentives and trades will happen over the course of the season — and was just an estimate. As it turns out, the actual bill was $11.4m, per reports, which… well, so what?

$11.4 million in today’s game, for today’s team, well, it’s just not a whole lot. That’s tough to hear for the average person, but it’s true. It’s slightly more than Dan Haren is guaranteed next year, and he’s a past-his-prime starter who probably could have made more if he’d been more willing to explore outside of California. The tax is a good thing for baseball, because it helps the smaller teams and somewhat limits the upper echelon, but it’s not something that should stop a team like the Dodgers from spending.

…For now, anyway. First-time offenders are taxed at 17.5% of their overage above the $189m limit, and that increases to 30%, then 40%, then a whopping 50%. This is why the Yankees (hit for $28m this year) are trying so hard to stay under that limit, though it seems like they’re not going to do it, and they can arguably afford the tax anyway. Ideally, you don’t keep exceeding that limit every year, because even one time under can reset you to the beginning.

That’s not going to happen for the Dodgers in 2014, since I have them down at approximately $240m already, and that doesn’t yet include Juan Uribe, J.P. Howell, anything else they might do, or the ~$11m worth of non-player administrative costs that are included as well. They’re well on their way to blowing past it in 2015 and ’16 as well, assuming that giant annual costs for Clayton Kershaw (and lord knows what else) gets counted in there.

Someday, if Stan Kasten’s vision of a big immediate splash giving way to a strong farm system comes to pass (and we’ve obviously seen huge strides in developing talent), maybe the Dodgers won’t be paying a luxury tax. But with years of Matt Kemp, Carl Crawford, Adrian Gonzalez, Zack Greinke, and Andre Ethier to come, plus possible extensions for Kershaw and Hanley Ramirez, plus future moves we can’t even theorize about at this point, it’s not going to happen any time soon. So long as that doesn’t restrict player acquisition, as it has for the Yankees, that’s a hit the team will have to live with. It seems they can, and so we should be thankful for approximately the 1,298,927th time that the Guggenheimers are here, and McCourt is not.

The Dodgers Are Going to Blow Past the Luxury Tax, & That’s Not a Bad Thing

Ever since the Guggenheim group purchased the Dodgers for a record-shattering price earlier this year and started giving Ned Colletti a blank check to do potentially crazy things like collect hundreds of millions of Adrian Gonzalez / Carl Crawford / Josh Beckett / Hanley Ramirez money, take a major gamble on unknown Yasiel Puig, win a posting on Korean lefty Hyun-jin Ryu, and make Brandon League a $22m pitcher, we’ve been struggling to understand just where the financial limit is – or if there even is one.

It’s an important question. If you don’t know just how bottomless the checkbook is, it’s difficult if not impossible to judge a signing fairly because you won’t understand how it affects everything else. Sure, it’s probably insane no matter what to give a non-elite reliever like League that kind of deal, but the level of insanity changes greatly based on whether that ~$7m per season represents 5% of your available budget or 95%.

As we enter an offseason where the Dodgers are expected to be one of the many teams making a run at making Zack Greinke the richest right-handed pitcher in history, we still don’t know the answer to where the budget runs out. If payroll doesn’t matter, then of course you want Greinke; he’s the clear best pitcher available and would make for a worthy addition to any team. But with Clayton Kershaw still unsigned past 2014, what if adding Greinke makes it difficult or impossible to then also spend on keeping Kershaw in Los Angeles? If it does, I’m guessing your view on signing Greinke just changed significantly. (I went into this in greater detail just after the Boston trade, in a post on August 28.)

Baseball doesn’t have a salary cap to slow down wealthy teams, but there is a luxury tax, which is really the only league-mandated impediment to a team spending endlessly. In the lean McCourt years, this was never anything we even had to worry about, but these are the new Dodgers. This is a team that after signing League already has about $193 million under contract for next year, and is all but certain to blow past $200m – perhaps considerably so. That’s because that $193m figure doesn’t include the posting fee or potential contract for Ryu, it doesn’t include Greinke or any other possible free agent signing, it doesn’t include A.J. Ellis‘ arbitration case that could triple or quintuple his salary, and it doesn’t include the several million set aside to cover pre-arbitration 40-man players like Kenley Jansen, Scott Elbert, Dee Gordon, & friends. (It also doesn’t include more than $10 million put towards buyouts and deferrals to eight players, including Manny Ramirez & Andruw Jones, but for the purposes of this exercise, they can be ignored for the moment.) Might we see $220m in 2013? $230m? Anything seems possible right now.

With that in mind, it’s time that we take a second to look into the luxury tax and see if there’s anything that could or should actually stop this steamrolling Dodger money train. Last March, Matt Gelb at philly.com took a long & detailed look into how the luxury tax works, and I encourage you to read it thoroughly. Here’s the pertinent thresholds to keep in mind:

Under the new collective bargaining agreement, the luxury tax threshold will remain at $178 million for 2012 and 2013. In 2014, it will climb to $189 million.

One notable change to the system in the CBA was the addition of punitive penalties. Repeat offenders will pay a higher tax each time. Teams are taxed for the dollars over the threshold. So if a team is $5 million over, the tax rate is applied to that figure, not the entire payroll.

Those rates change beginning in 2013:
First-time offenders: 17.5 percent
Second-time offenders: 30 percent
Third-time offenders: 40 percent
Four-time or more offenders: 50 percent

Let’s say the Dodgers add Ryu and/or Greinke, give Ellis (either through arbitration or a contract) about $2m/year, import some reasonably-priced additions in the outfield and the bullpen, and are able to dump some salary of extraneous starting pitchers like Chris CapuanoAaron Harang and/or Ted Lilly. Taken together, let’s call that about $27m-30m more coming, which combined with the $193m contracted and pre-arb salaries would put the Dodgers at about $230m.

Now, it’s here that I should add two points, both of which come from Gelb. First, the taxable number isn’t just player salaries. It’s also health insurance, worker’s comp, pension contributions, performance bonuses, etc., etc. A baseball source told Gelb this usually accounts for $10m-$11m per year (corroborated by Wendy Thurm at FanGraphs on Friday), so we’ll go with that. Second, a player’s hit against the number is that of his “average annual value”, not his actual cost in a given year. So while Hanley is on the books for $15.5m in 2013, his AAV (including the early years of his 6/$70m deal with the Marlins) is only about ~$11m per year.

While a contract like Matt Kemp‘s is relatively even over the length of the deal, contracts like Ramirez’ and many of Colletti’s run of backloaded two-year contracts from last year mean that AAV for the team should actually be less than what the real cost is in 2013. So that ~$193m the team is committed to right now may actually only count for an AAV of ~180m. (No, I’m not showing my work here, because this is getting too long and math-heavy as it is. Besides, we’re just trying to get to more of a ballpark than an official or rock-hard number, so if it’s off slightly in either direction the point won’t change.)

So let’s do this: $180m committed in AAV + $30m expected additions + $10m arb/pre-arb + $10m in administrative costs equals… $230 million. (!!) That’s $52m over the limit. Apply to that the 17.5% penalty for first-time offenders, which would be a little over $9m, and the total Dodger outlay for 2013 could be ~$240m. (North of $250m if we’re counting the deferrals from Ned’s past sins, though they do not count against the luxury tax, and up to about $275m if they pay out Ryu’s posting fee, which also would not count against the tax.) Again, that’s just an estimate at this point, and can easily change based on any moves they do or don’t make over the next year. (The final yearly payroll is counted at the end of the season, and that can change greatly from what you see on Opening Day.)

Is that more than the team can swallow? Last month, Steve Dilbeck asked chairman Mark Walter about the prospect of paying the tax:

While the luxury tax will figure into the Dodgers’ thinking at some point, that time hasn’t come yet, according to Walter. The Dodgers’ payroll is projected to exceed $200 million next season; any amount they spend over $178 million would be taxed at 17.5%.

Last week, ESPN’s Jayson Stark touched on the topic as well, in speaking to Colletti:

On the trade front, they’ve told other clubs they can still take on money in a deal for a big-name, big-buck starter or third baseman. And Colletti doesn’t deny that even with a payroll that could approach $190-200 million, “in the right situation, we can continue to add.”

Is there a limit to how high their payroll sky can rise? Of course. Is there a limit to how much luxury tax they’re willing to pay? Obviously. But will those limits remind anyone of the days, not so long ago, when McCourt was questioning every dollar they spent? You’re kidding, right?

“I’ll say this again. When they came in, they said, ‘Think bold thoughts,’” Colletti said. “So I think that way now. So if there’s an opportunity right now to make this club better, we can take advantage of that opportunity. Do we have financial responsibilities? No doubt. But we also have the ability to make this club better.”

So if there’s a payroll limit… it doesn’t seem to be near. After, all the limit to any payroll is simply A) how much money do you have available to spend and B) how much of a penalty are you willing to lose to the luxury tax.

Darren Rovell touched on the first point in ESPN the Magazine last week:

Now that the ownership has stabilized, that number seems low to Ed Desser, a Los Angeles–based media consultant who believes the next Dodgers deal is worth up to $225 million a year.

That’s if the team sells the rights rather than starting its own network, which suddenly looks like a far more profitable option. In talks between McCourt and MLB during the league’s attempt to get the team sold, they agreed to peg the market value of the Dodgers’ local rights at a preposterously low $84 million a year, escalating at 4 percent every year.

An MLB team normally has to give up a third of its TV rights fees for revenue sharing. But if you own some or all of your own sports station, that third is applied only to the amount MLB determines your ownership is worth. Hence the Dodgers’ opportunity. Desser estimates that a Dodgers-owned network — a la the Yankees’ YES — could earn up to $425 million a year. If so, the team could pocket all revenue above the first $84 million without sharing, assuming MLB doesn’t change its mind about the valuation. You can see where this is going.

…and that leads into the second point, which is that paying a $9m luxury tax penalty suddenly seems like small potatoes in the face of that kind of incoming cash. It’s that kind of thinking which is making Yankee fans cringe, given that the team has repeatedly said that they’ll be under the $189m limit by 2014, yet they collect something like $90m per year from the YES Network. Considering that the Guggenheim group is fantastically wealthy to begin with and is poised to blow away the Yankees television deal, it’s hard to get upset over the prospect of paying luxury tax fees simply because they disappear rather than go to a player. Better that than paying Juan Uribe, right?

Besides, while this may be a bit naive on my part, it’s not a guarantee that they’ll go over again in 2014 & 2015 and become repeat offenders, bumping them up to a 30% fine. (You can reset your standing by simply getting back under for one year, which is why the Yankees want to get back down rather than pay the higher fees for consecutive overages.) While they’ll of course continue to add players and hopefully sign Clayton Kershaw to a long-term deal, there’s a decent amount of cash coming off the books. After 2013, you lose nearly $50m worth of Uribe, Mark Ellis, Jerry Hairston, Nick Punto, Ted Lilly, Aaron Harang, Chris Capuano, & Matt Guerrier from a group which only has about $130m committed. After 2014, you’re free of nearly $32m to Hanley Ramirez & Josh Beckett from the year before, plus perhaps $12m of Chad Billingsley if his health is still in question, on a payroll that now has $94.5m committed. It’s possible that they’re able to stay under for at least one of those years, and suddenly the luxury tax is a minor concern for a group of such wealth.

It is of course important to note here that spending wildly isn’t the same as spending wisely, of course, and we’ll continue to hesitate at the idea of giving multi-year deals to relievers like League or spending tens of millions on someone mediocre like Kyle Lohse just because he’s there and you’ve got money to spend. There is such a thing as doing more with less, and though it may take some time to bear fruit, all of Stan Kasten’s recent hires in the front office and improvements in scouting should hopefully help with low-cost talent down the road.

Considering how far we’ve come in the last year, this is really still a massive culture shock, because we’ve never quite seen a team act like this. That makes it increasingly difficult to judge moves that they make in the same way as we may for other teams, because this is a strange new world that requires a good deal of adjustment in evaluation. And while we know there’s a point where “enough is enough”… it’s hard to see that the luxury tax is going to be what causes that line to finally be crossed.

Whether that’s the same thing as putting a winning team together remains to be seen. At the very least, this “eff you, that’s why” approach to free agency and team-building is a whole hell of a lot more fun than “will McCourt default on payroll this week?” Whether you agree with this direction or not, it sure is an interesting time to be a Dodger fan.