Guest posting: So how does MLB fix this?

March 15, 2010 by Jason@IIATMS

This afternoon, we have a guest posting from one of the readers, Larry in California. Larry’s a self-described “aging, opinionated Yankees fan exiled in Southern California, practicing law and running a software business, with no expertise and only a fan’s interest in sports economics.” He doesn’t pretend to be an expert and notes that he “welcomes comments and additional facts bearing on revenue sharing and other means to promote competitive balance in baseball.” What you see below has not been edited (in terms of content; minor graphical/formatting edits have been made).

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About a week ago, IIATMS’s Jason posted a list of sensible ideas to improve revenue sharing in baseball, and I was foolish enough to post some of my own ideas. In response, Jason challenged me to develop a full-blown guest post, and he also encouraged me to do some research.

I wish he hadn’t done that. It’s easier to post when you’re not confused by the facts.

But the research is interesting. Here’s what I’ve learned. First, major league baseball is ALREADY sharing a lot of revenue. Second, additional revenue sharing will not substantially improve the ability of the poor teams to compete with the rich teams. Third, we can tweak the existing system of revenue sharing, so that it does a better job of improving the competitive balance in baseball.

Let’s look at the facts. In preparing the following, I’m indebted to the information posted at BaseballAmerica.com and BaseballProspectus.com.

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The Current System

Major league baseball has three different forms of revenue sharing. The sharing we hear most about is the Competitive Balance Tax, also known as the “luxury tax”. This tax is computed against the excess of a team’s payroll over a limit set by Major League Baseball. For 2010, this limit is $170 million. As you probably know, the Yankees’ payroll routinely exceeds this limit. The Yankees paid a luxury tax of over $25 million last year, and has paid nearly $175 million in luxury taxes over the last seven years. The luxury tax is paid by the Yankees and nearly no one else. The Red Sox paid an aggregate of about $14 million in luxury taxes between 2004 and 2007; the Angels and Tigers have paid the tax only once.

The luxury tax does little to help the poorer teams in baseball. Most of the luxury tax goes to pay player benefits; relatively little is paid to poorer teams. The luxury tax might discourage rich teams from spending money on player salaries, but that’s about all it appears to do.

The other two forms of revenue sharing are more significant. Baseball shares revenues from two different sources: central fund revenues and net local revenues.

Central fund revenues come from national radio and TV deals and merchandise sales. Depending on where you read, these central fund revenues are divided equally between the 30 major league clubs (BaseballAmerica.com), or they are mostly allocated to the poorer major league clubs (BaseballProspectus.com).

Net local revenues are the total local revenues earned by each team from ticket sales, television, merchandising and the like, minus the cost of operating the team’s stadium. Each team pays 31% of its net local revenues into a common pool, and the pool is then divided equally among the 30 teams. The wealthier teams pay more into the pool than they get back; the poorer teams get back more than they pay in.

(click “view full post” to read more)

The Extent of Revenue Sharing

The division of net local revenues provides for significant revenue sharing.  How significant?  The most recent information we have goes back to 2005 (for a discussion of the lack of available statistics on revenue sharing in baseball, see here). Here are the 2005 figures:

The revenue sharing numbers shown above are from the Wall Street Journal in 2006.  The 2005 revenue numbers are from Forbes.  I put these two sets of numbers together in an effort to make sense of them both.

(If you’re interested in more recent numbers, baseball revenues in 2009 were about $6.6 billion, and total revenue sharing in 2009 was about $433 million.  I’ve seen no team-by-team figures yet for 2009, but there’s evidence that the amount of revenue being shared is growing faster than the amount of revenue being earned.)

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The Pluses and Minuses of Revenue Sharing

Looking closely at the 2005 numbers, we can draw a number of important conclusions: 

  1. There is a lot of revenue sharing going on.  Teams such as the Tampa Bay Rays are drawing something like 1/3 of their gross revenue from revenue sharing.
  2. The current system of revenue sharing narrows the gap between rich teams and poor teams.  The gross revenues for the richest team in baseball (the Yankees, naturally) are about five times higher than the gross revenues for the poorest teams, before we take revenue sharing into account.  With revenue sharing, this gap shrinks in half.
  3. Here’s another way to appreciate the extent of revenue sharing.  The revenue sharing paid (or received) by each team in 2005 is roughly equal to 47% of the amount by which a team’s gross revenues exceed (or fall short of) the league average.  From nearly any perspective, this is a significant amount of sharing.  Imagine for the moment that U.S. income taxes were calculated in this way, so that rich people paid taxes of 47% of gross revenues (i.e., NO deductions allowed) above the national average.  With this system in place, we’d probably eliminate the national debt in a few month’s time!  We’d probably also have rich people rioting in the streets.  (NOTE: to keep this piece as short and simple as possible, I have not shown the calculations I used to come up with my 47% figure.  However, Baseball Prospectus calculates that the actual rate of revenue sharing in baseball is 48%, so my 47% guesstimate is probably not far off the mark. 
  4. Is it possible to improve the competitive balance in major league baseball by increasing revenue sharing?  Well, let’s say that it was our goal to further narrow the gap between rich teams and poor teams.  At the moment, we’re guessing that with current revenue sharing, the Yankees have about 2.5 times more revenue than the poorest teams in baseball.  What if was our goal to narrow this gap further, say from 2.5 to about 1.75?  By my rough calculations, this would require baseball to raise the revenue sharing percentage from my estimated 47% figure to something like 66%.  I doubt that the rich teams would agree to anything like this.
  5. It should be the goal of the poorer teams to  become wealthier, so that they can better compete with the richer teams.   But the current system eliminates much of the incentive for poor teams to get rich.  For example, imagine that the Marlins came up with a program that would cost them $20 million but would result in $30 million of additional revenue.  This plan would normally net a $10 million profit, and you’d figure that any normal business would swiftly adopt such a program.  But with revenue sharing, the Marlins are NOT a normal business.  If the Marlins were to add $30 million of gross revenues, this would result in a reduction of roughly $15 million in the revenue sharing amounts paid to the team.  Add this $15 million cost to the $20 million cost of the program, and the Marlins end up losing $5 million on the deal.  (For another analysis reaching roughly this same conclusion, see here)
  6. One last factor to consider: there’s evidence that some baseball teams with low revenues are nonetheless making a lot of money.  According to John Henry (owner of the Red Sox), “Over a billion dollars [in revenue sharing] has been paid to seven chronically uncompetitive teams, five of whom have had baseball’s highest operating profits.”  It’s not likely that the richer teams would support increasing the revenue sharing payments to teams that are “poor” in terms of gross revenues but “rich” in terms of net profits.

The upshot of the above is obvious: baseball has pushed its system of revenue sharing about as far as it can go.  The current system has narrowed the gap between teams rich in revenue and the so-called “poor” teams, but the system has also eliminated much of the incentive for poor teams to become richer through their own efforts. 

So, how do we improve the competitive balance in baseball?  I personally believe that we should consider solutions in addition to revenue sharing, such as salary caps and floors.  However, a discussion of caps and floors is more than I can undertake here.  Let’s stay focused on revenue sharing.  How do we improve revenue sharing so as to improve the competitive balance in baseball?

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How To Improve Revenue Sharing

To improve revenue sharing, we need to recognize two things.  Number one: baseball is made up of teams located in large markets and teams located in small markets.  There is nothing that small market teams can do to earn the kind of net local revenues available to big market teams.  For this reason, small market teams can compete only if they receive continued and uninterrupted revenue sharing payments from the teams in big markets.

Second, revenue sharing should make the weaker teams stronger.  At a minimum, we should eliminate any aspect of the current system that discourages the poorer teams from earning more net local revenue.  Ideally, we want to focus more revenue sharing on teams that successfully use the revenue to make improvements.

To these ends, I make the following two proposals: 

  1. Look at the Media Markets:  Let’s divide revenue sharing into two pools: Pool “A” and Pool “B”.  Teams in small media markets would ALWAYS get revenue sharing money from Pool “A”, without condition.  (You can get a rough idea of media market sizes from this article.  Teams like Pittsburgh, Milwaukee and Kansas City would get a piece of Pool “A” regardless of how much revenue they earn.  In this way, small market teams would not be punished with loss of revenue sharing (at least, not from Pool “A”) if they managed to win more games and make more money.  The rule would work in reverse for teams from big markets, like the Phillies (a team that actually received revenue sharing during 2005).  These teams would NEVER receive revenue sharing money.
  2. Reward Success.  While Pool “A” funds should be paid to small market teams without condition, the remainder of the pool (Pool “B”) would be paid with strings attached.  Under my proposal, teams would apply to major league baseball to receive Pool “B” funds.  The application would include a proposal for how the team planned to use Pool “B” funds to make improvements.  The improvements would have to include measurable benchmarks, such as (a) improved attendance, (b) increased net local revenues, (c) increased payroll and (d) improved performance on the field (measured in terms of wins and losses).  In theory, any team would be eligible to apply for Pool “B” funds (in practice, I don’t think that the Phillies should be eligible for these funds, either).  If a team submitted a conforming plan, then the team would be eligible for Pool “B” funds in year 1, but the team’s ability to receive funds in year 2 and thereafter would depend on the team’s meeting its plan benchmarks. 

OK, I’ll admit that my proposal is short on details.  It adds a subjective element to revenue sharing, in that team proposals for Plan “B” money would have to be evaluated by major league baseball: some plans would be accepted and others rejected, with potentially disastrous results for the rejected teams.  Some teams would adopt meaningless “slam dunk” benchmarks that any team could reach, and call it “progress”.  Some teams would lose revenue sharing money because they missed a benchmark by an eyelash – the team’s ace pitcher might blow out an elbow and the team would win 74 games instead of the 75 set forth as the team’s benchmark. 

Also, my proposal would not work miracles.  It would not level the playing field.  It would not give the Royals the same chance as the Yankees to win the World Series. 

No proposal is perfect. 

But my proposal would improve the current system of revenue sharing.  It would provide a more competitive environment for small market teams like the Pirates, and would focus at least a portion of revenue sharing on teams like the Twins and the A’s who have historically achieved the best results with the smallest resources.  It would better use the existing revenue sharing pool to improve the competitive ability of at least some of the weaker teams in baseball.  It seems to me to be worth a shot.

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Thanks to Larry for providing us with some good discussion material. Have at it below.

 
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