A Closer Look At The Red Sox And The Luxury Tax

The Red Sox’ bullpen — or, really, its lack of fortification this offseason — has garnered plenty of recent attention. President of baseball operations Dave Dombrowski has not only downplayed the possibility of a reunion with Craig Kimbrel but also the addition of any notable arm. While Dombrowski has stated that there’s no mandate to remain south of the top luxury tax border, it also seems increasingly likely (if not apparent) that that’s exactly what the team is planning to do. Most onlookers have at least a cursory awareness of what that entails, but I felt it worth a deeper look to see exactly what the Sox are deeming the theoretical breaking point — if they are indeed set on avoiding that barrier.

This isn’t necessarily a call for the Red Sox to spend more, to be clear. Boston is poised to carry Major League Baseball’s highest payroll for the second consecutive season and stomached the hit when they incurred top-level luxury penalization last year. This offseason, ownership green-lit a $68MM expenditure on Nathan Eovaldi and another $6.25MM on Steve Pearce. The Sox have hardly refused to spend. Every team, though, has its limit, and at the very least Boston seems close to that point.

At present, Roster Resource’s Jason Martinez has the Red Sox with a 2019 payroll of $238,373,928. That’s how much money they’ll pay out to players — those on the roster and those either no longer on the 40-man (Rusney Castillo) or no longer even in the organization (Pablo Sandoval).

For the purposes of the luxury tax (labeled as the Competitive Balance Tax in baseball’s collective bargaining agreement), however, payroll is calculated by the average annual value of the contracts for which a team is responsible (in addition to a set level of player benefit costs, which include medical costs, moving/travel expenses, etc.). Jason has Boston’s luxury tax payroll (“actual” payroll, as termed in the CBA) projected at $241,269,197. Those numbers, both the 2019 payroll and the “actual” payroll, are estimates and aren’t exact, but they’re both close approximations that provide a reasonably accurate depiction of what the organization’s expenses currently entail. Before delving further into what additional spending would mean for the Red Sox, it’s important to note what those numbers mean for the team’s current taxation penalties.

For the 2019 season, the luxury tax line has been set at $206MM. Even without re-signing Eovaldi and Pearce, the Sox were always going to be well north of that line. The collective bargaining agreement stipulates that a second-time offender — the Red Sox were over the luxury line in 2018 but stayed shy of it in 2017 — will pay a 30 percent tax on the first $20MM over the initial luxury line. Teams are subject to an additional 12 percent tax on the next $20MM spent. If a team crosses the luxury limit by more than $40MM, it will pay an additional 45 percent tax from that point forward and also see its top pick in the next year’s draft dropped by 10 spots. Put otherwise:

• $206MM to $226MM: 30 percent tax (a total of $6MM)
• $226MM to $246MM: 42 percent tax (a total of $8.4MM)
• $246M or more: 75 percent tax and a loss of 10 spots in the following year’s draft

Using Jason’s figures above, the Red Sox are paying the full $6MM of that first level and are $15,269,197 into the second level of tax penalization. That sum is taxed at a 42 percent rate, meaning the Sox are paying a $6,413,063 tax on it. At present, then, the Red Sox are committed to paying about $12.413MM worth of luxury tax penalties. There’s a $4,730,803 gap between their current projection and the $246MM top luxury line. If they were to, theoretically, add another reliever for a dollar less in order to avoid top-level penalization, the Red Sox would be taxed an additional $1,986,937. Of course, that’d leave them unable to make a single in-season addition should the need arise.

That, however, is the gripe for many critics. A bullpen headlined by Matt Barnes, Ryan Brasier, Heath Hembree, Brandon Workman, Tyler Thornburg and Brian Johnson seems quite likely to necessitate trade-deadline augmentation — and that’s before even allowing for the possibility of an injury to a key player that would also require a trade acquisition. It’s not only possible that the Red Sox will have crossed the top luxury line by the time the July 31 non-waiver trade deadline has passed — it seems downright likely. Perhaps the plan is to find trade acquisitions whose salaries can be largely paid down by their current team, but doing so would require paying up a greater premium in terms of prospects and thus weaken an already thin farm system.

Should paying more in terms of prospects be preferable to lessening the 2020 draft budget? Some might argue that it’s preferable to go ahead and commit to taking the draft hit in order to gain the advantages of a bolstered bullpen from the start of the season. After all, the division is hardly a shoo-in and the Sox obviously have designs at chasing an elusive repeat title. But what does that actually mean from a financial standpoint?

For the sake of argument, let’s take a look at what the Red Sox would have to pay in order to sign Kimbrel at the four-year, $70MM term projected by MLBTR in our Top 50 Free Agent Predictions back in November. In trying to peg Kimbrel’s eventual contract, Tim Dierkes, Jeff Todd and I all felt that Kimbrel would seek to top Aroldis Chapman’s record guarantee (which he reportedly has indeed pursued) but ultimately fall shy and instead, ahem, “settle” for breaking Wade Davis’ $17.33MM annual salary record for a reliever over a four-year term. Kimbrel may very well fall shy of our $70MM prediction, but he could still set a new AAV standard with a three-year, $52.5MM deal. Even a one-year deal at the $17.5MM level would come with the same CBT hit for 2019. For purposes of this hypothetical, that seems a reasonable figure to work with.

If the Sox were to pay Kimbrel a $17.5MM annual salary, the first $4,703,803 of that salary would close the gap between Boston’s current “actual” payroll and the $246MM threshold. As noted above, that’d come with a $1,986,937 luxury hit, coming to a total of $6,690,740. The remaining $12,769,197 would come with a hefty tax of $9,576,898. That’s a total of $11.564MM just in taxes before considering the money the team would actually owe to Kimbrel himself.

Viewed through that lens, Boston would effectively be on the hook for a stunning $29,036,835 in 2019 if they were to sign Kimbrel at the record rate he’s quite likely eyeing. (A multi-year deal, of course, might have greater or lesser salaries in its various seasons, though that’s all averaged for the CBT.) Frankly, even beyond any concerns about lengthy commitment to a not-so-youthful reliever, it’s pretty clear to see why the Sox don’t have much interest in retaining Kimbrel unless his price tag craters (at which point a plethora of other teams would join the bidding). Though the total luxury tax bill would still not make up an enormous amount of the team’s total payroll-related spending, it would perhaps turn a Kimbrel signing from a hefty investment to an eye-popping splurge.

That math is also informative when examining why the Sox have passed over other top-end relievers. For instance, beating the Yankees’ three-year, $27MM offer to Adam Ottavino by a margin of $500K annually would’ve still been costly for Boston. As with any contract, the first $4,703,803 of the deal would’ve been taxed at $1,986,937. The remaining $4,796,197 would come with a $3,597,148. In total, signing Ottavino at a $9.5MM annual salary would effectively cost $15.084MM in 2019.

Boiled down, any relief addition for the Red Sox with an annual salary north of the $4,703,803 gap that exists between their current “actual” payroll and the $246MM luxury line could be viewed as such (where X = the average annual value of a new contract):

(X – 4,703,803) + (X – 4,703,803)*0.75 + 6,690,740 = Total 2019 expenditure

All of that, of course, is before even acknowledging the 10-spot drop they’d face in the draft for a second consecutive season. There’s no way of knowing precisely how much the Sox would be costing themselves in the 2020 draft, or even how much they stand to lose in the 2019 draft after crossing the top level last year, as 2019 slot values aren’t yet known. However, dropping from No. 30 in 2018 to No. 40 (the drop they’re facing this year) would have resulted in a loss of $489,500 in the team’s draft pool. Draft slot values increase incrementally each season, and the Red Sox’ exact placement in the draft order obviously can’t be known. But generally speaking, the Sox would be looking at a 10-spot drop and a loss of at least $500K in their 2020 draft pool.

Clearly, the price to add a reliever of any significance will be steep for Boston — possibly more so than most would expect before truly diving into the math behind further additions. That said, it’s still worth questioning the Red Sox’ decision to draw a line in the sand at this juncture. The current state of the ’pen makes it seem likely that Boston will need to add a reliever during the season anyhow, and that could still put the team over the limit while also costing prospects.

Beyond that, this it’s quite likely that this is the last time Boston will ever enjoy the Chris Sale, Xander Bogaerts and J.D. Martinez all on the same roster. Sale and Bogaerts are free agents after the 2019 season, and Martinez has an opt-out provision that he’ll presumably exercise if he produces anywhere near his 2018 levels. Add in the fact that Mookie Betts can become a free agent after the 2020 season — though the Sox surely hope to extend their franchise player — and there’s all the more urgency for Boston to go all out in its pursuit of another championship.

Further spending truly doesn’t appear to be in the cards for Boston, though perhaps they’ll be able to secure one of the market’s remaining relievers at a modest $2-3MM commitment that’d still allow them to avoid the top line. But the Sox look like they’re genuinely poised to enter the season with a glaring weakness — one that’ll be tough to account for during the season. While the staggering level of taxation they’d have had to pay on another notable ’pen arm (or two) makes their reluctance understandable, that’ll still be a tough sell to fans if the current group of relievers doesn’t exceed expectations in dramatic fashion. It’s an illustration of the potency of the current luxury tax rules — though, of course, the payrolls of virtually every other team in baseball presently reside comfortably out of range of this level of penalties.