Luxury tax (sports)
| League | Payroll rules |
|---|---|
| Major League Baseball | Luxury tax |
| National Basketball Association | Soft salary cap + luxury tax |
| National Football League | Hard salary cap |
| National Hockey League | Hard salary cap |
| Major League Soccer | Hard salary cap |
A luxury tax in professional sports is a surcharge put on the aggregate payroll of a team to the extent to which it exceeds a predetermined guideline level set by the league. The ostensible purpose of this "tax" is to prevent teams in major markets with high incomes from signing almost all of the more talented players and hence destroying the competitive balance necessary for a sport to maintain fan interest. The money derived from the "tax" is either divided among the teams that play in the smaller markets, presumably to allow them to have more revenue to devote toward the contracts of high-quality players, or in the case of Major League Baseball, used by the league for other pre-defined purposes.
In North America, Major League Baseball has implemented the luxury tax system. The National Basketball Association also has a luxury tax provision; its utility is somewhat limited by the fact that the league also has a salary cap provision. The "hard" salary cap of the National Football League and the National Hockey League has prevented any need for a luxury tax arrangement.
In the Big 4 North American sports leagues (Major League Baseball (MLB), National Basketball Association (NBA), National Football League (NFL), and National Hockey League (NHL)), there are three different methods employed to limit individual teams payroll: hard salary cap, soft salary cap with luxury tax, and luxury tax.
A hard salary cap is where the league sets a maximum amount of money allowed for player salaries, and no team can exceed that limit.
A soft salary cap has a set limit to player salaries, but there are several major exceptions that allow teams to exceed the salary cap. For example, in the case of the NBA, teams can exceed the salary cap when keeping players that are already on the team.
A luxury tax system does not have a limit to how much money can be spent on player salaries. However, there is a tax levied on money spent above a threshold set by the Collective Bargaining Agreement (CBA) between the players union and the owners. For every dollar a team spends above the tax threshold, they must also pay some fraction to the league. This system is used to discourage teams from greatly exceeding the tax threshold, with the goal of ensuring parity between large and small market teams.
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