Free Agency and Marginal Tax Rates

Taxes have been a hot commodity lately with the massive trade sending several big contracts north of the border. While tax rates are a very complex topic that I certainly am not an expert in, I know just enough to be dangerous and hope to walk you through what marginal tax rates are and how they work in relation to MLB Free Agency.

For this post we’re going to make the following assumptions:

1. Players are taxed on their playing income based on the state/country they play in (i.e. their home team’s location).

2. For the purpose of this exercise we’ll ignore the “jock tax” aspect of being a professional athlete. If you want to read more about this unique method of taxation check out this article.

3. All national tax rates used will come from the “Head of Household” figures provided by the US and Canadian governments. State taxes are based on the highest tax rate in that particular state (if that state has a marginal tax system). I’ve decided to disregard local taxes for the purpose of this exercise.

 

So what is a marginal tax rate? Essentially it’s the tax rate on each additional dollar earned by someone. For example, if someone makes between $0 and $12,400 they are taxed at 10% on every dollar they make. However, if someone else makes $22,400 then they are taxed at 10% on the first $12,400 and then 15% on the remaining $10,000.

Therefore, with a long-term contract worth several million dollars our concern is the tax rate for the highest dollar bracket, in this case 35% for all individuals making $388,351 or more. This is just the national figure though, so taking into account local impacts on marginal tax rates, here is the marginal tax rate for each state with an MLB team:

The table, sorted by highest marginal tax rate shows how poorly Toronto fares compared to many U.S. cities, especially those in Florida, Texas, and Washington (state). State figures are pulled from here.

So what does this all mean? Well, players should take into account taxes when considering big deals. In effect these two deals are the same in AAV:

3 year, $30,000,000 with a Florida team

3 year, $36,387,385.71 with the Toronto Blue Jays

Keep in mind that these numbers don’t even take into account cost of living adjustments which shift these numbers even more. Let’s look at Tampa Bay vs. Toronto with cost of living adjustments:

3 year, $30,000,000 contract in Tampa Bay

3 year, $45,793,524.92 contract in Toronto

The $6,000,000 difference in the first adjustment isn’t that big of a deal, but once you take into account the cost of living adjustment you find that Toronto essentially has to offer players roughly 50% more than what Tampa Bay would for the player to make the same amount at the end of the day.

As for Baltimore, this puts us generally in the middle of the pack. For example, Baltimore is taxed at a higher rate than Tampa Bay for example, and our cost of living is marginally higher depending on what components you focus on. You can easily compare Baltimore to other cities in the United States (or Canada) to get an idea of what type of value player’s contracts have.

For players, there is something crucial to understand and that is that money is not the same everywhere. In fact, agents might even be able to play a role in bargaining for some protections in their players’ contracts. At the end of the day it’s important for everyone – players and fans alike to have an understanding of how taxes and cost of living adjustments  matter when evaluating player contracts.