What Is the Luxury Tax in Baseball?

The $700 Million Wake-Up Call: Can MLB Fix This?

Shohei Ohtani’s $700 million deal with the Dodgers didn’t just make headlines—it raised eyebrows across baseball. If there's a system meant to keep the playing field fair, how does one team still land a roster full of stars?

That system is called the competitive balance tax, or CBT. Some know it as MLB’s luxury tax. But if you’re wondering whether it’s doing what it’s supposed to do… you’re not alone.

Let’s break it down: what it is, how it works, why it's falling apart—and what that means for baseball fans everywhere.

How the Competitive Balance Tax Was Supposed to Work

The Original Plan

Back in the mid-90s, after a player strike nearly broke the league, MLB came up with a way to control runaway payrolls. The idea? Make teams that spend over a set limit pay a penalty. That way, smaller teams could compete with big-spending giants.

Here’s how it works:

Sounds fair, right? In theory, yes. But in reality? Teams with deep pockets just pay the fee and keep stacking talent.

MLB luxury tax explained: how it works and why it matters

The MLB luxury tax, officially known as the Competitive Balance Tax, is designed to prevent high-revenue teams from vastly outspending smaller-market clubs. It sets a spending threshold for team payrolls. If a team exceeds this limit, they must pay a tax based on how far over the line they go—and how often they’ve done it in past seasons.

For example, in 2025, the base tax threshold is $237 million. Teams spending above that are penalized in tiers:

• Tier 1 (up to $20M over): 20% tax on the overage
  

• Tier 2 ($20M–$40M over): 32% tax
  

• Tier 3 (Over $40M): 62.5% tax, plus potential draft pick penalties
  
  

The longer a team exceeds the threshold year after year, the harsher the penalties. This system encourages payroll discipline while still allowing big-market teams some flexibility.

So why does it matter? Because it affects how teams spend, trade, and build their rosters. It also impacts competitive balance, free agent signings, and even ticket prices, making it one of the most important financial mechanisms in baseball today.

Dodging the Tax: Creative Contracts and Deferred Deals

Here’s where it gets tricky. Ohtani’s deal is worth $700 million—but most of that is deferred, meaning the Dodgers won’t pay it for years. That lowers their payroll on paper, which reduces how much they owe in tax.

It’s not illegal. It’s just smart, and rich teams can afford to do it.

These teams can:

• Stretch contracts to lower yearly payroll
  

• Stack multiple stars in one season
  

• Avoid the harshest tax tiers for now
  
  

The tax was meant to slow down spending. But with clever accounting, it’s just a bump in the road.

Why Smaller Teams Can’t Keep Up

Not every team has the resources of the Dodgers or Yankees. Clubs like the Pirates, Rays, and A’s play a different game entirely.

Here’s why:

• Smaller markets bring in less money
  

• TV deals and sponsorships are worth less
  

• They can’t always afford top free agents
  

• Revenue-sharing sometimes helps, but it’s not always used to build stronger rosters
  
  

Even when smaller teams do develop stars, they often lose them in free agency. Fans feel like their teams are stuck in a loop.

Is the Playing Field Really That Uneven?

Let’s look at some 2024 payroll numbers:

The difference is massive. You can’t buy wins, but having money sure helps you try.

Beyond Payroll: More Ways the Gap Grows

Spending doesn’t stop at big league salaries. Teams also pour money into scouting, development, and international signings.

Here’s how big-market teams stay ahead:

• They spend more on international free agents
  

• They build deeper farm systems
  

• They take advantage of draft loopholes
  
  

Smaller clubs may have the same rules, but not the same budget. Over time, that adds up.

What Fans Are Seeing—and Feeling

You don’t need a spreadsheet to feel the frustration. Fans in cities like Kansas City or Cincinnati are tired of waiting for a miracle season.

Meanwhile, teams like the Dodgers reload every winter. It doesn’t feel fair, and for many, it’s not much fun to watch.

Even the league knows this is a problem. But what’s being done about it?

What Could Fix This?

With the current agreement between players and owners set to expire in 2026, there’s a chance to make changes.

Here are some ideas floating around:

• Raise the tax rate so overspending hurts more
  

• Set a minimum payroll so teams have to try
  

• Cap spending with a hard salary limit (though the players' union isn’t into that)
  

• Try out a “relegation” system like in soccer (very unlikely, but interesting)
  
  

Whatever the fix, it has to be real. Because right now, the tax isn’t working.

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Where Does MLB Go From Here?

Without changes, here’s what we’ll keep seeing:

• Big clubs are stacking stars
  

• Small teams struggling to hold on
  

• Fans in half the league are wondering if they even have a shot
  
  

The CBT can work—but only if it’s enforced with more than a slap on the wrist.

FAQs

1. How does the competitive balance tax affect small-market MLB teams?

The competitive balance tax was originally introduced to help small-market MLB teams stay competitive, but its real-world impact has been mixed. While the luxury tax does impose financial penalties on high-spending teams, it hasn’t fully solved the problem of economic disparity.

Small-market teams like the Pittsburgh Pirates, Oakland Athletics, or Kansas City Royals often operate with significantly lower payrolls compared to franchises like the New York Mets or Los Angeles Dodgers. Even when the tax collects revenue from big spenders, there's no guarantee that money gets reinvested into smaller clubs’ rosters or player development systems.

In many cases, these teams lack the revenue streams—like large TV contracts or massive ticket sales—that help cover luxury tax penalties. This leaves them relying on drafts, trades, and player development rather than high-profile signings. Some critics argue that without a salary floor—a rule requiring all teams to spend a minimum amount—the competitive balance tax alone does little to encourage true parity.

So while the luxury tax in baseball was meant to close the gap, it may unintentionally reinforce a system where only some teams can afford to build championship-calibre rosters year after year.

2. What is the difference between the luxury tax and a salary cap in MLB?

The terms luxury tax and salary cap often get confused, but they’re two very different systems in the world of pro sports, especially in MLB.

A salary cap is a strict limit on how much a team can spend on its roster. Leagues like the NFL and NBA operate with either hard or soft salary caps, which force teams to stay within a specific budget (with limited exceptions). This creates more balance, as no team can consistently outspend everyone else.

On the other hand, MLB uses a competitive balance tax, or luxury tax, which is more like a financial threshold. If a team goes over the limit, they pay a penalty, usually a percentage of the overage that increases with repeat offences. But there’s no hard stop. Teams like the Dodgers or Mets can choose to exceed the threshold and simply pay the tax.

So while a salary cap prevents overspending, the MLB luxury tax merely discourages it. For wealthy franchises, it’s often just a cost of doing business. This leads many fans and analysts to argue that baseball’s current model doesn’t truly level the playing field, especially without a corresponding salary floor for low-spending teams.

3. Why do MLB teams defer player contracts to avoid luxury tax penalties?

Many MLB teams use deferred contracts to manage their payroll calculations and minimize luxury tax exposure. When a team defers payments—meaning they agree to pay a player most of their salary in future years—it reduces their annual payroll figure, which is used in calculating the competitive balance tax.

This tactic came into the spotlight when Shohei Ohtani signed a record-breaking $700 million contract with the Los Angeles Dodgers, with over 90% of the salary deferred until after his playing days. Even though the total value is massive, the Dodgers' luxury tax payroll number for Ohtani is much lower than it would be if the payments were immediate.

By deferring contracts, teams can:

• Sign elite players without triggering higher CBT tiers
  

• Avoid becoming repeat offenders (which increases tax penalties)
  

• Free up short-term payroll flexibility
  
  

Deferred payments aren’t illegal or new, but they’ve become more strategic as teams look for loopholes within the MLB luxury tax framework. For fans and critics, this raises concerns that the system can be manipulated, giving big-market teams even more financial leverage without paying proportionate penalties.

4. Has the MLB competitive balance tax created more parity?

While the competitive balance tax was designed to promote parity across Major League Baseball, many argue it hasn’t delivered on that promise. The idea behind the tax was to discourage excessive spending by big-market teams and redistribute money to smaller-market franchises, but in practice, the gap between rich and poor teams remains wide.

Look at postseason appearances over the past decade. Teams like the Dodgers, Yankees, and Astros have made the playoffs consistently, often thanks to large payrolls and deep benches. Meanwhile, smaller-market clubs like the Rays or Guardians have made impressive runs, but far less frequently, and usually with lower margins for error.

One issue is that tax revenue doesn’t always go directly toward roster improvements. MLB doesn’t force small-market teams to reinvest the luxury tax dollars they receive. Without accountability, those funds may be used for operations, debt service, or even saved, rather than used to acquire talent.

So while the MLB luxury tax has curbed some spending at the very top, it hasn’t meaningfully closed the gap. True parity may require not just a tax, but new systems like salary floors, stronger revenue-sharing rules, and draft reform.

5. What could replace the luxury tax to create real balance in MLB?

If the current competitive balance tax isn’t doing enough, what’s the alternative? Several solutions have been proposed to replace or strengthen the MLB luxury tax and create a more competitive league.

One idea is a hard salary cap, like in the NFL. This would limit how much each team can spend, period. But the MLB Players Association strongly opposes this, as it could suppress player salaries and reduce financial flexibility.

Another option is a salary floor—a minimum amount each team must spend. This would prevent teams from "tanking" by slashing payrolls to the bottom and cashing in on revenue sharing. A salary floor could pair well with the existing luxury tax to promote both high- and low-end balance.

Additional proposals include:

• Tougher repeater penalties to punish chronic overspending
  

• Limitations on contract deferrals
  

• More transparency in how tax revenue is used
  

• Even relegation systems, where the lowest-performing teams face consequences (similar to European soccer)
  
  

Whatever solution gains traction, one thing is clear: the current luxury tax in baseball needs more teeth if MLB wants fans to believe every team has a fair shot.

Final Thoughts

The luxury tax in baseball was supposed to make things fairer. Instead, it’s become something rich teams budget for, and smaller clubs can’t benefit from.

With the next CBA on the horizon, there’s a real chance to fix this. Fans deserve a league where every team has a shot. Whether that happens will depend on what the owners, the players, and the league decide to prioritize.

Until then, we’ll keep watching—and hoping.