A luxury tax is a financial penalty that teams have to pay if they spend more than a set amount on player salaries. The tax may be combined with a salary cap, although in Major League Baseball, the tax has been effective since the 2002 Collective Bargaining Agreement without a salary cap being in effect.
The aim of the tax is to discourage teams from over-spending on player salaries, as large contracts become much more expensive once the team has entered into luxury tax territory. The money collected is pooled and redistributed among teams that have kept their salaries within certain parameters. The money is normally to be spent on salaries, in order to "level the playing field", and not to be absorbed as windfall profits. It is a typical accusation of teams that have to pay a luxury tax that the beneficiaries simply pocket the money without using it to improve their on-field competitiveness.
In practice, the tax has not had much effect on limiting player salaries (although it is impossible to prove that salaries would not have grown even more without a luxury tax), but it has served its purpose of making the business environment more favorable to small-market teams, who can use receipts from the tax to keep some of their home-grown players longer, and bid for the occasional mid-level free agent. The richer teams, however, have simply integrated the tax they have to pay into the cost side of their business model, seemingly without restraining their salary outlays. A luxury tax is also imposed on signing bonuses paid to newly signed players, if these exceed pre-set spending limits. Teams have been known to accept incurring a 100% tax when it is the cost of signing a highly-sought international prospect, so the measure's impact has not been that great on teams rich enough to simply pay the fine and move on.
A luxury tax is a form of revenue sharing, although that concept includes a number of other possible measures.
- Bob Nightengale: "Dodgers' tax bill comes due at record $43.7 million", USA Today Sports, December 1, 2015.