2004 Regression Mlb

Did the implementation of the luxury tax in Major League Baseball prove to be effective in increasing a competitive balance the year after it was put into place?

I. Introduction

In 2003, Major League Baseball implemented a luxury tax forcing teams to pay an additional fee to the league on any payroll expenditure above a certain amount. In the first year of existence, any MLB team that spent more than $117 million on salaries for the year had to pay a tax of 17.5% of any overage into a league fund, which was then distributed to low-revenue teams as a form of revenue sharing. In subsequent years, the tax rate rises for second and third time offenders. The luxury tax can be seen as a weaker form of a salary cap. With a normal salary cap, no team is permitted to exceed the cap, but with the luxury tax, teams may choose to exceed the tax threshold as long as they are willing to pay the tax.

The whole purpose of the luxury tax is to increase revenue sharing and therefore increase the competitive balance. The idea is that teams will be less apt to have a higher payroll with the threat of giving up a chunk of their money to the league and lower revenue teams will get support from those who do. However, the luxury tax can be flawed. If teams have enough money, they can still spend as much as they want as long as they are able to pay the tax. On the other side, the revenue shared by larger market teams does not always get spent on players by the smaller-revenue teams. In 2004, the tax threshold was raised to 120.5 million. This paper analyzes the competitive balance between high payroll teams and low payroll teams and measures if the luxury tax was effective the year after implementation.

II. Data

When thinking about the 2004 season, there is no doubt that the first thing everyone thinks about is the Boston Red Sox World Series Championship. There is no arguing that the Red Sox were a great team and they played excellent throughout the season. However, this team was not cultivated from the Red Sox' farm system, but by high priced, free agency acquisitions. Players like Manny Ramirez, Pedro Martinez, David Ortiz, Keith Foulke, Johnny Damon, and Curt Schilling were all acquired on expensive contracts. The 2004 Red Sox had the second highest payroll in Major League Baseball at $125,208,542 or