This winter, much will be made of the Angels and the luxury tax. The big, bad scary luxury tax. The luxury tax that ruins franchises and tears families apart. The luxury tax of our impending doom.
The Hot Stove League has been open for business for less than a week and already it has become necessary that every Angel rumor is tagged with "but they have luxury tax concerns that will likely prevent such a deal." The way the rumor mongers would tell it, the Halos are more concerned about avoiding the luxury tax than actually improving their not-so-good baseball team. The question is should they really be cowering in fear of the luxury tax?
The math here is simple to understand. The luxury tax line is set at $189 million, the Angels are looking at a tax number of about $167 million right now if we assume they non-tender Jerome Williams, Juan Gutierrez and Tommy Hanson and factor in projections for the rest of the arbitration eligible players on the roster. For those who aren't aware, the basics of the luxury tax calculation is it takes the average annual value of everyone on the roster as well as about $12 million in miscellaneous figures for taxes and benefits. Some of that is hard to nail down, so the $167 million is not an exact calculation. What that means is that the Angels can hand out $22 million (give or take) in average annual value contracts this off-season before they cross the luxury tax line. That is not a whole lot of room to work with for a team hoping to add two new starting pitchers, at least one quality bullpen arm and extend Mike Trout. With that in mind, it is easy to see why there is so much hand-wringing going on right now.
That situation may sound dire, but it really isn't. First and foremost, the Angels can clear room by trading expensive players for cheap ones. This is why it has become a fait accompli that Howie Kendrick and his $8.375 million tax figure will be traded and why Iannetta ($5.183 million) and Trumbo (projected at $4.7 million) are strong candidates to be moved as well. Unloading one or two of those guys might be all the breathing room Jerry Dipoto needs to accomplish the rest of goals.
But here is the thing, the Angels don't have to do any of that. They don't have to feat the luxury tax. They don't have to trade someone. They don't have to limit their off-season spending (well, within reason). The way the luxury tax works is that the first time you breach the threshold, you are penalized 17.5% for every dollar spent over $189 million. That means the Halos could go $10 million over the tax line and their tax bill would be a mere $1.75 million. Money is money, but by the Angels' budgetary standard, $1.75 million is pocket change.
Where the luxury tax actually becomes scary is for repeat offenders. If you violate the tax threshold two years in a row, the penalty is up to 30%, then 40% in year three and 50% in year four and beyond. And that is consecutive years so the Angels could pay in 2014, get under the tax in 2015 then go back over in 2016 and would only be charged the first-time offender 17.5% tax rate. So if you look at it practically, the luxury tax isn't that big of a deal so long as you don't go over it by a huge amount and/or in consecutive seasons.
Based on their unofficial payroll limit of about $150 million, the Angels aren't a real threat to ever pass the tax line by a significant amount. The tricky part is avoiding the tax two years in a row. Only it really isn't that tricky for the Angels. A big part of their 2014 tax figure is the $18.6 million hit from Vernon Wells. That's nearly 10% of the tax number, but it rolls off the books after the season, as does the $7.5 million in dead weight that is Joe Blanton. As the roster stands now, the Angels are looking at $121 million in tax commitments (before arbitration) in 2015 and then $107 million in 2016, the last year of the current CBA. That's not a massive amount of room, especially when you factor in Trout hitting arbitration in 2015 (which we will get to), but it is more than enough for a savvy GM to workaround.
Part of being savvy means planning for the future and gaming the tax calculation some. This is where the Trout extension issue factors in heavily. While the luxury tax picture gets better for the Angels in 2015 and 2016, it isn't as if they can be carefree about it. Trying to tack an extension for the best young player ever on to that bill is not to be taken lightly. We all know that if Trout gets an extension it is going to be huge. Just to set a realistic example on the high end, his extension could be structured something like this:
2014: $2 million
2015: $11 million
2016: $14 million
2017: $18 million
2018: $25 million
2019: $28 million
That contract would pay Trout salaries in arbitration years that would be record values for the respective years (I think, they are definitely records for cases that actually went to trial, but it isn't clear if they are records for settlements). It also buys out two years of his free agency, but still allows him to hit the open market going into his age 28 season. From a luxury tax perspective, that contract would have a $16.33 million hit. That would leave the Angels with about $7 million in tax room in 2014 and $52 million in 2015. But if the Angels get too concerned about the tax in 2014 and opt not to extend Trout so that he only counts for $1 million or so, it makes an extension the next year even more complicated. Drop that one pre-arbitration year off the extension and the tax number rises to $19.2 million. Considering how much more pressing it is for the Angels to avoid the tax in 2015, that $3 million difference ends up being pretty important.
Of course, the luxury tax could prompt them to avoid and extension altogether. It is unlikely Trout would get paid more than $12 million through arbitration in 2015 or more than $16 million in 2016. Those would obviously be figures below the extension's tax number. But that also means they don't get to buy out any of his free agency and that if they sign him to an extension the year before he hits free agency or after he actually hits the open market, his tax number will be enormous. That is a big risk to take because it obviously means potentially losing Trout, but also because the CBA expires after 2016 and there is no telling what the luxury tax rules will be in the next agreement.
Because of those threats, the Angels have every reason to make an extension happen now. If it means going over the luxury tax line in 2014, so be it because getting the deal done now goes a long way towards making sure they avoid the tax in 2015 and beyond.
If we were to move forward in a hypothetical where the Angels give Trout that extension and sign Masahiro Tanaka for six years, $70 million and round out the roster with a $5 million per year reliever and a pre-arbitration pitching prospect, they'd be $10 million over the tax line and that is before trading anyone. So even with those payroll additions, their tax hit isn't that bad and they can get under the line easily by moving Kendrick and Trumbo or Iannetta.
Moving to 2015, the Angels could keep that same roster entirely intact and factor in arbitration raises (and maybe replacing Burnett's expiring contract with someone at the same value) to come out at a luxury tax number that is a few hundred thousand below the tax line. That is where that $3 million saving on Trout's extension becomes so critical. Sure, they could still avoid that tax by moving one of their mid-sized salary players, but because of the savings from doing a Trout extension prior to the 2014 season prevents them from having to make a move to stay under the tax line. Seldom ever do teams make good personnel decisions when they have a gun to their head.
See, kids, the luxury tax really isn't all that bad and scary. You just have to have a healthy respect for it and handle it with care. By planning ahead and keeping your distance, you can get near the luxury tax and come away unscathed.
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