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September 15, 2005

Lies, Damned Lies

The Hometown Discount

by Nate Silver

Baseball Prospectus hasn't spent a lot of time lately talking about baseball's economic issues. That's a good thing, because it means that there's not a labor dispute percolating, and that the Collective Bargaining Agreement agreed to in the summer of 2002 has gone over relatively well. Baseball's revenues continue to grow. Those teams that "needed" new stadiums have, in most cases, gotten them. Salaries are accelerating at a reasonable clip, but there's none of the insanity that characterized the 2000-01 off-season, when the Dodgers decided that Darren Dreifort was a $55-million pitcher.

What's interesting is that when talk about labor discussions dies down, so does talk about "competitive balance." Although the 2002 CBA introduced the luxury tax and raised the revenue sharing rate from 20% to 34%, measures that Park Avenue claimed would help smaller market teams to compete, there's little evidence that those teams on the wrong side of the tracks have found it any easier to emerge from the ghetto. The six smallest markets with MLB teams are, by most reasonable definitions, Cleveland, Cincinnati, Denver, Kansas City, Milwaukee and Pittsburgh. Since the new CBA went into effect in 2003, and including year-to-date results for 2005, the teams representing those cities have combined for just two winning seasons in 18 tries (the 2003 Royals and this year's Indians).

Let's shift gears for a second and revisit the finding I introduced last week, that from a revenue-generation standpoint, players are worth significantly more to teams with a reasonable near-term hope of competing for a playoff spot. One of the implications of this is that teams that are not competitive, particularly ones that play in smaller markets, are at risk of joining something of a permanent underclass. When Jason Bay becomes a free agent in a few years, and the Pirates still stink, they're going to find that he might be worth $8 million per season to them, while he would be worth $10 million to the Phillies, who presumably will have gone 85-77 for seven years running and will desperately need a player to get them over the playoff bubble. If the Phillies outbid the Pirates for Bay, it's because he really is worth more in Philadelphia, not because the Pirates are being cheap.

The current CBA doesn't do anything to address this structural problem. Revenue sharing acts as a flat tax that cuts against locally-generated revenues at the same 34% rate for all clubs, rich and poor alike. If Bay is worth $8 million to the Pirates and $10 million to the Phillies before revenue sharing, he's worth $5.3 million ($8 million less 34%) and $6.6 million to those clubs respectively after revenue sharing. The Pirates will wind up with a nice check from Bud Selig at the end of the season, and Bay's salary winds up being lower than it would be with a lower revenue sharing rate. That doesn't do enough to help the Pirates keep Bay in Pittsburgh.

If baseball is serious about encouraging competitive balance, it needs to develop incentives that specifically address this disparity--that the marginal economic value of a win is higher in some markets than others. The luxury tax potentially works in this fashion, but in practice has limited application, since the payroll thresholds are set so high that it only materially impacts the Yankees, and the problem isn't really the Yankees' hegemony so much as it is the Pirates' economically-reinforcing ineptitude.

A solution that would more adequately address the problem is what I'd call a Hometown Discount. Suppose for example that baseball agrees to pay 25% of Jason Bay's contract if the Pirates re-sign him. Now the Pirates can afford to pay Bay $10.7 million per season--$8 million of which they'll cover themselves, and the remainder of which is subsidized by MLB--and they'll outbid the Phillies. Let me introduce some parameters for how such a Hometown Discount might work.