question: What is a luxury tax as it refers to sports teams? How does signing potential free agents possibly impose the tax on a team?
comment: It is a sort of soft cap. A hard cap like football is you can’t spend more than x amount of money on player salary . A luxury tax is a soft because you can spend more than the cap but at a penalty. If you spend more than x amount of money you will have to pay a penalty of a certain percentage for every dollar you go over the amount ultimately making signing players over the cap even more expensive. This money in some sports is given to teams with lower payroll. It is meant to make up for some teams being in smaller markets.
passages: Section::::Efficacy.
   Section::::Luxury tax rules by league.:Major League Baseball (MLB).
  
  As explained by Fangraphs: "Technically called the 'Competitive Balance Tax', the Luxury Tax is the punishment that large market teams get for spending too much money. While MLB does not have a set salary cap, the luxury tax charges teams with high payrolls a considerable amount of money, giving teams ample reason to want to keep their payrolls below that level."
   The NBA utilizes a soft salary cap, meaning there is a salary cap but there are a variety of exceptions that allow teams to exceed that cap. For example, teams can re-sign players already on the team to an amount up to the maximum salary allowed by the league for up to five years regardless of where their payroll is relative to the cap. This provision is known as the "Larry Bird" exception, named after the former Boston Celtics player who was retained by that team until his retirement under the provisions of this rule. The result is that the majority of teams are over the cap at any given time.
   A soft salary cap has a set limit to player salaries, but there are several major exceptions that allow teams to exceed the salary cap. For example, in the case of the NBA, teams can exceed the salary cap when keeping players that are already on the team.
  
  Section::::Methods for limiting payroll.:Luxury tax.
   The luxury tax is separate from revenue sharing, which is a system to balance out the income distribution between large and small market teams by dividing money from merchandise sales and media contracts. The money generated from the luxury tax is not distributed to the rest of the league, as is the case with the NBA, but rather is used for other purposes. The first $2,375,400 and 50% of the remaining total are used to fund player benefits, 25% goes to the Industry Growth Fund, and the remaining 25% is used to defray teams' funding obligations from player benefits.
   Section::::Luxury tax rules by league.:National Basketball Association (NBA).
   Section::::Purported proof a tax works.
   Only eight teams have ever exceeded the luxury tax threshold: the San Francisco Giants, the Boston Red Sox, the Los Angeles Angels of Anaheim, the Detroit Tigers, the Los Angeles Dodgers, the New York Yankees, the Chicago Cubs for the first time in 2016 and the Washington Nationals for the first time in 2018. Only the Red Sox, Dodgers and Yankees have exceeded it more than once. The LA Dodgers have exceed it four times. Boston has exceeded it six times. New York has exceeded it fourteen times, or, every year since it has been in enforcement. In aggregate, the Yankees have paid out some $325.00 MM, 73.78%, of the total fines assessed since the luxury tax began. 
   In 2016 a record six teams were issued the luxury tax by the MLB. The Los Angeles Dodgers ($31.8 million), the New York Yankees ($27.4 million), the Boston Red Sox ($4.5 million), the Detroit Tigers ($4 million), the San Francisco Giants ($3.4 million) and the Chicago Cubs ($2.96 million).
   Section::::Reaction Across the League.
   Section::::Other MLB Revenue Sharing Policies.
   Section::::Luxury tax rules by league.:National Basketball Association (NBA).:Current tax levels.
  
  The resulting total is then distributed to the remaining teams that are under the tax threshold. 
  
  There was no luxury tax implemented in the 2004-2005 season due to insufficient basketball-related income.
  
  Although exceeding the luxury tax threshold costs a team twice as much money, it does not seem to limit teams' willingness to spend big money on players.
  
  Section::::Luxury tax rules by league.:Canadian Football League.
  
  The Canadian Football League has a luxury tax. Penalties for teams that breach the salary cap regulations are:
  
  Section::::Luxury tax rules by league.:Other leagues.
   In the Big 4 North American sports leagues (Major League Baseball (MLB), National Basketball Association (NBA), National Football League (NFL), and National Hockey League (NHL)), there are three different methods employed to limit individual teams payroll: hard salary cap, soft salary cap with luxury tax, and luxury tax.
  
  Section::::Methods for limiting payroll.:Hard salary cap.
  
  A hard salary cap is where the league sets a maximum amount of money allowed for player salaries, and no team can exceed that limit.
  
  Section::::Methods for limiting payroll.:Soft salary cap.
   Section::::History of the Major League Baseball Luxury Tax.:2002–present.
   In 2018 only two teams met the luxury tax by the MLB: The Boston Red ($9.4 million) and The Washington Nationals ($1.2 million). Several teams came just under the $197 million tax threshold: The San Francisco Giants ($196.66 million), The Chicago Cubs ($183.9 million), Houston Astros ($182.4 million), Los Angeles Dodgers ($181.99 million) and New York Yankees ($178.8 million).
   Section::::History of the Major League Baseball Luxury Tax.:1997–1999.
   The threshold level for the luxury tax will be $189MM in 2014 (up from $178MM from 2011-2013) and will remain at $189MM through 2016. From 2012 through 2016, teams who exceed the threshold for the first time must pay 17.5% of the amount they are over, 30% for the second consecutive year over, 40% for the third consecutive year over, and 50% for four or more consecutive years over the cap.
   A luxury tax system does not have a limit to how much money can be spent on player salaries. However, there is a tax levied on money spent above a threshold set by the Collective Bargaining Agreement (CBA) between the players union and the owners. For every dollar a team spends above the tax threshold, they must also pay some fraction to the league. This system is used to discourage teams from greatly exceeding the tax threshold, with the goal of ensuring parity between large and small market teams.
  
  Section::::Luxury tax rules by league.
   In addition to the soft cap, the NBA utilizes a luxury tax system that is applied if the team payroll exceeds a separate threshold higher than the salary cap. These teams pay a penalty for each dollar their team salary exceeds the tax level. From 2002 to 2013, if a team exceeded the luxury tax threshold, they must pay one dollar to the league for every dollar that they are over the limit. For the 2013-14 season and onward, teams paid an incremental rate based on their team salary. They also have to pay a repeat offender rate, which is an additional dollar for every dollar over. For 2014-15 teams pay the repeater rate if they also were taxpayers in all of the previous three seasons. For 2015-16 and all subsequent seasons, teams pay the repeater rate if they were taxpayers in at least three of the four previous seasons. The table of rates is shown below.
   In 2017 the same six teams from 2016 were issued the luxury tax by the MLB. Against the $195 million threshold + $13 million for player benefits, payrolls for the Los Angeles Dodgers ($244 million), New York Yankees ($209.3 million ), Boston Red Sox ($187.9 million), Detroit Tigers ($190.4 million), San Francisco Giants ($186.4 million) and Chicago Cubs ($199.5 million) were in excess. This was the 15th straight year the New York Yankees paid the luxury tax.
   In sports, the Luxury tax is the incremental tax team owners have to pay for their teams going over the salary cap, basically a financial penalty for high-spending teams.
  
  Section::::In popular culture.
  
  One of the squares on the "Monopoly" board game (U.S. edition) is labeled "luxury tax". While there is a picture of a sparkling diamond ring on the square, the only effect is that whoever lands on this square must pay $75.00 to the bank.
  
  Section::::See also.
  
  BULLET::::- Luxury Car Tax
  
  BULLET::::- Luxury tax (sports)
  
  BULLET::::- Positional good
  
  Section::::External links.
  
  BULLET::::- Columbia Encyclopedia entry on Luxury Tax
   The system today is based on the 2002 collective bargaining agreement. The luxury tax was eliminated from 2000-2002, and the MLB brought it back with a new change to the system. Instead of putting a level between the 5th and 6th team, they decided to set a threshold that a team could not pass without a fee. This allowed teams to control their own fate more, as they were not being compared to other teams. This meant they would get punished only if they passed a certain level, rather than if they were in the top 5 in the year for salary. The 2002 CBA set the threshold for the 2003-2006 seasons, was updated for the 2007-2012 seasons in the 2006 CBA, and was updated again for the 2013-2016 seasons in the 2012 CBA. The 2016 CBA has set the threshold for the 2017-2021 seasons. The tax threshold for the 2003-2021 seasons are in the table below.
   A luxury tax in professional sports is a surcharge put on the aggregate payroll of a team to the extent to which it exceeds a predetermined guideline level set by the league. The ostensible purpose of this "tax" is to prevent teams in major markets with high incomes from signing almost all of the more talented players and hence destroying the competitive balance necessary for a sport to maintain fan interest. The money derived from the "tax" is either divided among the teams that play in the smaller markets, presumably to allow them to have more revenue to devote toward the contracts of high-quality players, or in the case of Major League Baseball, used by the league for other pre-defined purposes.
   In North America, Major League Baseball has implemented the luxury tax system. The National Basketball Association also has a luxury tax provision; its utility is somewhat limited by the fact that the league also has a salary cap provision. The "hard" salary cap of the National Football League and the National Hockey League has prevented any need for a luxury tax arrangement.
  
  Section::::Methods for limiting payroll.
   While most NBA teams hold contracts valued in excess of the salary cap, few teams have payrolls at luxury tax levels. The tax threshold in 2005–06 was $61.7 million. In 2005–06, the New York Knicks' payroll was $124 million, putting them $74.5 million above the salary cap, and $62.3 million above the tax line, which Knicks owner James Dolan paid to the league. Tax revenues are normally redistributed evenly among non-tax-paying teams, so there is often a several-million-dollar incentive to owners not to pay the luxury tax.
  