By: Lloyd A. Miller, firstname.lastname@example.org, 202-822-1205
Last week, Gerrit Cole signed a $324 million, 9-year contract with the New York Yankees and Anthony Rendon signed a $245 million, 7-year contract with the Los Angeles Angels of Anaheim. A few days earlier, Stephen Strasburg signed a similar $245 million, 7-year contract with the Washington Nationals, except $80 million of which is deferred with 1% interest, adding an estimated $7 million to the contract’s total nominal value.
So, who won the Hot Stove? To ballpark each contract’s value-at-signing (and relative to each other), we can calculate their expected tax liability based on where they signed, and then the net present value using the average annual value of each contract.
Tax Liability: The first adjustment to these contracts is Uncle Sam’s cut. Due to the way the District of Columbia levies income taxes, Strasburg will actually pay Virginia’s more favorable tax rate of 5.75% compared to the district’s 8.95% top tax rate, saving him over $8 million. Cole and Rendon are paying some of the highest tax rates in the US, both giving up, at most, over 50% of their contracts to federal, state, and local governments. Strasburg wins big here compared to Rendon, paying $14 million less in taxes.
The Time Value of Money: A dollar today is worth more than a dollar tomorrow due to inflation and potential investment returns. Although these three contracts should have similar average annual values, Strasburg is actually making a lot less per year but over a longer period thanks to those deferrals. Assuming a discount rate of 10%, Strasburg’s nominal net tax advantage evaporates because of how far into the future his earnings are accrued.
This represents the minimum net present value for each of these contracts, which can also change based on how each player manages their finances, but those mechanisms (and probably the same accountants and tax attorneys) are available to all players equally, making them marginally useful in comparing contracts.
We could also account for some variation in cost of living, especially given these three players will be living in 3 of the 10 most expensive places in the country. However, at tens of millions of dollars, normal cost of living factors probably do not apply.
And one more thing: California, Virginia, and New York are very different states. It is much easier to imagine California raising taxes on millionaire baseball players than Virginia, and that makes the decision-making process much more interesting.
Lloyd Miller is a senior director at Hamilton Place Strategies.