Key Takeaways

  • A salary cap is a ceiling on the total amount of money a sports franchise can spend on its roster
  • In American professional sports, most major leagues have some form of a salary cap
  • The MLB is the only major American league without a formal salary cap

To understand the importance of the salary cap in sports, you must first look at what happens when the salary cap does not exist. In sports without a salary cap, it is common for a select few teams, traditionally those in big markets with higher revenue and a successful track record, to hoard talent by virtue of being willing and able to pay the best players the best salaries. The two most prominent examples of this dynamic are Major League Baseball (MLB) and European soccer—both sports where a small group of elite teams perpetually find themselves at the top. 

The salary cap is designed to provide parity between teams and incentivize clever team construction by providing a ceiling on the maximum amount of total salary a team is allowed to pay its players. While the salary cap does not ensure a perfectly even playing field, it does limit the ability of teams to dominate a league for decades on pure financial might. 

What is a Salary Cap?

Put simply, a salary cap is a limit on how much a single franchise can spend on its team. For example, the salary cap in the National Football League (NFL) is $198.2 million for the 2020-21 season. An NFL franchise cannot spend more than that amount on its roster of players. Teams are not required to fill the entire budget, but they cannot exceed it—at least in the NFL. Usually, the salary cap increases each year, but sometimes the cap may decrease or stay the same if the league's revenues fall. In 2012, a player lockout caused the NFL salary cap to decrease. As sports leagues begin their 2020-21 seasons, their salary caps may decrease due to financial challenges brought on by the COVID-19 pandemic.

Different leagues have different rules regarding how the salary cap is constructed and related to team spending. Some leagues have a hard salary cap, while others have a soft cap. Some leagues have no cap and attempt to keep wage bills low through other methods. Other sports leagues may have no regulations at all on what teams may spend.

The Hard Salary Cap

The most simple form of a salary cap is the hard salary cap. The hard salary cap is an absolute cap on total salaries; teams cannot exceed the specified limit for any reason. For the 2020 season, the NFL and National Hockey League (NHL) both had hard salary caps set at $198.2 and $81.5 million, respectively. In these two leagues, teams must fill out their rosters based on this overall number alone. However, they are not required to use the entire cap; they can opt out of using cap space if they decide to do so.

The Soft Salary Cap

The soft salary cap is more complicated. In the four major American professional sports leagues, the National Basketball Association (NBA) is the only one with a soft cap. In the 2020-21 season, this cap will be set at $109.14 million, the same level as the 2019-20 season. Unlike the NFL or NHL, this cap can be exceeded if a player meets certain criteria. These exceptions, including Bird Rights and minimum player salary exceptions, are numerous and complex, and allow teams to go over the cap if their signings qualify. These exemptions provide a myriad of possibilities to game the salary cap system, so the NBA has a second limit to reduce spending and promote equality: the luxury tax. If the luxury tax limit is surpassed, the team must pay a tax to the league based on how much it spends over the tax limit and how many years it has exceeded that limit. If the team is a repeat offender, its taxes increase. In the 2020-21 season, the NBA luxury tax level will be $132.627 million, the same level as the previous year.

Teams are still free to exceed the tax level if they choose, but since the tax usually comes out of the owner’s pocket, few teams are willing to do so. Thus, total salaries among the teams remain somewhat equitable, even if they are not officially capped.

No Salary Cap

The only American sports league with no stated salary cap is the MLB. Instead, the MLB has a competitive balance tax similar to the NBA's luxury tax.  This tax is set at $210 million for the 2021 season. Teams are charged a tax if they spend above the allowed limit, and teams must pay a repeater tax if they exceed the luxury tax level in two or more seasons. However, the tax penalties in the MLB are far less than in the NBA. In the NBA, teams are required to pay, at its lowest level, $1.50 in tax for every dollar spent over the tax level—an 150% tax rate. The highest nominal penalty in the MLB, on the other hand, is only 50% of money spent above the tax line. While the math can change based on the specifics of the team paying the tax, MLB competitive balance taxes are generally quite inexpensive.

There are other professional sports leagues, like European soccer leagues, that are even more lax when it comes to regulating team spending. In most major European soccer leagues, there is no salary cap and no luxury tax. Clubs can pay their players whatever they can afford, which can lead to major inequities among the top teams and those at the bottom of the table. For example, Manchester United, the team with the highest wage bill in the English Premier League, will spend $246.7 million on salary in 2020-21. Sheffield United, the lowest spender, will dish out only $26.5 million.