Many baseball fans and sports writers woke up yesterday morning scratching their heads to Cliff Lee’s decision to turn down a deal worth $154 million over 7 years with the New York Yankees to join the Philadelphia Phillies for a mere $120 million over 5 years. As ESPN columnist Jayson Stark put it, “Does anyone out there remember anything like this — a player who’d been portrayed as being obsessed with getting every possible dollar out there, who then decided he didn’t really need, like, 30 million of those dollars after all? Unbelievable.”
Although it’s possible that Mr. Lee was inspired by the season of giving, he is more likely driven by his pocketbook than anything else. You could mention, of course, that the average annual salary associated with the Philadelphia contract comes out to $2 million more per year than what the Yankees were offering, but that still leaves over $30 million on the table in New York. But this isn’t the whole story, as Cliff Lee stands to pay considerably less in taxes by going to Philadelphia rather than New York. Here’s the math:
The top marginal income tax rate in New York is among the highest in the nation, coming close to 7 percent. In addition, New York City imposes its own income tax on residents that tops out at over 3 percent on incomes over $60,000. On the other hand, Pennsylvania has a flat income tax of just over 3 percent, while Philadelphia assesses no special income tax on its residents. These differences are meaningful for most taxpayers, but are especially so for someone who stands to make as much as Cliff Lee.
In an average year playing for the Phillies, Cliff Lee will make $24 million and pay about $8.8 million in federal income and payroll taxes, as well as about $737,000 in state taxes. That comes out to about $14.4 million per year in after tax income or $71.9 million over 5 years. If Lee had gone to New York, he would have made $22 million and paid about $7.6 million in federal income and payroll taxes, about $1.5 million in state taxes, and just over $800,000 in New York City taxes (if living in the city). That translates into $12.0 million in after tax income per year, $60.2 million over 5 years, and $84.3 over 7 years.*
What this means is that the difference between the Phillies and Yankees contracts isn’t $34 million, but is rather $12.4 million or $6.2 million per year for what would have been years 6 and 7 under the Yankees contract. Therefore, Lee may be betting that when his contract expires after 5 years with the Phillies, he may be able to secure another contract worth at least this much in after tax income (perhaps back in Texas, where there’s no state income tax?).
Of course, this is only speculation. However, it’s important to realize that individuals regularly make decisions about where and how much to work based on their potential income after taxes are taken out. This is especially true for the most talented, productive and highly paid, as the cost associated with one choice over another is likely to be greater.
*Federal and state income and FICA taxes were estimated using the National Bureau of Economic Research’s TAXSIM program. New York City taxes were estimated by the author without the help of a tax model. The federal income tax calculations assume a top marginal rate of 35 percent. If the top marginal rate is allowed to increase next year, this will change the estimates a bit. These estimates also assume that Cliff Lee files as an individual and pays all the taxes on his salary as a resident of either Pennsylvania or New York.