Taxed! Cueto actually took less money with Giants than D-backs offered

Johnny Cueto is the Giants' second big rotation investment this offseason.

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On Monday, the San Francisco Giants reportedly agreed to terms with free-agent starter Johnny Cueto on a six-year contract that will guarantee him $130 million, a pretty nice haul for a pitcher who struggled significantly in the second half of the season. And when you factor in that Cueto also obtained an opt-out after the second year — he can re-enter the market after the 2017 season and land a significant raise if he pitches well over his next 400 innings — this deal offers a lot of reasons for Cueto and his representatives to be happy with how the market has developed. 

However, it’s interesting to see Cueto agree with the Giants for $130 million, when just a few weeks prior, his agent had publicly stated that a reported six year, $120 million offer from the Diamondbacks was a "low offer for the market". In fact, his agent made it sound like they were going to be aiming quite a bit higher.

"It was a low offer for the market," Dixon said. "We didn’t have to think hard to reject that offer. Arizona wanted to do something fast, but we didn’t want to take something below market value for a No. 1 starter, and with the recent events, I think that time gave us the reason."

Agents are known for public comments that might not be reflective of reality, since their job is to get as much money for their clients as possible, not be objective sources of information. But in light of Dixon’s comments, it’s worth noting that Cueto actually took a smaller guaranteed income by accepting the Giants’ offer than he would have received if he had taken the Diamondbacks’ offer, due to the very different tax climates in California and Arizona. 

For high-earners like Cueto, California has the highest marginal tax rate of any state in the country, coming in at 13.3% of all income over $1 million. Meanwhile, Arizona has one of the lowest tax rates in the country, with its marginal rate topping out at 4.5%. Of course, the tax code is complex, and it’s never just as simple as looking at the top marginal rate to figure out equivalent offers between teams in different states. 

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However, in this case, we’re in luck, because a CPA who does this kind of thing for a living has done most of the work for us. In a paper published at the Sloan Sports Analytics Conference last March, Alan Pogroszewski provided a formula he calls the Jock Tax Index, which provides the structure to compare contracts between offering teams. The JTI corresponds to the percentage of income an athlete is able to retain, and in his piece, Pogroszewski notes that players under contract to the Giants actually retain the lowest percentage of their income (50.3%) compared to any team in baseball. Players on the Arizona Diamondbacks, meanwhile, retain 55.2% of their income. 

Using the formula provided by Pogroszewski in his paper, we can quantify the difference in net income between an offer from the Diamondbacks and the Giants. To receive the same amount of after-tax income as the Diamondbacks were offering him with the reported $120 million contract, the Giants would have had to offer $131.9 million. At the $130 million he actually took from the Giants, the equivalent after-tax offer from the Diamondbacks would have been $118.25 million, so either way, it appears that Cueto left about $2 million in guaranteed dollars on the table by turning down Arizona’s offer in order to sign with San Francisco. 

Of course, we don’t know whether Arizona included an opt-out in its offer, which could very well make a substantial difference in the calculation. And the fact that the Giants front-loaded their offer — while the Diamondbacks made Zack Greinke defer a significant amount of the $206.5 million they’re paying him, suggesting that they might have asked Cueto to defer some of that offer as well — so that Cueto will get $46 million before the opt-out kicks in has to be accounted for as well. With the opt-out after the 2017 season, Cueto will be essentially tasked with deciding to pick up a four-year, $84 million player option, or hitting the free-agent market again, looking for another raise. Given that he’ll be the same age as James Shields was as a free agent last winter, and Shields got $75 million over four years (also with an opt-out after the second year), it’s not hard to think that Cueto will be able to increase his own earnings if he pitches well during his first two years in San Francisco. 

By getting the second-year opt-out, Cueto puts himself in line for a potentially much larger deal. And if he signs his next contract with a team outside of California, his after-tax income could be substantially larger than it would have been from accepting Arizona’s offer, especially if it did not contain an opt-out or included significant deferrals. Without knowing the specifics of each offer, we can’t say for certain what variables might have impacted Cueto’s decision to turn down Arizona’s offer but to accept San Francisco’s. 

What we can, say, though, is that the dramatic differences in tax rates between the two states means that if Cueto doesn’t opt-out of his deal, he might end up making less over the next six years than if he had taken Arizona’s "below market" offer. Of course, given that the Diamondbacks ended up with Greinke, I’d imagine they’re probably OK with how things worked out.