October 2011

Zach Lowe reportedly has the details on the new luxury tax system that the owners have proposed. As we now know, it was the differences of opinion the players and owners have regarding the system of the next collective bargaining agreement that has created the current impasse more so than the squabble over the amount of money each side would get.

And Lowe’s info gives us a pretty good idea why: Because the owners’ proposed luxury tax system would effectively create a hard salary cap for more than 80% of the teams in the league in any given year.

Rather than forcing teams to pay a dollar-for-dollar tax after any payrolls costs exceeding a certain limit, teams would now have to pay an increasingly large sum for each $5 million they spent above that limit. It would be a tiered system that starts at $1.75 owed per dollar spent above the threshold and then rises by $0.50 in each subsequent $5 million tier.

That sounds really complicated, I know. But it’s hard to explain such a complex scheme much simpler. In practical terms, for the 2010-11 season, here are the tax penalties teams would have faced:

spend $70.3 million to $75.3 million and pay a tax of $1.75 per dollar
spend $75.3 million to $80.3 million and pay a tax of $2.25 per dollar
spend $80.3 million to $85.3 million and pay a tax of $2.75 per dollar
spend $85.3 million to $90.3 million and pay a tax of $3.25 per dollar
spend $90.3 million to $95.3 million and pay a tax of $3.75 per dollar
spend $95.3 million to $100.3 million and pay a tax of $4.25 per dollar

It’s important to note that these penalties would be cumulative. (And the value of the top tier the team reaches would triple for any team that exceeded the luxury tax at all a third year during any five-year period.) With that accounted for, here is how all the millions would add up. Here is how much moving into each new tier would cost.

The first $5.0 million spent over the limit costs a team $8.75 million
The second $5.0 million spent over the limit costs a team another $11.25 million
The third $5.0 million spent over the limit costs a team another $13.75 million
The fourth $5.0 million spent over the limit costs a team another $16.25 million
The fifth $5.0 million spent over the limit costs a team another $18.75 million
The sixth $5.0 million spent over the limit costs a team another $21.25 million

And so on and so on and so on — presuming the team could find a way to keep increasing its payroll at such enormous costs. Oh yeah. Additionally,

If it’s not yet obvious, I will get to why this creates a virtual hard cap. (A concept our boy Tim Donahue already explained when discussing a different, even-less oppressive tax system was discussed.)

But first some background.

The difference between a hard cap and soft cap has become a “blood issue” for many owners and players. In short, it is so divisive because the owners feel that it is the ultimate cost containment measure for player salaries and will all but ensure that the league, collectively, will be profitable. It creates cost certainty — something all business executives desire, especially on their biggest line item. It ensures that poor teams cannot simply be outspent by their richer rivals. And it will even help owners protect themselves from bad, costly decisions made by their GMs. Most owners would love to operate under such a system.

But the players, probably accurately, believe a hard cap would lead to the end of guaranteed contracts for many of the league’s “middle class.” This is what drives their fundamental opposition more so than any effect a hard cap would have on overall players salaries. Really, it wouldn’t cost the players, as a collective, any money. The percentage of basketball-related revenue they negotiate for is the only thing that defines that. No, the logic says that the true threat of a hard cap is that teams will much less flexibility to make player moves. So in order to ensure they would never be forced to give up a star player due to the fact that they were too close to the hard salary cap — an unthinkable in a sport where one guy makes so much of a difference on the court and in selling tickets — the teams would begin offering guaranteed deals to only the top, say, 150 players in the league. They are the difference makers. They would be the coveted players. They would get the guaranteed deals — and all the financial security for your family and lifestyle that comes along with that guarantee.

This would leave, say, 200 guys (essentially everyone not in the top 150 or on a cheap rookie deal) who would be forced to accept partially or even non-guaranteed deals. And those types of deals offer little security. Just ask any NFL running back who has blown out his knee.

Now, Commissioner David Stern has claimed the owners have made “a concession” in abandoning their demand for a hard cap. Well, looking at the details of this proposed luxury tax system, the owners have not moved much.

Because this new system presents such an onerous financial penalty for spending. Just look at how much the seven luxury-tax-paying teams in 2010-11 would have been on the hook for this year under the owners’ new proposal. As crazy as Mavs owner Mark Cuban is, I sincerely doubt he would be willing to spend $46.2 million on tax.

In the previous luxury tax structure, there was a soft salary cap that teams could exceed via any number of exceptions. For 2010-11, that was set at $58 million. Teams could go above that with no penalty until they reached a payroll of $70.3 million. Any team that spent above that luxury tax threshold was require to pay the league $1 dollar for every $1 dollar they spent on players.

It was simple. And it resulted in the Magic, Lakers and Mavericks each paying back around $20 million last year. That money, plus the luxury payments from the other five teams that exceeded the threshold, became the revenue sharing pot that was distributed to all the teams that stayed below the $70.3 million limit. It’s an inelegant system — and one that I personally don’t think works particularly well. But it allowed thrifty teams to stay below the threshold and benefit from some revenue sharing while allowing those that wanted to spend away trying to chase a championship to do just that. Some stakeholders saw value in that.

For most of those owners who were cut a check at the end of the year (which, at $2.4 million, was nothing to shake a stick at), staying under the limit was a no-brainer. We don’t know the exact numbers, but teams like Indiana, Milwaukee and Memphis reportedly took in less than $95 million in total revenue last season. So even having a payroll approaching $70 million (which all three did at $65.1 million, $68.9 million and $69.7 million, respectively) was bad enough. Paying a dollar-for-dollar luxury tax on top of that would certainly mean even greater losses. Remember — the difference between their $95 million in revenue and $65 million in salary is a sum that has to pay for all arena costs, staff salary (including GMs, coaches, scouts, trainers, cheerleaders, ticket sellers, etc.), player benefits, travel, charter flights, jet fuel, hotels, food, medical treatment, marketing, merchandise … and so on and so on and so on. I’m not sure how much all that stuff costs — nobody outside of the NBA is — but it would not be surprising it if runs more than $35 million. Particularly when you consider all the debt servicing costs and other capital costs most of these teams deal with.

In short, the old tax was virtually a hard cap for at least the poorest third of teams in the league. (Although the Pacers and most teams not named the Clippers or Suns have exceeded it in years when they thought they had a chance to make a deep playoff run.) But the new proposed tax would virtually be a hard cap for about 25 of the league’s 30 teams in any given year.

Even a deep-pocketed team like Boston would have to really think it could win a title to spend the $76.0 million it did in 2010-11. And that isn’t some historic spending binge; compared to what other free-spending teams spent during their most glutonous years, Boston’s payroll last year was unmemorable.

And when we start talking about a tax approaching $50 million, it doesn’t take an auditing expert to understand that few teams — perhaps not even the cash cow that is the Lakers — would be willing to swallow such a price. In 2010-11, Los Angeles spent $90 million on payroll, $20 million on luxury tax and who knows how much on other operating costs only to get swept by Dallas in the second round. Now, team owner Jerry Buss has so much incoming revenue due to the fact that he operates in nation’s second largest market and Lakers Nation is willing to buy anything emblazoned with purple and gold. And he has a more passionate “title or bust” mentality than almost any owner in sports. So he can probably stomach spending all the money he did last year even if his team was embarrassed. At least he went down swinging. If you’re the Lakers, you have to at least try to win the Larry O’Brien trophy each year. But is even Buss going to be willing to set another $30 million on fire on top of that, knowing that it still doesn’t even guarantee his team will get out of the second round?

He might. Perhaps James Dolan, owner of the Knicks, would, too. But other than those two and — maybe — Cuban (who arguably has his own insatiable will to compete) or Trailblazers owner Paul Allen (who has $14 billion dollars) there isn’t another team in the league that likely to spend money like that. And if there are only — maybe — four teams that would even consider having a payroll north of $80 million, the league is essentially trying to institute a hard cap without technically instituting a hard cap.

Looking at such a detailed plan to create a hard cap without calling it a hard cap, it’s no wonder the players widely believe that the owners haven’t moved from their original push for a total “system reset.” And it’s no wonder that so many believe that the owners knew it would come to this — canceling games — all along.

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