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NBA Luxury Tax Projections For Next Season

There has been widespread speculation in NBA circles over the past year or so about the fate of the Miami Heat for next season and beyond. Articles that emphatically declare the inevitable financially-motivated implosion of Pat Riley’s brainchild have run rampant all across the internet universe.

The cost of doing business in the NBA has increased dramatically under the provisions of the new Collective Bargaining Agreement. The new rules are designed specifically to financially cripple high-spending teams like the Heat, in an attempt to promote competitive balance among all of the league’s 30 teams.

It’s working. Miami’s costs are soaring. But while predictions that call for the Big Three to be broken up to alleviate the hemorrhaging in the years to come are wildly premature and not very likely if things continue to run smoothly on the court, just how much Arison may be willing to spend to surround them depends largely on future luxury tax thresholds. 

Luxury Tax Explained

The luxury tax is a mechanism that helps control team spending in an effort to promote financial and competitive parity among the league’s thirty teams. It is paid by high-spending teams – those with a team salary exceeding a predetermined tax threshold – and distributed, in part, to those that don’t exceed the threshold.

The amount of tax a high-spending team pays depends on the season, its team salary as of its last regular season game in that season, and whether the team is a “repeat offender”:

  • For 2012-13, teams pay $1 for every $1 their team salary exceeds the tax level.
  • For 2013-14, teams pay an incremental rate (see below) based on their team salary.
  • For 2014-15, teams pay an incremental rate (see below) based on their team salary. They pay the repeater rate if they also were taxpayers in all of the previous three seasons.
  • For 2015-16 and all subsequent seasons, teams pay an incremental rate (see below) based on their team salary. They pay the repeater rate if they were taxpayers in at least three of the four previous seasons.

The incremental rates are as follows:

For example, a team with a team salary $12 million over the tax level in 2014-15 pays a tax of $21.25 million ($1.50 for each of the first $5 million, plus $1.75 for each of the next $5 million, plus $2.50 for the final $2 million). If the team was also a taxpayer in each of the three previous seasons, it would instead pay a tax of $33.25 million.

For payrolls far in excess of the tax threshold, the tax obligations can get severe. Therefore, for a high-spending team like the Heat, the determination of the tax threshold for each season is quite a significant event.

The tax level is computed as follows:

Prior to each season, the NBA (in conjunction with the players association) projects the total amount of revenues to be generated in the coming season both by the league collectively and by each team individually, and adds these individual revenue streams up into a combined total (called “Projected BRI”). The tax level is then determined by taking 53.51% of this total, subtracting projected player benefits from the total, and dividing the result by the thirty teams in the league. Adjustments are then made if total salaries and benefits paid to the players in the season prior were significantly higher or lower, as a percentage of league-wide revenues, than was agreed in the CBA.

Projecting the 2013-14 Luxury Tax Threshold

At the beginning of the season, the league was forecasting a Projected BRI for next season of $4.48 billion and benefits of around $200 million. The rest was basic math: (53.51% x $4.48 billion – $200 million) / 30 teams = $73 million. The league was therefore forecasting a tax threshold of approximately $73 million for 2013-14.

Four months later, speaking at a Beyond Sports United event at Yankee Stadium in November, Commissioner David Stern estimated that league-wide revenue for the season would increase by about 20% from the last full season in 2010-11, to an all-time record $5 billion. This was a shocking an unexpected surprise.

While it is not entirely clear to what extent Stern was rounding when he threw out the $5 billion number (or if he was even referring to BRI specifically), his reference to a 20% increase from 2010-11 levels still suggested a rather staggering $4.58 billion in BRI for the current season.

And if this season’s revenues are $4.58 billion, then next year’s revenue forecast would presumably be higher than that (and certainly higher than the $4.48 billion initial projection). At a modest 4% growth rate, the league’s initial growth rate target for next season, projected BRI for 2013-14 would then be set at roughly $4.76 billion. That, in turn, would lead to luxury tax projections of around $78 million for next season.

It was all great news for a Heat team focused on limiting its tax penalties in the years to come.

Over the next few weeks and months, however, the high degree of optimism on league-wide revenues was tempered. Many of the league’s teams reportedly had no idea what Stern was talking about. Was he perhaps just grandstanding in the wake of his impending retirement?

Most teams are now apparently forecasting revenues for this season tracking more in line with initial forecasts (which would still be a whopping 13% growth in league-wide revenues from the last full season in 2010-11). At the same time, however, some are forecasting a tax level as low as $71.5 million.

With revenues reportedly tracking to forecasts (or perhaps even better), how can luxury tax forecasts be dropping?

The answer could be in the adjustments to the luxury tax calculation mentioned above.

The most fundamental aspect of the CBA is the split of league-wide revenues. After years of negotiating, the parties agreed to a baseline 50/50 split. Players are therefore entitled to a 50% share of league-wide revenues (which can increase to as much as 51% or drop to as low as 49% based on whether revenues exceed or fall short of forecasts), which is paid to them in the form of salaries and benefits.

Players are paid throughout the season. League-wide revenues aren’t finalized until the season is over. So how do they ensure that the split ends up being exactly as was agreed to?

If, when the league-wide revenues are computed, it is determined that the players made too little, the league simply cuts the players a check for the difference. This has only ever happened once – in the 2010-11 season.

In this scenario, the new CBA calls for the following season’s luxury tax threshold to be increased by the amount of the difference divided by the league’s thirty teams.

To ensure that players don’t make too much, players are required to place 10% of their paychecks into an escrow account. If the players end up making more than their fair share (called an “overage”), the league simply takes as much of the escrow funds as it needs to maintain the agreed-to split, and the players take back the rest. This is what happens in almost every season.

But while the escrow system attempts to ensure that the integrity of the split isn’t compromised in any one season, it’s not infallible. There is a small possibility that players will make so much money that even the escrow funds aren’t enough to lower their share down to the agreed-to split (i.e., the overage is greater than the escrow funds). In this case, the league will take the full escrow but the players still end up making more than their fair share. This has only ever happened once – in the 2008-09 season.

Maintaining the integrity of the split is of paramount importance. The league doesn’t want to make less than it is entitled to (and rightfully so; it took years of painstaking negotiation and a lockout which threatened an entire season to come to agreement on the issue). Therefore, the new CBA affords them added protection measures (beyond just the escrow system) to ensure that what happened in 2008-09 doesn’t ever happen again.

If the overage in any season is so big that it is getting close to exceeding what the league can get back through the escrow system, then the salary cap and tax levels may be reduced in the following season in order help put the brakes on spending.

The reduction in the luxury tax threshold depends upon just how big the overage is:

  • If the overage is less than 6% of total salaries and benefits, then no adjustment is made.
  • If the overage is between 6% and 9% of total salaries and benefits, they look at the following season’s Projected BRI to determine the adjustment.
    • If Projected BRI does not exceed previous season’s BRI by more than 8%, the amount of the reduction is: ( Overage – 6% x Total Salaries and Benefits ) / 30.
    • Otherwise, the reduction is the greater of $0 and: ( Overage – 6% x Total Salaries and Benefits – ( ( Projected BRI – 1.08 x previous season’s BRI) * 53.51% ) ) / 30.
  • If the overage exceeds 9%, they put on the brakes without regard to Projected BRI.
    • The amount of the reduction is: ( Overage – 6% x Total Salaries and Benefits ) / 30.

The problem right now in the NBA appears to be that players are earning way too much more, in salaries and benefits, than the agreed-to split.

League-wide revenues are projected to be $4.3 billion for this season.

If we assume revenues come in at those levels, the players would be entitled to half that amount, or $2.15 billion, in the form of salaries and benefits.

So, let’s total up just how much the players are currently making in salaries and benefits:

Combined teams salaries are currently, according to Hoopsworld.com, somewhere around $2.0 billion and rising. This number may increase or decrease depending upon what bonuses players ultimately earn, which are determined at the end of the season, as well as if more players are signed during the rest of the season. The Heat alone currently has a team salary of over $83 million, which will increase if Juwan Howard gets signed through the end of the season.

Now add an additional $105 million or so in amnesty payments (which are excluded from team salary calculations but are included when determining the split of league-wide revenues).

Now add an additional $196 million or so in benefits.

Total it all up: We’re already at around $2.3 billion in total salaries and benefits.

That’s a lot. In fact, it produces a projected overage of around $160 million.

An overage of $160 million is around 7% of the $2.3 billion estimated total salaries and benefits. Using the formulas detailed above, that produces a downward adjustment to the tax threshold of around $700K for next season.

And that’s how a $73 million tax threshold projection for the 2013-14 season can become $72.3 million (or possibly even lower) in a hurry!

A $700K drop in the tax threshold doesn’t sound like a whole lot but it, alone, would increase Miami’s payroll obligations by up to $1.8 million for next season, perhaps causing the team to soar past the $100 million mark for the first time in team history. Whether it would have a ripple effect on the Heat’s willingness to utilize its $3.1 million Mid-Level Exception in the summer we can only speculate.

Of course, none of these figures — revenues, player salaries, player benefits, etc. — has been released by the league (nor will any be until the season ends). They’re all just estimates, prognostications, best guesses. Any number of things can change between now and the end of the season. Revenues could ultimately come in a lot higher than initially projected, as Commissioner Stern said they would. Player salaries and/or benefits can change, perhaps materially. The outlook for next season could change either for the better or for the worse.

But one thing is clear.

As a Heat fan, you should be voting for league-wide revenues to be as high as possible (so buy some premium game tickets, some overpriced paraphernalia, and some overpriced hot dogs!) and league-wide player salaries to be as low as possible. The more this happens, the higher the luxury tax threshold will be. And the higher the luxury tax threshold, the more dry powder Micky Arison will have to keep this potential dynasty together for years to come.

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