Revised Luxury Tax Projections Come in Below Expectations

The NBA’s salary cap and luxury tax threshold aren’t expected to rise as much as the league initially projected, a development that could have significant implications for the Miami Heat.

Estimates that were provided by the league to NBA teams on May 31 have the salary cap rising to just $58.5 million and the tax threshold to just $71.6 million for the 2013-14 season, both slight increases from the current levels but considerably lower than what had been projected. The league had previously guided to $60 million and $73 million, respectively, at the beginning of the season. The numbers will be finalized only after the NBA does a full season audit during the first week in July.

The revised projections suggest that revenues for the 2012-13 season are falling short of expectations and, as a result, player salaries are correspondingly too high, triggering escrow adjustments to the following season’s salary cap and tax threshold. 

The league was initially forecasting $4.308 billion in total revenues. The revised numbers suggest the total will be closer to $4.25 billion. While that is still a whopping 11.3% growth over 2010-11, the last full season, it is a slight 1.3% decline over initial expectations.

Revenue results for this season do not directly impact the salary cap and tax threshold for next season. Those figures are calculated based solely on revenue projections for next season. Those haven’t changed. However, the lower than expected revenues for this year can indirectly cause the cap and tax for next year to decline. To understand why requires a bit of technical knowledge (or an understanding of this post).

According to the terms of the new collective bargaining agreement, both the players and the owners are entitled to no less than 49%, and no more than 51%, of total league-wide revenues produced. The players have made roughly $2.3 billion in salaries and benefits. And so, when revenue projections were lowered to $4.25 billion, it meant that players were forecasted to earn approximately 54.25% of those revenues. That’s too much. So much, in fact, that if these numbers prove accurate when they are finalized next month, while the split of revenues would be corrected through the league’s escrow system, the 2013-14 cap and tax would be reduced to ensure such an overage doesn’t happen again. Therefore, implied within the new salary cap and luxury tax figures is an assumed $1.6 million downward adjustment due to these excessive salaries.

So why are the players making so much more in salaries and benefits than they should?

Most teams have already adjusted very well to the more restrictive salary cap environment.

Part of the problem is how they did it. Sixteen teams reduced their individual team salaries to more appropriate levels in part by means of the amnesty provision. Most of the players that were waived utilizing the amnesty provision are either no longer playing the NBA or are doing so under largely inconsequential contracts. But they’re still getting paid. And while the amnesty amounts don’t count against the cap, they most definitely count toward the players’ share of revenues.

A total of $307 million has or is scheduled to be paid out to the sixteen players who have been waived via the amnesty process thus far. Of that total, $106 million is from this past season alone. In fact, more than 5% of the entire league-wide salary obligations for this season are being paid to amnestied players by teams from which they are no longer employed. Without these amnesty obligations, there’d be no need to adjust the salary cap or tax threshold for next season at all.

The other part of the problem is the revenue miss. While league-wide revenues are only projected to fall short of expectations by a grand total of $58 million, every dollar counts when player salaries are already so high. Of that $58 million, around half is money that players have already earned but are no longer entitled to. Without the miss, the downward adjustment to the cap and tax would only project to be around $450K.

But we are where we are. There’s nothing that can be done.

So what does a lower than anticipated tax level mean for the Heat?

If the current luxury tax projection of $71.6 million holds true when the July audit makes the number official, the Heat would start the season roughly $14.9 million over the threshold. When accounting for the more punitive incremental tax system which takes hold next season, the Heat would be facing a tax bill of $28.6 million and total projected salary obligations of $115.0 million. That’s 20% more than the $95.8 million the team spent this past season (prior to any escrow funds to be returned), which itself was far and away the most in team history.

So how does a lower than anticipated tax level actually affect the Heat?

It would not, in and of itself, eliminate any alternatives the Heat would otherwise have at its disposal with which to improve during the summer.

There are only three tools available to teams over the salary cap that are restricted based on team salary levels – the ability to use the full mid-level exception instead of the mini mid-level exception, the ability to use the bi-annual exception, and, starting next season, the ability to acquire an outside free agent by means of a sign-and-trade. In order for teams to use any or all of these options, a team would be required to drop its team salary below the “apron” – the point exactly $4 million above the tax level – and stay below it at all times thereafter for the rest of the season.

That’s not happening, no matter what the finalized luxury tax number turns out to be. Because team salary for next season is already so high ($86.5 million), there is no scenario which involves the Big Three staying in Miami that would find the Heat at or below the apron. It’s a mathematical impossibility, even under the wildest of scenarios that could ever be reasonably hypothesized. The Heat, therefore, will once again find itself with access only to the $3.2 million mini mid-level exception and the minimum player salary exception, just as it did last year.

A lower than expected tax threshold, therefore, only really impacts the Heat financially. But it is a serious hit. The $1.4 million reduction in the tax figure projects to cost Heat owner Micky Arison between $2.5 million and $4.6 million next year, depending upon where team salary rounds out. That casts even more doubt as to whether he would be willing to utilize the mini mid-level exception at all, or if it’s just minimum salary contracts from here.

Keep in mind, however, that these latest cap and tax figures are still only estimates. And while they’re the best ones we’ve got, one thing to note is that in the past, early projections have frequently come in low. The summer of 2010 is a perfect example. Pat Riley was working under a projected $56 million salary cap right up until June 30 (a fact that was made apparent in how he handled the James Jones buyout situation). Seven days later, the salary cap was confirmed at $58.044 million. As a result, the Big Five was born.

The finalized numbers will be announced no later than July 10.

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