NBA Issues Updated Salary Cap Guidance to Teams

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At the Board of Governors meetings in New York, NBA teams were advised that the league expects the salary cap to increase from its current $63.1 million figure to $67.1 million next season and $89 million in 2016-17, while the luxury tax is expected to increase from its current $76.8 million figure to $81.6 million next season and $108 million in 2016-17.

The figures are non-binding forecasts that have been circulated several months before the official salary cap and luxury tax threshold for the 2015-16 season are announced on July 8 following a league-wide audit (that is what July Moratorium is for).

As part of the audit, accountants jointly appointed by the NBA and the players’ association will finalize the total revenue haul for the past season and, on that basis, project the revenues for the year ahead.

They will then take 44.74 percent of that projected amount, subtract projected benefits, and divide by 30 (the number of teams in the league) to get the salary cap for the season ahead. Adjustments are then made to the cap if players received way too much, or too little, in salaries and benefits for the then prior season relative to the finalized revenue figure; this serves as a mechanism to maintain the integrity of the agreed-to revenue spit between owners and players. The luxury tax uses a similar formula, but is based on 53.51 percent of projected revenues.

The latest projections suggest that the revenue haul for this season is expected to be much stronger than originally forecasted.

The league initially forecasted revenues for the 2014-15 NBA season of $4.66 billion when the current collective bargaining agreement was drafted back in 2011. The forecast was revised upward to $4.71 billion last July, off of which projection the salary cap was based. Today’s announcement suggests the league is now expecting that when they are finalized in July, revenues will come in at approximately $4.76 billion. 

The increases reflect the strength of the league across all of its various revenue streams. Factoring into the most recent uptick are significant gains in projected gate receipts (the NBA broke its attendance record by drawing nearly 22 million fans during the 2014-15 regular season), among other things.

In deriving its $67.1 million cap figure for next season, the league is projecting a standard 4.5 percent growth over the higher projected revenue from this season from sources other than national TV revenues, adding them to the revenues call for in the national TV deals (which were set when the deals were signed in 2007), and coming to a total of $4.96 billion.

But revenue growth is only part of the story. The other part of the story is the inability for teams to catch up with those increasing revenues in paying their players.

The system is designed such that the salary cap for each team is set at 44.74 percent of revenues, but the players are actually entitled to receive between 49 and 51 percent of revenues (the exact percentage is tied to the league’s financial performance).

In the past, this has never really been a problem. The NBA has a soft salary cap. Almost every team in the league used to exceed the salary cap by a large enough amount every season – many even exceed the luxury tax – that the players always wound up receiving their fair share of revenues. Typically, in fact, the players wound up getting far more than to which they were entitled, and the league’s escrow system would knock them back down.

Lately, however, it has become a far more significant problem. Punitive new cap rules — hard caps, increasing luxury tax consequences, etc. — coupled with more destructive roster construction models have caused teams to dramatically ratchet down their spending. For the first time ever, two teams failed to reach the league-wide minimum team salary requirement this past season. Eight teams ended the season below the salary cap (excluding cap holds). On the high end, a recording-tying low of five teams were taxpayers this year. Their cumulative amount by which they exceeded the tax threshold was a record-setting low of just $26 million.

Spending across the NBA was so far down this season that the NBA is apparently projecting that the players will fall $15 million short of their agreed-to split of revenues.

It’s okay. The league has a mechanism in place to ensure that players get their fair share of revenues if there is a shortfall – the league simply cuts the players a check for the difference between what they were supposed to get and what they got. So the players will get their extra $15 million. It will be paid to them, assuming it proves correct, after the audit in July.

The problem, however, is that if the league needs to cut the players a check, the salary cap calculation itself contains an adjustment mechanism that was theoretically designed to make sure this type of underpayment does not happen again (I have been an outspoken critical of the adjustment mechanism, and the overall salary cap calculation itself, since it was introduced).

If the players do not receive their fair share of revenues (before the issuance of the check), the league takes the amount of the underpayment, divides it by 30, and then simply adds the result to the salary cap the following year.

As a result, an estimated $500K (calculated as $15 million / 30) of the projected $67.1 million salary cap and $81.6 million luxury tax for next season has nothing at all to do with revenue growth but rather is actually the result of a cap adjustment caused by an unexpected shortfall in salary payouts for this season.

Still, revenue growth has been impressive. The league was generating around $3.84 billion prior to the lockout. That amount is expected to increase to $4.78 billion this season, and the league is projecting $4.96 billion for 2015-16. That’s a 30 percent increase over the first five years since the lockout.

That growth, however, pales in comparison to what the league is projecting 2016-17. That’s when the league’s new media rights deals with ESPN/ABC and TNT kick in, which will nearly triple the league’s current take!

The new deals escalate over time, starting at $2.1 billion in 2016-17 and climbing to $3.1 billion in 2024-25. The current agreement provides $1.1 billion for 2015-16, meaning the network TV revenue will jump by nearly $1.1 billion in 2016-17. By the league’s salary-cap math, a $1.1 billion increase in national TV revenues equates to a $16 million jump in the cap.

Other growth sources should be equally strong. Among other things, new local TV rights deal for the Los Angeles Clippers will also take effect that year, and it should be massive. Steve Ballmer wouldn’t have paid $2 billion for his team if it wasn’t.

The initial cap and tax projections — $89 million and $108 million, respectively – suggest the league is projecting around $6.3 billion of revenues in 2016-17!

While massive revenue growth is the main driver behind that cap increase, once again it doesn’t account for the entire increase. Modeled into the projections are an assumption that, much like what happened this season, players will once again fall short of their fair share of revenues next season. Only next time around, it won’t be a mere $15 million miss. Instead, it will be a much more substantial $100 million miss.

There are three primary reasons why the league is expecting team spending on player salaries to come up so short next season. First, teams will be saving up their cap room for the summer of 2016. Second, amnesty payouts will drop from $87 million this year all the way down to zero. That’s an extra $87 million that needs to be spent somewhere. And third, with the punitive new cap and tax rules (e.g., hard caps, incremental luxury tax rates, repeater tax consequence, etc.), many teams will either be reluctant or restricted from spending it.

As a result, an estimated $3.3 million (calculated as $100 million / 30) of the projected $89 million salary cap and $108 million luxury tax for the 2016-17 season is actually the result of a cap adjustment caused by an unexpected shortfall in salary payouts for the 2015-16 season.

Perhaps most surprising about the league’s announcement, however, is that it issued guidance a full six years into the future. The league typically never projects further out than two seasons.

Perhaps it was done to prove a point: that in the absence of salary cap smoothing for which the league so heavily lobbied but the union last month rejected, wild fluctuations in the salary cap can be expected in the years ahead. The league’s guidance was as follows:

 ($MM) 2015-16 2016-17 2017-18 2018-19 2019-20 2020-21
Salary Cap $67.1 $89 $108 $100 $102 $107
Luxury Tax 81.6 108 127 121 124 130

Projections beyond 2016-17, however, are something of an illusion.

They suggest that revenues will continue to grow sharply in 2017-18. But the vast majority of the $19 million cap increase projected for that season has absolutely nothing do to with revenue growth at all but rather with another, this time shocking, salary cap adjustment.

When the salary cap jumps from a projected $67.1 million next season to a projected $89 million in 2016-17, nearly every team in the NBA will be flush with cap space. In fact, teams will have so much cap space that they will certainly not be able to ramp up their spending quickly enough to accommodate the increased spending power.

Teams around the league will have far too much cap space upon which to compete for a select few quality players, leaving many in the lurch with nobody on which to spend it. Many may not even reach the salary cap. For the first time ever (in a tax-triggered season), the league could be facing a situation where not one team in the entire NBA will pay the tax.

In fact, a whopping $15 million increase projected for the 2017-18 salary cap the result of an adjustment that is based on the assumption that players will not receive their fair share of revenues from the season prior, suggesting that the league is forecasting an underpayment by teams to its players of $450 million when the new TV deal kicks in in 2016-17!

But that’s not the only problem.

League-wide revenues will eventually stabilize. And when they do, payrolls around the league will catch up. And when that happens, there won’t be any more payroll-related salary cap adjustments. But when you have a massive adjustment inflating the salary cap one year and that adjustment disappears the next year, the cap will naturally crater. And so, naturally, the league is projecting the cap to fall from $108 million in 2017-18 to just $100 million in 2018-19, despite what one could assume will be a steady increase in league-wide revenues.

The result of these salary cap adjustments are cap levels that will keep spiking and catering based on factors that have nothing to do with revenue performance.

But, more importantly, none of it is likely to matter.

Any projections you see that extend beyond the 2016-17 season will likely never happen. The collective bargaining agreement has a mutual opt out provision for both the players and owners for after the 2016-17 season, and it will likely be exercised by the Dec. 15, 2016 deadline. And any new collective bargaining agreement to follow will likely correct for its salary cap calculation shortcomings and avoid circumstances that cause these massive one-time swings. This remains true even if neither sides elects to opt out, and instead the sides agree to simply amend the existing collective bargaining agreement.

So every projection you see that extends beyond the 2016-17 NBA season should be taken with skepticism. They are not based on revenues, rather on cap calculation assumptions that are not likely to survive to fruition(1).

Strangely, then, the news that NBA teams were given today was not really news at all.

Teams were already expecting a salary cap level of approximately $67 million for next season, and most were reportedly preparing for cap levels to increase to approximately $90 million after the new TV rights deal kicked in for the 2016-17 season. Those projections were basically confirmed in the league’s latest update.

Teams were already expecting max salaries of $16 million (for players with less than seven years of tenure), $19 million (seven to nine years) and $22 million (greater than nine years) for next season, increasing to $21 million, $25 million and $29 million, respectively, after the new TV rights deal kicked in for the 2016-17 season. Those projections were basically confirmed in the league’s latest update.

And teams are surely well aware that none of the projections beyond 2016-17 even matter.

And so, they will trudge on, having received confirmation that their latest projections for the future were largely correct.

Notes:

(1) I cannot predict the future, so giving you a better estimate is a difficult task. But I would suggest that a better projection for the 2017-18 season than the league’s current $108 million would be: $93 million + $2 million to fix the current salary cap calculation error + $2 million for every percentage point you feel the players will win back on the revenue split as a result of a potential lockout to come. 

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