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Is Avoiding the Tax Worth Watching Quality Free Agents Pass By?

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This post is not a reflection of how I personally feel. I tend to agree with the approach the Miami Heat has taken. But I have been asked numerous times by frustrated fans as to why the Heat is so concerned about avoiding the luxury tax, and whether it is truly worth waiting so long to fill out the roster as quality free agents choose to sign elsewhere. This post is simply meant to address those questions, so that you can decide for yourselves. 

Pat Riley proclaimed in the days following the All-Star break that the Miami Heat’s trade deadline dealings in no way impacted the team’s competitiveness in its quest to make and advance through the playoffs.

He was right.

The Heat was $11.3 million over the NBA’s $84.74 million luxury tax threshold on July 10th. It rather brilliantly executed five trades over the course of the following eight months, two at the trade deadline, in achieving a season-long goal to fall below it.

In accomplishing that goal, the Heat managed to trade away just one rotation player (Mario Chalmers(1), but even at that, trading him, through a series of subsequent developments, also led to the emergence of newly-minted rotation player Josh Richardson) and just three future second-round draft picks.

And when the Heat did have the opportunity to materially improve its competitiveness, when Joe Johnson became available, it did not hesitate, not even for the mere eight additional days that would have prevented it from vaulting right back into the same tax territory it had spent eight months to avoid. Riley took care of that problem by asking Beno Udrih to accept a small discount in conjunction with his waiver, a request Udrih graciously granted.

The result? The Heat is now $46,108 below the luxury tax threshold, despite perhaps being in better shape competitively than it was to start the season. 

That, in turn, allows the Heat to avoid the punitive “repeater” tax, and affords the team a much more manageable salary structure for the season. Adding Miami’s $89.0 million in total salary obligations to the $3.4 million in cash surrendered in trade, less the $75K in cash received, yields total payroll and related obligations of just $92.3 million.

In addition, if it remains below the tax, which is not computed until the end of the regular season, the Heat would qualify to receive a tax distribution — distributed to non-taxpaying teams with the proceeds paid by taxpaying teams — which is currently estimated at $2.6 million. That suggests total projected (pre-escrow) payroll costs of $89.7 million.

On July 10th, the Heat’s total payroll costs had been projected as high as $126.9 million.

That’s a savings of $37.2 million!

However, to stay below the tax threshold, and qualify for the tax distribution, the Heat – which currently has 13 players under contract, two below the 15-player maximum – faces significant restrictions in filling out its roster.

Doling out even prorated minimum salary contracts, the cheapest contracts the NBA allows, would count $5,572 per day against the tax threshold (no matter which player is targeted).

With just $46,106 of room below the tax threshold, and each new contract counting $5,572 per day against the tax, the Heat will be able to offer such contracts for a total of no more than eight days. The Heat roster therefore needs to remain at 13 players until just prior to the end of the regular season.

If the Heat were to choose to sign only one player, it could do so the full eight days prior to the end of the regular season, on April 6th. With two players, the Heat would be able to employ any combination of eight days of salary – whether that be the first signing with seven days left in the regular season and the second signing on the very last day, each signing with four days left in the regular season, or any other combination that totals to no more than eight days.

Waiting that six weeks out until the calendar strikes April has already proven painful. Most of the Heat one-time hopefuls are now off the board. Among the since departed for the rest of the season: Kevin Martin (San Antonio Spurs), Marcus Thornton (Washington Wizards), Ty Lawson (Indiana Pacers).

Even Heat developmental target and Sioux Falls stand-out Briante Weber was signed by the Memphis Grizzlies on a 10-day contract. And if he performs over the course of up to two such contracts, there is every reason to suspect the Grizzlies would attempt to bring him back for the rest of the season and beyond, still a week or more before the Heat would even be in position to put in an executable competing bid.

Which begs the following question: While Riley was largely correct in his assertion that Heat’s trade deadline maneuverings did not reduce its competitiveness, would the team’s subsequent inaction qualify as such?

Did halting all efforts to sign any of its desired free agents, if any would have ultimately chosen the Heat, constitute a type of detrimental impact to the team’s competitiveness that Riley spoke of the Heat avoiding?

If so, does the reward for avoiding the repeater tax justify that detrimental impact?

First, let’s dispel the popular notion that paying the tax this season would have anything other than financial implications. It won’t. Paying the tax this season would not reduce the team’s flexibility going forward. Anything at all that could be done in the future if the Heat were to avoid the tax this season could also be done if it were to pay the tax this season. The only thing that might change is the potential cost.

But paying the repeater tax this season isn’t likely to have any future financial implications either.

Why?

Because the repeater tax, an extra $1 surcharge for every dollar by which a team exceeds the tax level (over and above the league’s already punitive incremental rates), is charged only if a team pays the tax for a fourth time in any rolling five year period.

The Heat has previously paid the tax in each of the 2011-12, 2012-13 and 2013-14 seasons, but avoided it last season.

If the Heat were to pay the tax this season, it would mark the fourth time in five years, which would trigger repeater rates.

Miami, however, is all but guaranteed not to pay the tax next season. The 2016-17 salary cap is currently projected (by me personally) at around $91 million. But wherever it is ultimately set, the luxury tax threshold will be approximately $19 million higher than it. And with limited means for a team utilizing cap space to exceed the salary cap, it would be virtually impossible for a team employing cap space to spend the extra $19 million that would ultimately cause it to wind up exceeding the tax threshold(2).

Do the resulting math and you get this: If the Heat avoids the tax next season, then paying the tax this season has the potential to impact only one future season: 2019-20.

And if the Heat were to avoid paying the tax in any one the 2017-18, 2018-19 or 2019-20 seasons, then paying the tax this season would have no bearing on the future whatsoever!

Projecting at least two years into the future is nearly impossible in the NBA, particularly when that timeframe spans a potential lockout, but it seems particularly likely that the Heat will avoid the tax in 2017-18 as well, with the salary cap currently projected to again jump substantially(3).

So, it seems likely that the Heat paying the tax this season will have no bearing on the future at all. And it will only impact this season from a cost perspective.

Given that, the overall cost of paying the tax this season is rather easy to calculate.

An analysis of incremental cost requires only a comparison between two alternatives – the current situation, versus what might otherwise have been.

The Heat, as of now, will add up to two additional players within the final eight days of the regular season. That will cost no more than $45K in salary payouts.

If the Heat were to have instead added its two additional players immediately (which I will take to mean last Wednesday, the day when two of its primary targets, Martin and Thornton, were signed), it would have vaulted the team right back over the tax threshold, producing three financial implications: (i) additional salary payouts, (ii) a luxury tax hit associated with exceeding the threshold, and (iii) a forgone luxury tax distribution.

The salary payouts would have been no more than $201K per person, or $402K total. The associated luxury tax hit would have been $888K. And the forgone luxury tax distribution, as noted above, would have been $2.6 million. That’s $3.9 million.

So… what would have been the incremental cost for the Heat of adding two players immediately (and in-so-doing, cross the tax threshold), versus waiting until the very end of the season in order to avoid the tax (and in-so-doing, missing out on all the prime free agents)?

Total maximum incremental cost: $3.9 million if signed immediately – $45K if signed at the end of the season = $3.8 million.

Fans (and players) have at times in the past criticized Heat management, perhaps unfairly, for what has been perceived as a penny-pinching approach to roster decisions. Releasing Mike Miller via the amnesty provision at the start of the 2013-14 season was wildly unpopular, even as it projected at the time to save owner Micky Arison upward of $40 million. Committing to bring in Josh McRoberts and Danny Granger at values equivalent to the mid-level and bi-annual exceptions the following summer (somewhat curious decisions both) had the furtive side-benefit of limiting the team’s total payout for the 2014-15 season, which was at the time projected to possibly save tens of millions of dollars.

Those, however, were big-time savings opportunities.

This situation is markedly different. We’re talking about a mere $3.8 million or less.

Consider this: The Heat is nearing a playoff birth, an outcome which would officially send its 2016 first-round draft pick to the Philadelphia 76ers as the final remaining obligation of the LeBron James sign-and-trade from July 2010. Miami also has no 2016 second-round picks. And no cash for trade with which to purchase a pick(4). Which means the Heat could largely be a spectator when draft time arrives. And things don’t get a whole lot better for a long time. The Heat will have just three first-round picks, and zero second-round picks, over the next six years.

But Miami very much likes Weber. It identified him as a tough, quick, defensive-minded point guard in the mold of Patrick Beverley after he went undrafted last June due to his ongoing rehabilitation from a torn ACL, MCL and meniscus in his right knee. The Heat signed him for training camp, and then waived him so that he could be directed to its D-League affiliate in Sioux Falls with his consent, which he gave.

Weber’s defense was NBA-ready from the moment he recovered his health. But the progress of his offensive development under the Heat’s developmental tutelage has been surprising. He has averaged 10.6 points (shooting 45.3 percent from the field, and 44.4 percent from beyond the three-point line), 5.3 rebounds, 4.0 assists in his 28.5 minutes over the course of 22 games with the Skyforce. Since effectively taking over the starting point guard role four games ago, he has increased those metrics substantially — averaging 20.0 points per game, while shooting 52.5 percent from the floor and 44.4 percent from three, to go along with 6.0 assists, 6.0 rebounds and 2.8 steals in 40 minutes.

The Heat was effectively considering Weber as a sort of 2016 second-round draft pick. To be signed to a multi-year contract in the final days of the 2015 season, when doing so wouldn’t force the team to cross the tax threshold. To be used in any number of ways, including as valuable depth or possibly even as a valuable asset in trade down the road. Now, as we wait, he’s gone.

Was it all that much to ask for the Heat to spend the extra $3.8 million(5) it would have required to fill out the roster for the 2015-16 season immediately and, in-so-doing, potentially bring Martin, Thornton, Lawson, Weber and others into play?

After all, that’s a re-deployment of just $3.8 million of the $37.2 million of savings the team had already locked in the for the season.

And, lest we forget, the Heat (and every other NBA team) is about to realize an instantaneous $18 million jolt in guaranteed profit next season – that’s profit, not revenue – from the league’s new national TV rights deal, an amount which will increase ratably over the following eight years.

On the other hand, is it fair to criticize a team which has consistently proven its willingness to spend for trying to save a bit of money on the rare occasion that the opportunity so perfectly presents itself?

After all, this is a team which has paid the luxury tax six times over the 12 prior seasons the tax concept has even been in existence. That’s fourth most in the entire NBA, behind just the huge market New York Knicks (10), L.A. Lakers (9), Dallas Mavericks (9) and Boston Celtics (7).

And this isn’t a massive market team that can offset cost increases with massive revenue generation. In fact, it is, by the league’s own definition, a small market team. The Heat’s primary designated market area, which has just 1.66 million TV households within it, is good for just 17th overall among the league’s 30 teams. That’s smaller market than even that of the Minnesota Timberwolves. Which greatly limits the amount of revenue the Heat can generate.

So, when thinking about why the Heat is choosing to wait to fill its two remaining roster spots, perhaps the best question to ask is this: Were there any two free agents that the Heat might have attracted that were truly worth it spending an extra $3.8 million, when considering where it’s been financially in past seasons, where it’s going both strategically and financially in future seasons, and what spending that money would mean strategically for this season?

The Heat apparently decided that there weren’t.

Whether you agree is up to you.

Notes:

(1) Allow me to take this opportunity to wish Mario Chalmers, and the person for whom he was traded, Beno Udrih, all the best in their recoveries from injury. 

 (2) The 2014-15 Cleveland Cavaliers are the only team in the history of the NBA that I can recall ever falling far enough below the salary cap to dole out a maximum contract (a position the Heat will surely be in next season) and then subsequently rising into luxury tax territory in the same season. But it had many tools at its disposal to increase its team salary (huge tradable contracts, draft picks to serve as sweeteners, etc.) that the Heat will not have.

 (3) I have reason to believe that the NBA’s current salary cap projection for 2017-18 will not withstand a lockout, which I have described in detail numerous times in various posts and tweets.

(4) The Heat could, however, negotiate the terms of a potential trade for a selection, including potential cash consideration, and actually complete the trade in the first week of July, as a means to circumvent this restriction. 

(5) Signing Briante Weber himself would have effectively cost a net $3.1 million. 

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