The NBA’s luxury tax first came into existence in 2001, the year in which the league’s new escrow system debuted. The escrow system, in layman’s terms, is a system that withholds a certain amount of player’s salaries and puts it into a separate account until the end of the following season’s moratorium. At that point, when the league’s annual audit is done (that’s what the moratorium is for; calculating the numbers), then if the league-wide player salaries exceed a certain percentage of the league’s overall revenue, that account is divvied up amongst the owners and the players never see it. Similarly, if the league-wide salaries do not exceed that percentage, the players get it back. Essentially, it’s a failsafe measure to prevent players from getting paid too much. Luxury tax is an extension of the escrow system, designed to put more money back into the owner’s pockets if they feel the players are getting too much of it.
If that sounds like something that might excite you, a longer description with all the relevant numbers and stuff was written by the seminal Larry Coon, and can be found here:
As you might presently yourself fully be aware of, the luxury tax is an owner-friendly system also designed to prevent rich teams from simply outspending the rest of the competition. It is calculated by using a projection of the following year’s Basketball Related Income (roughly 61% of it; a more detailed description of the calculation can be found here), and the idea behind it is simple – you can have a payroll of as much as you like, but if you cross that tax threshold, it starts costing you more. It’s designed to be a deterrent, and to emphasise parity amongst the league’s payrolls, thus tying in nicely with David Stern’s slightly socialist idea of all teams having a chance to compete.
Does it work? Let’s find out.
The escrow system and luxury tax have now been around for eight years, from 2001/02 through to the present day. In that eight-year period, there has been a luxury tax in six seasons. During the previous collective bargaining agreement (from 1999 to 2005), the luxury tax was not applicable in every season; the tax was only initiated in seasons where league-wide salaries and benefits exceeded 61.1% (recurring) of the actual BRI that year, and not projected BRI. Since that didn’t always happen – salary spending in 2001/02 was only 59.8% of all BRI, thus there was no tax that year, nor was there one in 2004/05 when it totalled only 60.4% of BRI – in the years when there was no tax, teams could spend as much on payroll as they wanted without fear of additional reprisal.
Of course, they didn’t know that at the time. Since the actual BRI was not calculated until the moratorium following the season’s end, teams didn’t actually know where the tax threshold was going to be until it was too late. They could project it, of course, but they had to make their roster moves around that projection, and that was never going to be an exact science. As such, teams would sometimes be caught out by their own guesswork, and become taxpayers when they didn’t want to be.
The 2005 extension of the CBA changed that system to a more sensible one, where the tax threshold was calculated before the season’s start based on a projection of that year’s BRI. The tax was also no longer implemented based on whether a percentage of BRI was exceeded; from 2005 onwards, it become enforced every year, regardless of what happened with the escrow system.
Those changes gave us the system that we have now, where the salary cap and luxury tax are projected for the following year based on projected BRI, minus benefits, adjusted slightly for the accuracy of the previous season’s projections, and finally divided by the number of teams in the league. The salary cap is calculated at 51% of that projected amount, and the luxury tax threshold is set at 61% of it; for this season, that leads to figures of $57,700,000 and $69,920,000 respectively.
(Again, all of the above save for the Wu-Tang references can be found at Larry Coon’s CBA FAQ. It’s a great resource for those of us really into forgoing social lives in pursuit of a finite understanding of the NBA’s finances. For those more into full frontal nerdity, try the actual CBA itself, and see how long you can tolerate its verbiage for before you are tempted to experiment with carbon monoxide. My record is about seven minutes.)
As mentioned earlier, there has been a luxury tax enforced in six out of the last eight seasons. There follows the amounts paid league-wide each season, and the teams that did it.
2005/06 Season: [Note: team specific figures rounded off.]
2003/04 Season: [Note: figures rounded off, annoyingly.]
– Knicks = $39,800,000
– Blazers = $28,800,000
– Mavericks = $25,000,000
– Timberwolves = $17,600,000
– Kings = $9,700,000
– Lakers = $8,300,000
– Nets = $7,300,000
– Sixers = $5,500,000
– Raptors = $4,100,000
– Pacers = $3,200,000
– Celtics = $1,600,000
– Pistons = $800,000
Total: $151,700,000 (rounded off)
No team-by-team breakdown available.
Total: $173.4 million, ish.
And now, this year. There follows a projection of all team’s projected luxury tax payments for the upcoming season.
– L.A. Lakers = $21,421,066
– Dallas Mavericks = $17,891,715
– Boston Celtics = $14,582,720
– New York Knicks = $13,510,463
– Cleveland Cavaliers = $12,740,694
– Utah Jazz = $12,628,526
– Orlando Magic = $11,068,795
– San Antonio Spurs = $10,160,736
– Washington Wizards = $8,731,745
– Phoenix Suns = $5,622,091
– Denver Nuggets = $5,383,687
– Miami Heat = $3,937,105
– Houston Rockets = $3,354,694
– New Orleans Hornets = $3,331,809
(Note: for the most part, calculating a team’s tax figure is essentially just looking at their team salary figure, and comparing it to the tax threshold. But there are a few subtle differences, the details of which can be found here. The most relevant one is the one that says “For players who signed as free agents (i.e. not draft picks), and make less than the two-year minimum salary, the minimum salary for a two-year veteran is used in place of their actual salary,” a stipulation that affects Marcus Landry, Coby Karl, and others on this list. Also, the suspensions for Rashard Lewis and Jamaal Magloire have to be accounted for; teams are billed for only 50% of the money players lose when suspended by the league. God bless that Mr Coon.)
The most obvious thing that will stand out there is the sheer number of teams paying it. It’s an unprecedented amount of them, and the tough economic climate is the reason why. League revenues were supposed to go up, taking the cap and tax thresholds with them, and teams had budgeted accordingly in previous years. But then the credit crunch hit, revenues went down, and so did the cap. As a result, a lot of teams that weren’t expecting to be taxpayers now are. And that’s why that list is so long.
Of course, this list is still subject to change. For tax calculations, a team’s salary figure from the last day of the regular season is used, and there will be a lot of changes before then. Some players will be traded, others signed, several more cut, and some players will have this year’s salary number retroactively altered if they meet (or miss) their performance bonuses. Since all this is in the future and hasn’t yet happened, an accurate figure is incredibly hard to predict, and therefore an accurate assessment cannot be made until the season’s end.
But as things stand, that’s where we are. It’s still pretty impressive.
Were the above numbers to be a static exhibit, the amount of tax that would be paid is the staggering $144,365,846, and it won’t go down a huge amount. There’s many a month left until the trade deadline, and even though there aren’t a huge number of cost-cutting options available for over-the-tax teams out there, the few that there are will almost certainly be utilised. Nevertheless, any inroads that can be made into that figure will be comparatively small. There just simply aren’t the means to cut much salary right now.
The teams below the tax stand to gain a tidy rebate this year. Teams that do not pay the tax are eligible for a payment of 1/30th of all the money collected as tax, whereas the teams that pay it get none. The rest of the money collected is reserved by the league for “league purposes”; that could mean many things, but a lot of it goes to the league’s revenue assistance plan.
In the 2008/09 season, $87,352,665 was paid in luxury tax (see the breakdown above). 23 teams did not pay it, and seven teams did. Each non-taxpaying team was therefore eligible for a rebate of $2,911,756 – one thirtieth of the overall tax kitty – and the league kept the remaining undistributed $20,382,277 – seven thirtieths of the overall tax kitty, i.e. the shares of the taxpaying teams that won’t get it – for themselves.
This year, as you can see from all the tax that’s projected to be paid, that rebate’s going to be a lot higher. If the $144,365,846 figure above is all paid as tax, that will mean each non-taxpaying team is eligible for a significant rebate of $4,812,195. And no matter how rich you are, $5 million is quite a lot of money. That rebate, plus the rebate teams get from the escrow system, can go some ways to offsetting a team’s salary commitment.
For example, last year, the New Orleans Hornets had a payroll of $66,858,141; to offset that, they gained a $2,911,756 luxury tax rebate, as well as a $6,467,847 escrow rebate (the players got none of their escrow back due to league wide salaries being so far in excess of the designated BRI percentage for them, so it was returned to the owners). That combined $9,379,603 made for a tidy 14% refund on their player salary expenses, and lessened their overall net salary commitment to $57,478,528.
In contrast, the Dallas Mavericks had a player payroll of $94,646,833 last year. That meant a luxury tax payment of $23,611,661 (when things such as Dirk Nowitzki’s one-game suspension and Devean George’s retroactive bonus were included), boosting their overall salary commitment to $118,258,494. As a taxpayer, they didn’t get a luxury tax rebate, and the escrow rebate brought their overall payroll commitment down to only $111,790,647, roughly double what the Hornets paid.
Such is the advantage of not being a taxpayer.
So, if you want to team to cross over into tax territory in order to make your desired transaction, ask yourself if it’s worth both the extra tax payments and the loss of that rebate to the owners. It might not be.