View Full Version : Interesting article on the luxury tax.

Will Galen
07-11-2005, 02:27 PM
The full article is below and fairly long. Here's the condenced version.

In the old contract, luxury tax penalties were only imposed in years when the total payroll for the entire league exceeded a set percentage. The new contract will stipulate that if a team goes over the luxury tax, they have to pay it.


Tipping The Cap
Authored by David Lord - 9th July, 2005 - 3:29 pm

The league's new agreement with its players will include a provision that mandates its luxury tax penalties will be applied every year, regardless of leaguewide spending levels, to teams that spend on player contracts beyond the luxury tax threshold. This is a notable difference from the old CBA, in which such penalties did not apply every year. Mavericks owner Mark Cuban has confirmed to us directly that such a change will definitely be a part of the new deal.

When the agreement on a new CBA was reached two weeks ago and the general details began to be reported, many observers wondered why the owners agreed to a deal that seemed to be a clear financial win for the players. With the revelation of this difference, we think that the owners may not have lost after all.

Why hasn’t this been widely reported already? Since the new CBA is still being condensed to writing, details so far have emerged haphazardly and have been sketchy. Most NBA analysts figured that since the luxury tax was still intact, the tax framework in the new deal would be the same as that in the old CBA. In the old version, such penalties were only imposed in years when the total payroll for the entire league exceeded a defined percentage of leaguewide revenues. In years when overall spending was lower, teams were allowed to spend as much as they desired on player contracts without penalty. As a result, the luxury tax was a soft penalty and an iffy proposition, and more aggressive owners were often willing to take their chances on an irregular penalty that was ultimately only imposed two years out of a possible six.

All that has changed now.

This modification to the tax framework explains quite a few items that heretofore had been puzzling us about the new rules negotiated between the owners and the players:

- It obviously is the reason for the new so-called ”Allan Houston rule’’ in which a team will be allowed a one-time opportunity this summer to jettison a contract and not have to pay tax on it, as owners scramble to avoid impending future tax liability.

- It also explains why the league dropped its demands during negotiations for a “super-tax’’ they wanted to add to rein in the highest spenders each taxable year, since this revision will make more certain the penalties to such teams as long as they exceed tax limits.

- It further explains why every owner will now be getting a share of the tax and escrow payments made to the league, since the penalties on offenders have become steeper because of their inevitability.

- It explains why the league is now willing to exempt teams from being taxed on permanently injured players after a year rather than two, since there is a degree of “couldnt be helped’’ in such a situation.

- It explains why minimum salary players are expected to be exempted from adding to a team’s tax liability, since in some situations a team may be forced to add on players to fill up the roster (and thus increase their payroll) even if close to the tax threshold.

- It may even explain why the league felt compelled to add a 57% floor to payroll, because of the Players Union’s reasonable fear that with this change teams now would be far more hesitant to spend.

Indeed, in the final analysis, this moves the league much closer to a de facto hard cap concept, in that teams may now become far more reluctant to surpass a line that has a certain and effective penalty attached. If that next contract is slated to cost a team $10 million a year for a player rather than the $5 million the contract says, wont they be much more hesitant to offer it? As a result, we think salary levels league-wide will tend to be scaled back over the course of the new CBA, as teams become more budget-conscious in rationing their spending. Although we haven't been able to confirm it, the possibility exists that the tax threshold for an upcoming year may now be determined in the summer at the same time that the cap level is announced - and the existence of a clear number to work with might cause teams to back away before offering a deal that causes them to exceed it.

We have already seen this development ripple throughout the league, but ‘til now those ripples have been attributed to the much-hyped “Allan Houston tax amnesty rule’’ or to other factors. But with the discovery of this crucial rule change, we theorize that the new severely tax averse attitude we are seeing is all due to the change in the certainty of a tax each year.

We saw the reports that the Mavs were seriously considering ditching long-time team leader Michael Finley (who is still talented) while continuing to pay him in full and getting nothing in return. We thought that was ludicrous when we first heard it - but now we see it as evidence of a severe change in the way teams will do business arising from this shift in tax rules. We now are seeing reports that the Knicks have been shopping Stephon Marbury for expiring contracts, and we find it interesting that such a move (when combined with their other expiring contracts plus the waiver of Allan Houston under the amnesty rule) would get them under tax level by next summer. One explanation is that the reports are inaccurate - but perhaps the new rule is a better explanation.

What about all the max-contract money that seems to be flying around in free agency so far? We note that such offers seem to be coming from teams spending their “under the cap’’ money, which we expect will still be spent in the same way as always.

We would be remiss if we didn’t note that others have a different take on the NBA landscape under the new CBA. NBA economics guru Dan Rosenbaum, one of the more renowned financial analysts on NBA issues, opines that the new CBA will motivate owners to spend more, not less. He feels that while initially some owners may pull back, in the long run the amnesty and the added tax exceptions in the new CBA, combined with the fact that those who are taxed will now get a share of the tax revenue, will motivate the spenders to spend more.

And for some teams he may be right. While we note above that the Knicks are reportedly looking to jettison Marbury, we also see reports that they are looking to spend their Mid-Level Exception (MLE) to the salary cap and add a free agent, which would raise their payroll rather than lower it.

The Mavs, while looking to dump Finley, also supposedly made an offer to Robert Horry using their payroll-raising MLE. If true, these actions show teams that might be cutting payroll on one hand - while adding to it with the other. So Dr. Rosenbaum may be right, if such practices are duplicated throughout the league.

But in our view the NBA landscape has been altered in a major way without much fanfare.

What will happen in Dallas? We think it possible that, like most other owners, Cuban will be tempted to severely reign in his spending over the next few years. If that is true, this summer you should look for Finley to be waived not traded, to get the maximum reduction in tax. Also, look for Abdul-Wahad to be waived (at his contractually guaranteed 50%) not traded, to ensure that the Mavs gain the max impact of such a salary reduction. And look for additions to the talent base to come primarily via trades (which swap salary rather than add it.)

Is it a certainty that Cuban will lower his payroll and flee from tax in upcoming years? No it isn’t. Like a spoiled kid, we Mavs fans would love to see him continue to overspend and lavish us with more and more talent like we have been used to in years past. But with the loss of Nash last summer, we were made aware that we might have to grow up and get used to more fiscal responsibility regarding the roster in future years. This new rule has indeed made that a higher likelihood - and if the Mavs somehow opt to still add new talent and payroll and continue with business as usual, be very very grateful.

(C) 2005, David Lord, all rights reserved. Use on free websites (only) permissible with full attribution to David Lord and DallasBasketball.com. All other use reserved.

07-11-2005, 02:49 PM
bye bye austin....

07-11-2005, 02:49 PM
At what payroll amount does the luxury tax kick in for a team? Isn't it a certain percentage spent over the salary cap?

Sounds like it's going to be more predictable now, so I'd expect to see quite a few cost cutting moves made by teams this summer, including our Pacers.