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NBA Goes Progressive: The Luxury Tax

November 28th, 2011 Leave a comment Go to comments

149 days into the 2011 NBA lockout, on Saturday a tentative collective bargaining agreement was reached between the NBA owners and the Players’ Association. Click here to view the memo sent to all NBA players outlining the agreement terms. All signs point to an imminent lockout end and a shortened 66-game NBA season beginning on Christmas Day.

via Wikipedia

Two interdependent items prolonging the agreement negotiations between the NBA owners and the Players Association: The “soft” salary cap and the luxury tax.

In professional athletics, a luxury tax penalizes teams for having a high payroll. The purpose is to prevent major market teams from adding all of the most expensive—and quite often the most talented—players to its rosters. Luxury tax proponents claim competitive balance is crucial for maintaining a healthy league following. The operation of the luxury tax is straightforward: A team must pay an annual tax to the extent its player payroll exceeds a certain amount for a given season.

In the NBA, the luxury tax applies only if a team’s payroll exceeds the “soft” salary cap. The salary cap for a given year is determined by formula, and the cap is “soft” because under certain circumstances, a team’s payroll may exceed the cap. At issue between the parties was defining (a) how a team’s payroll may exceed the “soft” salary cap; and, accordingly, (b) the luxury tax.

Mid-Level Salary Cap Exception

The tentative 2011 collective bargaining agreement contains several salary cap exceptions. Let’s briefly discuss one exception that was heavily negotiated: The mid-level exception (MLE).

The mid-level exception allows a team once a year to sign a player to a contract equal to the average NBA salary, even if the team is already over the “soft” cap, or if the signing would put the team over the cap. Under the prior 2005 collective bargaining agreement, the mid-level exception was set at $5 million for the 2005-06 season. For subsequent NBA seasons governed by the 2005 agreement, the mid-level exception was based upon the actual average player salary for that season. Simple as that. Under the tentative 2011 agreement, not so simple.

The 2011 agreement took the old mid-level exception and created a three-tiered mid-level exception, with each team falling under one of three tiers:

  1. Non-taxpaying teams;
  2. Taxpaying teams; and
  3. Room teams.

A non-taxpaying team is one whose payroll exceeds the “soft” cap but, because of an exception, does not pay luxury tax. A taxpaying team is one who does pay the luxury tax. Finally, a room team is one whose payroll is under the “soft” cap.

We’re just scratching the surface with the MLE. In some cases a team using the MLE will impact the availability of other exceptions. Scratching your head? Let’s leave more MLE details for future discussion.

The luxury tax

Absent exception, the luxury tax applies to the extent a team’s payroll exceeds the “soft” salary cap. The 2011 agreement defines the luxury tax for each year subject to the agreement.

For the first two years under the deal, a team must pay in luxury tax $1 for each $1 over the cap. After the first two years, the tax increases: $1.50 for each $1 over the cap, up to $5 million over the cap; $1.75 for each $1 between $5 million and $10 million over the cap; $2.50 for each $1 between $10 million and $15 million over the cap; and $3.25 for each $1 between $15 million and $20 million over the cap. For each additional $5 million beyond $20 million over the cap, add $0.50 to the previous rate.

The luxury tax is progressive, penalizing teams in greater proportion the greater its payroll.

At this time, the 2011 NBA collective bargaining agreement is not final. It requires a simple majority ratification by both the owners and players. Before the vote occurs, the players must first withdraw two pending lawsuits and re-certify their union. According to the New York Times, members of both sides are confident the tentative agreement will become final.

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