Pay to Play: Why It’s Time to End the NBA’s Luxury Tax
Despite introducing North America’s first salary cap, the NBA now boasts its least effective payroll model. To retake its leadership position, the league has drop luxury tax.
This article first appeared on Jason Hirschhorn’s Sports REDEF here. An excerpt is posted below:
Although professional sports have never been more valuable or more popular than they are today, successfully managing a league is harder than ever. Central to this challenge is the controversial ideal of competitive equilibrium. While a well-balanced league is often argued to be in everyone’s interests, the economics can disagree. Players resent artificial caps on their salaries, while owners want the freedom to build the team they desire, at the prices they deem appropriate. And ensuring the biggest cities have the most competitive teams can enhance a league’s total revenues and maximize its fan base.
For most of the 20th century, this wasn’t really an issue, as sports didn’t provide the financial incentives for owners to horde talent. But as revenues began to swell throughout the 1980s and 1990s, leagues faced a foundational problem: the vast majority of those revenues – and profits – were accruing to major-market teams.
Though no one expects the profits of a Utah-based team to compete with those of a New York City competitor, growth in “franchise inequality” threatened to lock teams in unending feedback loops. As major-market team revenues increased, so too did their willingness and ability to outspend smaller-market competitors, which led to more wins, more income and even more high-priced players. Tier 2 and Tier 3 market teams, meanwhile, struggled to afford a competitive team and, as a result, saw declining profitability and ever-worse on-court performance.
In a more conventional industry, these competitive dynamics would be OK – inevitable, even. But most sports leagues operate not as a competitive marketplace, but as a democratic club governed by individual team owners. Furthermore, the major-market teams need viable competition to drive higher TV contracts, attendance levels and concession sales. And too much salary-based competition can transfer much of a league’s profits to its players. No owner likes that.
Thus, in 1984, the NBA introduced North America’s first major league salary cap. For the 1984-85 season, team payrolls were limited to the greater of either a fixed sum of $3.6 million ($8.2M in 2015 dollars) or 53% of total NBA gross revenues divided by the number of teams in the league (23 at the time). Crucially, however, this cap included a number of exceptions that allowed teams to exceed the cap to retain players already on their roster. It was, proponents argued, in no one’s interest to force a previously undervalued player to abandon fans that loved him and a team that was willing to pay him more.
Despite good intentions, the salary cap quickly proved ineffective – and over the next 30 years, it has endured non-stop revisions that ultimately left it more complex and unpredictable than those it inspired worldwide. As the NBA hurdles toward a December deadline for the players’ association or owners to terminate their 2011 Collective Bargaining Agreement, you can bet all eyes will be on further tweaks to this payroll system. But the answer is not further change, but an end to this hybridized model altogether.
1984 TO 2002: THE SOFT CAP
Across its first six seasons, the NBA’s salary cap showed tremendous promise. Compliance rose from nearly half of the league’s 23 teams to all but one. At the same time, the offenders reduced their average overage from 30% above the salary cap to less than 10%.
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