Monday, August 08, 2005

Update: how will the new NBA collective bargaining agreement and new luxury tax rules affect the free agent market?

By Dan T. Rosenbaum

Shortly after the new deal was announced between the players and owners, I declared it a big victory for the players. But with a caveat. We shouldn't pretend that the fat lady was singing until the fat lady was indeed singing.

And not a peep was heard from the fat lady until more than a month later when the final details were hammered out. Based upon what I am hearing, the owners did quite well. This deal is pretty even for both sides and the ultimate outcome will depend largely on what happens to revenue growth over the life of the deal.

The initial details suggested that the teeth were taken out of the luxury tax, but that does not appear to be true. The luxury tax is guaranteed in every season of the deal at a lower threshold than used in 2004-05. Perhaps most importantly, teams not paying luxury taxes will likely continue to get larger luxury/escrow tax distributions than teams paying the tax. The new luxury/escrow tax system will be different, but it may deter spending just as much as the old system.

The increases in the salary cap were not extended to maximum salaries, which for owners takes a bit of the sting out of that change. Also, changes in the formula for the salary cap and for salary cap holds will, in effect, make the increase in the salary cap smaller than it appears. In addition, changes in the formula for the Mid-Level Exception (MLE) will result in it growing more slowly than it otherwise would.

Another important detail not known last month was that basketball related income (BRI) increased to $3.037 billion in 2004-05 - a 10.2% increase over 2003-04. That is a marked change from the 1.7% average growth over the previous two seasons. Part of the increase is due to the expansion Charlotte franchise and some accounting quirks, but some of it appears to reflect real growth. If so, the players may regret allowing maximum raises to decrease. It could be the case that revenue growth comes close to outstripping these maximum raises.

Before continuing, let me lay out the major provisions of this new deal. The provisions in green should significantly increase the overall compensation of the players, while those in red should decrease them. There is a lot in here that I believe is not reported anywhere else at this time, so I hope that this can serve as a resource for what this new deal looks like (at least until Larry Coon is able to update his FAQ). I think I have pretty good information on most of these provisions, but as new information becomes available, I will update this material.

  1. The luxury tax will be dollar-for-dollar on spending above the 61.0% of BRI luxury tax threshold (just below that used prior to 2004-05), except that the new deal guarantees that the luxury tax will be triggered in every season of the deal. [Note that in 2004-05 the threshold was at 63.3% of BRI.]
  2. All teams (including those who pay tax) under the new deal will receive a full share of the escrow tax collections. The most likely distribution of the luxury tax appears to be a full share to teams below the luxury tax threshold with the remainder being split evenly among all teams. This is likely to result in teams losing about $3 million in distributions in 2005-06 (more in later seasons) if they end up being taxpayers.
  3. Luxury Tax Amnestry Provision (Allan Houston Rule): Up through August 15, teams will be given a one-time opportunity to waive one player and eliminate the luxury tax on any future contractual payments to that player. The salary will still count towards the salary cap, and payment will still have to be paid to the player according to the contract, but the team will not be subject to tax on that player’s contract. This provision will also apply to previously waived players, but not players traded for after June 21st.
  4. For all minimum salary players, teams above the luxury tax threshold will pay luxury tax equal to the amount for a minimum salary player with two years of experience. This is also true of minimum salary players with zero or one year experience, whose salary for luxury tax purposes will be bumped up to that for players with two years of experience. Edit: This is how it reads in the CBA, but according to league sources this rule will be changed to only apply to free agents with zero or one year of experience who earn up to the minimum for a second year player.
  5. The salary cap and luxury tax exceptions for players who are deemed ‘permanently injured’ will begin after one year rather than two, but can only be applied by the team on which the player played at the time of injury. [Teams will not be able to trade Terrell Brandon to a team looking to create salary cap space and/or avoid the luxury tax.]
  6. The escrow tax on player salaries will be reduced from 10% in year one, to 9% in years two through five, and to 8% in year six of the agreement.
  7. The players will be guaranteed a total of 57% of BRI each year. My understanding is that, contrary to earlier reports, this percentage will not increase during the life of this agreement.
  8. The escrow tax will only be retained by the owners to offset salary costs when total salaries exceed 57%, just like in the last season of the prior deal, but in the new deal that threshold will be raised to 57.5% if BRI is 30% higher than in 2004-05 and to 58% if BRI is 60% higher than in 2004-05.
  9. The salary cap will be set at 49.5% iof BRI in 2005-06 and 51% thereafter, up from 48.04%. Maximum salaries will continue to be tied to the old 48.04% of BRI percentage.
  10. Gilbert Arenas Provision: Restricted free agents in their first two seasons can be offered contracts above the MLE by teams with salary cap room, but in the first two seasons of such deals players will be paid the MLE and 108% of the MLE. After the second year of the contract, the contract can increase to the maximum allowable salary for that player. For example, with no restrictions a player in their first two seasons could be offered a maximum deal of $69.6 million over five years ($12M, $12.96M, $13.92M, $14.88M, and $15.84M.) But this provision will limit that to $55 million over five years ($5M, $5.4M, $13.92M, $14.88M, and $15.84M). For the team offering this contract, the salary cap hold will be equal to the average value of this contract over each of the five years of the contract - in this case $11 million. Thus, the offering team would need to have $11 million in space under the salary cap in order to offer this contract. The original team can match if it has its MLE or early Bird exception available and for the original team the salary cap hold will be equal to the value of the contract in each year ($5 million in the first year, $15.84 in the last year).
  11. A team will have 7 days to match an offer for a restricted free agent (down from 14).
  12. The maximum length of a new contract will now be 6 years for a player who signs with his current team (down from 7), and 5 years for a player who signs with another team (down from 6).
  13. The maximum annual raises on a new contract will now be 10.5% of the first-year salary (not compounded) for a player who signs with his current team (down from 12.5%), and 8% for a player who signs with another team (down from 10%).
  14. First-round picks will be given standard contracts with two years guaranteed (down from 3), followed by two years of team options (up from 1). The contract amounts will remain standardized. [The option for year 3 will have to be picked up prior to year 2. This is very early to give up on a rookie, so it is likely that teams will rarely decline this option.]
  15. In general, there are no changes being made to the general salary cap exception mechanisms which allow teams to exceed the salary cap to add players, such as the Bird Exception, Million Dollar Exception (renamed the Bi-annual Exception), Mid-Level Exception (MLE), etc. However, the average NBA salary will be computed assuming 13.2 players per team (up from 12.5), which will result in the MLE being about five percent smaller than it would otherwise be.
  16. For teams over the salary cap, trades will be allowed as long as they trade away as much first-year salary as they receive within 25% (up from 15%) + $100,000.
  17. Gary Payton Rule: Players will have to wait 30 days in the regular season (20 days in the offseason) before being allowed to sign with the team that traded them away.
  18. Alonzo Mourning Rule: The league will have more discretion to fine players who refuse to play for a team they are traded to.
  19. Base-year compensation (BYC) rules (for trades involving players who just received a sizable raise) will expire on the later of (a) June 30 of the following year or (b) six months following the commencement of base year compensation player status.
  20. Minimum salary levels will be increased by 3.5%.
  21. Teams will be required to have 13 players (up from 11) under contract with the maximum staying at 15. Related to this, teams will have a salary cap hold for every roster spot under 12 (up from 11). The league has guaranteed that teams will have an average of 14 players and will be fined if that average is not met.
  22. The active roster will still be limited to 12 players, but the designation for the others will now be ‘inactive’ rather than ‘injured.’
  23. The NBA age limit will be 19, and one year past high school for Americans, based on calendar year. [There is likely to be a related league rule implemented that prohibits NBA scouts and personnel from scouting any high school games.]
  24. The NBA Developmental League (NBDL) age limit will be 18, down from 20.
  25. Teams will be able to send players with less than two years experience to the NBDL for needed development during the year, while still retaining full rights, with the ability to recall any such player at any time as desired. Such players will receive their full NBA pay.
  26. Teams will be able to send an assistant coach to their associated NBDL team to work with and monitor the development of their players.
  27. Players will be subject to as many as 4 random drug tests per year (up from 1), with penalties increasing for failing a test on a 4-strike system (5-10 games, 25 games, 1 year, lifetime).
  28. Suspensions for on-court misbehavior will be subject to arbitration if the penalty exceeds 12 games (formerly there was no arbitration regardless of length).
  29. More money will be added to pension payments for the older retired players, pending approval under IRS regulations. [I am not sure what happened with this. I certainly hope this made it into the final deal.]

From the beginning, I have argued that the big enchilada in this deal is the change in how luxury and escrow taxes are distributed back to the teams. In the old deal the bulk of the $300 million or so a year (in luxury and escrow taxes) went to teams below the luxury tax threshold. This resulted in the first $3 to $4 million spent above the luxury tax threshold costing teams $3 to $4 million in luxury taxes and $8 to $10 million in lost distributions. That, in effect, was a 300 to 400 percent effective tax rate for spending just above the luxury tax threshold. That got teams attention and for some teams made the luxury tax threshold a "hard cap."

The new deal results in the escrow taxes being distributed evenly to all of the teams. Non-luxury tax payers also get 1/30th of the luxury taxes and mostly likely all teams will get about 1/30th of what is left over. That would mean that the first dollar of luxury tax would cost teams $3 to $4 million in lost luxury tax distributions. It is not the $8 to $10 million in the last deal, but if teams might lose all of that money with their first dollar of luxury tax it might result in many teams treating the luxury tax threshold as a "hard cap."

This is bolstered by the the luxury tax being guaranteed to be triggered in every season and the luxury tax threshold being known prior to the season (at a level below that of 2004-05). I suspect this might result in more teams treating the luxury tax threshold as a "hard cap."

On the other hand, as soon as teams take the $3 to $4 million hit, the effective tax rate will be just 100 percent, which is lower than it was in the old deal. Also, the luxury tax teams will be richer because they will be getting a higher share of the distributions. This could result in more spending. The luxury tax amnesty provision, in essence, redistributes income from low-spending to high-spending teams, which likely will result in more spending, especially since it puts more players into the free agent market.

So the luxury/escrow tax system will be different, although it is possible that it may deter spending as much as the old deal. (Note also that the players will be paying less in escrow tax at the end of this deal. That is a clear benefit for the players.)

As mentioned above, the salary cap increase is a benefit to the players. But it is phased in (starting at 49.5% in 2005-06 and rising to 51% thereafter) and the salary cap hold for the 12th roster spot will in effect make the increase a bit smaller. Also, the welcome changes in how projected BRI is calculated will likely result in the salary cap being a bit smaller than it otherwise would have been. Finally, not allowing maximum salaries to rise with the increase in the salary cap is a big deal, because maximum salary players account for a significant share of total player compensation. All told, the increase in the salary cap is good for the players, but not as much as it appeared a month ago.

And finally, if the over 10 percent increase in BRI is the start of a new trend, the legislated reduction in maximum raises could result in players not being able to keep pace with BRI growth. Potentially that more than anything could result in this being a great deal for the owners.

This author initially claimed that the players may have taken the owners to the cleaners with this new deal. Well, about the only thing that needs to be taken to the cleaners is perhaps my mouth for suggesting that the league may have negotiated a bad deal. (I expressed a lot of caveats, but should have been more skeptical of those initial details.) So if the league would like to send a bar of soap down here to Greensboro, I promise to oblige them by sticking it in my mouth.

Last updated: 11:59 PM, August 26, 2005

9 Comments:

Anonymous Kevin Broom said...

The piece that interests me (well, one piece -- the entire thing is an interesting read) is the one about the MLE calculation. Previously, the calculation was 108% of the previous season's average salary. To my understanding, that was determined by total league salaries divided by 362.5 (12.5 players per team, 29 teams). How will the new calculation work?

8/08/2005 3:55 PM  
Anonymous Anonymous said...

My curiosity was aroused
when I saw that 2 of the 14 garunteed players would now be "Inactive" instead of "Injured"?

I have not seen anything about it, what are the rules regarding this status, is it similar to the "Injury" status, meaning you have to be out for 5 games before coming off, or will teams be able to designate "Active" and "Inactive" status before every game, or at some number in between? Also, can you bring multiple players off of "Inactive" status at once, or is it limited?

8/08/2005 5:04 PM  
Anonymous Anonymous said...

I have a question. If a player is waived under the amnesty rule, then signs, say, a mid-level contract with another team, how much does that player get paid in salary? For example, if A. Houston is waived I know he's entitled to his 20 million. But what if he signs with Detroit for the mid-level (5mil). Is he paid 25 million?

8/08/2005 9:22 PM  
Blogger Dan Rosenbaum said...

Kevin: My understanding is that the new calculation uses 13.2 players per team rather than 12.5. And that the 108% multiplier is still used.

Anonymous (injury): I have no reason to believe that inactive players will be treated diffently than injured players were under the old CBA. In fact, I cannot find where the arrangement we are used to is even in the old CBA. Any help on that would be greatly appreciated.

Anonymous (amnesty): My understanding is that the league negotiated the right to "set off" these contracts waived under the amnesty provision. That would mean that Detroit would pay Allan Houston $5 million, while New York would pay him $20 million minus half of the difference between $5 million and the minimum salary for a player with two years of experience. I think that would result in New York having to pay Houston about $17.9 million. All told, Houston would earn about $22.9 million.

8/08/2005 11:26 PM  
Blogger The Zoner said...

All I can say is fantastic! I just found your blog and have linked over at mine. Outstanding work.

All the best,
The Zoner

8/10/2005 8:40 PM  
Anonymous paulpressey25 said...

Dan, no apologies needed. I still think the players made out like bandits here because Stern was afraid to push the button for another lockout, especially in light of the NHL situation.

I thought it would be a lock that max contract years would be 4/5yrs instead of 5/6. Annual raises are still substantial. And having the escrow money go equally to all teams further helps the big markets.

If revenues keep rising, and the owners can keep a lid on things, great, but I think this deal was still bad for small and mid size markets.

8/10/2005 10:58 PM  
Blogger Dan Rosenbaum said...

PP: I agree that this deal probably was not a great one for the mid-size and small markets. But that probably makes up for the last deal that really hammered the deep pockets teams.

8/11/2005 12:23 PM  
Anonymous Anonymous said...

I calculate that the first pick of this draft if granted two max 6 year contracts during his career will earn $235 million if the salary cap never increases. If the salary cap increases 10% per year, the earnings will be $438 million. How many teams can survive this payout schedule?

8/16/2005 12:33 PM  
Blogger Paul Farago said...

I too was hoping for a faster reduction in the guarantees. At this rate, effort and reward in the NBA will remain disconnected for at least another generation or two. The union position on guarantees results in players who are less coachable and makes team play more difficult. I wish there was a way to quantify this!

Meanwhile, under this collective bargaining regime of guaranteed contracts, in order to reconnect effort and reward, non-elite teams must go younger/cheaper and take the time to build chemistry. Re-sign restricted FAs if they produce, rewarding them for effort, while letting expirations walk.

The owners' weak knees in the face of the union position on guarantees hurts the NBA in many ways. Personally, I feel the pay is high enough to withstand the removal of guarantees beyond the current year - period. If that were done, players would be more coachable and we would witness a revival of NBA teams competing to win the right way.

8/17/2005 9:52 AM  

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