Sliding penalties would make the luxury tax more fair across the NBA

The NBA’s luxury tax was instituted in the early 2000s to curtail spending at the top of the league. Like the salary cap and the draft, the luxury tax is another way in which the owners, as a unit, have decided that they want a more even playing field between the teams in large markets and the teams in smaller markets. Under the current rules, teams that pay the luxury tax help to subsidize the teams who do not – up to 50 percent of the money collected from team’s tax payments is distributed to the non-taxpayers, which can be a significant chunk of change for teams in small markets who struggle to make a profit each year. There are additional team-building penalties that come with being a tax team, such as reduced flexibility in trades and a reduced mid-level exception in free agency.

One of the key components to the luxury tax is the repeater tax – if a team has been a taxpayer in three of the past four seasons, then they are subject to the repeater tax in that fifth year, which institutes harsher financial penalties. Each payment band goes up by a dollar – instead of paying $1.50 for every dollar over the threshold (up to $5 million over the tax), repeater tax teams instead pay $2.50 per dollar.

The issue with the repeater tax and the loss of tax revenue sharing for tax teams is that it’s binary – a team is either a tax team or it’s not. Whether a team is $25 million over the tax or a few hundred thousand, they’re treated the same (other than the actual tax payment).

It’s not a world-changing idea like some of the others featured in this series, but I’d like to see the next CBA make slight changes to the tax system to curb one specific behavior: teams just slightly over the tax making a trade purely for financial reasons to get back under the tax.

Instead, the tax should be something of an overall sliding scale, where teams within a few million of the tax threshold lose a portion of their revenue from the other taxpaying teams, rather than all of that revenue. As well, the repeater tax should not be a binary question of “did they pay the tax three of the last four years?” Rather, there should be additional penalties for overspending, but let those penalties stack on each other for the determination of the luxury tax.

For example, such a system could call for a 20 percent decrease in tax revenue received for every $1 million over the tax threshold a team spends for that season. Let’s say the Clippers are $1 million over the tax, the Lakers are $4 million over the tax, and three further teams (Knicks, Nets, and Trail Blazers) are $8 million, $10 million, and $15 million over the tax. All five teams are non-repeater teams. The total tax revenue from these five teams would equal $1.5 million from the Clippers, $6 million from the Lakers, $12.75 million from the Knicks, $16.25 million from the Nets, and $21.25 million from the Trail Blazers for a total of $57.75 million.

Under the current system, half of that amount would be split among the 25 non-tax teams, for an even $1.155 million per team. But why should the Clippers be punished the same as the Trail Blazers in terms of this lost revenue? And if the Clippers were in this situation in the current system, they’d make a move at the deadline to duck under the tax, which would normally lead to a financially-motivated trade that makes the team worse.

Under my idea, the Clippers and Lakers would each get a small amount of tax revenue from the overall pool, while the teams more than $5 million over the tax would not receive any revenue sharing from the tax dollars. The Lakers would lose 80 percent of their new amount, which would be the total tax revenue sharing amount divided by 27 teams (the 25 non-taxpayers and the Lakers and Clippers), and would receive $213,889. The Clippers would lose 20 percent of their revenue sharing for being $1 million over the tax and would receive $855,556. The remainder would be split evenly among the 25 non-taxpaying teams for a payment of $1,029,835 per team.

In the grand scheme of things, these example numbers are relatively small, as teams generate a lot more revenue that this each season, but this sort of sliding scale for tax revenue received would cut down on trades made at the deadline for purely financial reasons to get a team out of the luxury tax.

The tax also prevents teams just under the threshold from signing or trading for players who would push them over, while teams that are already over the tax aren’t hit nearly as hard for acquiring an additional player. Teams just under the threshold are usually unwilling to go over not only due to the additional costs on their books, but also due to the total loss of tax revenue received as a result. The marginal cost of adding a player to their roster outweighs the marginal benefit nearly every time for these teams.

In the almost two decades since the luxury tax was first implemented, there have been big changes to the marginal rates for tax teams which have dampened the relative impact on teams going over the tax, but another factor was introduced that has significantly hurt teams right on the margin of the tax: the repeater tax.

Rather than a binary question of “did they pay the tax three of the past four years?”, an updated system would look at how much tax a team has paid over the last four years and assess penalties based on that number. This system could set up in a similar way to the above example, where there are lesser penalties for teams just over the tax, or there could be some sort of overall scale that goes up as far as needed depending on how far over the tax a team has been in the last four years.

For example, let’s say the Clippers are $1 million, $14 million, and $20 million over the tax three years in a row but stay out of the tax in the fourth year. Under the current system, those three years would be treated the same by the repeater tax system, but there’s a massive difference between being $1 million over and $20 million over. Instead, the new repeater tax system would take their four-year total of $35 million and assess repeater tax penalties based on that number.

How those penalties would work are entirely up to negotiation; they could use $5 million bands with increasing additional penalties, or they could tie it to a percentage of that year’s salary cap, or a number of other systems.

The point of an overhauled system would be to get away from the binary question of whether a team paid the tax or not and lessen the impact on teams who just barely scraped over the luxury tax threshold.

There are several other things the league could do to lessen the impact on keeping an expensive team together, should they choose to make changes to the luxury tax system. There are already adjustments to player salaries for tax purposes. A free agent with fewer than two years of experience in the NBA counts at the two-year veteran’s minimum for tax purposes if his salary is lower than that number. The CBA already takes into account bonuses earned and unearned for tax purposes, rather than likely and unlikely, as is the case for the salary cap.

A key way for the new system to keep developed teams together would be to give a tax break to teams who retain their own free agents. We saw that the Milwaukee Bucks decided to move on from Malcolm Brogdon over the offseason, a decision that was at least in part due to the impending luxury and repeater tax bills that would have come as a result of matching on his new contract. There were certainly other factors that contributed to Brogdon’s departure, but the tax was a concern as well. If the league wants to incentivize small market teams to keep the players they drafted and developed, then giving them a tax break for retaining those guys would make sense.

The tax is punitive enough that some small market teams are priced out of it completely, which is expressly the opposite purpose from what it was designed to do. In the wake of the luxury tax being instituted in the early 2000s, the league said that the tax would “foster on-court competitive balance”, but the result is the opposite. Richer teams are still willing to go into the tax, while poorer teams are not, creating a wider gap between those two groups than previously existed. Creating a system that lessens the penalties for teams just over the threshold and gave those teams breaks for retaining their own developed players would help teams in smaller markets keep up with the bigger teams.

Of course, the league’s stated goals for the tax might have been different from their actual goals. The tax curtails spending across the board, as there are fewer teams spending their full mid-level exceptions and using fewer of their other financial tools in order to avoid the tax. This drops spending across the board, which helps to dampen the market for free agents and saves owners money. Loosening the restrictions on teams right around the tax threshold would remove the excuse a team has not to spend when they get to that level, which would not necessarily be in the owners’ best interests financially, even if it would be better for the players and the league as a whole.