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  • Writer's pictureNandan Malhotra

Underlying Role of Luxury Tax in the NBA

Introduction


A salary cap is a rule that is written out in a contract or otherwise legally stated that enunciates the maximum amount of remuneration earned by an employee. This means that the cap is well-known in the industry, and professionals can earn salaries up to a certain number but not more than that number. The cap varies from industry to industry, as does the manner in which it can be used. The cap may also be subjected to raises. The term salary cap can be used synonymously with “wage cap’.[1] Professional sports league in the United States , such as the National Football League (NFL), National Basketball Association (NBA), and Major League Baseball (MLB), are all subject to salary caps. In sports, the team salary cap refers to how much a team can spend on its players.[2] The NBA recently announced that its salary cap and tax level have been set at $123.655 million and $150.267 million, respectively,[3] for the 2022-2023 season.


Certain positions in sports, such as the quarterback in American football or a point forward in basketball, are considered to be some of the most important positions in their respective sports. Teams are willing to shed a chunk of their salary cap in order to acquire marquee players at these two positions in a highly competitive market. The cap is enforced to ensure that no single team can disproportionately outspend their rivals to create an unstoppable and expensive team.[4] However, there are two types of salary cap. The first type of salary cap is the hard cap, which sets out a monetary threshold on the purse of a team. A team cannot exceed the threshold set under the hard cap regime violation results in fines, penalties, and the loss of future draft picks.[5] Owing to the NFL’s owner-friendly Collective Bargaining Agreement (CBA) it is no surprise that the league has a hard salary cap regime. The National Hockey League (NHL) has also employed a hard salary cap regime[6]. On the other hand, leagues like the NBA and MLB have employed a soft cap regime, wherein teams are allowed to spend more than the threshold amount set out in the CBA.


NBA Salary Cap Overview


The NBA has employed a soft cap plus luxury tax regime, which means that if ‘team salary’ exceeds the salary cap the team automatically falls into the ‘luxury tax’ bracket. Team salary encompasses whether a team is under or above the salary cap, it includes player compensation to players under contract and to players who have been waived by the team but whose contracts stipulates that team must pay them guaranteed money even if they are waived from the team. In recent season there have been multiple teams in the luxury tax bracket. The Golden State Warriors, Los Angeles Lakers, Philadelphia Seventy-Sixers and Brooklyn Nets, to name a few. The total revenue generated from the luxury tax is collected by the league and distributed to the teams that are within the salary cap as a form of financial field levelling. It is noteworthy that when determining the salary cap of a team in the NBA, the “Basketball-Related Income” (BRI) of the team is taken into account.


The CBA has laid down an exhaustive thirty-page definition of BRI, which includes a wide range of activities include revenue generated from jersey sales, arena naming rights, gambling on NBA games or any kind of NBA games and various other non-NBA events . Any income-generating activity included in BRI under the CBA will have a cascading effect on the salary cap. The basic rule being that higher the BRI, the higher will be the salary cap[7], thereby allowing the players to benefit from the league growing revenue. Salary cap for the subsequent year is determined by league revenue and accumulative BRI generated by the teams during the previous salary cap year. [8] Anecdotal evidence shows that league revenue and other factors determining the NBA salary cap have seen continuous progression over the years, as a result of which the salary cap and tax level have seen an upward vertical shift.


NBA Luxury Tax Regime under the CBA


The tax level refers to the monetary threshold that, when a team hits or surpasses it, requires them to pay a tax to the league. The tax level for a salary cap year is calculated by multiplying the projected BRI by 53.31%[9]. The league has classified team salaries into different tax slabs and levies tax based on the salary tax slabs alone. A tabular representation of taxes levied is discussed hereinafter.


Incremental team salary above the cap, for standard tax rates:

$0 – $4,999,999

Tax Level Tax Rate for Increment: $1.50-for-$1

$5,000,000 – $9,999,999

$10,000,000 – $14,999,999

$15,000,000 – $19,999,999

$20,000,000 and over

The league has also levied a hefty amount of tax for teams who are ‘repeat offenders’. A team is characterized as a repeat offender when, for three consecutive salary cap years, its team salary hits or exceeds the tax level. A tabular representation of the tax levied on repeat offenders is discussed hereinafter. [10] [11] [12]


Incremental team salary above the cap, for repeater tax rates:

$0 – $4,999,999

Tax Level Tax Rate for Increment: $2.50-for-$1

$5,000,000 – $9,999,999

$10,000,000 – $14,999,999

$15,000,000 – $19,999,999

$20,000,000 and over

Return for part 2 next week...


References





[5] Alan M. Levine, “Hard Cap or Soft Cap: The Optimal Player Mobility Restrictions for the Professional Sports Leagues”, Fordham Intellectual Property, Media and Entertainment Law Journal, https://ir.lawnet.fordham.edu/cgi/viewcontent.cgi?article=1105&context=iplj





[9] 2017 NBA- NBPA Collective Bargaining Agreement, Article VII, Section 12(a)(17)(i) , https://cosmic-s3.imgix.net/3c7a0a50-8e11-11e9-875d-3d44e94ae33f-2017-NBA-NBPA-Collective-Bargaining-Agreement.pdf


[10] 2017 NBA- NBPA Collective Bargaining Agreement, Article VII, Section 12(f)(1)(i) , https://cosmic-s3.imgix.net/3c7a0a50-8e11-11e9-875d-3d44e94ae33f-2017-NBA-NBPA-Collective-Bargaining-Agreement.pdf


[11] 2017 NBA- NBPA Collective Bargaining Agreement, Article VII, Section 12(f)(1)(i) , https://cosmic-s3.imgix.net/3c7a0a50-8e11-11e9-875d-3d44e94ae33f-2017-NBA-NBPA-Collective-Bargaining-Agreement.pdf


[12] 2017 NBA- NBPA Collective Bargaining Agreement, Article VII, Section 12(f)(1)(i) , https://cosmic-s3.imgix.net/3c7a0a50-8e11-11e9-875d-3d44e94ae33f-2017-NBA-NBPA-Collective-Bargaining-Agreement.pdf

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