Luxury tax in football, what can the NBA teach us?
UEFA president Aleksander Ceferin has suggested that the governing body of European football is ready to impose a luxury tax aimed at curbing the power of the largest, most successful clubs in the continent.
UEFA has before attempted to achieve a balanced playing field with its introduction of the Financial Fair Play regulations (the “FFP”). The FFP encourages clubs to spend within their means. However, clear and obvious issues have arisen from this. For example, Manchester United live within a much greater means than a newly promoted club. This club may wish to compete for Champions League football by investing considerably in its squad and infrastructure. The FFP will then penalise this team for spending beyond its means – as in, it is spending more than what it earns. The question begs whether this team can even dream of competing with the likes of Manchester United when it is not supposed to spend more than it earns. This fails to address the imbalance that exists in football and could actually make it more difficult for smaller clubs to compete and improve without the risk of penalty.
By exploring other ways to bring fairness and balance to European football, Ceferin’s observations are very welcome, and indeed a luxury tax system may be the more appropriate mechanism to achieve this.
Luxury tax in the NBA
The NBA has adopted a luxury tax system for some time. Franchises have salary caps that they must consider when selecting their rosters. If a team exceeds its salary cap, a luxury tax is imposed on them for doing so. The resulting total is then distributed evenly to the other teams that did not exceed the cap. Simply put, there are penalties for teams who exceed the threshold and benefits for those that do not. The NBA’s system can be difficult to grasp, but it is generally made up of three components: the salary cap, exceptions and the luxury tax.
(i) Salary Cap
A salary cap is a limit that franchises can spend on player contracts. This system imposes some sort of balance in the league. In its absence, there could be infinite spending where it becomes a competition focused on money and wealth rather than basketball and management.
The cap is considered a soft cap. This means that the cap can be exceeded under certain conditions rather than operating as a hard cap, which would prohibit exceeding the cap no matter the circumstances.
This season, the salary cap is set at $99,093,000. This number is based on projected basketball-related income for the upcoming year. The final number that the cap will be set at is negotiated between the NBA and the players association under the Collective Bargaining Agreement, which is the contract between the NBA and the players association. The 2017/18 salary cap is the highest yet as a result of improved and lucrative TV rights deals.
Whilst a team is not supposed to exceed this cap, it is also supposed to meet a minimum team salary, which is $89,183,700 this season. This is 90% of the salary cap, so a team must spend more than this number but be expected to spend less than the salary cap. This prevents franchises simply reaping the financial rewards from the lucrative broadcasting deals and cashing in with low-paid rosters. The minimum cap ensures that franchises benefit financially from the money that the sport amasses but remain competitive in the league, once again striking a seemingly fair balance.
The NBA permits teams to exceed the salary cap without being taxed if it makes use of an exception. This allows teams to function despite being above the cap. Whilst a description of each exception and how it interacts with the system will be discussed in a following post, for now it should be sufficient to understand that a team can exceed its cap without penalty by using an exception.
One exception is the Larry Bird exception, named after the three-time MVP and Boston Celtics legend, Larry Bird. This exception allows a team to exceed its cap by re-signing one of its own players. When a player is out of contract, he will enter free agency and be free to join any franchise he wishes because he is no longer bound to an existing contract. It would be unfair if a team could not re-sign one of its players (entering free agency) simply because it would exceed their salary cap. Instead, the NBA permits the team to make use of an exception to sign the player even if it exceeds the cap as a result. In this instance, the exception applies to franchises with a player on its roster who has been with the franchise for three consecutive seasons and is entering free agency. Larry Bird qualified for this exception, enabling the Boston Celtics to become the first franchise in NBA history permitted to exceed its salary cap to re-sign one of its own players by re-signing Larry Bird. This is why the cap is considered soft, because under specific circumstances, it can be exceeded without penalty.
(iii) Luxury tax
Whilst the salary cap operates at $99,093,000 this season, the luxury tax threshold is $119,266,000. If a team exceeds this threshold, they will be charged a tax per dollar that it is in excess of the threshold. This can cost a team twice the amount of money by paying the sums due to the player over the cap, and then paying those same sums as a tax to the league. The tax system for this season is implemented as follows:
|Team salary exceeding the threshold||Non-repeat offender||Repeat offender|
The higher a franchise spends above the threshold the higher the penalties increase. Repeat offenders, who are franchises exceeding the threshold for a third consecutive season, will be taxed at a higher tax rate.
The NBA will distribute roughly half of the total luxury tax paid to non-tax paying franchises and the NBA retains the surplus for ‘league purposes’. Taxpaying franchises will not benefit from the distribution of the tax and if they exceed the ‘apron’ they will receive further restrictions. The apron is a point that is set above the luxury tax – this year it is $6,000,000 higher than the luxury tax threshold. Further restrictions for exceeding the apron include losing entitlement to use certain exceptions to the salary cap rule. So where a team could usually sign a new player by using the relevant exception, this exception will no longer be available for the franchise to use for the season.
In the 2015/16 season, the LA Clippers paid a reported $19,900,000 in luxury tax payments along with six other franchises. The remaining 23 non-tax paying teams received $2,500,000 each as part of their share of the tax payments totalling $120,000,000 (remember; only 50% of the total tax is distributed to franchises, who shared $60,000,000 here).
Being under the cap has its advantages. It can improve a franchise’s bargaining position when negotiating trades with other franchises that may need to trade players who are consuming a large portion of their salary space.
The NBA seems to have struck a good balance with this system: it encourages wise and shrewd spending where compliant franchises have financial and tactical incentives whilst non-compliant franchises are punished proportionately. The flexibility of the system – incorporating a soft cap and exceptions – still enables a new ambitious owner to wield their wealth and ‘transform’ a franchise to glory but this does come at a cost: a cost that will benefit other franchises. Rather than simply creating a system to deter and punish spending, the NBA recognises a system that intends on closing the gap between the wealthiest and the least wealthy, restoring a fair and balanced competition where money does not always win.
The effect luxury tax could have on football
A similar system may be useful for football. Newly promoted Huddersfield Town FC and Brighton & Hove Albion FC reported a wage bill of £11,000,000 in the 2016/17 season whilst Manchester United reported a total bill of £264,000,000 for the same season. This recognises a huge disparity between the financial prowess of these major European clubs and their smaller domestic counterparts. An even and uniform system as adopted in the NBA could provide the even ground that smaller clubs have been seeking, granting them a legitimate contest to compete in.
Logistically, this may be difficult. The NBA has a set 30-team roster whereas European football consists of leagues and divisions, involving promotions and relegations. This poses the question as to how the tax could be implemented. One suggestion would be for the tax to be imposed on a league basis – teams within the same league are liable to one another per season. Therefore, the taxes that (let us suppose) Manchester United would pay would then be recouped by other Premier League teams. The same can be applied to the English Football League divisions and then replicated in the same way in Spain, France and Germany, introducing a uniform system into European football.
However, it would not be sensible or realistic to confine Premier League clubs to the same salary cap as La Liga clubs due to the differences in revenue and format of each league. A possible solution is for UEFA to create a formula to determine the salary cap and luxury tax thresholds and for the chief organisations of each tier in each league to calculate what the bespoke thresholds will be. This responsibility would fall upon the Premier League to determine tax levels each season, the English Football League would carry out the same task for its leagues (Championship, League 1 and League 2) and other European leagues such as La Liga and the Segunda Division will perform the task bespoke to its leagues.
A salary cap and luxury tax mechanism may not limit the spending power of Manchester United but the trickle effect as seen in the NBA may aid smaller clubs trying to compete legitimately for the Premier League title. In an analogy, smaller clubs may be able to step up the ladder at the expense of wealthy clubs taking a step down, decreasing the gulf between them.
When Aleksander Ceferin was elected as UEFA’s president in 2016, he suggested that the greatest problem facing football is “the competitive balance between teams”. Referring to the idea of a luxury tax, Ceferin comments “it is not a tax for the government, but for UEFA. We still need to decide how we will redistribute the money”.
When one considers the myriad permutations and formulae that would be required, the relative simplicity of FFP may be considered preferable.
Whilst some consider the system of FFP as failing to fully execute and achieve its purpose, Ceferin’s willingness to consider further financial reform is a welcome breath of fresh air to the sport. By following the NBA’s footsteps, it may be achievable.