With free agency officially underway, the Dwight Howard 24-hour news cycle has begun. Pundits from around the country will weigh in on where he should go and why he should go there. In ESPN's latest edition of 5-on-5, four of the five responders chose Houston as the best place for Dwight with the fifth splitting his choice between LA and Houston. The consensus was that Houston was a much better fit with a young James Harden and a solid supporting cast of shooters to give Howard the space he needs to thrive. The biggest advantage the Lakers had over Houston was the ability to offer more money. Unfortunately, that may be the biggest myth perpetuating the discussion right now, for it is Houston that can actually offer Howard the most money.
The most common misunderstanding about the differences between what Houston can offer (4 years, $88 million) and what LA can offer (5 years, $119 million) is that fifth year. As our own C.A. Clark previously discussed
Why is the statement above about leaving $30 million on the table so terribly misinformed? Because that extra year doesn't just go away if a player signs somewhere else. The player doesn't die. He isn't forced to take a year off. That's what makes the $30 million number so ridiculous. The player does not lose $30 million, the player simply has to enter free agency again one year earlier than he otherwise would have if he stayed with the same team.
Unless Howard truly feels like he won't be worth max money in 4 years then he has no reason to be concerned with the 5th year of the deal. Dwight doesn't appear to have any concerns about his back long term and he certainly isn't short on confidence in his ability to be a max level player. So let's take the distorting effect of the 5th year out of the equation and look at what Houston and LA can offer over similar 4 year deals.
The collective bargaining agreement (CBA) does include a couple of provisions that are intended to help teams retain their current players. The provision that impacts Howard the most is that the Lakers are able to include annual salary increases of 7.5% while another team can only offer 4.5%. So while both LA and Houston can offer the same salary for the first year of Howard's next contract, the Lakers can increase the remaining three years at a faster rate than Houston can, thus providing Howard with more money. How much more? Roughly $4M more over the four years ($92 million vs $88 million). Unfortunately Howard would never see an additional $4 million in his pocket should he sign with LA because of the tax difference between California and Texas.
California passed Prop 30 last year which specifically increased income tax rates for the highest earners in the state, the people like Dwight Howard. California now has the highest marginal tax rate (13.3%) of any state in the nation. By comparison the majority of states fall in the range of 5-8%. Texas on the other hand is one of nine states with no income tax on wages. One thing to keep in mind is that the income earned is based on the location of the game so even if a player plays for Houston, they still pay the California income tax on games located in California. A switch from LA to Houston would move roughly half of the games from California to Texas, saving 13.3% of his salary on those games. Over a 4-year span that translates into roughly $6 million in reduced taxes, more than offsetting the perceived benefit from the CBA allowing 7.5% annual increases. The financial benefit of being in Texas doesn't stop there, though.
A player like Howard makes roughly the same amount via endorsements as he does on the court. This means that Howard could be looking at a tax savings of ~$3M per year from earning his entire endorsement contract in Texas rather than California. Some would argue that if he were in LA with the bigger market that his endorsement contracts would be larger and probably offset the higher tax rate. That may well be the case, but Houston has had a long time connection with the Asian market via Yao Ming and, subsequently, Jeremy Lin. If Howard were to go to Houston, who's to say he couldn't gain additional endorsements in the vast Chinese market that more than make up the difference.
Therein lies the problem for the Lakers. In the past the Lakers always had the ability to throw more money at players than other teams. The new CBA is far more punitive and has reduced the Lakers' ability to do that. Furthermore, the tax structure within California is essentially the worst in the nation for professional athletes. It doesn't help that Texas, Florida, and Tennessee are states with no income tax on wages which provides six teams with significant advantages comparatively speaking. The Lakers will have to pitch their long history of winning championships, the weather, and any other soft benefits of being a Californian to entice Howard to turn down more money to stay. That may be a tough sell. We will find out soon enough if the Lakers can seal the deal.
ESPN posted a similar article today with further details around the tax implications of California relative to no income tax states like Florida and Texas. Click here to read their piece.