All Salaries are not Created Equal: The Remedy

Neilson Barnard

The goal of the collective bargaining agreement is to level the playing field. Unfortunately, it fails to take into consideration the complex landscape that is the US tax code. Today we propose a simple solution to correct the largest disparity: state income tax rates.

Our own C.A. Clark recently donned his imaginary Commissioner's hat for a day and proposed the not too radical idea that a collective bargaining agreement (CBA) that aims to make salary offers equal should in fact actually make salary offers equal. The premise for those who haven't read his piece - and if you haven't you really should read it - is that the difference in state income tax rates throughout the country directly results in very different amounts of net (after tax) salary even though the gross (pre-tax) salary starts out the same. He does a great job discussing some of the complexities of the issue and I agree wholeheartedly with 99% of his piece. So what's the 1% of his argument that I don't quite buy?

...the key here is to determine the salary benchmarks which are supposed to be even for all teams based upon a criteria which is actually even for all teams.

To do so is incredibly complicated.

Despite the complexity of the underlying issue, the solution is actually rather simple: Allow each team to make an offer according to the CBA, but then adjust the offer by a state factor using the equation below.

Statefactor_medium

Essentially, this equation increases the salary offer by half of the highest tax rate in the state. Why only half? As C.A. Clark mentioned, in the NBA you pay income taxes not only in the state of the team you play for, but you also have to file and pay income taxes in every state that you play. Thus every player's road schedule results in similar tax rates applied to those games and therefore we only need to adjust for the tax disparity associated with the home games.

Using the Lakers as an example, where the highest marginal tax rate in California is 13.3%, the adjustment factor would result in an increase to the offer by roughly 7%.

Statefactorexample_medium

This means that if a team like Houston, residing in Texas where there is no income tax, were able to offer a contract for $10 Million, then the Lakers would be able to offer a contract worth $10.71 Million. The result would be similar take home salaries as the additional money from the Lakers would be going to cover the higher tax burden.

Why does this simple method work? The key assumption is that we don't have to make the post-tax salaries exactly identical, we only need to make them close enough that the money is no longer a driving factor. Put another way, if a player was offered $10,000,000 by team A and $10,000,001 by team B, is money really the deciding factor? One dollar is unlikely to sway the decision in anyway. On the other hand an additional $5 Million would certainly tip the scales (in the economic realm this is similar to the concept of price elasticity). So how much money is enough to be influential? The exact number can't be calculated as it will always depend on the individual and the situation (again for those familiar with economics think utility and indifference curves). What I do know is that whatever the number is, the current CBA misses the mark.

How do I know the current CBA misses the mark? In the current CBA there are some incentives built in for teams to help them retain their players. One of those incentives is the ability to offer an additional 3% increase in salary per year for the retained player above and beyond what another team could offer. This implies that the creators of the CBA believe that 3% is enough to influence a decision. As we derived above, the tax difference between California and Texas (applied to half the games) results in 7% difference; over twice the level deemed influential. Clearly the CBA structure is not fully accomplishing it's objective and taxes can play a major role.

Another reason the simple method that I have laid out works is that it accounts for the majority of the tax differential that a player faces. While federal income tax rates are higher than state income tax rates, federal tax rates apply to income after the deduction for state income taxes paid. This means that if we can equalize the income post-state tax, then federal taxes will by definition be roughly the same as well. This method essentially adjusts for both.

Other contributing factors to the tax rate differences are quite complicated and include subtleties such as: whether a states tax code is progressive or flat, whether there are additional income taxes at the local city level, small differences in the road schedules based on conference and division, etc...These are the numerous other factors that some would argue make the equalization of net (take home) salaries essentially impossible. I would argue though that the impact of each of these pieces is very minor and any attempt to address them will introduce significant complexities. If we can live with the salaries not being perfectly equal in every situation, this adjustment would make them reasonably close and most likely close enough that money is no longer a driving factor.

The final comment with regards to the CBA and taxes is how this adjustment would apply to salary cap, luxury tax, and other constraints applied to a team's overall payroll. The beauty of this adjustment is that each player on a roster would be given the same adjustment factor, thus backing out the adjustment factor for the entire team's payroll results in all teams essentially playing by the same rules. Basically players get offered the CBA salary adjusted by the state factor (to equalize take home pay) while teams adhere to the rules based on salary prior to the adjustment. Perhaps if C.A. Clark were the Commissioner he would give some consideration to this amendment of the CBA as it tries to eloquently address his number one goal.

Here on SSR, we try to focus on basketball and typically avoid turning the site into a discussion of tax policy and economic theory. However, being mired in the doldrums of summer we've taken the liberty to explore these issues. We hope you have found them informative. If not, don't worry...the season will be upon us before you know it and we can get back to the content that makes this the best Lakers site on the web (in my slightly biased opinion).

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