SH Blog: More on Grizzlies-Cavs trade: NBA Taxonomics

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As the Memphis Grizzlies and Cleveland Cavaliers completed a deal Tuesday  that will send three players and a future first-round draft pick to Cleveland in exchange for forward/perennial D-Leaguer Jon Leuer, we must all become more aware of the bigger picture at stake.

The clock is expiring on the NBA’s practical, dollar-for-dollar luxury tax era.

The rules are changing, and these deals will become more of the norm than the exception.

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Hamilton: Welcome To Free Agency Under The 2011 CBA

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NEW YORK — Once the clock struck midnight on the East Coast and the calendar read July 11, NBA free agents were free to sign their deals and offer sheets.

By the end of today, there will be a resolution to the Dwight Howard saga. “It’s all coming to a head (today),” a source close to the trade talks told SheridanHoops.com editor-in-chief Chris Sheridan.

For everyone involved—the fans, press, players, agents, and owners—the past 11 days have been pretty exhausting. In all, there were more than 150 free agents when July 1 came around. And though many free agents that hit the market are still in search of new deals, the cream of the class—Tim Duncan, Steve Nash, Deron Williams, Kevin Garnett, Ray Allen, Nicolas Batum, and Eric Gordon—are all locked up.

Teams like the Brooklyn Nets and Boston Celtics came into the process concerned about retaining their stars while other teams like the Dallas Mavericks, Houston Rockets and Phoenix Suns were concocting grand schemes to steal them away.

If you’re exhausted, spend August doing wind sprints and stomach crunches, because under the NBA’s 2011 collective bargaining agreement, this is going to become the new norm.

The NBA: Where All Hell Breaks Loose Each and Every July.

In the old economic era of the league, we saw six- and seven-year deals, huge extensions, and owners like Mark Cuban, Jerry Buss, and Jim Dolan laugh in the face of the so-called dollar-for-dollar “luxury tax.”

Today? Four year deals are the norm, superstar extensions are practically obsolete, and the luxury tax penalties are stiff enough to make even Paul Allen—the Portland Trail Blazers billionaire owner—keep an eye on his checkbook.

The seeds were planted long before the 2011 NBA Lockout. Since the 1983 CBA created the salary cap and bird rights, different features of subsequent CBAs and the creation of the “midlevel exception” in 1999 yielded a system under which imprudent managers and players who didn’t fulfill their promise, together, created a faulty business model that saw the NBA’s owners collectively lose in excess of $300 million during the 2010-2011 season.

David Stern vowed to change that in 2011, and he made good.

But where does that leave us?

Shorter Contracts

Today, player contracts may only be four years in length if a team does not own a player’s bird rights, and five years if they do and the player re-signs. This is a measure that helps to protect teams from making a mistake that straps their payroll for a longer than reasonable term. It’s one thing if it’s 2004, you’re Jim Buss and you sign Kobe Bryant to a seven-year, $136 million deal, but it’s another if you’re Stan Kroenke, who—in the same summer—signed Kenyon Martin to a seven-year deal worth $92 million.

For every one Bryant, there have been 10 Martins. And that’s why the 2005 CBA limited non-bird and bird contracts to five and six years, respectively, and the 2011 CBA limited deals to four and five.

The net effect is that players of today will become free agents more often. After his first 11 seasons, Martin had been a free agent just once.

For sure, those days are gone. Guys will be hitting the market more often, and while it’s a great protective measure for the NBA’s owners, it’ll result in NBA teams being tighter with their dollars in the short-term, especially since superstars will be hitting the market much more frequently.

Incentive To Become a Free Agent

Prior to the 2011 CBA, extensions were commonplace. Back in 2004, Bryant cut against the grain when he became an unrestricted free agent only to re-sign with the Lakers — although by doing so, he was able to get a rare no-trade clause. For the most part, a player who wished to remain with his team would continually extend his contract when he became eligible to do so. After being drafted by the Timberwolves, Kevin Garnett played his first three seasons under a rookie scale deal before signing a six-year extension in 1998 that would pay him $126 million to remain with the Timberwolves.

Garnett then signed a five-year extension in 2004 and another three-year extension prior to the 2007 trade that sent him to the Boston Celtics. And on June 30, the day before his contract with the Boston Celtics was set to expire, Garnett agreed to extend his contract for three more years.

Technically, Garnett has never been a free agent. And in days past, that wasn’t uncommon.

However, the 2011 CBA saw the NBA’s owners crack down on extensions and “extend-and-trade” scenarios. Carmelo Anthony became the poster child for an extend-and-trade deal, but he only followed Kevin Garnett’s example.

The bottom line here, though, is that under the terms of the 2011 CBA, a player extending his contract may not extend the contract beyond the fourth season in the future. So, if Player X has two years left on his current deal, his extension cannot be for more than two additional years.

Deron Williams opted out of the final year of his contract with the Brooklyn Nets and became an unrestricted free agent. Shortly after 9 p.m. in Las Vegas, he signed a new five-year contract worth nearly $100 million. Had he opted to extend his then existing contract with the Nets, he would have opted into his 2012-2013 contract year and could have only signed a three-year extension, giving him four guaranteed years.

That’s the same reason why Chris Paul recently turned down the offer from the Los Angeles Clippers to extend his current contract.

Under the 2011 CBA, the same rule applies to an extend-and-trade, with the difference being  that under any such agreement, a player may not extend the contract beyond the third season in the future. So in essence, by executing an extend-and-trade deal, a player is receiving two less guaranteed years of income than if he became a free agent and re-signed with the team holding his Bird rights.

That’s why it would behoove Dwight Howard to not extend his contract with any team and go the route that Williams did. Accept a trade, become a free agent, and re-sign.

The moral of this story is that the NBA’s owners sought to make it more difficult for modern players like Anthony to execute extend-and-trades and they removed the incentive for doing so by shaving a year off.

The problem? In the process, and in practice, they’ve made it more attractive to any player and any agent that understands the new system and new rules to become a free agent.

So, just as we have the Dwightmare this summer, we may have the CP3-For-All next summer. Let’s just hope that no other NBA owner pulls the plug on a championship team the way Mark Cuban did back in the Summer of 2011.

The Super-Duper Luxury Tax

The luxury tax was born under the 1999 CBA and was simply a dollar-for-dollar tax until the 2011 CBA.

The NBA’s “soft” cap system makes it possible for a team to continually increase its payroll, even if it’s over the salary cap. So back in July 2008, though the NBA’s salary cap was set at $58.7 million for the 2008-2009 season, the New York Knicks managed to have a season ending payroll of about $94 million.

That season, the luxury tax threshold was about $71 million, meaning that any team whose payroll exceeded that number had to pay one dollar for each dollar that it’s payroll exceeded the threshold.

In other words, that summer, the Knicks paid the NBA a luxury tax of about $23 million.

Beginning with the 2013-2014 NBA Season, though, the NBA will implement a much harsher luxury tax system. Under that system, a team that exceeds the luxury tax threshold by $25 million would have to pay a tax bill of about $64 million.

A team $20 million over the threshold would owe $45 million, while a team $10 million over the threshold would owe $16.25 million.

No, those are not typos, and yes, I’m sure.

So don’t expect to see any payrolls approaching $100 million in the near future. If that happened, it could create a scenario in which the taxpaying team would be paying more in luxury taxes than its actual payroll. For example, if the tax threshold was $75 million and a team managed to field a payroll of $115 million, the tax charge in that instance would be about $135 million.

Under the new system, tax-paying teams will pay an incremental tax that is higher the more they exceed the cap. The NBA’s purpose was to make the tax so oppressive that teams would be more discerning with their payrolls. Small market owners wanted the tax to be so oppressive that even the Lakers, Knicks, Bulls, and Celtics would be reluctant to pay it. It’s the second best thing to a hard cap.

With the 2011 CBA, the NBA changed the economic landscape of the league and as a result, owners will probably be more discerning when signing free agents to long-term contracts.

Together, over the life of this CBA, these three factors will work in concert to ensure that—at least until July 2017— scores of free agents will hit the market.

Depending on which team you root for, that could be a good thing, or a bad thing.

Either way, every future July is going to be like this July.

Moke Hamilton is a Senior NBA Columnist for SheridanHoops.com and will be providing the latest news and commentary during the NBA’s free-agency period. Follow him on Twitter to stay up-to date.