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Analyzing the NBA's upcoming Salary Cap spike

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Due to the lengthy nature of this article, I will gloss over certain calculations and descriptions. For the intrepid reader, I have discussed the issues that I gloss over in a post on the upcoming National TV contract, discussed the calculation of the 2015--16 Salary Cap financials, and the Hawks potential for extensions in the 2016 Offseason. Further, Albert Nahmad has discussed the initial future Salary Cap projections and then updated the projections and elaborated on the issue. These articles serve as a nice primer to understanding future Salary Cap projections.

Jason Getz-USA TODAY Sports

When the July Moratorium finished, the NBA announced certain financial terms associated with the 2014--15 Season. The NBA compiled a projection of future Salary Caps, but this should not be taken as a forecast of what we should expect. In spite of what you may have read elsewhere, you should not expect a large Salary Cap spike under the current Collective Bargaining Agreement (CBA)1. In this article, I will describe how the NBA compiles their projection, how it is flawed, attempt to explain why the NBA did this, and what we should expect to see for the future Salary Caps. So let's dig in, hold onto your butts.

Current NBA Projections

The components necessary to understand the NBA projections involve estimating future revenues and costs. Below, I have provided the current NBA projections of the Salary Cap and Luxury Tax via Albert Nahmad. These projections contain some helpful information that we can back out through some algebra (explained here) to get the amount of Basketball Related Income (BRI) that the NBA is using for their projections. I also do this with the Benefits, but these are incorrect because I do not account for the Salary Cap adjustments that result in a projected shortfall of player Salaries plus Benefits being less than 51% of BRI for a particular season(explained later):

Season

Salary Cap

Luxury Tax

Implied NBA Projected BRI

Implied NBA Projected Benefits

Implied NBA BRI Estimate

Implied NBA Projected Benefits

2015

$63,065,000

$76,829,000

$4,708,323,831

$214,554,082

$4,548,850,556

$205,314,911

2016

$70,000,000

$84,740,000

$5,042,189,282

$155,875,485

$4,869,630,892

$203,994,556

2017

$89,000,000

$108,000,000

$6,499,429,875

$237,844,926

$6,309,980,741

$227,602,800

2018

$109,000,000

$129,000,000

$6,841,505,131

-$209,110,604

$6,642,708,259

-$200,105,841

2019

$102,000,000

$123,000,000

$7,183,580,388

$153,933,865

$6,975,435,778

$147,305,134

2020

$104,000,000

$126,000,000

$7,525,655,644

$246,978,335

$7,308,163,296

$236,342,905

2021

$109,000,000

$133,000,000

$8,209,806,157

$403,067,275

$7,968,235,557

$385,710,311

Season refers to the calendar year the Season ends on, so 2015 is the 2014--15 Season. Because of how Salary Cap and Luxury Tax are calculated, I cannot disentangle the amount of benefits from a projected shortfall (adjustment) and are thus displayed together. Clearly, in the 2017--18 Season, the projected shortfall is much larger than the projected benefits, which is why this gives us a negative value.

The NBA uses Projected BRI in calculating a Salary Cap, as opposed to the actual BRI from a particular year, which is the difference in columns.

For some of the underlying financial terms that make up these projections, the NBA has a real good idea of what they would be due to contractual obligation: TV contracts (national, international, and local), Arena Naming Rights, some player contracts, certain player benefits, and various others. If the NBA has knowledge of a contract's value in future years, then they account for it. However, a sundry list of other values are unknown. Think along the lines of ticket sales, merchandising, free agent contracts, etc. When the NBA faces uncertainty with respect to unknown values, they look to the CBA for agreed upon rules to set forth projections. This boils down to projecting the current value of the unknown value to increase by 4.5% per annum.

So let me explain how the NBA came up with these projections for Revenues and Costs, then provide you with what I have estimated as their values for the NBA projections.

Revenues

For revenues, the NBA takes the known revenues and separates this from the unknown. To simplify, I take BRI and break apart TV revenues from Non-TV. According to Larry Coon, total BRI in 2014--15 was $4.84 billion. I've previously backed out the TV revenue for the 2014--15 Season to be $1.005 billion and the 2015--16 value as $1.035 billion. This implies that the Non-TV Revenues in 2014--15 totaled $3.835 billion and these are widely considered an unknown source of revenue.

As I've mentioned before, the NBA projects the unknown will grow at a constant 4.5% forward which is what I do and you can see in the table below. My data are not as good as the NBA's, but I should at least be in the same ballpark.

Cost

Costs are a bit more complicated. There are two components: Player Benefits and Player Salaries. Let me deal with these two separately.

Under the current CBA, there is a special pool of programs for Player Benefits that is funded by 1% of BRI plus a largely unknown aspect which involves 401Ks, medical benefits, certain salary reimbursement, etc. For 2014--15, the unknown aspect (which I call residual benefits) equaled $158,400,000. This amount is projected to grow at 4.5% indefinitely. I add the residual benefits to 1% of what I have projected for BRI in the future years. This makes up my best estimate for the NBA projection of Benefits in the future years.

With the Benefits and BRI projections known, this largely makes up the Salary Cap and Luxury Tax Projections:

$$SC_{t} = \frac{ \text{Projected BRI}_{t}*0.4474 - \text{Projected Benefits}_{t} } { \# \text{ of teams (30)}}$$

Except for the complication that the CBA requires that the players are guaranteed a certain percentage of BRI each year. This guarantee is the combined amount of both Salaries and Benefits. The value is between 49 and 51% based on what is called Forecasted BRI. In 2014--15, players were guaranteed 50.39% of BRI. This amount equaled $2.439 billion but Total Salaries and Benefits were $2.382 billion. So the NBA made up the difference by paying the NBPA $57 million. The Salary Cap was then adjusted upwards by $1.9 million for the following Season (this is roughly $57 million divided by 30 teams). See my post on the 2015--16 Salary Cap figures for more details. By all reasonable accounts, future BRI will be much larger than Forecasted BRI and this will imply that for all seasons beyond the 2015--16 the players are entitled to 51% of BRI.

So here's the rub. How does the NBA project Salaries?

The NBA does have some player contract values that are guaranteed for future years. The NBA would include these for future years, but this not a substantial amount especially for 2 years into the future. Most of the Salaries component is of the "unknown" kind (free agent contracts), which they project this amount forward by expecting it to grow by 4.5% to stay consistent with the rest of the CBA. But they also know they have an additional constraint that Total Salaries must be at least equal to 90% of the Salary Cap times 30. This last part stems from the Minimum Team Salary that is stipulated in the CBA and is binding for each team. So the NBA needs to be in compliance with the CBA and not project Salaries to be below the Total Minimum Team Salary. Therefore, the NBA takes the maximum of these values and projects forward.

All in all, a rough table of their projections given the 2014--15 NBA data would look as such:

Season

Salary Cap

Luxury Tax

Basketball Related Income

Non-TV Rev

TV Revenue

Benefits

Salaries

Adjustment

2015

$63,065,000

$76,829,000

$4,840,000,000

$3,839,415,581

$1,005,000,000

$206,800,000

$2,175,000,000

---

2016

$69,849,349

$84,589,349

$5,042,189,282

$4,007,189,282

$1,035,000,000

$215,949,893

$2,272,875,000

$55,554,881

2017

$88,738,613

$107,134,383

$6,292,737,799

$4,192,737,799

$2,100,000,000

$235,904,138

$2,395,942,555

$82,691,641

2018

$109,544,435

$128,857,176

$6,606,411,000

$4,381,411,000

$2,225,000,000

$246,824,824

$2,957,699,738

$577,449,585

2019

$100,213,620

$120,468,152

$6,928,574,495

$4,578,574,495

$2,350,000,000

$258,180,691

$3,090,796,226

$164,745,048

2020

$105,418,481

$126,640,742

$7,259,610,348

$4,784,610,348

$2,475,000,000

$269,991,322

$3,229,882,056

$184,596,075

2021

$110,681,798

$132,898,891

$7,599,917,813

$4,999,917,813

$2,600,000,000

$282,277,182

$3,375,226,749

$202,527,899

Bolded values are what I assume to be known and are not actual projections. All the rest of the values are projections. Projections are calculated how I describe in the text. Adjustment is applied to that Season's cap, but is calculated through the previous year's values.

The obvious check is to verify how similar my projections of the Salary Cap and Luxury Tax are to what the NBA released. I would say my projections are pretty close to the official projections, but clearly my numbers lack precision. My data are not as good as what the NBA has at their disposal. Oh well.

This section demonstrates the method of the NBA's current projection system and matches their announced values fairly well. The clear implication is that an anticipated shortfall of Total Salaries in 2016--17 is causing the spike in the Salary Cap. I am projecting a shortfall of approximately $577 million. Adam Silver has gone on the record of claiming a shortfall of around $500 million for the 2016--17 Season, so my numbers are within reason. I feel confident in claiming this is the method the NBA is using for their projections. So now, let's turn to what is so strange about these projections.

The Problems

The NBA projections follow the letter of the CBA-law as it pertains to any sort of future projection. In one sense, following laws and regulations help keep order in society. I find this commendable to some degree, but I also recognize this is where the phrase "bean-counter" arises. This is what I believe to be the simplest and best explanation for these projections. However, these projections do not account for any human behaviour or reflect what reasonable people would expect to occur in a market.

It is also possible that the NBA is touting these numbers as a negotiation tactic for upcoming negotiations with the National Basketball Players Association (NBPA). I find this to be less likely than the previous explanation because certainly the NBPA has someone on payroll to give an independent projection of the Salary Cap (right?). A third, and a highly unlikely explanation, would be that my predictions match the NBA's projections purely by coincidence and their method for computing projections is vastly different and in err. I totally dismiss this possibility.

Whatever the reason is does not matter too much. The crux of the flawed projections clearly comes from Salaries.

Salaries and Salary Cap Relationship

A Salary Cap is put into place in order to restrict total spending. It is put into place due to the collectively bargained position of NBA teams which are attempting to restrict total spending to make their whole enterprise better off. Each team has an incentive to acquire more talent than others, which is done through outbidding other teams for the fixed supply of NBA talent. This is cartel behaviour 101. Teams compete for talent by offering higher wages, yet all the teams are better off when wages are low because wages are the biggest expense for a team.

The current Salary projections are only tied to the Salary Cap through the Minimum Team Salary Requirement. Seeing that teams continually make claims about how they are specifically limited in spending through the Salary Cap, this is inconsistent with what one should expect teams to pay for talent. If given the option of exceeding the Salary Cap, teams attempt to do so. This is why we see teams doing things like waiting to sign one of their own players after signing an opposing team's free agent to utilize cap space (see: Kawhi Leonard). If the Salary Cap weren't an issue, then timing would not matter.

The above is theoretical conjecture with anecdotal evidence, might I be able to demonstrate a all of the NBA team's desire to exceed the Salary Cap with actual data? Sure. We can look at a straight-forward relationship of Total Salary Cap (Salary Cap times number of Teams) and Total Salary since 2000:

Season

Salary Cap

Total Salary Cap

(Percent Increase)

Total Salary

(Percent Increase)

Ratio

2000

$34,000,000

$986,000,000

13.33%

$1,309,000,000

23.40%

1.328

2001

$35,500,000

$1,029,500,000

4.41%

$1,523,171,296

16.36%

1.480

2002

$42,500,000

$1,232,500,000

19.72%

$1,525,856,481

0.18%

1.238

2003

$40,271,000

$1,167,859,000

-5.24%

$1,650,600,000

8.18%

1.413

2004

$43,840,000

$1,271,360,000

8.86%

$1,645,682,870

-0.30%

1.294

2005

$43,870,000

$1,272,230,000

0.07%

$1,721,338,968

4.60%

1.353

2006

$49,500,000

$1,435,500,000

12.83%

$1,856,000,000

7.82%

1.293

2007

$53,135,000

$1,594,050,000

7.34%

$1,971,000,000

6.20%

1.236

2008

$55,630,000

$1,668,900,000

4.70%

$2,054,000,000

4.21%

1.231

2009

$58,680,000

$1,760,400,000

5.48%

$2,146,000,000

4.48%

1.219

2010

$57,700,000

$1,731,000,000

-1.67%

$2,114,000,000

-1.49%

1.221

**2011**

$58,044,000

$1,741,320,000

0.60%

$2,013,000,000

-4.78%

1.156

2012

$58,044,000

$1,741,320,000

0.00%

$2,000,303,030

-0.63%

1.149

2013

$58,044,000

$1,741,320,000

0.00%

$2,109,000,000

5.43%

1.211

2014

$58,679,000

$1,760,370,000

1.09%

$2,134,000,000

1.19%

1.212

2015

$63,065,000

$1,891,950,000

7.47%

$2,175,000,000

1.92%

1.150

New CBA came into effect for 2011, that season lasted 66 games and data are extrapolated to reflect an 82 game season. Bobcats were removed from data in 2005 and 2006 because they operated under a different salary cap due to expansion rules.

The key to look at here is the Ratio column, which is the Total Salaries Spent divided by Total Salary Cap. If teams were not constrained by the Salary Cap, then we would expect to see this ratio to be less than 1. But across all years, the ratio is 1.247 and at no point in time lower than 1.14. Under the current CBA, this value is slightly lower at 1.180. I believe the result is straight-forward and intuitive, Total Salaries are a function of the Salary Cap and any projection should account for this in some way.

As another cross-check, we can look at what is the current commitment to Total Salaries for this Season through HeatHoops. If no further players are signed, and all those with non-guaranteed contracts are not waived, then Albert has $2,343,839,018 in Salaries for the year. The NBA is currently projecting around $2.273 billion in Salaries, so the NBA is off by approximately $70 million. The Total Salary Cap is $2.1 billion, which would result in a ratio of 1.116. This is still larger than 1, although there is a slowdown whereby the Total Salary Cap grew by 11% and the Total Salaries are currently anticipated to only grow by less than 8%. But keep in mind that both Teams and Players knew that the 2016--17 Season will have a large increase in the Salary Cap (larger in percentage terms under all projections than the 2017--18 Season, as you will see). This is another change in behaviour that one would want to account for.

But let's take some time to evaluate what changes in the projection system would do to the projected Salary Cap. Let's assume a few different things about what Player Salaries will do. Suppose that Player Salaries will collectively increase by the same percentage as the Salary Cap is anticipated to increase by. What will our projections then look like?

Season

Salary Cap

Luxury Tax

Basketball Related Income

Non-TV Rev

TV Revenue

Benefits

Salaries

Adjustment

2015

$63,065,000

$76,829,000

$4,840,000,000

$3,839,415,581

$1,005,000,000

$206,800,000

$2,175,000,000

---

2016

$69,849,349

$84,589,349

$5,042,189,282

$4,007,189,282

$1,035,000,000

$215,949,893

$2,408,980,167

$55,554,881

2017

$85,982,225

$104,377,995

$6,292,737,799

$4,192,737,799

$2,100,000,000

$235,904,138

$2,965,374,449

$0

2018

$90,563,372

$109,876,113

$6,606,411,000

$4,381,411,000

$2,225,000,000

$246,824,824

$3,123,370,066

$8,017,691

2019

$94,722,118

$114,976,651

$6,928,574,495

$4,578,574,495

$2,350,000,000

$258,180,691

$3,266,797,851

$0

2020

$99,551,760

$120,774,021

$7,259,610,348

$4,784,610,348

$2,475,000,000

$269,991,322

$3,433,363,637

$8,594,450

2021

$103,930,868

$126,147,961

$7,599,917,813

$4,999,917,813

$2,600,000,000

$282,277,182

$3,584,391,318

$0

Ah. So there is no spike. Which is what one should expect, a steady increase in Salary Cap due to a steady increase in BRI through the steadily increasing National TV Contract.

But what if we prognosticate that Salaries may only grow at half or a quarter of the rate that the Salary Cap grows at? What would our outcome look like in that case?



50%



25%


Season

Salaries

Adjustment

Salary Cap

Salaries

Adjustment

Salary Cap

2015

$2,175,000,000

---

$63,065,000

$2,175,000,000

---

$63,065,000

2016

$2,291,990,084

$55,554,881

$69,849,349

$2,233,495,042

$55,554,881

$69,849,349

2017

$2,591,446,130

$63,576,557

$88,101,444

$2,431,384,517

$122,071,599

$90,051,278

2018

$2,810,968,394

$381,946,010

$103,027,649

$2,925,801,972

$542,007,622

$108,363,036

2019

$2,937,461,972

$311,476,392

$105,104,664

$3,057,463,061

$196,642,814

$101,276,878

2020

$3,069,647,760

$337,930,330

$110,529,623

$3,195,048,898

$217,929,241

$106,529,586

2021

$3,207,781,910

$362,762,195

$116,022,941

$3,338,826,099

$237,361,057

$111,842,903

Aha. We can see that as the growth in Salaries slows, there appears to be a more pronounced spike. This is lesson #1. Under the current CBA, the Salary Cap can spike if Salaries paid do not keep up with growth in BRI. But if they move in lockstep? Then there should not be reason to believe a shortfall would occur.

Revenue Growth?

I anticipate that some may be concerned that the BRI projections are too low. There is some merit to this as we can see from historical values of BRI and Non-TV Revenue growth since 2005:

Season

BRI

(Percent Increase)

Non-TV Rev

(Percent Increase)

2005

$3,037,000,000

---

$2,277,000,000

---

2006

$3,174,000,000

4.51%

$2,399,000,000

5.36%

2007

$3,384,000,000

6.62%

$2,594,000,000

8.13%

2008

$3,519,000,000

3.99%

$2,714,000,000

4.63%

2009

$3,608,000,000

2.53%

$2,783,000,000

2.54%

2010

$3,643,000,000

0.97%

$2,788,000,000

0.18%

**2011**

$3,817,000,000

4.78%

$2,932,000,000

5.16%

2012

$4,193,181,818

9.86%

$3,056,363,636

4.24%

2013

$4,293,000,000

2.38%

$3,346,083,751

9.48%

2014

$4,522,000,000

5.33%

$3,548,075,992

6.04%

2015

$4,840,000,000

7.03%

$3,839,415,581

8.21%

The lockout year of 2011 has been adjusted by a factor of (82/66).

Growth under the new CBA in Non-TV Revenues has exceeded 4.5% in all but one year, while the NBA currently projects 4.5% growth in this category. This is a bit of disconnect from reality, but to what degree? Can we account for larger Non-TV Revenue growth in our projections to see what the Salary Cap would do in the future years? Sure. Let's take a look at two scenarios, one where Non-TV Revenue grows by 8% and the other by 15% to see how the Salary Cap projections change:



8%



15%


Season

BRI

Salaries

Salary Cap

BRI

Salaries

Salary Cap

2015

$4,840,000,000

$2,175,000,000

$63,065,000

$4,840,000,000

$2,175,000,000

$63,065,000

2016

$5,176,568,827

$2,476,551,355

$71,808,603

$5,445,327,918

$2,611,693,730

$75,727,110

2017

$6,578,294,333

$3,108,963,223

$90,145,639

$7,177,627,105

$3,410,330,720

$98,883,911

2018

$7,061,557,880

$3,351,303,603

$97,172,396

$8,064,271,171

$3,853,550,682

$111,735,252

2019

$7,573,482,510

$3,591,082,328

$104,124,877

$9,065,161,847

$4,341,155,891

$125,873,562

2020

$8,116,361,111

$3,862,066,449

$111,982,170

$10,197,436,124

$4,903,643,439

$142,183,114

2021

$8,692,670,000

$4,133,869,015

$119,863,195

$11,480,801,542

$5,535,848,455

$160,514,153

I have kept my assumption that Salaries grow at the same rate as the Salary Cap, which makes it so any adjustment for a shortfall is negligible in these calculations.

The implications from above are clear. If Non-TV Revenue growth maintains a consistent amount of growth, then the Salary Cap also has a consistent amount of growth to match. There is no spike, only a smooth increase in revenues.

Closing

So long as teams spend money, the "spike" will smooth out. And so long as you expect teams to spend additional revenues and Cap Space that they receive, then we should not observe a spike. Personally, I think most of the owners have taken a few business classes and will understand their incentive to spend their additional funds. In a competition like basketball, you win by having better players and you obtain better players by offering them higher wages than your competitors. So count me in the group of people that think we will not see a spike.

Teams will find a way to spend beyond their collective minimum. Part of this will be spent bidding on free agents. I can already anticipate an argument that there is only a limited amount of free agents and certain teams may ignore the free agent market. This may be true, but another area where teams will spend their extra Cap Space is through renegotiations and extensions with their current players. This new-found Cap Space will inevitably be spent on free agents and players eligible for raises. So long as you expect owners to be driven to compete against other owners for players, and for players to demand higher wages, then you will not see a spike.


1. If the CBA changes substantially in the 2017 Offseason (which is likely), then my projections for those years will not apply. But seeing that no one knows what a future CBA will look like, we should not pontificate about potential changes to the labor relations for the NBA.