The Cost of Winning

By Darryl Howerton #21

Part 1: The Kyrie Crisis

Nobody wants to be the man left holding the bag, and the Cleveland Cavaliers—despite three Finals runs in 2015, 2016 and 2017—certainly have their fair share of candidates to blame as costs are growing out of control at an exponentially high level.

Keep in mind during these championship runs, Cavaliers owner Dan Gilbert footed expensive luxury tax overage and penalty (LTOP) bills of $11.37 million in 2014-15, $75.87 million in 2015-16 and $78.78 million in 2016-17, with his Cavs now entered into repeater tax penalty range for being over the luxury-tax line in at least three of the last four seasons.

Remember, this three-year overage-and-penalty sum adds up to a cumulative $166 million that goes against the company’s bottom line, approximately cutting more than one-half into its annual profits.

This three-year bottom-line deficit has finally led to Gilbert’s hard-line stance this summer: Enough is enough.

Jason Miller/Getty Images

LeBron James read the writing on the wall; so too did Kyrie Irving.

As a result, Gilbert would not reward GM David Griffin with an extension and raise one month ago, despite producing championship contenders annually.

On top of that, Gilbert would no longer cater to LeBron’s ceaseless pleas to continually upgrade the roster, ever mindful of the cost taxations these moves eventually made.

With the 2017-18 players budget temporarily frozen at $142.2 million—$22.9 million over the current luxury-tax line—it seems obvious Gilbert is limiting every spending dollar (Ed note: the Cavs signed free agent point guard Derrick Rose to a one-year, $2.1 million contract Monday, and would not give him the available $2.6 million mid-level exception remainder from the Cavs’ second round pick Cedi Osman’s deal. It is worth noting the $500,000 expenditure would have resulted in $3.375 million more in penalties that Gilbert refused to pay).

So with the Cavs now at $22.9 million in luxury-tax overage, their penalties in the repeater tax dollars figure to be $74.5 million, bringing luxury-tax overage and penalties costs to $97.4 million.

Translation: Expect more cuts to be made this summer—or once the season gets underway. There is just no way Gilbert can withstand a $74.5 penalty bill, not when he can unload, say, Iman Shumpert or J.R. Smith and reduce that number in half.

Indeed, the days of high spending are over, when the Cavaliers are nickel-and-diming Rose down to a $2.1 million contract. LeBron knew this day was coming, and consequently began to signal his possible summer of 2018 exit weeks ago.

Ronald Martinez/Getty Images

What surprised everyone, however, was that young and talented Kyrie Irving, aged 25 with two more years on a relatively low salary, preemptively made known of his own exit strategy, secretly telling ownership he too would like to leave town ASAP, via a trade now as opposed to LeBron’s free agency route next summer.

It appears young Kyrie did not want to be the figurehead leader of a team undergoing a fire sale this year and next, especially if LeBron was going to be gone, too.

As long as organizations like Golden State showed they could field a championship team at cheaper rates, the days of overspending in Cleveland are now officially over.

And neither Uncle Drew nor Business LeBron wanted to be the last man standing when the taxman came, having to take the public fall for their franchise.

Part 2: The NBA’s New Standard-Setting Championship Budget

A funny thing happened during Kevin Durant’s free agency period this summer.

When Durant worked with Golden State ownership and took a $9-plus million pay cut in 2017-18 so that the Warriors could retain Andre Iguodala and Shaun Livingston via three-year contracts, the 2017 NBA Championship team set a standard of what the Dubs would—and would not—pay to keep a title team together.

By agreeing to Durant’s opt-out $25 million deal, Iguodala’s annual $16 million and Livingston’s annual $8 million, the Warriors signaled they were willing to pay $28.75 million in luxury-tax penalties, triggered by their $15 million luxury-tax overage. With that known, if they were to top out at their allotted $134 million players budget after all 2017-18 seasonal transactions are complete, their luxury-tax overage & penalty costs would total $43.75 million.

Noah Graham/NBAE via Getty Images

Since Golden State did not enter the luxury-tax zone last season, that’s a $43.75 million hit that the 2017 NBA champion Warriors did not have to take following the 2016-17 campaign.

Keep in mind, the 2016-17 Warriors made an estimated $90 million in profit that ownership got to keep in full because the team had no luxury-tax debt.

By that same token, if the 2017-18 Warriors make similar profit, half of their estimated $90 million margin will now be re-allocated to the $43.75 million luxury tax overage & penalties figure we just addressed.

When you consider that, it is admirable ownership is willing to pay such a penalty this season to keep the team together for another run.

With that said, now consider the other scenario. Had the Warriors circumvented the salary cap and paid Durant a 20 percent raise from his 2016-17 salary—allowing themselves to retain Iguodala and Livingston—KD would now be earning $31.85 million first-year salary this summer. The additional $6.85 million in luxury-tax overage would result in additional $15.74 million in luxury-tax penalties, bringing the total luxury-tax overage (LTO) to $21.85 million, the luxury-tax penalties (LTP) to $51.94 million and LTOP to $73.79 million.

TABLE 1: Luxury Tax Overage & Penalty Rates

Luxury Tax Overage (Range) Luxury Tax Rate … Penalty Repeater Tax Rate … Penalty
$5 million ($0M-$5M) 1.50 … $7.5M 2.5 … $12.5M
$10 million ($5M-$10M) 1.75 … $16.25M 2.75 … $26.25M
$15 million ($10M-$15M) 2.50 … $28.75M 3.50 … $43.75M
$20 million ($15M-$20M) 3.25 … $45M 4.25 … $65M
$25 million ($20M-$25M) 3.75 … $63.75M 4.75 … $88.75M
$30 million ($25M-$30M) 4.25 … $85M 5.25 … $115M
$35 million ($30M-$35M) 4.75 … $108.75M 5.75 … $143.75M
$40 million ($35M-$40M) 5.25 … $135M 6.25 … $175M
$45 million ($40M-$45M) 5.75 … $163.75M 6.75 … $208.75M

 

NBA teams that have been over the luxury tax rate at least three of the past four seasons pay the higher repeater tax rate. All other NBA teams pay the normal luxury tax rate found in the middle column above.

Note: Both the Cavs and Clippers will have to pay the repeater tax rate in 2017-18 because they have been over the luxury-tax line in the 2014-15, 2015-16 and 2016-17 seasons. Even if they were to come under the luxury-tax line in 2017-18, they have been over the mark in three of the past four seasons, making them have to pay the repeater tax rate in the right column above.

Example 1:  If an NBA team has not been over the luxury-tax line in two of the last three seasons and has $8 million in luxury tax overage, it then pays a Tier 1 tax rate of 1.50 on the first $5 million overage, which subtotals $7.50 million, and then a Tier 2 tax rate of 1.75 on the remaining $3 million overage, which subtotals another $5.25 million, bringing the total luxury tax penalty on an $8 million overage to $12.75 million in luxury tax penalties. Of course, that then translates to our definition of $20.75 million in luxury tax overage & penalties.

Example 2: Now, if an NBA team has $8 million in luxury tax overage and they are also a repeater tax team, they then pay a repeater Tier 1 tax rate of 2.50 on the first $5 million and 2.75 on the remaining $3 million. That brings the luxury tax penalty to $20.75 million on an $8 million overage for a repeater tax team, totaling $28.75 million in luxury tax overage & penalties.

There was just no way Warriors owners Joe Lacob and Peter Guber were going to pay nearly $74 million of their $90 million profit margin at the expense of keeping Durant, Iguodala and Livingston on the team. Someone had to take a pay cut; Durant was the willing partner.

By doing so, the team signaled to other NBA teams what their limitations were. Translation: They are willing to pay luxury tax overage and penalties on approximately half of their profit margin, but not much more.

Right?

By that same token, these media-darling Warriors in the near future have new income revenue streams flooding their cash registers when next year’s new television deal raises TV annual income from $30 million to an estimated $100 million, while their new arena could bring in another $90 million annually in profit when it opens in 2019-20.

Should the Warriors profit margin rise as high annually as $250 million in 2020 (current $90 million profit plus $70 million TV deal increase plus $90 million arena increase in margins), perhaps then Golden State ownership may be willing to foot, say, $125 million in luxury tax overage & penalties.

But not before that time.

However, when the 2017-18 LTO&P bill is an expected $43.75 million, the Warriors can splurge on that cost, which they just reluctantly demonstrated.

However, when the 2018-19 players budget is conservatively estimated to be $150 million off an estimated $123 million luxury tax—and that comes after replacing free agents Nick Young, Zaza Pachulia, Omri Casspi and David West with players $3.7 million cheaper—that brings the total overage ($27 million) and penalties ($99.25) to $126.25 million, when you consider Golden State enters its first season of repeater tax penalties (see Table 1 above), meaning it will soon go over the the luxury tax for the third time in four seasons (2015-16, likely 2017-18 and probably 2018-19).

Were the Dubs to cut costs and trade, say, Klay Thompson for a projected top-5 first-round draft pick, the $19 million in immediate savings comes off the luxury-tax overage, which then re-totals at $8 million, and then lessens the luxury-tax penalties to $20.75 million.

Those 2019 Warriors would still go into the playoffs with a strong squad—starters Stephen Curry, Nick Young, Durant, Draymond Green, Zaza Pachulia, along with Iguodala and Livingston off the bench—while saving their franchise $105.5 million in LTO&P.

Ya dig?

That is one reason, we predict, why Klay Thompson will not be in Golden State for another full season beyond 2017-18. And as you will soon read, there are hundreds of million more reasons to come during the following seasons.

Jesse D. Garrabrant/NBAE via Getty Images

Let us take a step back to review this situation again.

Golden State ownership can afford to keep Thompson and the team together in 2017-18, taking an estimate $43.75 million hit in luxury tax overage & penalties.

However, when the LTOP escalates to $126.25 in 2018-19, the team goes deep into the red.

And we have not even considered similar damage done in 2019-20, when Thompson becomes a free agent in the summer of 2019 and will be eligible for a first-year salary of an estimated $30.6 million, which is an $11.6 million increase of his previous season salary of nearly $19 million.

As Table 2 shows below, the Warriors LTOP bill will be downright out of control—and these numbers are conservative considering they have been figured with us waiving Livingston’s costs from the team, while also buying out and stretching Iguodala’s contract, as we also give every other free agent minimal $2 million contracts.

Table 2: Hypothetical Costs of 2019-20 Warriors

2019-20 Warriors Projected Salary
Stephen Curry $40.23M
Kevin Durant $37.48M
Klay Thompson $30.6M
Draymond Green $18.53M
Looney, Jones, Bell $7.46M
8 others $16M
waived Shaun Livingston $2M
waived Andre Iguodala $5.7M
Players Budget 158.00

 

Summary: If Klay Thompson re-signed at first-year salary of $30.60 million middle-max contract (30 percent of estimated 2019-20 salary cap), Warriors could bring players budget as low as $158.00 million if they waive both Livingston and Iguodala. On estimated $131 million luxury tax, Warriors would pay $27.00 million in overage and $99.25 million in repeater tax penalties for a total of $126.25 million in LTO&P.

This conservative 2019-20 players’ budget estimate is $158 million if the Warriors re-sign Klay Thompson in 2019 at his middle-max rate, even after Golden State waives Livingston’s non-guaranteed deal, while also buying out and stretching Iguodala’s payments over the next three seasons. With an estimated $131 million luxury tax in 2019-20, the Warriors would have $27 million in luxury tax overage, resulting in repeater luxury-tax penalties of $99.25 million, bringing the grand LTOP total to $126.25 million, based on our conservative estimates.

Now do you see how Thompson’s fate is unavoidable?

Do you see why GM Bob Myers used his $5.2 million mid-level exception on wing Nick Young, giving the Warriors three viable shooting guard replacements in Iguodala, Young and Patrick McCaw?

The Warriors may be able to stomach paying $44.75 million in luxury tax overage and penalties this season.

But $126.25 million more in LTOP in 2018-19? Another $126.25 million in LTOP in 2019-20, even after waiving Iguodala and Livingston? And still yet another $132.19 million more in LTO&P in 2020-21? (see Table 3 below).

Table 3: Hypothetical Costs of 2020-21 Warriors

2020-21 Warriors Projected Salary
Stephen Curry $43M
Kevin Durant $39.26M
Klay Thompson $33.05M
Draymond Green $32.4M
Damian Jones $3.45M
10 others $20M
waived Iguodala $5.7M
Players Budget 176.86M

 

Summary: If Draymond Green signed at first-year salary of $32.4 million middle-max contract (30 percent of estimated salary cap), Warriors could bring players budget as low as $176.86 million, considering they are still paying for waived/stretched-out contract of Iguodala. Warriors would then pay $39.86 million in luxury tax overage, if we are generous and raise luxury-tax line from $131 million in 2019-20 to $137 million in 2020-21. That would result in $174.12 million in repeater luxury tax penalties and $213.98 million in LTOP costs.

Mind you, these are the most conservative, cost-cutting efforts we could make, trimming every last dollar of the supporting cast around the core group. And even then the nine-figure overages and penalties are out of control.

We do not even dare raise the possibility of keeping Iguodala and Livingston through 2019-20 for the length of their three-year contracts because the team’s $45 million luxury-tax overage alone would trigger $208.75 million in repeater luxury-tax penalties, which then becomes a $253.75 million LTO&P albatross that few owners, not even championship-winning billionaire ones would dream to carry.

Part 3: Cavaliers bring costs down to Warriors’ standard-setting championship budget

Do not think the Warriors are the only NBA team that concerns themselves over such matters.

Au contraire, mi amigo. These luxury tax overages and penalties have struck downtown Cleveland like a thunderbolt, with Cavaliers management motivated to now go in a new direction.

That is right.

The Cavaliers saw the Warriors’ $15 million overage limit and have begun to set similar standards for themselves, much to the chagrin of Irving, James and former Cavs GM David Griffin.

Part of the reason why Griffin was not retained and part of the reason why Kyrie and LeBron are dismayed with Cleveland Cavaliers ownership now is because team owner Gilbert is admiring the Warriors’ self-imposed budget of not going $15 million over the luxury-tax line.

Gilbert hopes one day he can align his costs in similar fashion, while still fashioning an Eastern Conference playoff contender.

Mitchell Leff/Getty Images

With 15 Cavaliers already signed at $142.2 million for this 2017-18 season, Cleveland now faces $22.9 million in luxury-tax overage on a $119.3 million luxury-tax line in 2017-18, which triggers $74.5 million in repeater luxury-tax penalties, adding up to a grand total $97.4 million in LTOP this season.

Mind you, the Cavs are paying repeater tax rates now; the Warriors do not face such fees until following the 2018-19 season.

If Cleveland makes similar profit margins as Golden State does, then those $97.4 million in luxury tax overage and penalties eat up all the profits.

With that in mind, it is tough to blame Gilbert for maintaining costs, considering he too has a business to run.

Just signing another Jeff Green-type player to a similar $1.5 million contract costs the Cavs an additional $7.125 million in penalties since Cleveland is a Tier 5 repeat tax offender (tax rate of 4.75 times every dollar spent over the line).

Is it worth it to sign, say, a Derrick Rose, who reportedly has been offered a $2.3 million contract by Cleveland when the Cavs then would have to pay another $10.93 million in penalties and tally another $13.23 million in LTO&P?

Perhaps.

If Rose is worth $13.23 million on the court.

Then—and only then—is Rose worth signing at a $2.3 million salary. That is the predicament the Cavs now find themselves in; it is very difficult to add a player of significance when you are a tier 5 repeat tax offender.

During the Cavaliers 2015, 2016 and 2017 Finals runs—when repeat tax rates and Cavaliers’ overage figures were lower—LeBron held Gilbert’s feet to the fire and forced ownership and management to sign these type of contracts, using his own super-max contract as hostage until the team signed the last holdout, whether that be J.R. Smith or Tristan Thompson.

Now with starters inked long-term—except for LeBron—Gilbert is essentially signaling that he wants to control costs and not pay more than twice in LTOP next season ($97.4 million) as the Warriors will pay ($43.75 million).

Ezra Shaw/Getty Images

If LeBron leaves Cleveland next season over this issue, Gilbert figures, “So be it.”

If Kyrie wants to be traded sooner, that is fine.

Ownership had planned—if LeBron were to leave Cleveland next summer-—on going with a quality starting lineup that the fans could get behind in 2018-19—Kyrie Irving ($20.1 million), Smith ($14.7 million), Kyle Korver ($7.0 million), Kevin Love ($24.1 million) and Thompson ($17.4 million)—while maintaining five-man roster costs at $83 million, with reserve Cedi Osman ($2.8 million) adding a bit more to the till.

That’s a lineup that could still make the 2019 playoffs in the Eastern Conference, right?

But now that Irving wants to go a different route, ownership too is willing to change things on the fly.

One thing is certain, however.

The Cavaliers will be cutting costs as they deal Irving or as they deal with LeBron.

Should Irving not be traded and the Cavaliers remain intact until LeBron left them next summer, Cleveland would be $16 million under the 2018-19 salary cap, according to the estimates supplied by capologist Albert Nahmad ($102 million and $108 million salary caps in 2018-19 and 2019-2020, respectively; $123 million and $131 luxury tax in 2018-19 and 2019-2020, respectively).

To get there, the Cavaliers still will have to cut costs somewhere. By merely trading, say, Iman Shumpert, who makes $10.3 million, for a second-round pick, Cleveland saves as much as $48.25 million in repeater luxury-tax penalties in 2018-19, bringing Cleveland out of the tier 5 entrance on the tax rate chart to the tier 3 entrance.

If that happens—when that happens in 2017-18—LeBron surely will not be a happy camper.

But the Cavaliers have to cut costs somewhere. And if Kyrie and LeBron do not like it, this will be their last season in Cleveland.

Part 4: Luxury tax penalties are the NBA’s way of creating League parity by eventually hitting superteams in the owner’s pocketbook

Not too long ago, the Los Angeles Lakers used to run similar super-team strategy by outspending the rest of the League by anywhere from $16 million to $33 million in luxury-tax overage fees, happy to pay the $16-to-$33 million in luxury-tax dollar-for-dollar penalties, and the ensuing millions in LTO&P costs.

It is how they landed Pau Gasol on a team that already had Kobe Bryant, Lamar Odom and Andrew Bynum, and were able to keep that quartet together as the team’s budget ballooned from $72 million (2007-08) to $78 million (2008-09) and to $91 million (2009-10) during their Finals runs.

Brian Babineau/NBAE via Getty Images

Other NBA teams did not like the advantage this gave the Lakers, so during the 2011 NBA lockout, those franchises instituted a more punitive luxury-tax penalty (see Table 1 above) to punish big-spending teams moreso than the old dollar-for-dollar model.

While this form of punishment no longer affects a non-contender like the Lakers, who bottomed out this decade, the ramifications of this luxury-tax hike is definitely felt by today’s super-teams constructed in Cleveland and Golden State.

So after three straight seasons of Warriors-Cavs Finals—and as it looks now, a shaky outlook on a fourth matchup—just know that there is a day of reckoning ahead for both Cleveland and Golden State organizations.

And that day—for both franchises—is not that far in the future, as the uniformed fates of LeBron James, Kyrie Irving and Klay Thompson should soon tell us, sometime during the 2018 calendar year, if not sooner.

 

NBA salaries and luxury-tax information come from Basketball Insiders, Spotrac and CBAFAQ