In a 60 Minutes interview this month, Rep. Alexandria Ocasio-Cortez proposed a 70 percent marginal tax rate on income earned above a $10 million threshold. In the moment, interviewer Anderson Cooper described the idea as “radical,” but recent polling suggests that a majority of Americans would support the hike. It isn’t a formal policy proposal yet, but the fact that a tax plan has captured public attention and weathered multiple news cycles indicates the idea isn’t going away. At the very least, it provides fodder for some fascinating thought experiments.
One field with a disproportionate number of high earners is professional sports. Athletes aren’t pharmaceutical execs, though, and their careers rarely last past their mid-30s. What would a 70 percent marginal tax rate do to a league like the NBA?*
To predict what might happen to Stephen Curry’s salary in an America with a much different approach to taxation, I spoke with Matthew Notowidigdo, an associate professor of economics at Northwestern University. Notowidigdo teaches labor economics and has worked with professional sports teams on issues like ticket pricing, revenue sharing, and media rights. Our conversation has been condensed and edited for clarity.
Nick Greene: Have there been any monumental tax changes in recent history that can give us hints about how a 70 percent marginal tax rate would affect a sports league like the NBA?
Matthew Notowidigdo: In the U.S., I’m not familiar with any high-quality work on that, but there’s been a lot of work on taxation in Europe for high-tax individuals. There’s actually a paper studying soccer players in European countries [“Taxation and International Migration of Superstars: Evidence From the European Football Market“]. One of the co-authors is Emmanuel Saez, who is one of the economists who’s cited a lot in the discussion of the 70 percent tax rate in the U.S. He’s studied how soccer players react to taxes in Europe, and what they found is that it looked like they were reacting by going to countries that had lower marginal tax rates after the Bosman ruling [a European court case that allowed professional soccer players to migrate more freely] relative to before.
Europe has multiple leagues that are comparable in quality. Spain’s La Liga is similar to England’s Premier League, and the German Bundesliga is up there, too. If NBA players were to leave to play in Europe, I imagine it would be a much greater change, both personally and professionally.
I don’t think [the NBA and European soccer are all that similar to each other], but this is an example of an academic paper by very well-respected people that are looking at the migration responses to tax changes. I thought about it and looked at some of the contracts in the NBA, and one thing I’d want to look out for is at that $10 million mark, that’s a huge jump in the marginal tax rate as it’s being talked about right now. I think what you’d expect to see is a lot of what economists would call “bunching” of people’s salaries at $10 million, using deferred compensation to get people away from paying that 70 percent tax rate. A natural way to get around it would to be to just backload your compensation so that after retirement or at some point in the future you’re going to get lots of money, but you never earn more than $10 million in any year of your contract.
So you’d have players signing contracts for 25 years rather than five years.
Yeah, it’s like the Bobby Bonilla days. [Retired New York Mets player] Bobby Bonilla is getting paid for the next 20-something years, and I could imagine NBA players would commit to earning $10 million a year—they could still sign a higher contract, but all the compensation is just going to get pushed to the end.
Wouldn’t that hinder player movement in trades? Some long-term contracts are like poison for NBA teams in the current setup.
The answer is I don’t know. If Steph Curry’s not getting paid $40 million this year, but he’s getting paid $10 million with $30 million coming much later in life, then that means somebody’s got to pay it if he gets traded. I would think that’s something that would be negotiable, but it’s possible the collective bargaining agreement could put constraints on what can be negotiated.
If there’s less incentive for players to hold out for contracts that pay only slightly more than $10 million annually, wouldn’t management be benefiting rather than labor?
I think that intuition is right. Individuals near the $10 million mark aren’t going to bargain more for raises, and that surplus is either going to go to management or it’s going to be redirected to other players. That’s one mechanism where lower-paid players could benefit, where management transfers those resources to them.
Seems like the salary floor would become more important than the salary cap.
You’d see a lot more earnings compressed around the $10 million mark. It’s a kink in the tax code, and you’d expect a lot of people to end up right around that kink if they would have been close to there or slightly above there before. The same thing happens with the earned income tax credit at the bottom of the income distribution. There are a lot of people who are self-employed who end up reporting their income right around the point that maximizes their earned income tax credit.
What about endorsements?
Endorsements are going to be ordinary income and would be subjected to the tax once you hit $10 million. One way that deferred compensation wouldn’t work very well is if that person is already earning significant endorsements and so they would be hitting that 70 percent tax rate no matter what.
Do you think it would be possible for teams and companies to work together to structure deferred contracts that maximize a player’s payout?
My guess is that you would instead see something more creative, where the endorsement would be paid in something that would allow them to get into capital gains rather than ordinary income. If LeBron James endorses an energy drink, the energy drink could pay him in stock rather than income, and then that stock could be treated as a long-term capital gain. I imagine that’s what you would see on the endorsement side. I think there are examples of Under Armour and Vitaminwater doing this already.
The NBA is in a weird spot because it has one team in Canada. The Toronto Raptors would seemingly have a huge advantage in free agency due to Ontario’s lower tax rate on high earners.
That sounds more like the European soccer players I was talking about. Yeah, that’s a huge advantage, just like the state tax gap.* [*Correction, Jan. 22, 2019: Readers have pointed out a mistaken assumption in this question and in the questions below that reference Canada, namely that U.S. citizens and permanent residents have to file U.S. income tax even if they work outside the country. That means that in this hypothetical scenario, American players wouldn’t actually accrue a sizable advantage by playing in Toronto but foreign players would. Unless American players decide to renounce their citizenship while playing for the Raptors. It’s all on the table in this future.]
Yes, but Steph Curry, Kevin Durant, and LeBron James all play in California, which has the highest top income tax rate in the country. There’s no income tax in Florida, for example, but the Orlando Magic aren’t perennial Finals contenders.
Which is just a reminder that after-tax income isn’t the only thing people think about. There might be some individuals for whom that would be relevant. It’s just a question of how many people we’re talking about. The soccer paper suggests it’s not a lot of people [who migrate for tax reasons], but it’s some, and so at the margins some teams might get a little bit better if they have the tax advantage.
So, Toronto wouldn’t ruin the league?
If you really went to 70 percent, then maybe some of the highest-paid players might think about going to Toronto. I don’t think the overall effect on the league would be very large. These are large amounts of money we’re talking about. The players will have sophisticated financial advisers who will do everything they can to minimize the actual tax implications. That’s my prediction.
Could the NBA impose a separate salary cap on Toronto to make up for the tax rate disparity? Is that legal?
My understanding of the revenue-sharing agreements is that they have a lot of ability to do whatever they want. They can charge teams differently depending on what media markets they’re in or what the value of their television station is, so I don’t see why they couldn’t treat Toronto differently under the justification that this is important to maintain competitive balance.
So the decadeslong Raptors dynasty isn’t set in stone?
It’s fun to think about, though.
*Correction, Jan. 22, 2019: Readers have pointed out a mistaken assumption in this question and in the questions below that reference Canada, namely that U.S. citizens and permanent residents have to file U.S. income tax even if they work outside the country. That means that in this hypothetical scenario, American players wouldn’t actually accrue a sizable advantage by playing in Toronto but foreign players would. Unless American players decide to renounce their citizenship while playing for the Raptors. It’s all on the table in this future.