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August 31, 2018

Wondering how your favorite NFL team will do this year? Check the tax rates of its home state, study suggests

Grousing about taxes is nothing new. But, as the 2018-19 NFL season kicks off, some new accounting research gives many football fans an extra reason to gripe: High state taxes, the research suggests, may be a considerable barrier to a fan’s favorite team reaching the Super Bowl.

A paper presented at last month’s annual meeting of the American Accounting Association finds, in its words, "a significant negative relation” between the performance of NFL teams and the personal income tax rates of their home states.

According to the study presented at the AAA meeting by Matthias Petutschnig of the Vienna University of Economics and Business (abbreviated WU), "the most straightforward reason why personal income tax rates might affect team performance is that higher taxes on a mobile labor force is a negotiating disadvantage for teams in high-tax states, hindering their ability to attract quality players.”

As the paper further explains, “NFL players are paid very well and therefore have strong incentives to consider the tax implications of the teams they choose to play for…So, when negotiating with high-tax teams, players might ask for higher gross income to recapture the cost of paying higher personal income taxes. Under a strict salary cap, teams might not be able to satisfy this demand and the players might choose to play for a team in a low-tax state."

And the impact of such decisions, the research finds, is substantial. Over the 23-year period 1994-2016 covered by the study, "teams in high-tax states win on average 0.2 games less per each percentage point of tax differential. For example, a team from California, which has the highest average state personal income tax rate over the whole observation period wins 2.75 fewer games per year (or 17% of the 16-game season) than a team located in a state without personal income tax, such as Florida or Texas."

Thus, it comes as no surprise that the average state tax rate for players on teams that failed to make the playoffs in 2016 (the last year covered by the study) was almost 30% higher than the rate for playoff participants – 5.93% versus 4.62%.

Moreover, the major federal tax reform bill passed late last year, which limits the deductibility of state and local taxes to $10,000, promises to markedly increase the disadvantage of NFL teams in high-tax states even further, Prof. Petutschnig says. In effect, the legislation adds insult to injury – the insult of non-deductibility of high state levies compounding the injury of high state rates.

That the NFL salary cap drives the negative relationship between state taxes and team performance emerges clearly from the study’s comparison of the 10-year periods before and after the cap’s implementation in 1994. In striking contrast to the lack of a significant relationship prior to implementation, a strong negative relationship is seen in its aftermath.

Does the same negative relationship hold for the country’s two other leading professional team sports? While the study reaches no definitive conclusion on that score, Prof. Petutschnig notes that team salary regulations in the National Basketball Association and Major League Baseball have loopholes that the NFL caps lack. As the professor notes, MLB does not have a salary cap but does require teams with a total annual payroll above a predefined threshold to pay a “luxury tax” on the excess amount to the League, which distributes that money to the teams with the lowest total payrolls. As the professor writes, “Major League Baseball teams are therefore not bound to an upper limit when negotiating player contracts, and teams in high-tax states can still attract high quality players as long as the teams compensate the players for their higher personal income tax dues.”

Similarly, the NBA regulates player salaries through a luxury tax rather than a salary cap, imposing a 100% surcharge on amounts exceeding a pre-defined team limit, the proceeds of which are redistributed to the teams with the lowest total payrolls.

If salary caps can diminish team performance, why have them? Because, Prof. Petutschnig explains, it is “in the overarching interest of the owners of the sports teams to ensure a certain level of competitive balance among all participating teams. There is wide agreement in the literature that salary caps can indeed mitigate competitive imbalances in sports leagues because they prevent wealthy clubs with high market potential from bidding the full marginal value for additional talent. This effect allows small market, less wealthy clubs to retain star players.”

The paper’s findings emerge from analysis of the relationship between state tax rates and won-lost percentages of all 32 NFL teams that competed between 1994 and 2016. Records in playoff competition, which culminates in the Super Bowl, are not included in the analysis, because, the study explains, “salaries for the playoff games are paid by the NFL [and] therefore do not count against any team’s salary cap.” In order to zero in on the effect of state taxes, the professor controls for an array of factors that would influence a team’s record in a season, such as the length of its head-coach’s tenure, the club’s success in prior seasons, the record of teams in its division, the number of starting quarterbacks it uses, and the amount of experience of the principal one. Also included in the equation is a variable called “fixed effects,” which reflects the influence over time of various unmeasured factors associated with a franchise (e.g., the perspicacity of its owners or the devotion of its fans).

The salary cap for the current NFL season is $177.2 million per team, up from $167 million last year and a far cry from the $34.6 million limit imposed in 1994, the first year the cap was implemented. Based on a roster of 53 players per team, the current cap amounts to an average of about $3.3 million per player, all of which is taxable by states – via the so-called “jock tax” – whether players are state residents or not. “Players’ location attachment is small,” the study notes. “In general, professional athletes are aware of and react to tax rate differentials whether by migrating to low-tax locations or by negotiating the higher tax cost into their salary packages.”

While the study focuses on the NFL, Prof. Petutschnig believes its findings have relevance to the wider corporate world, where the vast difference between the pay of top executives and that of rank-and-file workers has lately aroused considerable public outrage. As the professor writes, “salary cap regulations have been introduced more frequently into the policy debate over the last several years. In a world of perceived growing inequality, this discussion has raised questions such as whether and how to regulate firms’ payments to their executives. One of the discussed methods of regulating and reducing executive compensation is a mandatory upper boundary (‘maximum wage’) which is a similar concept to the NFL’s salary cap.”

Unlikely though it may be in the near future, is it conceivable, the professor is asked, that at some point the mandated capping of CEO pay will produce tax-related outcomes similar to what we see in the NFL? “Top managers are usually highly mobile and can get jobs everywhere,“ Prof. Petutschnig answers, “particularly with English increasingly serving as the world’s business language. Yet, the link between able managers and company success is much weaker than the link between player performance and team success in the NFL; thus, even if we see an emigration of some top executives from regulated areas, we probably would not see a negative effect on firm performance – not, at least, in the short run.”

The paper, “Touchdowns, Sacks, and Income Tax: How the Taxman Decides Who Wins the Super Bowl" was among hundreds of scholarly studies presented at the American Accounting Association annual meeting, which attracted some 4,000 scholars and practitioners to National Harbor, MD, outside Washington, from August 3rd to 8th. The AAA is a worldwide organization devoted to excellence in accounting education, research, and practice. Journals published by the AAA and its specialty sections include The Accounting Review, Accounting Horizons, Issues in Accounting Education, Behavioral Research in Accounting, Journal of Management Accounting Research, Auditing: A Journal of Practice & Theory, The Journal of the American Taxation Association,  Journal of Financial Reporting, and Journal of Forensic Accounting Research.

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