The Media Cares More About The Impact Of State Income Tax Than Players Do

Friends,

Over the last few years sports media has continuously pushed the narrative that state income taxes make professional sports free agency unfair. Their argument hinges on the basis that an athlete is more inclined to sign with a team located in a state with no income tax, than with a team located in a state with a high income tax. But do states with lower income tax really get preferential treatment in free agency? And if so, shouldn't teams in those states win more championships?

Let’s Talk Taxes

Surprise! Taxes make a difference - take a look at how the state income tax changes from state to state, ranging from 0% in states like Florida & Texas to 13.3% in California.

On the sports front, let’s take a hypothetical look at Manny Machado’s 10-year $300M deal he signed last year. Machado ended up signing with the San Diego Padres, taking on a 13.3% state income tax in the process. How would his net wages have changed if he chose the Chicago Cubs instead? Machado could have pocketed almost ~$13M extra over the lifetime of his contract based on the difference in state income taxes (Source).

The problem? It’s not always that easy. Things like “Jock Taxes” - taxes imposed by states on the earned income of visiting teams playing in their state - can have a significant impact on net wages, and aren’t always easy to calculate years in advance. Along with “Jock Taxes”, players also routinely have homes in other states which they can claim as their “primary residence”. On top of that, you are taxed in the state you play in - with half your games on the road, it tends to confuse the tax equation even more (Source).

With so many variables, the effective tax rate a player will pay by signing with one team over another can’t be figured out correctly for any contract longer than a year. And even if there was an obvious tax advantage for a free agent choosing a team, it would still be just one of many factors including: the overall size of the offers, the relative quality of the teams, the player’s schematic fit or their desire to work with a specific coach.

Take Tom Brady for instance, he continuously took below-market value contracts throughout his time with the Patriots. Business Insider estimates that Brady sacrificed between $60 million and $100 million in potential earnings to give the Patriots flexibility within the salary cap. Given his six super bowl rings, his prioritization of winning paid off. It’s hard to imagine that Brady would turn around and sign with the Tampa Bay Buccaneers just to pocket an extra million or two.

Winning Time

If lower tax states were really at an advantage to sign superstar players, wouldn’t they win more? Let’s take a look..

The chart below awards a state 1 point for one of its teams qualifying for its championship final. Then, a state is awarded 3 points for actually winning a championship title. To make sure states with more sports teams aren’t unfairly rewarded, total championship points are divided by team-years played to determine the winner (Source).

As we go down the list, it certainly doesn’t look like there’s any connection between states with the lowest income-tax rates and competing for sports championships. But sometimes the playoffs are weird and some cities with only one team might be at an inherent disadvantage, so what about overall winning percentage? When you look at the four major US professional sports leagues (MLB/NBA/NFL/NHL), there is effectively zero correlation in wins to a low income tax either. Nevada is the lone outlier given they have no state income tax and made the Stanley Cup Final in their first year of existence.

So why aren’t teams in low income tax states recruiting more superstars and winning championships? I believe it comes down to a combination of three things: First, the low income tax incentive is more of an advantage for lower tier paid players who are trying to maximize their earnings during what could potentially be a short career. Secondly, guys like Manny Machado are already financially set, which potentially moves other priorities above the net wages section of his free agency wish list. Lastly, the traditional “big markets” like Los Angeles & New York carry higher tax rates but give superstars the ability to build their brand and maximize endorsement earnings.

Extra Credit

"Kneading Dough," a series of intimate and honest conversations with professional athletes about how they've navigated their unique financial and career pathways. In this episode LeBron James discusses first generation wealth and betting on himself, but I encourage you to check out other episodes also with Draymond Green, Emmitt Smith, Jalen Rose, Ben Simmons and more.

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