Tuesday, December 23, 2014

Why are the lowly Milwaukee Bucks worth $550 million? Soaring inequality

Two guys named Marc Lasry and Wes Edens purchased the Milwaukee Bucks NBA franchise on Thursday, April 17 for $550 million. You may thing this is of picayune interest to professional basketball fans or Wisconsin residents, but it's actually an incredibly telling episode about the nature of inequality in the United States.

To understand why, you have to start with who the Bucks are. They are, this year, one of the worst teams in the NBA. And it's been a long time since they've been good. It's a small market that, unlike Salt Lake City or Portland, the NBA doesn't have all to itself. The Bucks need to compete with a pro baseball team in Milwaukee and with a pro football team in Green Bay for the allegiance of Wisconsin sports fans and corporate sponsors. In other words, this $550 million sale price probably reflects a floor on the possible value of an NBA team. The other 29 are all even more valuable than this.

Why are the teams so valuable? Two reasons, both deeply related to the growth of economic inequality in the United States.

One is labor relations. At the expiration of the last collective bargaining agreement, the NBA's owners got together and locked the players out in order to force large givebacks from the unions. Now player salaries are capped at 50 percent of league revenue. The players, of course, are the entire draw. The whole basis of the business. But they get just half the pie to divide up amongst themselves. At the end of the day, NBA players are still quite prosperous. But this kind of structural weakness of labor has been a key driver of inequality, and the NBA shows that it's extended all the way up the pipeline to the richest and most-skilled classes of workers.

The flipside is that inequality is itself a cause of surging team valuations. The NBA and other North American pro sports leagues are structured as cartels where the supply of teams is fixed. So the richer the rich become, the more they bid up the price of scarce commodities like beachfront mansions and pro sports franchises.

Lasry and Edens even work as perfect exemplars of contemporary inequality in the United States — they got rich in the hedge fund game, as have so many of today's richest people.

But the really interesting thing about the sale of the Bucks is that it challenges a piece of longstanding conventional wisdom among economists. Traditionally, economists have believed that investment income should be taxed at a lower rate than labor income or even not taxed at all. An alternative way of putting it is that the economics profession generally believes that consumption should be taxed rather than income. This is because you want to create incentives for people to defer consumption, save, and invest in building up the country's stock of capital goods. Yet something Thomas Piketty points out in his celebrated new book on wealth inequality around the world is that at the high end the distinction between wealth and consumption tends to break down.

For a normal middle class person, the difference between spending $5,000 on a vacation and putting $5,000 into the stock market to save for retirement is obvious. But while buying a professional basketball team is technically a business investment, it's also the case that owning a pro sports team is pretty fun.

It's no coincidence, for example, that NBA teams are invariably purchased not just by rich guys but by rich basketball fans. Similarly, baseball fans own MLB teams and football fans own NFL teams. It's a business investment, in other words, but it's also a form of consumption.

And while owning a sports team is a bit of a special case, it's generally true that this is an important difference between being an average investor in a company and being an owner or CEO (or both simultaneously, like Facebook's Mark Zuckerberg or Google's Larry Page and Sergei Brin) who actually controls the company. When you're the guy in charge, you don't collect a share of the economic value of your enterprise. You collect a share of the psychological value of being able to shape the enterprise. You ride on the company jet, you help design the corporate campus, you acquire startups you admire, you set the dress code, you punish friends and reward enemies.

In other words, while it's easy to write down an economic model that features a sharp distinction between investment and consumption it's very difficult in practice to know where high-end consumption ends and high-end investment begins. If you want to tax the consumption of the very rich, you need — in practice — to be taxing their wealth.

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