chapter 7 the public finance of sports: who pays and why? fifth edition the economics of sports...

Chapter 7

THE PUBLIC FINANCE OF

SPORTS: WHO PAYS AND WHY?

FIFTH EDITION

The Economics of Sports

MICHAEL A. LEEDS | PETER VON ALLMEN

Copyright ©2014 Pearson Education, Inc. All rights reserved. 7-2

Introduction: The Face of Evil

• In the late 1950s, two New York reporters—independently --choose Stalin, Hitler and Walter O’Maley as the most despicable human beings who ever lived

• Why O’Malley?• He was the Brooklyn Dodgers owner• He moved the team – in the middle of the night – to

Los Angeles• Recall that a team can become a public good• He realized that he had market power• Many never forgave him


Learning Objectives

• Appreciate the connection between the mobility of sports franchises and the increase in public funding of stadiums and arenas

• Understand the ways that sports teams, leagues, and institutions exercise monopoly power in their dealings with municipalities

• Grasp the impact that exchange rates and stadium location have on the ability of cities to retain franchises and subsidize facilities.

• Appreciate the advantages and disadvantages of different methods of financing public support of sports facilities


7.1 How Cities Came to Fund Stadiums

• Today it seems normal for teams to threaten to find a new home unless their current host city builds a new facility or restructures the rental agreement on the current one

• This section provides a historical context for the growing mobility of sports franchises and their consequent increase in market power


Teams on the Move

• The Dodgers left Brooklyn after the 1957 season• They were not the first team to move

– The Braves, Browns, & A’s moved earlier– But they were all neglected stepsisters in cities

• The Braves’ move ended MLB’s “Golden Age”– Golden Age lasted fifty years: 1903-53– It was a period of absolute stability– No teams entered or left MLB– No teams moved– Major parks were built (Shibe, Forbes Field, Comiskey)

• Boom ends in 1923 with Yankee Stadium


The Dodgers Were Different

• The Dodgers did not have to move– They were the most profitable MLB team in the 1950s

(1947-57)– They accounted for 47% of the National League’s profits– They were a “cultural totem” for Brooklynites and all

Americans


Opportunity Costs

• The Dodgers moved because they could earn even more in LA

• Staying in Brooklyn imposed a high opportunity cost • Accounting profit = revenue-explicit costs• Economic profit = revenue – all costs (explicit as

well as implicit) – revenue that could have been earned with the given resources elsewhere

• Dodgers revenue was much higher in LA (2 million fans) than Brooklyn (1 million fans)


The Three Eras of Stadium Construction

• Judith Grant Long identifies three phases of stadium funding

• The “entrepreneurial period” lasted from 1890 to 1930

• The “civic infrastructure” period lasted from 1953 to 1980

• The “public-private partnership” began after 1980 and is still ongoing


Era #1: 1890 – 1930

• All facilities are called “Park” or “Field”– The names reflect pastoral origin of baseball – The term stadium was not used until Jacob

Ruppert applied the name to his new “Yankee Stadium” in 1923

• All facilities bear the name of a team owner who built the stadium to house his team– Exception – sort of – Wrigley Field

• It was originally “Weeghman” Field built by Federal League

• The team and stadium were later bought by Wrigley

– Public financing of facilities is an exception


Era #1: 1890 – 1930 (cont.)

• “Golden Age” kept teams in the facilities they built in the early 20th century

• Football teams rented space in baseball parks – got their names from them (Bears/Cubs; Lions/Tigers; Giants/Giants)

•Most no longer exist (Wrigley; Fenway are exceptions)


Era #2: 1953 – 1980

• Cities started to view teams and stadiums as centerpieces of urban development

• Cities frequently bid against one another to attract or retain teams

• Names reflect change of funding source– Facilities are municipally built and leased to

teams– Named for city, geographic trait, or patriotic

theme• Most of these have also disappeared


Era #3: 1980 – Present

• Local and state governments have funded about half the construction costs•Some are completely publicly funded (FedEx Forum)

• Firms have sought new revenues– They sell “Naming rights” to firms

• Extra– Dallas had the first football only stadium (1971)– Edward Jones built for the Rams in St. Louis

(1995) even though the baseball team was still there


How Teams Exploit Monopoly Power

• The Dodgers’ move fundamentally altered the relationship between teams and the cities that host them

• If the highly profitable Dodgers could be uprooted, so could any team

• Cities have bid for teams to keep them or to lure them

• They offer better facilities to do so• Cities have exploited their monopoly power and

used the all-or-nothing demand curve• Cities have also fallen prey to the winner’s curse


Leagues, Cities, and Market Power

• North American sports leagues have limited the number of teams

• They seek to increase both competitive balance and profits

• Before WWII, neither the LB nor NFL had any teams on the west coast

• The Depression delayed any moves• After WWII, both MLB and the NFL placed teams on

the West Coast, but neither sport increased the number of teams


Westward Ho

• The NFL’s Rams left Cleveland for Los Angeles in 1946

• This was in response to the creation of the Cleveland Browns of the new All-American Football Conference

• MLB almost admitted the Pacific Coast League (PCL) as a third major league– The PCL was a high minor league where Ted

Williams and Joe DiMaggio had once played– The deal fell through when MLB refused to honor

PCL contracts• Instead, MLB allowed the Giants and Dodgers to

move to the West Coast


Baseball’s Expansion after 1961

• The expansion had two goals– Appease Congress, which was angered by the

move of the Senators to Minneapolis–St. Paul (where they became the Twins)

• Congress threatened to mull over the anti-trust exemption

– Prevent the formation of a new league • Branch Rickie wanted new teams in NY and Houston,

two key cities for MLB• MBA created the Angels in LA (to help round out the

American League) • It created new teams in NY, Houston, and DC


Football’s Expansion

• The NFL’s first expansion came in 1960 – The NFL tried to prevent the creation of American

Football League (AFL)– The NFL put franchises in Dallas and Minneapolis

to prevent the AFL from putting teams there• Its second expansion was also tied to AFL

– It was linked to AFL/NFL merger in 1966-67– Limited antitrust exemption needed the support

of a Louisiana Congressman and Senator– The New Orleans Saints were born as a result


Missteps by Cities and Leagues

• Some cities have committed to funding before seeing what the cost would be– This enhances the teams’ monopoly power– Cleveland overpaid millions for Gund (now Quicken Loans)

Arena and Jacobs (now Progressive) Field in 1990 as a result

• Some feel that MLB & NHL have over-expanded– The lack of bidders for franchises lessens their monopoly

power– Few cities bid for the Expos when MLB sought to move

them from Montreal• Australian Rules Football teams lack monopoly power because

of the regional appeal of their game– 10 of the18 teams are located in or around Melbourne


The All-or-Nothing Demand Curve

• When NASCAR sought a host city for its Hall of Fame, it did not offer cities a choice of how much material they wished to house– It was the whole collection or nothing

• The all-or-nothing choice gave NASCAR an advantage that very few monopolists ever get to exercise

• Even the most powerful monopolist cannot tell consumers how much to pay and how much to buy


All-or-Nothing Demand

• In a competitive market– At Pe consumers buy Qe

– Consumers get blue surplus

• Even a monopolist is restricted to a demand curve: chooses Pe or Qe, not both

Surplus

P

Q

D

Pe

Qe


Firms Can Extract Surplus

• Consumers must choose Qm or nothing– They cannot buy Qe

• Consumers lose red area– To get the surplus they

must absorb the loss– They are still better off

because the blue area is larger than the red

Surplus

Q

D

Qe Qm

Loss

P

Pe


How Far Can The Firm Go?

• Consumer buys Qe as long surplus > loss– Buying Qm beats

buying nothing• The maximum Qm sets

loss equal to surplus– Area of red triangle =

Area of blue triangle

Surplus

QQe Qm

Loss

P

Pe

D


Present Value

• To value facilities and mega-events today, we must consider their future cash flow streams – Benefits often occur over many years– Funding also occurs over many years

• Future costs and benefits are not worth the same as current costs and benefits – We would rather have $1 today than $1 tomorrow– We must discount future costs and benefits

• Assume a stadium brings benefits over T years

– Each year’s benefits are given by Bt

– The total value of the stadium is less than B1 + B2 + B3 + … + BT


The Arithmetic of Discounting

• If the interest rate is r– Having $1 today can bring $1*(1+r) in one year

• The future value of $1 in one year is $1*(1+r)

– This means that having B1 in one year is like having B1/(1+r) now

• B1/(1+r) is the present value of B1

• By extension, having B2 in two years is like having B2/(1+r) in one year

• Or [B2/(1+r)]/(1+r) = B2/[(1+r)2] today

• B2/(1+r)2 is the present value of B2

• The value of the stream of benefits is thus: B1/(1+r) + B2/(1+r)2 + B3 /(1+r)3 + …BT/(1+r)T


Contingent Valuation (CV)

• CV surveys ask residents what they would be willing to pay to attract or retain a franchise

• There are three types of CV surveys– Open-ended: “What would you be willing to pay?”– Bracketed: “Which of the following would you be

willing to pay?”– Closed-ended: “Would you be willing to pay $X?”

• Drawbacks of CV surveys– They are non-binding so there is no penalty for giving

a large answer– Some believe that respondents undervalue the

burden of a stream of future payments so the answer varies with the payment method


The Winner’s Curse

• The buyer pays more than the good is worth• This occurs in auctions with an uncertain payoff

– First noted in auctions for oil leases as winners overbid

– Now seen in bids to host teams, facilities, or major events

– In an auction the winner is willing & able to bid the most

• The winner expects greatest payoff because he is– The bidder best suited to exploit the opportunity or– The most (over-)optimistic bidder or the bidder most

intent on winning for the sake of winning • This result is the winner’s curse


7.3 Stadium Location and Costs

• In 2012, Minnesota approved a new stadium for the Vikings– The anticipated cost of the new stadium is $975 million– This is over $900 million spent on their old facility in 1982– This reflects a general skyrocketing of construction costs

• Why have costs risen so dramatically?– New facilities are far more elaborate– New stadiums take up more space to accommodate all the

extra amenities they offer– The per-unit cost of urban space has risen, so location

becomes important• Location decisions also take place on a larger scale when

leagues cross national boundaries


How Exchange Rates Affect Costs

• Hockey Returns to Winnipeg—a round-trip story• In 1996, the NHL’s Winnipeg Jets left for Phoenix to

become the Coyotes– The Quebec Nordiques had left the year before– Some felt that soon only the Montreal Canadiens

and Toronto Maple Leafs would remain• In 2011, the Atlanta Thrashers moved to Winnipeg,

and the Jets were reborn


Explanation

• There are several reasons for this reversal– Greater revenue sharing– An improved – equally shared – US TV deal– A much stronger Canadian dollar, on which we

now focus• See Figure 7.2 for the determination of exchange

rates• Seven of the 30 NHL teams are located in Canada


Exchange Rates and Sports Franchises

• Assume that a Canadian NHL franchise:– Receives revenue in Canadian dollars– Pays salaries in U.S. dollars

• To pay players it must exchange C$ for US$– For most of 2011, C$1 has equaled US$0.95 to

US$1.00– In early-mid 2000s C$1 was worth about US$0.62

• When the C$ was weak v. US$– Players became more expensive – Canadian teams became less competitive on the

ice and off• Many moved to the US


Why Most Stadiums Are Not in the Center of Town

• A sports facility typically provides the greatest benefits to a city if it is integrated into the fabric of the city

• Nevertheless, most facilities are located on the outskirts of cities

• Arenas and stadiums take up a lot of space– Land costs are a large component of their

costs


A Circular Model

• Consider a circular city– Firms are identical except

for location– Residents are uniformly

distributed• A & B move to the center of

the circle• That is why central business

districts are central• The competition for space

drives up land prices at the center

A B


The Cost of Space: The Rent Gradient

• Urban economics is another branch

• Land farther from the center of town is cheaper

• It is cheaper to build a stadium on the outskirts

Cost of land

Distance from city center


7.4 Stadium Costs and Financing

• Between 1995 and 2009, teams, leagues, and cities spent almost $18 billion on sports facilities

• Teams spent a little over $7 billion, while the public sector spent over $10 billion, almost 60 percent of the total

• This section examines how cities underwrite the construction of new facilities

• It shows that the actual subsidy might be far greater than what the official figures indicate


Bidding Wars

• Cities do not literally bid for teams– All major leagues forbid municipal ownership

• Teams would be immobile• Teams would have to disclose their finances• Teams must have individual majority owners

– Instead cities bid for the right to host the team• Cities do not generally offer cash

– They typically offer payment in kind (it is a barter!)– Common subsidies are funding for stadiums, practice

facilities, or land


Explicit Costs

• Table 7.1 shows the total cost and public share of facilities built for major league sports teams since 2000

• Adding up the figures in Table 7.1 shows that $11.34 billion has been spent since 2000 to construct new facilities for the major North American sports leagues

• About $6.1 billion has come from state and local governments– The spending on sports facilities comes even

when the city has other pressing needs


Table 7.1


Table 7.1 Cont.


Additional Costs

• The data in Table 7.1, however, tell only part of the story

• These data alone can lead analysts to misstate the full burden of a facility on a city

• Construction costs are not the only expenditure that a city makes on a sports facility

• The city also pays for infrastructure, such as roads and utilities, and for support services, such as police and sanitation


Public Participation

• As Table 7.1 shows, the public share of the expenditure on individual facilities has ranged from 0 to 100 percent

• This variation is reflected in the facilities’ ownership structure

• Five facilities have been built since 2010– Amway Center and Marlins Park—are owned and

operated outright by the cities– Target Field and Consol Energy Arena—are run

by public authorities created for them– MetLife Stadium, is jointly operated by Giants

Stadium LLC and Jets Development LLC


7.5 Paying for Stadiums

• There are two reasons for publicly funding sports facilities• Public goods

– If people can enjoy the team without paying, they will not do so

– Governments have a hard time determining how to allocate the burden because the benefits are so intangible

• Externalities– Teams and facilities provide benefits to people who do not

go to a game– Markets under-provide goods that have positive externalities

• This section examines ways cities and states fund facilities– What sales tax should a city apply?– Is debt a good idea?


Three Criteria for Taxation

• Ramsey rule for efficient sales taxes– An efficient tax minimizes deadweight loss– Thus, the tax is inversely related to the elasticity of

demand– Compare the deadweight loss in Figures 7.5 and 7.6

• Vertical equity compares the impact of the tax on citizens with different income levels– Those with the greatest ability to pay should pay the

most• Horizontal equity suggests that equals should be treated

equally– Those who benefit the most from a facility should bear

the highest tax burden


Figures 7.5 and 7.6


Who Pays a Sales Tax?

• Tax burdens are sometimes borne by people who were not the target of the tax

• Hotel taxes are popular ways to fund facilities– They “export” the tax to out-of-towners – Taxing those who come to town to watch a game

is horizontally equitable• Why do hotel owners object to such taxes?

– The tax raises the price of a hotel stay– It rises by less than the tax– Some of the tax is “paid” by local hotels– See Figure 7.5


Sin Taxes

• Sin taxes are levied on “sinful” products, such as cigarettes and alcohol– Cleveland funded its facilities with a sin tax

• Sin taxes are billed as having two virtues– They raise funds– They discourage undesirable behavior

• Unfortunately, achieving one of these goals precludes achieving the other– Figure 7.5 shows that when demand is elastic, a tax

discourages activity but fails to raise many funds– Figure 7.6 shows that when demand in inelastic, a tax

raises funds but fails to discourage the activity


Tax Incremental Financing (TIF)

• TIF does not impose new taxes• TIF earmarks added tax revenue for a project

– San Diego and San Francisco expected hotel stays to rise because of new baseball stadiums

– More hotel stays would cause hotel tax revenue to rise

– The added tax revenue would pay for the ballpark• TIF assumes a sustained rise in hotel revenue

– Without a sustained rise, there will not be enough revenue

– That seems to be a problem now in San Diego


Taxes That Spread the Burden

• Milwaukee funded Miller Park with a five-county sales tax– The wider tax increases horizontal equity

• Wealthier suburbanites help pay the burden• Wealthier suburbanites are the largest beneficiaries

• Seattle funded Safeco Field in part with a sales tax on restaurants & bars in King County– The tax on businesses that benefit from the

stadium increases horizontal equity• The tax was too broad at it burdened fancy French

restaurants across town as well as sports bars across the street


The Benefits of Debt

• Borrowing does not let cities escape taxation– They must eventually pay back debt by raising taxes– The “equivalence theorem” posits that the two are

equivalent – taxpayers anticipate the future burden• Tax laws give debt an advantage

– Municipal bonds are tax deductible – see Figure 7.7– Lower tax burden means cities can pay less interest

• Tax law reduces tax burden on city residents– This increases the tax burden on taxpayers elsewhere


Figure 7.7


Who Benefits from Borrowing?

• Tax breaks may save the Yankees $786 million• The Miami Marlins might be in legal trouble

– The SEC is investigating whether the team misled local officials by claiming that the team could not afford a new stadium without public support

• Borrowing from future residents might be efficient– If they also benefit – they should also pay– Unfortunately, they often pay without benefiting

• They often pay for an empty stadium• New Jersey still owed $100 million in bond debt on

Meadowlands Stadium when it was demolished in 2010

chapter 7 the public finance of sports: who pays and why? fifth edition the economics of sports...

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