Chapter 7

1. The Economics of Sports FIFTH EDITION Chapter 7 THE PUBLIC FINANCE OF SPORTS: WHO PAYS AND WHY? Michael A. Leeds | Peter von Allmen

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

3. 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

4. 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

5. 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

6. 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

7. 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)

8. 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

9. 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

10. 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)

11. 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

12. 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

13. 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

14. 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

15. 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

16. 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

17. 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

18. 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

19. 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

20. 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 P D Surplus Pe Q Qe

21. Firms Can Extract Surplus P • 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 D Surplus Pe Loss Q Qe Qm

22. How Far Can The Firm Go? P • Consumer buys Qe as long surplus > loss • Buying Qmbeats buying nothing • The maximum Qm sets loss equal to surplus • Area of red triangle = Area of blue triangle D Surplus Pe Loss Qm Q Qe

23. 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

24. 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

25. 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

26. 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

27. 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

28. 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

29. 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

30. 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

31. 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

32. 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

33. 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

34. 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

35. 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

36. 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

37. Table 7.1

38. Table 7.1 Cont.

39. 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

40. 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

41. 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?

42. 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

43. Figures 7.5 and 7.6

44. 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

45. 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

46. 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

47. 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

48. 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

49. Figure 7.7

50. 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