This is not news. The IRS issued this opinion in April and released it publicly on June 27. (I likely missed it because June 27 was also the last day of the O’Bannon trial, so I was a tad busy.) But the IRS was kind enough to put a spike into the heart of all of the concern-trolling about how the Northwestern Union vote was going to create a change in the tax treatment of athletic scholarships. In short, it won’t.
My evidence is the following IRS advisory letter (sent to the Senate), which is available publicly on the web at http://www.irs.gov/pub/irs-wd/14-0016.pdf
Regarding the NLRB decision, whether an individual is treated as an employee for labor law purposes is not controlling of whether the individual is an employee for federal tax purposes. Accordingly, the NLRB decision does not control the tax treatment of athletic scholarships. The treatment of scholarships for federal income tax purposes is governed by the Internal Revenue Code (Code)….
Section 117 of the Code allows a taxpayer to exclude a qualified scholarship from gross income. …
It has long been the position of the Internal Revenue Service that athletic scholarships can qualify for exclusion from income under section 117. Revenue Ruling 77-263,1977-2 C.B. 47, addresses the tax treatment of athletic scholarships where the studentathlete is expected to participate in the sport, and the scholarship is not cancelled in event the student cannot participate and the student is not required to engage in any other activities in lieu of participating in the sport. The ruling holds that the athletic scholarship awarded by the university is primarily to aid the recipients in pursuing their studies and, therefore, is excludable under section 117….
There are two competing theories about the value of the marginal athletic recruit. Folks like me say that even the 85th guy on a football team, or the 25th recruit in a given year, is worth at least a full scholarship, otherwise the school wouldn’t offer it. There are those (and I usually blame Seth Davis for this incorrect thinking, so why stop now) that think that the school loses money on the last guy on the roster.
Today’s announcement that Penn State is going to have its full set of scholarships restored is a perfect chance to test the issue.
If Seth Davis is correct, then Penn State, having been granted the freedom from past tradition and now able to judiciously expand its roster, will only offer a few more scholarships than it would have under sanctions (or perhaps none) and will thus avoid the error of so many other teams by overspending on marginal talent not even worth the value of the scholarship. Or perhaps they will route that money to non-athletes. But in any case, if Davis is right the last thing we’ll see is Penn State aggressively trying to offer every newly allowed scholarship to football players.
On the other hand, if I’m correct, Penn State will use all 25 slots next year and will try as quickly as possible to get up to 85 athletes on scholarship. Despite having the choice to avoid those costs, the school will look at the market and will say that the cost is worth it. “The cost is worth it” is a sign that the profits associated with that last recruit are positive. It may be because of a desire for insurance against injury; it may be for a desire for insurance against can’t-miss guys who turn into flops; it may just be that most recruits end up being worth it before they finish school. In any event, if we see Penn State make the conscious choice to max out its restored limit of scholarship (or fall short but not for lack of trying), then once again, we’ll have strong evidence.
So Seth, care to bet?
And for the rest of you, what do you think? Will Penn State expand as quickly as it can for a full 85 scholarships? Ask yourself why, and if the answer isn’t “because Penn State thinks its recruits are worth the cost of a scholarship” then you need to explain why Penn State is being irrational.
John Infante is my favorite “I often disagree but always respect him” college sports analyst. In this case, I think he has captured the essence of the economics of the market in which there is lots of demand for football of varying quality and lots of supply of players of varying quality. Namely, that tiers of quality will emerge and that talent will sort out broadly by the value of that talent to generating revenue. In other words, Infante’s analysis is consistent with the Invariance Principle (from a paper published by Simon Rottenberg in 1956), which was the first sports economics paper and considered by many as the the foundation of the discipline.
I don’t agree with every point in Infante’s analysis, but I strongly agree with the idea that expecting schools to quit playing football if they can’t match the market price for a 5-star athlete is wrong. Instead, as Infante explains they will stay in the market and acquire fewer stars worth of talent at lower prices. (again,like they do now)
I recommend it and you can find it here:
 The paper itself is available at http://www.vanderbilt.edu/econ/faculty/Vrooman/rottenberg.pdf
For more on this, see http://www.vanderbilt.edu/econ/faculty/Vrooman/vrooman-econsport-intro.pdf
”The economics of sport is celebrating the golden anniversary of its origin in a seminal paper by Rottenberg , where he presages the Coase theorem  in a cogent argument about the impact of free agency on the baseball players’ labor market. According to Rottenberg’s invariance proposition, free agency would yield the same talent distribution as the reserve system in American baseball. The difference was that free agency would weaken monopsonistic exploitation of players trapped in the reserve system, and allow them to be paid their marginal revenue product. The theoretical foundations of the economics of sport are found in the elegant mathematical proofs of El Hodiri and Quirk , in public policy awareness of Noll , and for Europe, in Sloane’s  early discussion of the European football market. The modern awakening of sports economics came when Quirk and Fort  published a popular version of Quirk’s early models, followed by two separate adaptations of the model to the new realities of the rapidly changing American sport-scape [Fort and Quirk, 1995; Vrooman, 1995].”
Having just returned from a father-and-son road trip that included a trip to Deadwood, SD, I just wanted to clarify one thing. In the *actual* Wild West, what made things so scary was the absence of law enforcement. People had to take the law into their own hands, and violations of the law were plentiful.
In contrast, in a world in which the NCAA as well as “… its respective officers, servants, employees, agents, and licensees, and all persons in active concert or participation with it, including its member schools and conferences,” (plus anyone who receives the injunction via service) is prohibited from fixing prices, what’s scary is not that lawlessness will run rampant, but actually the opposite — that violations of the law will now be punished.
To continue the metaphor, the people who are worried now are those who for years have thrived in the wild west — those who have violated the law with impunity, and in taken the law in their own hands. They are now scared because their natural lawless habits are going to be punished if they don’t change their ways. In other words, it is the gunslingers, not the peaceful citizens of Deadwood, for whom the new era is scary.
[I’ll note that according to School Bus Dave who took us on the Kevin Costner Bus Tour of Deadwood, one of the theories for why Wild Bill Hickok was shot was for this very reason — the town of Deadwood was afraid he might bring with him an enforcement of the law and so many of them made their living through illegal activities (gambling, prostitution, claim jumping) that they wanted to make sure that the West *stayed* wild so they could continue their non-law-abiding ways]
I’d recommend pushing back on people when they say enforcement of federal law is ushering an era akin to the Wild West. I think the concern people are expressing is an actually a worry that the New Sheriff in Town is actually a sheriff, and the new rules being imposed are actually the law.
"Nearly everyone recognizes the corrupting effect of money on college sports" — Tom McMillen.
This quote comes from commentary written by former Congressman and Maryland basketball star, Tom McMillen. McMillen also explained:
"There has been no real effort to curb the massive spending in college sports, which is financially and morally bankrupting our institutions of higher learning."
"…big money sports will go on corroding the core educational purposes and values of our colleges…"
I try very hard in my writing not to create straw men, or caricatures of other’s arguments, but I think I captured McMillen’s view of money and of the goals of NCAA reform when I described “Team Reform” in a recent piece I wrote for Deadspin:
I think the theory behind de-commercialization is that if the product isn’t selling quite as well, there will be less incentive for schools to provide the product at any cost, and as a result the economic pressure to pay more for coaching, facilities, and even players will decline. As will, goes the theory, the incentive to invite in athletes unable to perform academically or to provide them with phony educations designed to keep them eligible just so they can continue to generate revenue through athletics. At core, it is rooted in the idea that money itself is a corrupting force to academia and that absent the lure of filthy lucre, the administrators of college campus would return to their quasi-parental role of educating young men, independent of their ability to generate revenue as athletes. It is rooted in paternalism, in that assumes the problem is that the men and women who run campuses are letting money divert them from their duty to serve in loco parentis for these young, unmolded, uncorrupted men.
But as I explained, this focus on money as the root of all evil misses the real problem:
In America, we’re supposed to value hard work and money well-earned. Corruption is what you get from violating the law, not from earning what you’re worth in the marketplace.
Tom McMillen is classic Team Reform. I hope his proposed Presidential Committee has some representation from Team Market.
And yes, I hereby volunteer. :-)
Here are the three rulings issued today, along with a 2000 Paper that I co-authored explain 14 years in advance, why today’s ruling was correct.
Timing being everything in life, I was sitting in a chain Mexican restaurant in Elko, Nevada on day 2 of a 9-day roadtrip with my son when my email buzzed that there was an entry in the O’Bannon case docket. I grabbed it and saw it was a holding in favor of the plaintiffs. My son and I hit the road and he had the duty of reading it to me as we drove towards Salt Lake City, where we now are. I plan to read these in detail, but in case you want to do so as well, they are presented below.
Clerk’s Order: https://drive.google.com/file/d/0BxM4wdtZ5uI-WHNtMjNTd2dIQkE/edit?usp=sharing
Rascher & Schwarz Article explaining why this should have happened, published in 2000:
(Yes, this is a bit of a gloat link here, please forgive me my exuberance!)
In the fabulous movie “This is Spinal Tap,” Fran Drescher plays a character named Bobbi Flekman, self-nicknamed “the hostess with the mostest”
At one point she goes from being all fake smiles to trying to explain a business decision and she says “Money talks and Bullshit walks”
I’m going to start using #MTBSW as my new short-hand for whenever I see someone claim something economically irrational or, conversely,do something economically rational after claiming they would not do it. If a school says they are too poor, and then spends large amounts of money, or if a school claims it would join division iii if forced to do x, but then doesn’t, they will get the #MTBSW hashtag.
I say this because over the next couple of years, as rules changes and (possibly) Court injunctions change the landscape, it feels like we’re going to need a short way to quote the insighful wisdom of Bobbi Flekman.
Imagine tomorrow the NFL CBA changed so that instead of getting approximately 50% of revenue, athletes got 25%. What would happen to ticket revenues, tv licensing fees, and cable bills to consumers. Extra credit for mentioning David Ricardo in context.