A Primer on the
Vehicle License Fee

The VLF is an annual fee on the ownership of a registered vehicle in California, in place of taxing vehicles as personal property. The VLF is paid to the Department of Motor Vehicles (DMV) at the time of annual vehicle registration. The fee is charged in addition to other fees, such as the vehicle registration fee, air quality fees, and commercial vehicle weight fees. Figure 1 shows a sample of the various fees that a vehicle owner might pay to the DMV as part of the registration renewal process. The various proposed VLF tax cuts would only affect the license fee (shaded in Figure 1) and would not affect these other DMV fees.

How Is the VLF Calculated?

The fee rate is 2 percent of a vehicle's current estimated value and calculated on the basis of the current owner's purchase price (see Figure 2). For each year the vehicle is owned, the fee paid declines in accordance with a statutory depreciation schedule--to reflect the declining value of the vehicle. Figure 3 shows the depreciation schedules for vehicles and trailer coaches (trailer coaches have a different schedule due to their longer expected life span and higher values). When an individual purchases a used car, the new owner pays the VLF based on the price paid when acquiring the car and the depreciation schedule returns to year one.

Why Is the VLF Not Subject to Proposition 13?

Proposition 13, passed in 1978, set the tax rate for real property (homes, buildings, land, etc.) at a 1 percent rate statewide. Because the State Constitution also requires personal property (furniture, other household possessions, etc.) to be taxed no higher than real property, Proposition 13 effectively limits the tax rate for both real and personal property. However, motor vehicles were exempt from the personal property tax over four decades before the passage of Proposition 13. In 1935, the VLF was created and the tax rate was set at 1.75 percent which approximated the average property tax rate at the time. The VLF rate was increased to 2 percent in 1948, and has not changed since then. As a result, the relative connection to the property tax rate has not been maintained.

In 1998-99, the VLF is expected to raise about $3.9 billion in revenues under current law. In general, the revenues are distributed to cities and counties for two purposes:

• Base VLF. About three-fourths of the funds sent to local governments can be used for any spending purpose. These funds are mostly distributed on a per capita basis.

• Realignment VLF. The remaining quarter of local government VLF revenue is restricted for funding "realignment" programs (various health and social services programs). The state increased VLF revenues in 1991 (by changing the depreciation schedule) and dedicated these additional revenues to realignment programs.

Figure 4 shows the proposed distribution of VLF revenues for 1998-99 under current law.

What Type of Vehicles Are Subject to the VLF?

Generally, any vehicle required to be registered with the DMV is also required to pay the annual VLF. The DMV groups these vehicles into four categories--tomobiles, motorcycles, commercial/trucks, and trailers. In 1997, about 23.5 million vehicles paid the VLF. Figure 5 shows the various DMV classifications, including an estimate of the average fee paid by each vehicle type.

The DMV "commercial/trucks" classification includes larger pick-up trucks, based on their weight--regardless whether they are used as a commercial or personal vehicle. In addition, the automobiles classification contains all passenger vehicles, including those used for commercial purposes (such as a rental car or a corporate fleet vehicle).

Which Vehicles Provide The Most Revenues?

How Does VLF Paid Vary by Income?

What Is the Governor's VLF Proposal?

In his May Revision, the Governor proposed to reduce the current 2 percent VLF tax rate. Beginning January 1, 1999, the rate would be reduced to 1 percent. Each owner's fee would therefore be cut in half. Then, beginning January 1, 2002, the rate would be halved again--to 0.5 percent. The revenue losses resulting from the Governor's proposal are shown in Figure 7.

The Governor proposes to hold local governments and realignment "harmless" from the tax reduction by using General Fund revenues to backfill the foregone VLF revenues. The funds to repay local governments would be continuously appropriated and would not need to be approved in the annual budget process.

What Are the Other VLF Proposals?

Another proposal to provide a VLF tax reduction is contained in AB 1776 (McClintock). (A similar proposal is contained in SB 1723, [Haynes].) This bill would phase-out the VLF over five years, so that the fee would be eliminated beginning January 1, 2003 (see Figure 7 for estimated revenue losses). The phase-in of this tax reduction would use an exemption on vehicle purchase price. Beginning January 1, 1999, each vehicle's purchase price would be reduced by $5,000. For instance, for a vehicle purchased for $22,100, the owner would only pay the VLF on $17,100 of value. In the following three years, the exemption would increase to $10,000, $15,000, and $20,000, successively.

Is the VLF Tax Deductible?

The VLF is tax deductible for the roughly 40 percent of Californians who itemize on their tax returns. As a result, the full impact of a fee reduction would not be received by those itemizing taxpayers who claim the amount paid. Instead, part of any reduction in VLF revenues would be offset by increased income tax revenues paid to both the federal government and the state. For instance, a California taxpayer currently paying federal taxes at the highest marginal tax rate would only realize about three-fifths of any VLF reduction.

Would Local Governments Be Affected by a VLF Tax Cut?

The VLF is local governments' third largest source of general purpose tax revenues (after the property and sales taxes). Proposition 47, passed by the voters in 1986, constitutionally guarantees that VLF revenues are sent to local governments. However, the state retains authority over both the amount of revenues that are collected and the method of their distribution. As such, the Legislature holds the authority to alter the level of VLF revenues. Local governments hold no constitutional authority to their current level of revenues, only that the state cannot choose to keep VLF revenues which are collected.

Recognizing that VLF revenues represent an important source of general purpose revenues for cities and counties, both the Governor and AB 1776 propose to backfill local governments for any lost VLF revenues. The Governor's proposal is to continuously appropriate General Fund revenues in order to repay local governments for lost revenues. Assembly Bill 1776 specifies that state sales tax revenues would be used for the same repayment purpose.

In both cases, the local government backfill mechanism would occur automatically without being subject to the annual budget process. However, as statutory mechanisms, the Legislature would retain the ability to alter the method or amount of the backfill. Local governments have expressed concern that under both of these
proposals the state would have an incentive during difficult economic times to reduce the level of these backfill funds provided to local governments. In the early 1980s, before the constitutional protection of VLF revenues to local governments, the state did reduce VLF payments to local governments in order to help balance the state budget.

Would Realignment Be Affected?

Would Proposition 98 Be Affected?

The stated intention of both the Governor and the AB 1776 VLF proposals is not to affect the Proposition 98 education funding guarantee. Because VLF revenues are special fund revenues, their reduction would not have a direct impact on the calculation of the minimum funding guarantee for K-14 education. These proposals, however, significantly increase General Fund spending to backfill the VLF losses to local governments. This commitment of resources would make fewer resources available if the Legislature wanted to overappropriate the minimum funding guarantee in the future. Similarly, fewer resources would be available for other non-Proposition 98 General Fund spending in the future.