Legislative Analyst's Office The 2002-03 Budget Bill: Perspectives and Issues

The Vehicle License Fee and The 2002-03 Budget

What Is the VLF?

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. In 1998, the Legislature began a series of reductions in the VLF. The fee was reduced from a level of 2 percent down to an effective rate of 0.65 percent—a 67.5 percent decline.

How Is the VLF Calculated?

The statutory 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 1). 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. The depreciation schedule charges 100 percent of the purchase price for the first year of ownership, declining to 15 per cent in the eleventh year of ownership and thereafter. 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. Once the VLF owed is calculated using the 2 percent tax rate, the 67.5 percent tax reduction—or "offset"—is applied to the amount owed. The amount of the tax reduction is shown as a credit on the vehicle owner's registration bill.

How Has the VLF Been Cut in Recent Years?

As shown in Figure 2, the Legislature has reduced the VLF through a series of decisions associated with the annual budget agreements. The first VLF reduction began on January 1, 1999, as part of the 1998-99 budget agreement. The fee was permanently reduced by 25 percent with the possibility of reductions increasing to 67.5 percent based on state revenue growth. A series of statutory triggers were constructed to determine future reductions by comparing General Fund revenue levels to the Department of Finance's 1998-99 May Revision forecasted amounts. The maximum percentage reductions could increase to 35 percent in 2001, 46.5 percent in 2002, and 67.5 percent in 2003 and thereafter. The tax reduction level in place for 2004 would remain permanently.

The Legislature, however, eliminated the need for the revenue triggers as part of the 2000-01 budget—by implementing the maximum 67.5 percent reduction beginning in 2001 on an ongoing basis. The 67.5 percent reduction, therefore, was instituted two years earlier than would have been possible under the 1998 agreement. For the first half of 2001, vehicle owners received this additional tax relief in the form of a rebate check. Since then, owners have received the full amount of tax relief as an offset on their registration bill.

Figure 3 lists the VLF reduction percentages by year that resulted from the Legislature's actions.

How Does the Backfill Work?

The revenues from the VLF are allocated to cities and counties. The tax reductions, therefore, would have resulted in significant local government revenue losses. Instead, for each of the tax reductions, the Legislature has replaced the reduced VLF revenues with General Fund allocations to local governments on a dollar-for-dollar basis. Thus, this VLF backfill has provided cities and counties the same amount of revenues as under prior law. Currently, for every $325 collected in VLF payments from vehicle owners (and allocated to local governments), an additional $675 is contributed by the state's General Fund for allocation to local governments. Figure 4 summarizes the annual backfill costs since the VLF reductions began. The backfill is continuously appropriated and, therefore, is not subject to annual appropriation in the budget bill.

How Is the VLF Allocated?

In 2002-03, the VLF is expected to raise about $1.8 billion in revenues from vehicle owner payments. The General Fund backfill will contribute an additional $3.8 billion for allocation to local governments. Thus, a total of about $5.6 billion will be allocated in 2002-03. In general, the funds 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 funds is restricted for funding "realignment" programs (various health, mental 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 5 shows the proposed distribution of VLF revenues for 2002-03 under current law.

What Is the Average VLF Paid?

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—automobiles, motorcycles, commercial/trucks, and trailers.

In 2000-01, about 27.1 million vehicles paid the VLF. Figure 6 shows the estimated average fee paid by each of these classifications, as well as the corresponding level of tax relief under the 67.5 percent reduction.

The DMV commercial/trucks classification includes larger pick-up trucks (based on their weight)—regardless of 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).

What Determines Growth in VLF Revenues?

Absent any new or used car sales, VLF revenues would decline by roughly 10 percent annually due to the statutory depreciation schedule. The sale of a used car to a new owner will generate additional VLF revenues only to the extent that the value of the vehicle sold differs from the value determined by the depreciation schedule. For most vehicles, the depreciation schedule will roughly mirror a vehicle's declining value. As a result, used car sales generally do not generate increases in VLF revenues.

The two most important factors in the growth of the VLF, therefore, are (1) the number of new vehicle registrations (both from new sales and out-of-state registrations) and (2) the price of these new vehicles. Over the past five years, California has averaged more than 6 percent annual growth in the number of new vehicle registrations. Over that same time period, the prices of new cars on a national level have increased by about 4 percent annually. As a result, total VLF revenues have grown by more than 8 percent annually over that period. In our most recent revenue fore.

Text of the Insufficient Moneys Provision

Revenue and Taxation Code Section 10754 (a)(3)(C)

"During any period in which insufficient moneys are available to be transferred from the General Fund to fully fund the offsets required by subparagraph (A) [67.5 percent], within 90 days of a reduction of funding, the department [DMV] shall reduce the amount of each offset computed pursuant to that subparagraph by multiplying that amount by the ratio of the amount of moneys actually available to be transferred from the General Fund to pay for those offsets to the amount of moneys that is necessary to fully fund those offsets." cast, we project VLF revenues to grow slightly slower over the next five years—at about 6 percent annually.

What About the Insufficient Moneys Provision?

The original VLF rate reduction legislation in 1998 included a paragraph governing VLF tax relief during periods in which insufficient moneys are available to pay for the General Fund backfill to local governments (see shaded box). In those cases, the level of tax relief was to be reduced in the proportion necessary so that there would be sufficient General Fund dollars to pay for the backfill. This provision remains in effect today and has not been amended since its original enactment. If this provision were activated, General Fund expenditures for the backfill would be reduced, with a commensurate increase in VLF payments by vehicle owners. Local governments would not be affected.

Although the state is projected to face a large budget shortfall in 2002-03, it is unclear whether this provision would be activated in the budget year absent any additional legislative action. This is because the provision is ambiguous in a number of important regards.

• Lack of Specified Decision Maker. The provision fails to specify an actor (such as the Department of Finance or Controller) to make a determination over whether the state is experiencing a period of insufficient funds. Without a designated decision maker, it is unclear who would have the authority to instruct the DMV to adjust the rate reductions and by how much.
• Lack of Definition of Insufficient Moneys. The statute also fails to define the term insufficient moneys. Since the VLF backfill is continuously appropriated, the Legislature does not annually determine the level of funding provided. It is unclear what definition of insufficient would be used to determine whether moneys are available for a General Fund transfer.

Given the ambiguity regarding this insufficient moneys provision, the Legislature may wish to enact legislation clarifying the provision's meaning. The budget-year costs of the VLF backfill would be better known by specifically defining (1) who is responsible for making a determination of insufficient moneys and (2) under what circumstances. Additionally, the Legislature may wish to amend this provision to specify that any period of insufficient funds last an entire year—so that taxpayers are treated equally in the VLF rate that they pay within any 12-month period. While the vote requirement on legislation implementing these types of changes would depend on a bill's exact language, further defining the meaning of the insufficient moneys provision could be viewed as expanding the conditions of the provision's use and, therefore, be subject to a two-thirds majority vote as a tax levy.

Are Local Government Revenues Protected?

Proposition 47, passed by the voters in 1986, provides that all VLF revenues—except those from trailer coaches—must be allocated to cities and counties (Article XI, Section 15 of the State Constitution). The Legislature, however, maintains control over both the tax rate and allocation formula. The Constitution specifies only that those funds which are collected must be transferred to local governments. Thus, the state is not constitutionally obligated to provide for the General Fund backfill of funds, and the Legislature could reduce the backfill appropriation through a majority-vote bill. If the appropriation were reduced, vehicle owners would continue to receive the same level of tax relief, while local governments would receive fewer dollars.

Both the base VLF and the realignment VLF dollars are an important part of local government finances. In providing for the statutory backfill, the Legislature recognized that the base VLF is an important revenue source for local governments. Along with the property tax and local portion of the sales tax, the base VLF provides a major source of discretionary revenues. For instance, the base VLF represents roughly 10 percent of city tax revenues and 25 percent of county tax revenues.

For counties, the realignment VLF dollars pay for a portion of a number of health, mental health, and social services programs. Realignment contains a number of "poison pill" provisions which render the program's components inoperative under specified circumstances. The elimination or reduction of the VLF backfill for realignment revenues could result in the activation of one of these poison pills.