LAO 2003-04 Budget Analysis: General Government

Legislative Analyst's Office

Analysis of the 2003-04 Budget Bill

Tax Relief (9100)

The state provides tax relief—both as subventions to local governments and as direct payments to eligible taxpayers—through a number of programs contained within this budget item. The budget proposes total 2003-04 relief of $1.6 billion, of which $627 million is appropriated in the budget bill. The remainder is spending on the Vehicle License Fee (VLF) "backfill," which is distributed to localities and budgeted through a continuous appropriation. The budget proposes major reductions in VLF backfill spending in both the current year and budget year as detailed below.

After the VLF backfill, the second largest tax relief program is the homeowners' exemption ($420 million), which provides tax relief to approximately 5 million homeowners. This program, which is required by the State Constitution, grants a $7,000 property tax exemption on the assessed value of owner-occupied dwellings, and requires the state to reimburse local governments for the resulting reduction in property tax revenues. The exemption reduces the typical homeowner's taxes by about $75 annually. In order to accommodate the expected growth in the number of homeowners claiming the exemption, the Governor's budget proposes an increase of $5.4 million, or 1.3 percent, over the amount budgeted for 2002-03.

VLF Backfill Reduction Proposed

The VLF is an annual fee on the ownership of a registered vehicle in California, levied in lieu of taxing vehicles as personal property. The revenues are distributed to cities and counties.

Reductions in the VLF Rate. Since 1998, the Legislature has reduced the VLF by 67.5 percent—from the historic 2 percent rate down to 0.65 percent. This rate is assessed on the depreciated value of the vehicle. For all VLF reductions, cities and counties continue to receive the same amount of revenues as under prior law, with the reduced VLF amounts replaced by General Fund spending. Thus, the state makes up the difference between what would be raised with a 2 percent VLF rate and the amount actually raised with the effective 0.65 percent rate. This spending for local government subventions is known as the "VLF backfill."

The backfill is comprised of two components: (1) the base VLF backfill, which constitutes about three-fourths of the total; and (2) the realignment VLF backfill, representing the remaining one-quarter. The base VLF backfill may be used by local governments for any spending purpose, while the realignment VLF backfill must be used only for programs associated with the 1991 realignment of various health and social services programs.

Governor Proposes to Eliminate Base Backfill. Under current law, the amount of the VLF backfill that is scheduled to be provided to local governments is approximately $3.8 billion in 2002-03. Roughly $2.9 billion of this is base backfill and the remaining $900 million is realignment backfill. The Governor's proposal is to eliminate the backfill associated with the base VLF in both the current year (beginning February 1, 2002) and the budget year. The realignment portion of the backfill would continue under the Governor's proposal.

The proposed budget would allow for substantial General Fund savings through reductions in state subventions to local governments in both the current and budget years. Based on the Governor's elimination of the base backfill beginning in February, the savings would amount to approximately $1.3 billion in the current year, with budget-year savings of approximately $2.9 billion. The elimination of the base VLF backfill would not result in an increase in the VLF paid by vehicle owners, but simply eliminate the amount paid by the state to localities.

Revenues From the VLF Are Important for Local Governments. The VLF revenues distributed to cities and counties typically represent one of their three largest sources of general-purpose revenues. Cities and counties use general-purpose revenues to pay for a wide variety of services, including police, fire, and health care.

Should Localities Bear the Burden? In response to the Governor's proposed reduction in the VLF backfill, there has been extensive legislative debate regarding measures that would increase the effective VLF rate paid by vehicle owners. Given the fluidity of these proposals and accompanying discussion, it is difficult to develop a specific recommendation regarding the VLF backfill for this publication. In general, however, we believe that is it inappropriate for cities and counties to bear major fiscal losses due to a state decision to offer tax relief. In addition, deleting funding for the backfill without a commensurate increase in the VLF rate would cause significant disruption in local government budgets and increase intergovernmental tension.

Elimination of Subventions for Open Space

We recommend that the Legislature provide for the phaseout of the Williamson Act contracts instead of ending this program immediately, as proposed by the budget.

The Williamson Act allows cities and counties to enter into contracts with landowners to restrict their property to open space and agricultural use. In return for the restriction, the property owner pays reduced property taxes because the land is assessed at lower than the maximum level. The amount of the state subvention to localities is based on the amount and type of land under contract, rather than the actual reduction in local property tax revenues.

The contracts entered into between local governments and property owners are ten-year contracts. Such contracts are typically renewed each year for an additional year, such that their term is always ten years. In the event the contract is not renewed, the tax on the property gradually returns over a ten-year period to the level at which comparable but unrestricted land is taxed.

In 2002-03, $39 million was budgeted to subvene to local governments that had entered into Williamson Act contracts. The 2003-04 budget proposes to eliminate the entire funding for this item, thus ending state support for the program. Since the contracts are noncancelable under most circumstances, this elimination of the subvention would result in immediate uncompensated tax losses to local governments. We have previously questioned the effectiveness of the program, but believe there is a more reasonable means of achieving the Governor's intent to eliminate the program. Specifically, we recommend that the Legislature phase out the subventions generally coinciding with the gradual increase in property taxes received by participating local governments. An alternative to the Governor's budget would be to reduce the funding for the program by 10 percent annually. This approach would save $3.9 million in 2003-04, with the full $39 million in annual savings realized after the full ten-year phaseout of subventions.

Return to General Government Table of Contents, 2003-04 Budget Analysis