SunnyvaleRTC

December 18, 2003

SUBJECT: Update on Status of City's Vehicle License Fee Revenue and Budgetary Impact

The purpose of this report is to provide background to the City Council on the Vehicle License Fee ("VLF"), its importance to the City, and the risks currently associated with this revenue source. This background includes history of the fee, how it is allocated, the amount Sunnyvale has historically received, the use of the funds, and the status of VLF backfill funding at the State level. Finally, the report will describe a set of initial options that the Council has for dealing with one-time or on-going reductions in VLF revenue. It is expected that this report will be for information only at the meeting of December 18, 2003, with further Council discussion and direction at the meetings of January 6, 2004 and January 13, 2004.

BACKGROUND

VLF History, Rate, and Allocation Methodology

The Motor Vehicle License Fee ("VLF") is a tax on the ownership of a registered vehicle. The VLF is paid annually on vehicle registration based upon the current value of a vehicle as estimated by a depreciation schedule established in state law. Prior to 1935, motor vehicles in the State were subject to the property tax, which is administered by and allocated to local governments. In 1935, the VLF was established as a uniform statewide tax for ease and simplicity of administration. The VLF is paid to the Department of Motor Vehicles (DMV) at the time of annual vehicle registration. The fee is deductible for federal income tax purposes.

When the VLF was created in 1935 as a statewide tax, the tax rate was set at 1.75%, which approximated the average property tax rate at the time. The VLF rate was increased to 2% in 1948 and has not changed since then. For each year that the vehicle is owned, the fee paid declines in accordance with the depreciation schedule to reflect the declining value of the vehicle.

VLF is a local revenue source and the ultimate recipients of the fees are cities and counties. For Sunnyvale, the VLF is the third largest source of unrestricted local revenue, behind property tax and sales tax. VLF represents on average 10% of revenue for cities and 25% for counties. In 1986, following State takeaways of VLF in the early 1980s, Proposition 47 was passed by the voters to ensure that VLF revenues would be designated for local governments. However, the Legislature retains authority over both the rate and the allocation methods for VLF.

The allocation of VLF funds is a very complicated process that has evolved from a variety of budgetary and legislative actions since 1986. In summary, about three-fourths of the VLF funds are sent to local governments to be used for any spending purpose. This portion is split equally among cities and counties and allocated to each jurisdiction on the basis of population. The remaining quarter of VLF revenues go to counties as part of a major realignment of state and local health and social services funding in 1991. The state increased VLF revenues at that time by changing the depreciation schedule and dedicated these additional revenues to the realignment programs.

VLF "Backfill"

While the VLF is only a minor cost of owning and maintaining a vehicle, it is one of the most visible since it is paid in a single payment at the time of registration. For this reason, it has in recent years been very unpopular with a number of voters. In FY 1998/1999 the State found itself with over $4 billion in unexpected revenues and decided to return a portion of this windfall to citizens through a cut in the VLF.

In 1998 Governor Pete Wilson signed a bill "offsetting" the tax by 25% (from 2% to 1.5%), with deeper cuts possible in future years depending upon the adequacy of state general fund revenues. In 1999 the law was amended to accelerate the tax cut in 2000. In 2000, the cut was further accelerated to 67.5% beginning January 1, 2001. This means that the rate went from 2% to the current .65% between 1998 and 2001. The term "offset" was used in this process because the total amount of VLF legally due from the taxpayer was not changed. Instead, the state pays or "offsets" a portion of the amount due and the taxpayers pay the remaining balance.

Under the VLF offset law, local governments are "backfilled" by the state general fund for any loss of revenue due to VLF reductions. This backfill is through a continuous appropriation, which means that the appropriation continues from year to year unless the legislature takes action to stop or suspend it. For FY 2003/2004 the state's budget virtually eliminated the VLF backfill and pulled the "trigger" in the law that causes the VLF rate to return to its original 2% level. The increase in VLF rate was reversed by Governor Schwarzenegger in November. Absent any action to reinstate the backfill appropriation for FY 2003/2004, cities and counties will lose all VLF backfill revenue for this fiscal year. However, since the backfill is a continuous appropriation, the Legislature will need to take action to reduce or suspend the funding in FY 2004/2005. The Governor will be submitting his proposed budget for next fiscal year on January 10, 2004, which will provide information as to his intentions regarding VLF on an ongoing basis. Staff will be reviewing the state budget as soon as it is submitted and will bring this analysis to Council at your meeting of January 13, 2004.

DISCUSSION

The Vehicle License Fee is an important source of discretionary funding to Sunnyvale that is used for basic services such as police, fire, libraries, and parks. Currently, VLF represents about 8% of the City's General Fund revenues. As can be seen in the table below, VLF revenues to Sunnyvale have been relatively stable over the years and in general growing faster than inflation. Further, it has not been as subject to wild economic swings as the Sales Tax.

Table 1

CITY OF SUNNYVALE

VLF RECEIPTS

FY 1990/1991 - FY 2002/2003

Fiscal Year

Total Received

% Change

FY 1990/1991

$4,122,583

FY 1991/1992

$4,093,581

-0.70%

FY 1992/1993

$4,229,979

3.33%

FY 1993/1994

$4,676,323

10.55%

FY 1994/1995

$4,342,399

-7.14%

FY 1995/1996

$4,656,372

7.23%

FY 1996/1997

$4,894,696

5.12%

FY 1997/1998

$5,347,791

9.26%

FY 1998/1999

$5,831,230

9.04%

FY 1999/2000

$6,469,770

10.95%

FY 2000/2001

$6,970,515

7.74%

FY 2001/2002

$7,392,772

6.06%

FY 2002/2003

$7,925,774

7.21%

Potential VLF Revenue Loss

As discussed earlier in this report, the continuous appropriation for the VLF backfill for FY 2003/2004 was virtually eliminated as part of the State's budget, and the "trigger" was pulled to restore the VLF rate to its former level in late June. Because there is a 90-day delay between the time that the trigger is pulled and the time that the new fees are levied, local governments were subjected to a budgetary shortfall of approximately 25% of their VLF revenue for FY 2003/2004. For Sunnyvale, this loss was estimated to be $1.8 million. As the Budgetary Year-End Report presented to Council earlier in this meeting indicates, staff had anticipated that the General Fund would end FY 2002/2003 with a positive variance in fund balance about equal to the projected VLF shortfall. However, in the interim, the VLF situation has deteriorated significantly.

In November, Governor Schwarzenegger fulfilled his campaign promise to roll back the VLF increase. To accomplish this, the Governor made a finding that the trigger was pulled in error because the State in fact did not have a fiscal crisis that would make the increase in rate necessary. Unfortunately, this action was not accompanied by a corresponding appropriation of VLF backfill funds. To remedy this problem, and keep the State's promise to local governments, three bills were introduced in extraordinary session of the legislature to restore the backfill. In spite of concerted lobbying by cities and counties, the bills were not considered by the legislature before they adjourned for the remainder of the year.

The VLF rate rollback in November and the lack of legislative action on the backfill appropriation have caused receipts from the state for November and December to be significantly lower than anticipated. As indicated earlier, it was anticipated that receipts for July through September would be about 32.5% of actual, for a loss of about $1.8 million. This reduces the original budget for VLF from $7.5 million to $5.7 million. Receipts through December total $1.7 million.

The lack of legislative action to restore the VLF backfill also creates an uncertainty for local governments, including Sunnyvale, as to what will be received for the remainder of the fiscal year. As of Friday, December 12, 2003 several attempts to bring legislation restoring the VLF backfill to the Assembly floor failed on a party-line vote. Since then, the Assembly and Senate have recessed for the holidays without considering pending backfill legislation. It is therefore probably reasonable to conclude that our VLF payments through December will remain at the reduced rate. The League of California Cities is continuing to press for action on the VLF backfill through legislation or possible court action. Staff will continue to monitor the situation closely and keep Council informed.

Depending upon when and if action is taken after the first of the year, it is also possible that we will be at risk for the entire backfill amount of approximately $5.1 million. While we have anticipated a loss of $1.8 million in VLF backfill, this leaves another $3.2 million to absorb. Further, if consideration of the backfill legislation is delayed for any significant period of time, this will reduce the amount of time that the City has to react to the loss with cost saving measures.

A further question raised by the rollback of the VLF rate and lack of backfill is what will happen next fiscal year and in the future. While the VLF backfill is a continuing appropriation, and therefore should take effect again in FY 2004/2005, it is very clear that the Legislature and the Governor could take action to suspend the appropriation in order to balance the State's massive budgetary structural deficit. The Governor's proposed budget for FY 2004/2005 will be made public on January 10, 2004 and should contain information as to his intentions. Of course, even if the backfill appropriation is included in the proposed budget, the Legislature could take action during budget negotiations to remove or reduce the appropriation.

Cities and counties across California are being forced to take drastic actions in response to the Governor's and State Legislature's failure to backfill VLF revenues. For example, the City of Fremont would lose an additional 80 positions including 45 police and fire positions if the VLF backfill is not replaced this fiscal year. City officials in Bakersfield ordered 35 police positions cut, nearly 10% of its force. California League of Cities Executive Director Chris McKenzie reports that cities and counties have cut more than 1,200 public safety positions since the State began reducing VLF revenues. That number could top 15,000 by the end of this fiscal year.

Initial Options

Sunnyvale may be forced to join other California cities and counties in taking drastic action if revenue from VLF is not restored. In addition, our financial planning systems multiply the problem that the State is creating when it drastically reduced VLF funding. These systems require us to account for current VLF funding reductions projected for the balance of FY 2003/2004, and to incorporate the reduced funding in revenue projections for the 20 year financial plan. Most other cities and counties only have to solve the "VLF problem" for the current fiscal year.

This problem becomes even more complicated. For reasons described earlier, it is not clear whether the State has cut VLF revenues only for the current fiscal year (which creates a one time problem), or on a continuing basis beginning this fiscal year (which creates a more severe on-going problem). Different methods could be used to respond to the reduction in VLF funding, but they need to be matched to the "right" problem. Otherwise, Council may opt to use a method that results in long-term negative consequences when only a short-term problem exists. Until the State takes additional action(s), we do not know whether we are facing a one-time or on-going reduction in VLF revenues.

Staff has developed an initial inventory of actions that Council could consider. It's important to note that other actions or responses may emerge as new information comes out of Sacramento and as Council considers this issue. These potential actions are organized into two groups: potential responses to a one-time VLF reduction and responses to an on-going VLF reduction.

One-Time VLF Reduction

Problem/Projected Funding Reduction:

Current 90 day VLF reduction in FY2003/2004

Problem: $1.8 million

Addressed through FY 2002/2003 year-end results

December 2003 VLF reduction

Problem: $500,000

Potential options:

Freeze all current position vacancies and approve temporary service reductions
Use 5% Service Level Stabilization Reserve
Draw down further 20-year Resource Allocation Plan Reserve

Continuing VLF reductions for the balance of FY 2003/2004

Problem: $3.2 million

Potential options:

Freeze all current position vacancies and approve temporary service reductions
Use 5% Service Level Stabilization Reserve
Draw down further 20-year Resource Allocation Plan Reserve
Eliminate selected filled positions and approve service reductions

On-Going VLF Reduction

Problem/Projected Funding Reduction:

VLF backfill revenue eliminated altogether

Problem: $5.1 million

Potential Options:

Eliminate selected filled positions and approve permanent service reductions
Explore wage/benefit adjustments
Explore alternative benefit packages for new employees
Reexamine new and/or increasing existing taxes

Staff will seek direction from Council in January on these and any additional potential actions identified by Council.

FISCAL IMPACT

The VLF and the various levels of possible reduction to the VLF backfill have been discussed in detail throughout this report. Loss to the City of Sunnyvale ranges from an additional $500,000 in FY 2003/2004 to $5.1 million on an on-going basis.

PUBLIC CONTACT

Public contact was made through posting of the Council agenda on the City's official notice bulletin board, posting of the agenda and report on the City's web page, and the availability of the report in the Library and City Clerk's office. Notification of this item on the December 18, 2003 meeting was sent to representatives of the City's four employee associations.

ALTERNATIVES

This report is for information only. Further developments on the issue will be reported to Council at the January 6, 2004 meeting. Staff will also analyze the Governor's proposed budget which will be released on January 10, 2004 and brief Council on January 13, 2004. At that time, Staff will request direction from Council on options to address the VLF problem.

RECOMMENDATION

There is no recommendation at this time.

Prepared by:

Mary J. Bradley
Director of Finance

Prepared by:

Charles J. Schwabe
Deputy City Manager

Approved by:

Robert S. LaSala
City Manager