Title
Report regarding the Property Tax in-lieu of Vehicle License Fees shortfall (Rich Lee, Assistant City Manager)
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RECOMMENDATION
Recommendation
It is recommended that the City Council receive an update regarding the Property Tax in-lieu of Vehicle License Fees shortfall.
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BACKGROUND
Proposition 98 | Educational Revenue Augmentation Fund (ERAF)
In 1988, California voters approved Proposition 98 (Prop 98), which was a constitutional amendment that establishes an annual minimum funding level for K-14 education each fiscal year. Prop 98 supports K-12 schools (including transitional kindergarten), community colleges, county offices of education, the state preschool program, and state agencies that provide direct K-14 instructional programs.
In present day terminology, public school districts that generate enough property tax to meet the Prop 98 requirement (and thus no state subsidy is required) are considered a basic aid school district. Conversely, public school districts that do not generate sufficient property tax to meet the Prop 98 requirement are considered non-basic aid school districts.
ERAF began in 1992 due to the state facing budgetary pressures and not being able to meet its requirements to fund public education pursuant to Prop 98. ERAF permanently shifted cities and counties’ share of the 1% property tax levy away to meet this requirement.
Property Tax in-lieu of Vehicle License Fees
In 1935, as a uniform statewide tax, the vehicle license fee is a tax on the ownership of a registered vehicle in place of taxing vehicles as personal property. By law, all revenues from the vehicle license fee fund city and county services, but the state legislature controls the tax rate and the allocation among local governments.
In 2004, to balance its budget, the State of California permanently reduced the vehicle license fee tax rate and eliminated state general fund backfill to cities and counties. As a part of the Budget Deal of 2004, to address the substantial financial impact of the loss of vehicle license fee revenues to cities and counties, the state agreed to a swap of property tax revenues and ERAF revenues from non-basic aid school districts to cities and counties, which is known as Property Tax in-lieu of Vehicle License Fees (VLF). The state then backfills the non-basic aid school districts up to the Proposition 98 requirement by the amount of the VLF shift.
DISCUSSION/ANALYSIS
There are 23 public school districts in San Mateo County. Over the past six years, due to the relatively high assessed value of the county relative to other counties in California, the property tax growth has shifted non-basic aid school districts to basic aid status. According to the most recent data (2025), there are only five non-basic aid school districts that remain. The shift from non-basic aid to basic aid status is the primary impetus for the VLF shortfall, as the property tax and ERAF from non-basic aid school districts is the sole funding source for Property Tax in-lieu of Vehicle License Fees.
The relationship between the non-basic aid districts and the VLF shortfall is inverse, in that as the number of non-basic aid school districts decrease, the VLF shortfall increases exponentially, as the property tax from non-basic aid school districts that shift to basic aid status is no longer available to backfill the VLF that is owed to the county and cities. The Budget Deal of 2004 did not contemplate what would happen if there was insufficient funding from non-basic aid school districts. As such, every year since fiscal year (FY) 2019-20, in August of each year, San Mateo County has filed a claim with the State of California, inclusive of the county and local cities within the county, for the VLF shortfall for the preceding fiscal year. Table 1 below provides a breakdown of the VLF by fiscal year.
Table 1. VLF by Fiscal Year (in millions)
|
Fiscal Year |
VLF Amount Due |
VLF Available |
VLF Countywide shortfall |
County Share of shortfall |
SSF Share of shortfall |
All Other Cities Share of shortfall |
|
2020-21 |
$223 |
$127 |
$96 |
$57 |
$4 |
$35 |
|
2021-22 |
232 |
200 |
32 |
19 |
1 |
12 |
|
2022-23 |
251 |
181 |
70 |
41 |
3 |
26 |
|
2023-24 |
268 |
154 |
114* |
68 |
5 |
41 |
|
2024-25 |
283 |
164 |
119 |
71 |
5 |
43 |
|
The fiscal years below this line are projections. |
|
2025-26 |
297 |
172 |
125 |
74 |
5 |
46 |
|
2026-27 |
325 |
133 |
191 |
113 |
8 |
70 |
|
2027-28 |
346 |
101 |
245 |
145 |
10 |
90 |
|
2028-29 |
369 |
116 |
253 |
150 |
11 |
92 |
|
2029-30 |
393 |
107 |
286 |
170 |
12 |
104 |
|
2030-31 |
419 |
151 |
268 |
159 |
11 |
98 |
|
2031-32 |
447 |
114 |
333 |
197 |
14 |
122 |
As highlighted in Table 1, while San Mateo County filed a claim in August 2024 for the full amount of the FY 2023-24 VLF shortfall of $114 million, the State of California only appropriated 2/3 of what was owed in its adopted budget, or $76 million. $38 million of the FY 2022-23 VLF shortfall is still owed. San Mateo County filed a lawsuit against the State of California in response to not receiving the full VLF amount for FY 2022-23.
All but one of the remaining five non-basic aid school districts are anticipated to shift to basic aid status within the next five years or sooner. What was a $119 million countywide shortfall in FY 2024-25 (of which the City’ proportional share is over $5 million) in the prior fiscal year will then grow exponentially to a $333 million countywide shortfall by FY 2031-32. Based on the City’s proportional share of the VLF shortfall, the projected impact to property tax revenues, which are the City’s primary funding source for core services, is $14 million. Given the order of magnitude of the financial impact, staff has prepared an analysis of required actions to balance the General Fund operating budget and ensure compliance with the City’s reserves policy.
VLF Shortfall Impact on City Operations
An annual loss of $14 million in Property Tax in-lieu of Vehicle License Fees by FY 2031-32 would substantially alter the City’s ability to provide basic core services to the community. The brief narratives below describe, in order of magnitude, the impacts to services provided by specific departments. The narratives below reflect exploratory analysis and are not definitive. Any elimination of a job classification would be subject to the procedures in the City’s Personnel Rules and Regulations and respective Memoranda of Understanding (MOU).
Fire Department - $5.1 million
Closure of one fire station, which would delay response times and limit the department’s ability to respond to calls for mutual aid from neighboring jurisdictions and state wildfires.
Police Department - $2.5 million
Elimination of the Community Outreach Team (COT) and School Liaison Officer (SLO) programs. COT officers provide support for unhoused individuals, while SLO officers provide a presence in South San Francisco middle and high schools and build a relationship between students and the Police Department.
Parks and Recreation - $2.5 million
Increase preschool fees by 75% between present day and 2032, which runs counter to the City Council’s goal to provide affordable childcare. Elimination of Concert in the Park.
Library - $0.9 million
Both the Main Library and Grand Avenue Branch could only be open five days a week.
Public Works - $0.9 million
Response to clean up unhoused encampments, maintenance of traffic lights.
All Other Departments - $2.7 million
Elimination of holiday decorations and attendance at Bio conference, deferred replacement of legacy agenda management software, long-term deferral of filling vacant positions.
Legislative Efforts
At the regional and state level, over the past four years, San Mateo County (County) has led the efforts to collaborate with state delegates on finding a legislative fix to address the VLF shortfall.
On April 7, 2026, San Mateo County held a press conference to highlight the VLF shortfall and the need for a permanent legislative correction. The event was attended by over 500 local, regional, and state leaders. More information is available at <https://www.smcgov.org/ceo/news/san-mateo-county-leaders-urge-state-provide-157-million-funding-owed-21-peninsula>
As of the date of preparation of this staff report, a large contingent of local and regional representatives will be attending two important meetings to discuss San Mateo County’s VLF funding request:
1. State Assembly Budget Subcommittee hearing on April 28, 2026; and
2. State Senate Budget Committee hearing on May 7, 2026
FISCAL IMPACT
Loss of property tax in-lieu of VLF would have a severe impact on the City’s resources. Absent a permanent legislative correction, by FY 2031-32, the City will need to significantly modify its core services by $14 million, primarily through reduction.
RELATIONSHIP TO THE CITY COUNCIL PRIORITIES ACTION PLAN
Discussion of the Property Tax in-lieu of Vehicle License Fees shortfall supports the Modern and Sustainable Organization Major Focus Area, Long-Term Fiscal Sustainability Plan Key Strategy.
CONCLUSION
Property Tax in-lieu of Vehicle License Fees is a critical revenue source for South San Francisco and every city in San Mateo County. Absent a permanent legislative correction, the City’s core service levels will deteriorate due to exponential loss of funding.
ATTACHMENT
Attachment 1 - PowerPoint Presentation