Both. VLANs allow Layer 2 devices to create broadcast domains (separate subnets). Since the VLAN changes the default switch behavior from creating collision domains to creating broadcast domains, moving traffic between VLANs usually requires L3 processing.
A VLAN, like Cluebird alluded to earlier, is a virtual broadcast domain created on a switch. Having said that, if you were to create four VLANS on a switch, they would each individually work fine without any layer three presence on the switch. The devices on the different VLAN's couldn't talk to each other, but they would still be ok inside thier respective vlan.
If you were to turn on the layer 3 capability of switch or use an external router to route between the vlans so they could talk to each other, this wouldn't make the VLAN a layer 3 protocol. It's a layer 2 protocol. That's why you need to have that layer 3 presence like the switch itself (3550 w/EMI and ip routing enabled) or an external router (router-on-a-stick).
This link gives you a little bit of an explanation along the same lines as what I gave you.
Page 116 in Cisco LAN Switching(great book)... VLANs are layer 2 provided you dont have a layer 3 device on it to pass traffic between VLANs. ONce you hang a router/RSM/etc it bcomes layers 2 and 3. Layer 4 can also be part of this VLAN discussion depending on the equipment being used.
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