General obligation vs revenue bonds

A general obligation bond is paid back from taxes

Who pays you back when a city borrows money? A municipal bond, or muni, is a bond from a state, a city or a town. A bond is a loan you make to them. Munis come in two main kinds, and the difference is who pays you back. The first kind is a general obligation bond, or GO bond.

A GO bond is backed by the issuer's full faith, credit and taxing power. In plain words, taxes pay you back. Say your town needs a new school. A school earns no money, so the town borrows and pays the bonds from property taxes.

Cities and counties lean on property taxes. States lean on income and sales taxes. Because taxpayers foot the bill, GO bonds often need voter approval. They also count against the legal limit on how much the issuer can borrow.

A common mistake is thinking the federal government stands behind munis. The state or town that issued the bond stands behind it. A GO bond is backed by the issuer's full faith, credit and taxing power. Taxes pay you back.

A revenue bond is paid back from what the project earns

What if the project earns its own money? A muni is a bond from a state, a city or a town, and the second kind is a revenue bond. A revenue bond is paid back only from what the project earns, like tolls, fees or rents. The issuer's taxes don't back it.

Say a city builds a toll bridge. Every driver who crosses pays a toll, and those tolls pay the bondholders. The project has to earn enough to pay its debt. So a feasibility study comes first, to check that it can.

Taxpayers aren't on the hook. So revenue bonds generally don't need a vote, and they don't count against the debt limit. Compare it with a GO bond, which taxes pay back. GO means taxpayers pay. Revenue means the people who use the project pay.

The common mistake is calling a bond GO because a government issued it. Both kinds come from governments, so follow the money. A revenue bond is paid back only from what the project earns. The people who use it pay you.

Special tax bonds count as revenue, double-barreled as GO

What about a bond paid from a tax, but only one tax? A GO bond is backed by the issuer's full taxing power. A revenue bond is paid from one specific source. A special tax bond is paid only from one specific tax, like a gas, tobacco or hotel tax.

Say a state pays its highway bonds only from the gas tax. It can't dip into income taxes to pay you. That gas tax is one source, the same as a toll. So a special tax bond counts as a revenue bond.

A double-barreled bond has two sources. It's paid from a project's revenue, and if that falls short, from the issuer's taxing power. Think of a county hospital. Patient fees pay the bonds first. If they fall short, the county's taxes cover the rest.

Because taxing power stands behind it, a double-barreled bond is rated and analyzed as a GO bond. The common mistake is calling any tax-backed bond a GO. One specific tax makes it revenue. Full taxing power makes it GO.

If the issuer's full taxing power stands behind the bond, it's GO. If not, it's revenue.

Worked example: sort three muni bonds

1. Three muni bonds. Sort each one: GO or revenue. GO bonds are paid from the issuer's taxes. Revenue bonds are paid from what a project earns.
2. First, a school district bond paid from property taxes. Property taxes are the district's taxing power, so it's a GO bond.
3. Second, an airport bond paid from landing fees. Airlines pay those fees to use the airport. That's the project's own income, so it's revenue.
4. Third, a highway bond paid only from a gas tax. It's a tax, but it's one specific tax, not the state's full taxing power.
5. One specific tax makes it a special tax bond. Special tax bonds count as revenue bonds, not GO.

Common mistakes

taxes back GO bonds, project income backs revenue

You mixed up GO and revenue. Ask who pays the bondholders. If taxpayers pay, through property, income or sales taxes, it's a GO bond. If the project's users pay, through tolls, fees or rents, it's a revenue bond. Follow the money. Who pays decides it.