How Do City Bonds Work?

The only money the government -- any government -- has to spend comes from its citizens. Although municipal bonds provide lower interest than corporate stock dividends, the income is dependable and traditionally tax-free. Conservative but reliable, city bonds are the instruments that cities, towns, counties and even states use to manage their revenues so money is available when it is needed.

How Cities Finance

Employee wages, including public safety, maintenance and supplies for water and sewer facilities, utilities and insurance for public facilities are just a few of the costs incurred by municipalities for the benefit of their residents. To fund these expenditures, municipalities use tax payments, user fees, such as liquor and dog licenses, and miscellaneous income from grants and revenue sharing with other governments. The problem is that the expense stream is uniform but the income stream is not. Property taxes come in the year following their assessment, sales taxes slump during certain periods and miscellaneous income can be sporadic. Issuing municipal bonds help cities anticipate costs and operate smoothly. The interest rate that they pay is determined by the credit rating of the city and the current bond market.

General Obligation Bonds

Sometimes called “tax anticipation bonds,” general obligation bonds provide timely finance for government operation and are supported by a promise to pay bondholders back, known as “full faith and credit.” They are often issued for a short period, such as six or 12 months -- just until the tax revenues arrive to satisfy the bond issue. Because municipalities have no collateral to insure their bonds -- note that physical property such as City Hall, the parks and libraries belong to the taxpayers -- they add additional costs and interest for general obligation bonds to the tax levy the year following their issue. Legislative councils and boards authorize general obligation bonds.

Revenue Bonds

Projects like subdivision sewer systems, swimming pools and new roads require more immediate revenue than yearly taxes, user fees and miscellaneous receipts can provide, so cities do what many property owners do: they finance the project over a longer period of time. Repayment of these bonds comes from special assessments and fees for the use of the improvements -- memberships or tolls, for example. Revenue bonds may be approved by legislative councils or boards or by referendum. Cities with good credit ratings have little difficulty selling revenue bonds.

Development Bonds

In order to attract new industry and housing, municipalities might provide incentives to businesses, non-profit corporations and commercial developers. The bonds are authorized by the legislative council or board and the proceeds are invested directly into projects such as infrastructure for subdivisions, business incubators, hospitals or other facilities. The beneficiaries repay the principal on the bonds to the bondholders, either directly or through the municipality. Development bond offerings are often related to the development of Tax Incremental Funding, or TIF, districts, which are blighted or underdeveloped areas where property taxes are waived until the development is finished and the developer begins to recover an initial investment.

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