States, counties and cities that seek financing for public projects may issue municipal bonds. By issuing these debt securities, the government is borrowing money from the public. The bondholders will be repaid the principal plus interest over a specific span of years. The two types of municipal bonds are general obligation bonds and revenue bonds. The difference between them lies in how the government issuer secures the money to repay the bondholders.
General Obligation Bonds
General obligation bonds are securities guaranteed by the “full faith and credit” of a government with taxing power. These bonds typically are used to finance capital improvement projects such as streets, roads and public buildings. With these bonds, the state or local government bond issuer pledges to use its general taxing power to repay the bondholders. Because these bonds place a general obligation on all taxpayers to cover bond repayments, the voters of a state or local government typically must approve general obligation bonds before they are issued.
General obligation bonds can be an unlimited tax type backed by all the taxes the government collects, or they can be limited tax types backed by one specific tax, such as a property tax, or by a specific class of tax, such as excise taxes. General obligation bonds may be subject to a debt ceiling in the government’s constitution, charter or statutes that puts a limit on the amount of general obligation bonds the government can issue.
Revenue bonds are repaid from the revenues generated by the project the bonds financed. These bonds finance revenue-producing projects such as industrial parks, toll roads, convention centers, sports stadiums or water and sewer utilities. Projects may generate revenues through things like user fees, admission charges, rents or lease payments, or concession fees. In most instances, revenues from the project go into a revenue fund from which operating expenses and bond repayments are drawn.
Revenue bonds typically come with a variety of “protective covenants” that serve as guarantees to protect the bondholders. There may be covenants that guarantee that rates or fees are high enough to cover costs and debt service or a pledge to keep the facility open and operating for the life of the bonds. Covenants may also include a promise to have the facility completed and operational by a specific date or a pledge to maintain an insurance policy against bond default. Revenue bonds are not subject to debt ceilings.
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