Types of Tax-Exempt Municipal Bonds
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Municipal bonds are tax free because there was a ruling in 1819 stating that the governments at the state federal and local levels did not have the authority to tax each other. This is a boon for the investor as there are several types of tax-exempt municipal bonds for him to take advantage of. There are three main types of tax-exempt bonds, these are the general obligation bond, the revenue bond and the industrial development bond. We will look at each of these classifications in more depth.
A general obligation bond is backed by the issuer and is also backed by the full faith and credit that the issuer has. This means that the issuer, which is the local government will make certain, and furthermore use its resources to make certain, that this debt is paid. The local government has the right to honor their pledge even if they have to raise taxes, such as property taxes to do so. These types of bonds get high credit ratings because most taxpayers will not lose their property even if their taxes on said property do go up. This makes the chance of the government being able to pay off the bondholders a very sure bet. A further breakdown of the general obligation bond is that of limited tax obligation or unlimited tax obligation. The former means that the government will be able to levy a tax rate upon property of the taxpayers in order to meet the obligations of the bonds issued.. However there is a statutory limit in effect as to how high that rate can be raised. The unlimited tax obligation is exactly as it says, the government can levy whatever rate on their property tax is necessary, in order to recover enough revenue to pay off the bond holders.
A revenue bond is dependent only on certain listed revenue (which is yet to be generated) to pay the obligations owed the bond holders. The credit of the bond issuer is not at stake. In other words if you are buying bonds for an airport parking lot , that may be the revenue that will pay the amount due you when the bond reaches maturity. The government will certainly not be increasing property taxes to pay off the bond amounts. You can see that the revenue bonds do not have the certainty of payment as do the bonds that are issued as general obligation. The revenue bonds are, however, generally thought of as only slightly less secure than the general obligation bonds.
The industrial development bonds are those that are going to be used to either renovate or improve public facilities of some sort. These are only tax free in certain instances such as in the use of water or sewer facilities or airports or in other cases such as these.
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