Understanding General Obligation Bonds
What Is a General Obligation Bond?
A general obligation bond, or GO bond, is a type of municipal bond that a state or local government issues to raise money for public projects like roads, parks, or schools. Here’s a simple way to understand them:
- Backed by Taxes: Instead of being paid back by the revenue from a specific project (like tolls from a bridge), GO bonds are backed by the government’s ability to tax its residents. This is known as the government’s “full faith and credit.”
- Voter Approval: Because they are repaid using taxpayer money, GO bonds often require approval from voters.
- Low Risk: They are generally considered a safer investment than revenue bonds because the government has a wide range of revenue sources (like property taxes, sales taxes, or income taxes) to ensure repayment. In theory, the government can even raise taxes if needed to cover the debt.
How does General Obligation Bonds Work!
A general obligation bond, or GO bond, is a type of municipal bond that a state or local government issues to raise money for public projects like roads, parks, or schools. Here’s a simple breakdown:
Key Characteristics
- Backed by Taxes: Unlike a bond that’s paid back by a specific project’s revenue (like a toll bridge), a GO bond is secured by the government’s entire ability to tax its residents. This is known as the government’s “full faith and credit.” If property taxes alone aren’t enough to cover the debt, the government can use other revenue sources, or in some cases, even raise taxes. 💰
- Voter Approval: Because GO bonds are paid for with taxpayer money, they often require approval from voters. This ensures that the public agrees to take on the debt. 🗳️
- High Credit Quality: Since the repayment is backed by the government’s broad taxing power, GO bonds are generally considered a very safe investment. Credit rating agencies typically give them high ratings, which allows the government to borrow money at a lower interest rate. ✅
GO Bonds vs. Revenue Bonds
General Obligation Bonds: Repayment comes from the general fund, which is supported by a variety of taxes (property, sales, income, etc.). The funds raised are used for public projects that don’t directly generate revenue, such as schools or public parks. 🏫
Revenue Bonds: Repayment comes only from the revenue generated by the specific project being funded, such as tolls from a bridge, fees from a public utility, or airport landing fees. These bonds are riskier because if the project doesn’t generate enough income, bondholders might not get paid back. 🚧
When a government issues a general obligation (GO) bond, the pledge it makes to repay bondholders can be either limited or unlimited. The main difference lies in the government’s ability to raise taxes to cover the debt.
Limited-Tax General Obligation Pledge
This type of pledge means the government promises to use its taxing power to repay the bond, but with a statutory limit on how much it can increase property taxes.
- How it works: The government can use a portion of existing tax revenue or raise property taxes up to a specified maximum rate to make its debt payments.
- Risk: Because the government’s ability to increase taxes is capped, this type of pledge is seen as riskier for investors compared to an unlimited pledge. As a result, these bonds may have lower credit ratings.
Unlimited-Tax General Obligation Pledge
With this pledge, the government can raise property taxes as much as necessary, without a statutory limit, to ensure it can repay the bondholders.
- How it works: To issue these bonds, residents must often first agree to allow the government to increase taxes to cover the debt. This voter approval provides a strong assurance of repayment.
- Risk: This is considered the strongest type of general obligation pledge. Because the government has virtually unlimited power to raise taxes to meet its obligations, these bonds typically have the highest credit ratings and are viewed as a very safe investment.
The Bottom Line
What’s the “Bottom Line” on General Obligation Bonds?
The bottom line is that general obligation (GO) bonds are a relatively secure and stable investment for funding public projects. They stand out because their repayment is backed by the full financial power of the government that issues them—typically through its ability to collect taxes—rather than by the revenue from a specific project. This makes them generally less risky than other types of municipal bonds, like revenue bonds.
Key Takeaways
- Security: GO bonds are considered safe because the government pledges its entire tax base and financial resources to pay back the bondholders. If a municipality doesn’t have enough money from one tax source, it can legally use other available funds or even raise taxes to cover the debt.
- Purpose: These bonds are used for public projects that benefit the community but don’t necessarily generate their own income, such as schools, parks, or bridges without tolls.
- Pledge Types: The level of security can vary. An unlimited-tax general obligation pledge allows the government to raise property taxes without a cap to meet its obligations, providing a higher level of security. A limited-tax general obligation pledge, on the other hand, restricts the amount taxes can be raised, making it a slightly riskier investment.
- Credit Ratings: Due to their strong backing, GO bonds often receive high credit ratings from agencies. This allows governments to borrow money at lower interest rates, which benefits taxpayers.
- Investing: Investors who prioritize safety and a predictable, tax-exempt income stream often find GO bonds to be an attractive option for their portfolios.