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Classifying Municipal Bonds

Municipal Bonds are debt obligations issued by state or local governments of US territories, authorities and special districts. There are two main types of municipal bonds: General Obligation and Revenue bonds. General Obligation bonds (GOs), are backed by the full faith and credit of a taxing municipality, which pledges to raise taxes if necessary in order to pay its outstanding debt. Revenue bonds; on the other hand, are used to finance a municipal facility or a project such as either a department of water and power or a toll road which has a dedicated revenue stream to pay off bondholders. General Obligation bondholders, have a legal claim to assets generated by a municipal government for payment of principal and interest due them. General Obligation bonds, normally raise funds to build municipal facilities that benefit the entire community. General Obligation Bonds issued by state or local governments are often backed by license fees, sales tax, and income taxes. Some states also back payments on GO bonds with their state taxes, ad valorem taxes, fines, license fees as well as other sources of revenues available for municipalities. Ad Valorem is a property tax imposed on property values within a municipality. School and park districts can also issue GO bonds backed by property taxes of their local districts. It is common for GOs to have a statutory limit as to the amount of debt outstanding. This statutory limit serves to protect taxpayers from excessive tax assessments. Municipalities that wish to underwrite more debt and surpass their statutory limit, must first seek voters’ approval. A municipal issuer may have either limited or unlimited taxing power. Some states limit their property taxes to either a certain percentage; such as $1 per $1,000 of the assessed property value, or to a certain percentage increase in any single year. Debt limits should not be confused with limited tax General Obligation bonds. Limited tax GO issues are limited to a specific tax, such as income tax. Limited tax GOs bear more risk because the tax servicing the debt outstanding is limited to a specific source of income.