General obligation bonds and revenue bonds are two types of bonds issued by municipalities, such as cities. Both types of bonds promise regular interest payments to investors along with a return of principal at maturity. The primary difference between the two is in how those payments are financed. Neither type is necessarily safer or better than the other.
Full Faith and Credit
General obligation bonds are backed by the "full faith and credit" of the issuing municipality. This means that the issuer can use its taxing authority or ability to issue new credit to finance the payments on a GO bond. As the name implies, the proceeds from the sale of GO bonds is used for any general purpose that the municipality deems necessary, rather than a specific purpose as in the case of revenue bonds. Money raised through the sale of general obligation bonds often goes towards roads, schools, parks, and other projects for the general good.
Municipalities sell revenue bonds to raise money for specific projects, such as toll roads. Money raised from user fees or tolls on that project is used in turn to pay off the investors in those bonds. Unlike with GO bonds, the proceeds of a revenue bond sale cannot be used for general, unrestricted purposes.
Both GO bonds and revenue bonds are generally safe investments, although GO bonds are typically considered to be safer than revenue bonds. A municipality can always issue more bonds or raise taxes to pay off a GO issue, while a revenue bond is restricted to a single revenue stream. However, some municipalities are not well-capitalized, and sometimes income streams dry up. As a result, both types of bonds can have repayment issues. Outside agencies such as Standard & Poor's provide ratings attesting to the relative safety of individual bonds, with a AAA rating indicating the highest likelihood of repayment. A revenue bond with a AA rating can be considered safer than a GO bond with an A rating, and vice versa.
Most municipal bonds, whether revenue or GO, are exempt from federal taxes. Most are also exempt from state taxes in the state of issue. However, certain municipal bonds are actually taxable. The federal government only grants a tax exemption to municipal bonds used to benefit the general public. Bonds used to finance certain enterprises, such as sports stadiums and investor-led housing, are not considered public-interest bonds, and interest payments on those bonds are therefore taxable. Revenue bonds tend to be more susceptible to taxation, since they finance specific projects. However, general obligation bonds that are used for purposes such as replenishing a city's pension account are also considered taxable. Every bond has an official statement attached to it that must specify the proposed use of the bond proceeds along with the tax treatment of the bonds.
After receiving a Bachelor of Arts in English from UCLA, John Csiszar earned a Certified Financial Planner designation and served 18 years as an investment adviser. Csiszar has served as a technical writer for various financial firms and has extensive experience writing for online publications.