Municipal bonds are debt obligations issued by states, cities, counties and other governmental entities. They are used to build schools, highways, hospitals, sewer systems, and other projects for the public good. Most municipal bonds are free of federal taxes, and they are often exempt from taxes on interest paid to residents of the state of issuance as well.
There are two basic types of municipal bonds:
- General Obligation Bonds: Principal and interest are secured by the full faith and credit of the issuer and usually supported by either the issuer’s unlimited or limited taxing power. In many cases, general obligation bonds are also voter-approved.
- Revenue Bonds: Principal and interest are secured by revenues derived from tolls, charges or rents from the facility built with the proceeds of the bond issue. Public projects financed by revenue bonds include toll roads, bridges, airports, water and sewage treatment facilities, hospitals and subsidized housing.
Many of these bonds are issued by special authorities created for that particular purpose. Some private activity municipal bonds are subject to the federal alternative minimum tax.