Putting “no tax increase” in front of “bonds” is designed to dampen opposition to increased taxes, as it is with many political words. But, to be clear, there is no category of bonds issued by school districts that does not result in an increase in your taxes. Bonds with no tax increase raise your taxes.
How? Bonds are frequently issued by school districts to fund capital projects such as the construction of new facilities or the renovation of existing infrastructure. The bonds are paid off over time by the taxpayers, usually through an increase in their property taxes. Bonds are issued for a set period of time, and when they are paid off, the tax payments of the taxpayers are reduced.
Are taxpayers responsible for paying bonds?
Roads, bridges, airports, schools, hospitals, water treatment facilities, power plants, courthouses, and other public structures are examples of significant, expensive, and long-term capital projects for which state and municipal governments issue bonds. State and municipal governments can, and do, pay for capital investments using current income, but borrowing allows them to spread the expenses across numerous generations. Future users of the project pay a portion of the cost through rising taxes, tolls, fares, and other fees that help pay off the obligations.
To assist smooth out unbalanced financial flows, states and municipalities issue short-term loans or notes (e.g., when tax revenues arrive in April but expenditures occur throughout the year). They also issue debt for private companies (e.g., to build projects with public benefit or for so-called public-private partnerships).
HOW LARGE IS THE MUNI BOND MARKET?
State and local governments had $3.85 trillion in debt at the end of 2019. (figure 1). Approximately 98 percent of this debt was long term, having a maturity of at least 13 months, while only 2% was short term. As in previous years, states issued around 40% of municipal debt while local governments issued 60%.
Municipal debt has more than tripled in nominal terms since the mid-1980s, but the shift as a proportion of GDP has been less significant.
What Are the Main Types of State and Local Government Debt?
General obligation bonds are backed by a company’s “full faith and credit,” which includes the ability to tax. Future revenue streams, such as dedicated sales taxes, tolls, and other user charges generated by the project being financed, may also be used to secure bonds.
Generally, general obligation bonds require voter approval and are subject to debt-to-equity limitations. These rules and limits do not apply to revenue bonds or bonds secured by projected legislative appropriations. In 2018, revenue bonds accounted for 58 percent of state and local issuances, general obligation bonds for 36%, and private placements for 6%.
Who Holds State and Local Government Debt?
Households hold the majority of state and municipal bonds, followed by mutual funds (which also represent household investors) (figure 3). Until the Tax Reform Act of 1986 and subsequent lawsuits, banks and life insurance corporations were the most major municipal bond holders.
How Does the Federal Tax Exemption Work and What Are Proposals for Reform?
The federal income tax has exempted interest payments from municipal bonds from taxable income since its introduction in 1913. Interest on bonds issued by the taxpayer’s home state is usually free from state and municipal taxes. In Department of Revenue of Kentucky v. Davis, the US Supreme Court maintained states’ power to tax interest on bonds issued by other jurisdictions.
For a given degree of risk and maturity, state and local governments can borrow more cheaply than other debt issuers, such as companies, thanks to the federal tax exemption. As a result, the federal tax exemption acts as a federal subsidy for state and municipal infrastructure spending. This subsidy comes with a price tag of $28 billion in lost tax revenue in fiscal year 2020.
The federal tax exemption has been criticized as wasteful since it provides high-income taxpayers with more than the required incentive to buy municipal bonds. A high-grade tax-exempt municipal bond, for example, yielded 3.53 percent in 2018. A comparable taxable corporate bond yielded 3.93 percent. As a result, taxpayers with a federal tax rate of around 10% should be able to choose between the two types of bonds (the yield difference—0.4 percentage points—is roughly 10% of 3.93 percentage points). Anyone in a higher tax bracket earns a windfall, while the borrower receives no further advantage.
Because of this inefficiency, ideas to reduce the federal tax exemption have long circulated, most recently by former Vice President Joe Biden as part of his 2020 campaign tax proposals. However, whether states and localities respond by issuing more or fewer bonds, and whether bondholders respond by changing their portfolios toward taxable bonds or other investments, will determine the revenue benefit from eliminating or reducing the deduction (Poterba and Verdugo 2011). It’s also difficult to keep all key bond characteristics constant, such as risk, maturity date, fixed versus variable interest payments, and liquidity (Congressional Budget Office and Joint Committee on Taxation 2009).
Notably, the bond interest exemption has not been capped in any of President Donald Trump’s previous budget plans.
How are municipal bonds funded?
Municipal bonds (also known as municipal debt) are a type of debt “State, city, county, and other local agencies issue debt securities to support day-to-day commitments as well as capital projects such as the construction of schools, roadways, and sewer systems. When you buy municipal bonds, you’re effectively lending money to the bond issuer in exchange for a promise of regular interest payments, usually semi-annually, and the return of the original investment, or a combination of the two “I am the principle.” The maturity date of a municipal bond (the day on which the bond’s issuer repays the principal) could be years away. Short-term bonds will mature in one to three years, whereas long-term bonds will take a decade or more to maturity.
Municipal bond interest is generally tax-free in the United States. If you live in the state where the bond was issued, the interest may be free from state and local taxes. Bond investors are often looking for a consistent stream of income payments and, when compared to stock investors, are more risk conservative and concerned with preserving rather than developing capital. Due to the tax benefits, tax-exempt municipal bonds typically have lower interest rates than taxable fixed-income assets such as corporate bonds with equal maturities, credit quality, and other characteristics.
- States, cities, and counties issue general obligation bonds that are not backed by any assets. General obligations, on the other hand, are backed by the government “the issuer’s “full faith and credit,” which includes the ability to tax inhabitants in order to pay bondholders.
- Revenue bonds are backed by earnings from a specific project or source, such as highway tolls or lease fees, rather by the government’s taxing power. Some revenue bonds are available “The term “non-recourse” refers to the fact that bondholders have no claim to the underlying revenue source if the revenue stream ceases to exist.
Municipal borrowers also occasionally issue bonds on behalf of private businesses such as non-profit universities and hospitals. The issuer, who pays the interest and principal on the bonds, often agrees to reimburse these “conduit” borrowers. The issuer is usually not compelled to pay the bonds if the conduit borrower fails to make a payment.
Where can investors find information about municipal bonds?
The Municipal Securities Rulemaking Board’s Electronic Municipal Market Access (EMMA) website makes municipal securities documentation and data available to the public for free. You will have access to:
- Economic reports and events that may have an influence on the municipal bond market are listed on this calendar.
It’s worth noting that many issuers have dedicated websites or webpages for municipal bond investors. Some issuers link to those pages from their EMMA main page. Learn how to use EMMA to locate issuer homepages.
In 2009, the Securities and Exchange Commission recognized EMMA as the official depository for municipal securities disclosures. The MSRB is supervised by the Securities and Exchange Commission (SEC). The MSRB is a self-regulatory body whose objective is to promote a fair and efficient municipal securities market in order to safeguard investors, state and local governments, and other municipal entities, as well as the public interest. The disclosure materials are not reviewed by the SEC or the MSRB before they are posted on EMMA.
What are some of the risks of investing in municipal bonds?
Municipal bonds, like any other investment, carry certain risk. Municipal bond investors are exposed to a number of dangers, including:
Call it a gamble. Call risk refers to the possibility of an issuer repaying a bond before its maturity date, which could happen if interest rates fall, similar to how a homeowner might refinance a mortgage loan to take advantage of reduced rates. When interest rates are constant or rising, bond calls are less likely. Many municipal bonds are “callable,” thus investors who plan to hold a bond to maturity should look into the bond’s call conditions before buying it.
There is a credit risk. This is the risk that the bond issuer will run into financial difficulties, making it difficult or impossible to pay interest and principal in full (the inability to do so is known as “default”). For many bonds, credit ratings are available. Credit ratings attempt to measure a bond’s relative credit risk in comparison to other bonds, yet a high grade does not imply that the bond would never default.
Interest rate risk is a concern. Bonds have a set face value, which is referred to as the “par” value. If bonds are held to maturity, the investor will get the face value of the bond plus interest, which might be fixed or variable. The market price of the bond will grow as interest rates fall and fall as interest rates rise, hence the market value of the bond may be greater or lesser than the par value. Interest rates in the United States have been historically low. If interest rates rise, investors who hold a cheap fixed-rate municipal bond and try to sell it before it matures may lose money due to the bond’s lower market value.
There is a chance of inflation. Inflation is defined as a widespread increase in prices. Inflation diminishes purchasing power, posing a risk to investors who are paid a fixed rate of interest. It may also result in higher interest rates and, as a result, a decrease in the market value of existing bonds.
There’s a danger of running out of cash. This refers to the possibility that investors may be unable to locate an active market for the municipal bond, prohibiting them from buying or selling the bond when they want and at a specific price. Because many investors purchase municipal bonds to hold rather than trade them, the market for a given bond may be less liquid, and quoted values for the same bond may range.
In addition to the risks, what other factors should you consider when investing in municipal bonds?
There are tax implications. Consult a tax specialist to learn more about the bond’s tax ramifications, such as whether it’s subject to the federal alternative minimum tax or qualified for state income tax benefits.
Brokerage commissions. The majority of brokers are compensated by a markup on the bond’s cost to the firm. It’s possible that this markup will be revealed on your confirmation statement. If you are charged a commission, it will appear on your confirmation statement. You should inquire about markups and commissions with your broker.
How do revenue bonds get their money?
General obligation, or GO, bonds are backed by the issuing municipality’s general revenue, whereas revenue bonds are secured by a specific revenue stream, such as toll road, hospital, or higher-education system revenue.
How do bond issues get funded?
You can decide, just like at home, that you need to build a new garage or rebuild the kitchen. The problem is figuring out how to pay for it. You might either pay with cash from your savings or take out a loan.
School districts confront similar challenges and have similar solutions. They may desire a new school or require renovations to an existing structure.
A common option for a school district to borrow money is to issue a bond, which functions similarly to a loan, and ask taxpayers for a Bond Levy, or a tax increase. The extra tax revenue is used to repay lenders or bondholders, as well as to pay interest on the loan.
Most of these levy requests must be approved by the state, especially if the state gives matching funds or contributes. A bank or a financial institution will sell and oversee the bond.
Voters provide their approval for a school district to raise taxes to pay for a loan or a bond.
The bonds, also known as IOUs, are sold by a financial institution and the proceeds are given to the school system.
The bond and interest are paid back to the bondholders by the tax money over a period of years.
What bonds are free from federal taxes?
Federal income from state, city, and local government bonds (municipal bonds, or munis) is normally tax-free. However, you must record this income when you file your taxes.
In most cases, municipal bond income is tax-free in the state where the bond was issued. However, take in mind the following:
- Occasionally, a state that normally taxes municipal bond interest would exempt special bonds when they are issued.
Municipal bond income may potentially be free from local taxes, depending on your state’s regulations. For further information on the rules in your state, see a tax advisor.
Are my bonds tax-exempt?
- State and municipal taxes are not levied on Series I savings bonds. You won’t have to pay state or local taxes on the interest income you earn if you invest in Series I savings bonds. That means you’ll have more money in your pocket at the end of the year than if you owned a traditional bond.
- Federal taxes apply to Series I savings bonds. The interest income you generate while holding I bonds will be taxed by the federal government. This is because they are a “zero-coupon” bond, which means that you won’t receive regular checks in the mail; instead, the interest you earn is added back to the bond’s value, and you’ll earn interest on your interest.
How do I go about purchasing tax-free bonds?
These tax-free bonds are available in both physical and demat form to investors. The subscription period for tax-free bonds is open for a limited time, and you must purchase these bonds within that time frame. If the bonds are purchased in tangible form, the investor must provide his or her Permanent Account Number (PAN).
Who is responsible for the bond?
A judge determines the amount of bail. If the defendant is unable to pay the bail sum on their own, a Bail Bond can be obtained from a bail bondsman. A defendant is normally required to pay a bail bondsman 10% of the bail amount to post a bail bond.
What is the purpose of tax-exempt bonds?
Every state has a state-chartered bond authority. Healthcare facility authority, housing finance agencies, higher education facility authorities, and industrial development finance authorities are all examples of these. Energy efficiency retrofits for existing facilities owned by eligible borrowers are among the projects that are eligible for those powers. The federal tax code defines the following individuals as eligible borrowers for tax-exempt bonds:
Tax-exempt bonds typically have lower interest rates and longer tenors than taxable bonds, making them an ideal and appealing way for qualifying borrowers to fund energy efficiency or renewable energy projects.
The term “tax-exempt” refers to the fact that the interest component of bond debt service payments is exempt from federal and, in some cases, state and local income taxes. As a result, the interest rate will be lower than a taxable bond in terms of credit quality and bond length. Fixed interest rate bonds with 10- to 15-year durations are prevalent. Tax-exempt bonds also have a large market of potential buyers. The ability to sell bonds is always contingent on the borrower’s credit quality, however credit improvements can help the bond’s credit quality.
When clean energy finance initiatives target the eligible industries, state and municipal governments should consider tax-exempt bonds as a financing option because of the lower rate, longer duration, and deep buyer market (listed above). It is recommended that state and municipal governments meet with respective bond authority to discuss how they might engage in local or state financing initiatives.
Bond authorities, as public bodies, are often mission-driven and focused on employing their financial resources for the greater good. To accomplish state economic development goals, such as encouraging lending to small and medium-sized businesses, several authorities also issue taxable bonds and offer other financial products. Bond authorities can serve as a conduit for finance as well as a marketing partner; they already have loan portfolios and can, for example, approach their current borrowers with an offer of energy efficiency or renewable energy engineering evaluations and services, if they are available.
Low-cost funding is helpful in driving project development, but it must be combined with marketing and project development. Bond authorities and state and local government energy efficiency finance initiatives could establish natural alliances. Utilities, energy efficiency and service companies, end-user associations (for hospitals, higher education, private schools, and industry), and others can pool their resources to generate project deal flow and market energy efficiency/renewable energy finance products that the bond authority can arrange.
Private Placements Versus Capital Markets Bond Sales
Loans for energy efficiency retrofits of existing facilities are typically minimal, ranging from $75,000 to $150,000. When it comes to arranging funding, streamlining bond issuance procedures, managing transaction costs, and finding interested bond purchasers, these tiny loan sums might be difficult.
Bond authorities are, in general, conduits for financing rather than lenders. That is, they issue bonds, but bond purchasers must be found and the borrower’s credit must be approved. Bonds can be offered in the capital markets as a public sale with a credit rating from a bond rating agency like Fitch or Standard & Poor’s, or as a private placement to a bond purchaser without a credit rating. A private placement might be as small as $500,000 or as large as $1 million. For smaller bond offerings, certain authorities have established expedited methods.
A public bond sale’s minimum size is usually in the $10 million to $20 million range, if not considerably more. Credit improvements and letters of credit can frequently assist in obtaining a rating from the rating agencies. Some bond authority can fund projects with their own funds, then pool them and refinance via a bond issue. Alternatively, the bond authorities might collaborate with a partner financial institution to originate renewable energy loans, which could subsequently be pooled for refinancing via a bond sale.