General obligation bond financing

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General obligation bond financing is a method of raising capital in which jurisdictions or organizations borrow funds from investors in order to fund capital projects by promising to repay the debt with interest over time. General obligation (GO) bonds are typically backed by a pledge of the full faith & credit of a state or local government. The issuers of GO bonds typically has the option of raising tax rates or levying new taxes in order to meet its obligation to bondholders. Many local governments GO bonds are secured by a pledge of the issuer’s ad valorem property taxes, whereas state government GO bonds typically are secured by a pledge of the State’s general fund, which may cover personal income tax, corporate income tax and sales tax revenues. Most states legislate that local governments must seek voter approval prior to issuing GO bonds. There are two types of General Obligation Pledge, limited-tax GO pledge and unlimited-tax GO pledge.

CONCEPT


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Goals
Example

A jurisdiction is struggling to pay for badly-needed new schools, roads and bridges to accommodate a growing population. Previously, the jurisdiction has been funding such items out of annual taxes each year. However, funding such items, which are expected to have a useful life spanning several decades each, would require a large increase in current taxes and would require present-day taxpayers to wholly fund something that would continue to benefit taxpayers for years to come. In order to raise the necessary funding, the jurisdiction instead decides to borrow money through GO bonds, which it will pay back from local tax revenues over thirty years. By using GO bonds, the jurisdiction is able to smooth out tax increases over time, develop new infrastructure, and subsequently see its population grow, thereby supporting economic development, ensuring more predictable tax liabilities, and aligning the payment of taxes for such investments with the many-year beneficiaries of them throughout the assets' useful lives.

The New York City, for instance, issued $950 million of GO bonds in 2014 to fund its infrastructure, [1] In California, counties, cities and school districts may use GO bonds to finance the acquisition, construction, or completion of projects involving " real property" such as hospitals, parks and school buildings. The government issued $820 million of GO bonds to support the funding. [2]

Tradeoffs

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Tradeoffs of implementing this policy may include:

  1. The jurisdiction is on the hook to pay back the general obligation bond even no matter what and might worsen the debt situation, while a revenue bond project might limit the jurisdiction's liability.
  2. Requirement to pay back GO bonds is legally prioritized above other potential municipal expenditures and services, which could face budget cuts or require tax increases if debt service costs outstrip local finances.
  3. GO bonds may require the use of public referenda to approve bond issuance, which tends to be a difficult task.
  4. Bondholders may require higher interest rate when the credit rating is low during the economic downturns.
  5. Tax-exempt on GO bonds might reduce the overall tax revenue.
Compatibility Assessment

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If answered yes, the following questions indicate superior conditions under which the policy is more likely to be appropriate:

  1. Do future revenue and expense forecasts indicate that the bond issuer faces little risk of not being able to repay the bonds?
  2. Would the GO bonds be used to finance non-revenue producing capital expenditures (e.g., schools), which are unlikely to be able to be funded via revenue bonds, user fees or other sources??
  3. Would the GO bonds be likely to receive a high credit rating, resulting in favorable interest rates and borrowing capability??
  4. Does the jurisdiction possess, or can it secure, the competency and expertise necessary to issue bonds?
  5. Does the jurisdiction have a successful track record of completing capital projects on-time and under budget?
  6. Whether or not a jurisdiction has a reserve fund?
  7. Whether or not the projects are vital to the continued maintenance and growth of the tax base?
  8. Whether or not the expenditures are legally permissible for tax-exempt bonds?
Design

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The following questions should be considered when determining how to implement this policy

  1. What amount of bonds will be issued?
  2. What interest rates are likely to be required by bond investors?
  3. What is the size and composition of the tax base?
  4. What will be the total impact of debt service on the annual budget be going forward, and how will it be funded (e.g., by cutting services or raising taxes)?
  5. Will the jurisdiction itself issue the bonds, or will another government entity (such as a public authority or school district) issue the bonds?
  6. How will the jurisdiction manage the expenditure of such funds to ensure that the bonds remain tax-exempt?
  7. What is the socio-demographic profile of its residents?
  8. What timelines, if any, will be considered for potential re-financing at lower interest rates?


ADOPTION


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Adopters


STAKEHOLDERS


Supporters

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Opponents

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  • Constituent Groups - Commercial Property Owners. Assumption: Commercial property owners would like to limit their property taxes as much as possible while GO bonds are back largely by ad valorem taxes. [8]
  • Government Agencies - Departments of Taxation. Assumption: The issuers have always the option of raising tax rates or levying new taxes in order to meet its obligation to bondholders. Departments of taxation would thus meet the great challenges on political acceptance of implementing such actions.


REFERENCES


Research

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Resources

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Footnotes
  1. The City of New York Announces Successful Sale of General Obligation Bonds March 2014
  2. http://www.bloomberg.com/news/articles/2014-03-06/california-readies-1-6-billion-general-obligation-bond-sale California prepares 1.6 billion General Obligation Sale
  3. http://bonds.about.com/od/munibonds/a/The-Difference-Between-General-Obligation-And-Revenue-Bonds.htm
  4. http://comptroller.nyc.gov/general-information/nyc-bonds/#jquery5
  5. http://www.treasurer.ca.gov/graphs/go.asp
  6. https://www.austintexas.gov/department/capital-planning/about
  7. http://www.mn.gov/mmb/images/14aug.pdf
  8. Steven M. Rice, How to Analyze General Obligation Bonds on the Series 7 Exam, 2nd Edition
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