General Obligation Bond

A general obligation bond, or GO bond, is a municipal bond whose repayment rests on the issuer's general credit rather than on a pledged asset or a dedicated revenue stream. The SEC's investor glossary defines it as "A municipal bond not secured by any assets; instead it is backed by the issuer's power to tax residents to pay bondholders." The MSRB's definition is more guarded about what that backing consists of: a GO bond "Typically refers to a bond issued by a state or local government that is payable from general funds of the issuer, although the precise source and priority of payment for general obligation bonds may vary considerably from issuer to issuer depending on applicable state or local law. Most general obligation bonds are said to entail the full faith and credit (and in many cases the taxing power) of the issuer, depending on applicable state or local law."

The municipal bond page introduces the two basic municipal pledges, the taxing power behind a GO bond and the project revenue behind a revenue bond, and answers the question of how they differ. This page is about the GO pledge itself: what "full faith and credit" promises, the difference between a tax that is limited and one that is not, how the pledge differs between a city and a state, and the neighboring structures that are easy to mistake for it.

"Full faith and credit" is a commitment whose shape varies. The MSRB defines the phrase, in the GO context, as "the commitment of the issuer to repay the bonds from all legally available funds, including a good faith commitment to use its legal powers to raise revenues to pay the bonds, although the precise nature of such commitment may vary considerably from issuer to issuer depending on applicable state or local law." That is a promise to find the money, backed by the issuer's whole treasury and its power to raise more, rather than a lien on anything in particular. The SEC's phrase "not secured by any assets" means exactly that: a GO bondholder has no collateral to seize. The holder's security is the issuer's willingness and legal ability to tax, and because both are set by state and local law, the same words on two bonds from two states can describe two different promises.

Local and state pledges usually rest on different sources. The MSRB observes that "General obligation bonds issued by local units of government often are payable from (and in some cases solely from) the issuer's ad valorem taxes, while general obligation bonds issued by states often are payable from appropriations made by the state legislature." The SEC's bond guidance makes the same point: local GO bonds "are often payable only from property taxes while general obligation bonds issued by states are often said to entail the full faith and credit (and in many cases the full taxing power) of the issuer." An ad valorem tax, in the MSRB's definition, is "A direct tax calculated "according to value" of property," and it is "normally the one substantial tax that may be raised or lowered by a local governing body without the sanction of superior levels of government," subject to any rate limits the state imposes. A city's GO bond is therefore, in substance, a claim on its property tax base.

Unlimited tax and limited tax are the two species that matter to a holder. The MSRB defines an unlimited tax bond as "A bond payable from ad valorem taxes that are not limited by law in rate or amount," and a limited tax general obligation bond as "A general obligation bond payable from ad valorem taxes that are limited by law in rate or amount." The difference is what happens when the tax base shrinks. Behind an unlimited tax pledge the issuer can raise the rate as far as is needed to cover debt service, and the pledge commits it to do so. Behind a limited tax pledge the rate stops at the legal cap, and if the capped levy no longer covers the payments the shortfall has to come from other general funds or does not get paid. Two bonds both labeled "general obligation" can sit on opposite sides of that line, and the official statement is where the answer is printed.

Voter approval is the usual gate. The MSRB describes a bond referendum as the process "whereby the voters of a governmental unit are given the opportunity to approve or disapprove a proposed new issue of municipal securities," and notes that "An election is most commonly required in connection with general obligation or full faith and credit bonds." Because a GO bond commits the taxpayers' future, state constitutions and statutes commonly require the taxpayers' consent first, which is one reason issuers sometimes prefer structures that do not.

Three structures that sit next to a GO bond without being one. A moral obligation bond adds to its primary security "a non-binding covenant that any amount necessary to make up any deficiency in debt service will be included in the budget recommendation made to the governing body," but, as the MSRB stresses, "The governing body, however, is not legally obligated to make such an appropriation." A double-barreled bond is "secured by both a defined source of revenue (other than property taxes) and the full faith and credit or taxing power of an issuer that has taxing powers," a revenue bond with a GO pledge behind it. A special tax bond is "secured by revenues derived from one or more designated taxes other than ad valorem taxes," such as sales, cigarette, fuel or business license taxes; it is a tax-backed bond but not a general obligation, because only the named tax is pledged. Reading the pledge language rather than the marketing label is what separates these.

What the pledge does not do. A GO pledge does not make the bond federal-tax-exempt or taxable; that is a separate question governed by IRC 103 and covered on the municipal bond page. It does not set the bond's credit rating, which is a rating agency's opinion of the issuer's capacity and willingness to pay, covered on the bond rating page. And it is not a guarantee by any government other than the issuer. If an issuer's finances fail, what a GO bondholder actually recovers depends on the specific pledge, the issuer's other obligations and the law of that state, which is exactly why the MSRB and the SEC both hedge their definitions with the words "may vary."

A state or local government proposes to borrow for a public purpose, obtains whatever approval its law requires, often a vote, and issues bonds that pledge its full faith and credit and, in most cases, its taxing power. Debt service is paid from the general fund each year, which for a local issuer usually means from the property tax levy. If the levy is unlimited, the issuer sets the rate each year at whatever level covers its obligations; if it is limited, the rate is capped and the issuer must cover any gap from other resources.

A hypothetical example with invented figures. A town has a taxable assessed value of $2,000,000,000 and annual debt service on its GO bonds of $15,000,000. Covering that from property taxes requires a levy of $15,000,000 ÷ $2,000,000,000 = 0.75 percent of assessed value, or $7.50 per $1,000 of value. A home assessed at $400,000 pays $3,000 a year toward the bonds.

Suppose assessed values fall 20 percent, to $1,600,000,000.

Under an unlimited tax pledge, the town raises the rate to $15,000,000 ÷ $1,600,000,000 = 0.9375 percent, or $9.375 per $1,000. The same home, now assessed at $320,000, pays $3,000 as before. The bondholders are paid in full; the taxpayers carry the adjustment.

Under a limited tax pledge capped at $8.00 per $1,000, the most the levy can produce is $8.00 × 1,600,000 thousands of value = $12,800,000, leaving a shortfall of $15,000,000 − $12,800,000 = $2,200,000. The town must find that from other general funds, cut something else, or fall short on the bonds. Same town, same bonds, same label; the cap is the difference between the two outcomes, and it is why the two kinds of GO bond are rated and priced differently.

Pros

• The pledge reaches the issuer's whole tax base rather than one project's revenue, so a single failed project does not by itself impair payment.
• Voter approval and constitutional debt limits impose discipline on how much GO debt an issuer can take on.
• An unlimited tax pledge commits the issuer to raise rates as needed, which is among the strongest promises a municipal issuer can make.
• Interest is generally exempt from federal income tax, subject to the exceptions the municipal bond page explains.

Cons

• The bond is not secured by any asset, so the holder's remedy in a default is a claim against a government's willingness and legal ability to pay, not collateral.
• The content of "full faith and credit" varies by state and local law, and a limited tax pledge can leave a shortfall the issuer is not obliged to cover.
• A shrinking tax base, population loss or a large unfunded pension can erode the capacity behind the pledge over decades.
• GO bonds from small issuers can be thinly traded and hard to price.
• A moral obligation or special tax bond can be mistaken for a GO bond by a buyer who reads the issuer's name rather than the pledge.