What Is Special Tax Bond?

Special tax bonds are a type of municipal bond that are typically repaid with tax revenues that are generated by a specific activity or asset. They are a type of hybrid security that combines the features of both general obligation bonds and revenue bonds. Special tax bonds are repaid using either excise taxes or special assessment taxes, but they cannot be repaid using ad valorem taxes.

Basics

Municipal revenue bonds, commonly known as special tax bonds, constitute a distinctive class of municipal bonds. They are structured such that their repayment is facilitated through the revenue generated from taxes imposed on a pre-existing activity or asset, exclusively earmarked for the bond's purpose.

Exploring Special Tax Bonds

Municipal bonds, often issued by local or state governments, serve as a financial means to support various community projects, including infrastructure, healthcare facilities, and educational institutions. Notably, a particular subset of municipal bonds, known as special tax bonds, draws its backing from revenue generated via targeted tax increments.

Special tax bonds are a unique financial instrument, blending attributes of both general obligation and revenue bonds. They source their debt servicing from funds generated through specialized taxation, all while being fortified by the unwavering faith and credit of the municipal issuer. Typically, these bonds impose specific taxes on the broader populace, the revenue from which is collected to meet the interest and principal obligations of the outstanding bonds.

Purchasers of special tax bonds receive regular interest payments from the issuer throughout the bond's tenure, culminating in the principal repayment upon maturity. This financial commitment is upheld through tax increments expressly levied for debt redemption, often utilizing excise or special assessment taxes instead of ad valorem taxes.

Special tax revenue can encompass a variety of sources, such as taxes on gasoline, tobacco, hotel stays, road usage, and sales, to name a few. In contrast, ad valorem taxes are generally excluded from consideration in the context of these bonds. Notably, the generated revenue must be exclusively allocated to fulfill obligations towards bondholders and the specified project. The bond's indenture or resolution typically outlines the utilization of tax proceeds throughout its lifecycle.

For instance, consider a scenario in which a city issues a special tax bond to finance the construction of a dedicated cancer treatment wing within a hospital. Investors who acquire these bonds anticipate receiving interest income in return for their investment. The city guarantees these interest payments by imposing an excise tax on cigarette sales, with the collected revenue earmarked for servicing the debt owed to bondholders.

Special Assessment Bonds: Funding Community Projects

Special assessment bonds represent a unique category of special tax bonds. These bonds derive their payment security from the revenue generated by levying additional taxes on residents who experience direct benefits from a specific project. In essence, those who directly profit from property improvements are subject to supplementary taxes aimed at servicing the interest payments on the bond issuance.

To illustrate, consider a project like the construction of a new freeway. Residents residing near the proposed freeway might face an elevated property tax based on their anticipated use of the new roadway. It is worth noting that the interest accrued on special assessment bonds is funded by the taxes imposed on the community that reaps the rewards of the development. Consequently, it is not uncommon for members of the benefiting community to invest in these bonds, effectively mitigating the impact of the additional taxes levied to support the bond financing.

Conclusion

Special tax bonds offer a unique funding approach for municipal projects, bridging general obligation and revenue bonds. They rely on specific activity or asset-generated revenues, such as excise or special assessment taxes, excluding ad valorem taxes. This ensures that those directly benefiting from a project bear the financial responsibility, exemplified by residents contributing through additional property taxes when special assessment bonds are issued. These bonds represent an equitable and practical financing solution for essential community developments.