What are Special Tax Bonds? Definition, Mechanics, and Benefits

A special tax bond is a type of municipal bond issued by state or local governments to finance community projects, such as highways, schools, or hospitals. Unlike general obligation bonds, which are backed by the issuer’s full faith and credit, special tax bonds are repaid using revenue generated from specific taxes imposed for the purpose of servicing the debt.

Special tax bonds blend characteristics of both general obligation and revenue bonds. They are secured by the revenue derived from designated taxes, ensuring investors’ repayment. These bonds commonly finance projects benefiting the public, with their repayment tied to taxes related to the funded project.

Special tax bonds operate on the principle of earmarking revenue from particular taxes to service the bond debt. Municipalities may levy excise taxes on goods like gasoline or tobacco, or special assessment taxes on properties benefiting from the financed project. This revenue stream is then used exclusively for interest and principal payments on the bonds.

Investors in special tax bonds receive periodic interest payments until the bond matures, at which point the principal is repaid. These bonds offer a reliable income source and are considered relatively secure due to the dedicated revenue stream. However, they may carry higher risks compared to general obligation bonds, depending on the stability of the tax base supporting them.

A subtype of special tax bond is the special assessment bond. These bonds guarantee repayment through taxes levied on residents directly benefiting from the project financed. For instance, a new freeway project might be funded through special assessment bonds, with nearby residents facing increased property taxes to cover interest payments.

Special assessment bonds often involve direct community participation, as residents benefiting from the project may choose to invest in the bond issue. This investment can offset the additional taxes imposed for bond repayment, fostering local support for infrastructure development initiatives.

Special tax bonds offer a dedicated revenue stream for repayment, making them relatively secure investments. However, their safety depends on the stability of the tax base supporting repayment and the overall financial health of the issuing municipality.

Special tax bonds may be repaid using excise taxes on goods like gasoline or tobacco, or special assessment taxes on properties benefiting from the financed project. These taxes are specifically earmarked for bond repayment and are not derived from general taxation.

Unlike general obligation bonds, which are backed by the full faith and credit of the issuer, special tax bonds are repaid using revenue from specific taxes imposed for the purpose of servicing the debt. This revenue is earmarked exclusively for bond repayment and is not derived from general taxation.