Purpose

• General obligation bonds finance basic municipal expenses such as costs related to the school system or the construction of roads. These bonds are backed by the "full faith" of the issuing entity. This means that the bond issuer promises to raise enough tax revenue to repay the debt, so general obligation bonds are basically debt obligations of the local taxpayers.
  
  Governments sell revenue bonds to raise money for new projects, such as the construction of a parking lot. The bonds are backed by the project being financed, so the government uses revenue from parking meters or other types of income generating ventures to repay the debt.
  
  

Risk

• Revenue bonds are viewed as riskier investments than general obligation bonds because you stand to lose your money if the project being financed fails to generate sufficient income to repay the bondholders. If a parking lot or toll road makes a loss, the government that issued the bond has no obligation to repay the debt with tax revenues.
  
  You can lose money on a general obligation bond if a municipality becomes insolvent, but this rarely happens because municipalities can increase taxes to cover any cash shortfalls. In California, bondholders take precedence over state employees. This means that if the government runs short of cash, the state cannot pay its employees until it has paid its creditors.
  
  

Interest

• Bond issuers, like all debtors, have to pay interest on borrowed funds. Municipalities are rated for creditworthiness and the most creditworthy government entities can borrow money at the lowest cost. General obligation bonds expose investors to lower levels of principal risk than revenue bonds, which means that the yields on these bonds are typically lower than on revenue bonds. Some highly speculative revenue bonds have very low credit ratings, which means that investors are exposed to a high level of risk. However, these so-called "junk bonds" often provide investors with interest payments well in excess of the rates paid on general obligation bonds.
  
  

Considerations

• Generally, you do not have to pay federal income tax on bond interest payments. However, the federal government only exempts municipal bonds from taxation if the bonds are used to finance something that provide significant benefits to the community. You would have to pay taxes on interest from a revenue bond that was issued to finance the construction of a stadium. However, while many revenue bonds are taxable, some general obligation bonds, such as bonds issued to cover pension plan deficits, are also taxable. Therefore, both revenue and general obligation bonds can provide you with taxable or tax-exempt income.