Revenue bonds are a specialized type of municipal bond issued by state or local governments (or their agencies) to finance infrastructure and public projects such as roads, bridges, airports, water systems, and public facilities. The defining feature of revenue bonds is that their repayment comes exclusively from the income produced by the specific project they fund, rather than from a government’s general tax revenues. This distinguishes them from general obligation bonds, which are backed by the issuing government’s taxing power and are considered less risky.
How Revenue Bonds Operate
When a government entity issues a revenue bond, it essentially borrows money from investors who buy these bonds. The capital raised finances the construction, maintenance, or improvement of a public project. Once operational, the project generates revenue — for example, tolls from a new highway, fees from an airport, or payments for water and sewer services. This income is then used to repay the bondholders, covering both principal and interest.
The flow of funds is cyclical: bond issuance → project funding → revenue generation → debt service and operation costs. This means the project is designed to be largely self-sustaining.
Why Governments Prefer Revenue Bonds
Municipalities favor revenue bonds for several reasons:
- No Tax Increase Required: Since repayment comes from project revenues rather than taxes, this option avoids raising or adding new taxes, which can be politically sensitive.
- Project-Specific Financing: It establishes a clear, direct link between the bond issuance and the infrastructure it supports, making the use of funds transparent for taxpayers and investors.
- Off-Balance-Sheet Financing: Sometimes, revenue bonds may not count against a government’s general debt limits, allowing more borrowing flexibility.
Examples of Revenue Bond-Funded Projects
Revenue bonds fund many everyday infrastructure projects:
- Toll Roads and Bridges: Toll fees pay back bonds issued for construction or upkeep. The iconic Golden Gate Bridge is an example.
- Airports: Airports issue revenue bonds for terminals and runways; fees paid by airlines and passengers fund repayment.
- Water and Sewer Systems: Monthly utility bills contain charges that service bonds financing infrastructure improvements.
- Public Universities and Hospitals: Dormitories, academic buildings, and healthcare facilities may be funded with revenue bonds, repaid through fees and services.
- Sports and Convention Centers: Income from events, ticket sales, and rentals help repay bonds issued for these venues.
Who Benefits and Who Invests?
Residents using the funded services benefit through improved infrastructure without direct tax hikes, though they may see service fees or tolls corresponding to bond repayment needs. Investors include individual buyers seeking tax-exempt income, municipal bond mutual funds and ETFs for diversification, and institutional investors like pension funds looking for steady returns.
Revenue bonds are generally exempt from federal income tax, and often state and local taxes for residents in the issuing state, enhancing their appeal. However, some revenue bonds categorized as private activity bonds may be subject to the Alternative Minimum Tax (AMT). Consulting a tax professional is advisable.
Investor Considerations and Risks
Because repayment depends on the project’s revenue, these bonds can carry higher risk than general obligation bonds. Investors should evaluate:
- The viability and demand for the project (stable utilities versus discretionary venues).
- Credit ratings assigned by agencies such as Moody’s or S&P.
- Bond maturity and callable features that might affect income timing.
- Diversification across projects and locations.
Higher yields often signal increased risk, so comparing yields and ratings is essential to making informed investment decisions.
Common Misunderstandings
- Not All Municipal Bonds Are Revenue Bonds: Many municipal bonds are general obligation bonds backed by taxing power.
- Revenue Bonds Are Not Risk-Free: They depend on specific project revenues, which may fluctuate or fail.
- Highest Yield Isn’t Always Best: Elevated yields could reflect higher risk.
Summary
Revenue bonds enable governments to fund public projects without raising taxes by relying on the income those projects generate. For investors, they offer a tax-advantaged income stream but require careful evaluation of the associated project risks.
For more, see our articles on Municipal Bonds and General Obligation Bonds.
Useful References
- IRS Publication 9475 (for municipal bond tax considerations)
- Investopedia: Revenue Bond
- FinHelp’s Municipal Bonds Glossary
This comprehensive understanding helps residents and investors navigate the benefits and risks of revenue bonds effectively.
