What Is an Unlimited Tax Bond?
Unlimited tax bonds are municipal bonds guaranteed by the full faith and credit of a government that can levy taxes until the debt is repaid.
The repayment of an unlimited tax bond is based on the issuer’s ability to levy taxes on its residents; a municipality may increase property taxes accordingly to cover its payments and obligations.
Key Takeaways
- Feasible Taxation Mechanism: Unlimited tax bonds are municipal bonds guaranteed by the full faith and credit of a government that can levy taxes until the debt is repaid.
- Enhanced Credit Ratings: These bonds may have higher credit ratings and offer lower yields compared to other municipal bonds of the same maturity.
- Voter-Approved: They can only be issued when taxpayers vote to approve them, indicating strong demand and support for these bonds.
The Fundamentals of Unlimited Tax Bonds
Unlimited tax bonds fall under the category of tax-supported bonds, also called general obligation (GO) bonds. GO bonds enable local governments to generate income streams for public amenities such as roads, parks, equipment, and bridges, typically funding projects that serve the community.
Revenue bonds are another type of GO bond, supported by revenue streams from projects such as toll bridges, highways, local stadiums, or essential services, including water, sewer, and electricity providers.
The level of taxation allowed by a specific GO bond may be categorized as either limited or unlimited.
Unlimited Tax Bond vs. Limited Tax Bond: A Comparative Analysis
Backed by the full taxing power of the issuer, unlimited tax bonds can utilize property taxes, sales taxes, special taxes, and various other income sources to repay the bonds and the accrued interest owed to investors. Conversely, limited tax bonds are secured by the issuer’s limited taxing power, such as a town’s property tax subject to an imposed maximum rate.
While issuing authorities of unlimited tax bonds theoretically have the liberty to raise taxes without restriction, practically, this can be challenging. Credit analysts often assess an issuer’s capacity to enforce penalties and collect overdue taxes when rating these bonds. With government guarantees, unlimited tax bonds typically feature higher credit ratings and offer lower yields compared to similar maturity municipal bonds.
Historically, unlimited tax municipal bonds have been considered low-risk primarily because their issuance necessitates voter approval, signifying public support. The positive voter approval often incorporates more than adequate assets or taxing power to ensure investor repayment.
On the other hand, limited tax bonds require the local government to raise property taxes, if required, to fulfill existing debt service obligations. Nonetheless, there is a statutory cap on how much they can increase the property taxes.
%
Related Terms: Municipal Bonds, General Obligation Bonds, Revenue Bonds, Credit Ratings, Property Taxes.
References
Get ready to put your knowledge to the test with this intriguing quiz!
---
primaryColor: 'rgb(121, 82, 179)'
secondaryColor: '#DDDDDD'
textColor: black
shuffle_questions: true
---
## What is an unlimited tax bond?
- [ ] A bond with no maturity date
- [ ] A bond that has fixed interest payments
- [x] A bond backed by the issuing entity’s power to levy taxes without limit
- [ ] A bond that is tax-exempt for investors
## Which type of entity is most likely to issue an unlimited tax bond?
- [x] Municipal governments
- [ ] Private corporations
- [ ] Non-profit organizations
- [ ] Federal government
## What is the primary benefit for investors in unlimited tax bonds?
- [ ] The potential for high capital gains
- [x] Assurance of repayment through unlimited taxing power
- [ ] Immunity from default risks
- [ ] No need for credit ratings
## How are unlimited tax bonds typically secured?
- [ ] By corporate assets
- [ ] Through revenue from projects
- [x] By the issuing government’s authority to levy unrestricted taxes
- [ ] By shares of public stock
## For what type of projects are unlimited tax bonds usually issued?
- [ ] Funding new business startups
- [x] Public infrastructure projects
- [ ] Research and development initiatives
- [ ] Private housing developments
## Which risk is associated with unlimited tax bonds for investors?
- [ ] Interest rate fluctuations
- [x] The political risk of taxpayer resistance to high taxes
- [ ] Corporate bankruptcy
- [ ] Changing federal regulations
## How do unlimited tax bonds differ from limited-tax municipal bonds?
- [x] Unlimited tax bonds allow issuers to levy taxes without limit, whereas limited-tax bonds cap the amount of tax levy.
- [ ] Unlimited tax bonds must be repaid in gold, limited-tax bonds do not.
- [ ] Unlimited tax bonds cannot be traded in secondary markets.
- [ ] Unlimited tax bonds require voter approval, limited-tax bonds do not.
## What is a unique feature that gives unlimited tax bonds credit strength?
- [ ] Collateral of physical assets
- [ ] Higher interest rates compared to other municipal bonds
- [x] The unrestrained ability of issuers to increase property taxes
- [ ] Backing by the federal government
## What makes unlimited tax bonds appealing to municipal bond investors?
- [ ] Flexibility in investing without predefined terms
- [x] Reduced risk due to the issuer’s power to collect enough taxes to meet bond obligations
- [ ] Higher risk activities promising higher returns
- [ ] Invitation to proactive management and trading
## Why might a municipality prefer to issue an unlimited tax bond over other types of bonds?
- [ ] To expedite project funding without voter approval
- [ ] To provide higher interest rates to attract more investors
- [ ] To reduce administrative overhead
- [x] To offer lower yields due to the higher security of the bond, decreasing overall borrowing costs
These quizzes will help participants to understand the general concept, peculiarities, benefits, and risks associated with unlimited tax bonds according to the information provided in financial dictionaries like Investopedia.
