On November 3rd, 2015 the Town of Chapel Hill, NC passed a bond referendum that appropriated $5.2 million for solid waste facilities and $5.9 million for stormwater improvements. Both were General Obligation (GO) bonds where the town pledged its full faith and credit via taxing authority to repay the debt over a specified term. General obligation bonds are regarded as “safer” than bonds backed by a single revenue source, and generally command lower interest rates and lower reserve fund requirements. A bond is a written promise to repay borrowed money on a defined schedule, usually at a fixed rate of interest, for the life of the bond. Bonds represent a large source of capital, but can be a complex and more expensive way to borrow. The high expense results from the legal and other fees and administrative time required for issuing bonds.
There are two primary types of GO bonds: unlimited ad valorem tax debt and limited ad valorem tax debt. Ad valorem taxes are based on the assessed value of property. Unlimited ad valorem tax debt occurs when the government pledges its full faith and credit with no limitations on possible property tax rates. Limited ad valorem tax debt occurs when the government pledges its full faith and credit, but with a cap or restriction on possible property tax rates. Occasionally, a GO bond may be backed by a specific revenue source, as in this case; Chapel Hill has a debt fund with the capacity to repay the debt. A portion of the property tax (8.5 cents per $100 value) is dedicated to the Debt Management Fund and is pledged for the solid waste portion of the bond. As the town pays off existing debt, additional capacity is created in the fund to pay new debt. Thus, there is a renewable dedicated funding source for the repayment of the bonds, so that the repayment of bonds will not compete with other Town funding needs.
The portion of the referendum bonds that will be issued for Stormwater Improvements ($5,900,000) will be paid from the Stormwater Enterprise Fund. An enterprise fund is a financially self-sustaining entity that generally collects revenues through a pay-as-you-go system. For example, the electricity bill you pay goes to the electric company or municipal utility; ideally (and legally with respect to stormwater enterprise funds) none of the municipal general fund budget goes towards these entities and vice versa. It is expected that the Stormwater fee in Chapel Hill will need to be increased about $5 per Equivalent Rate Unit (now $20, up from $15) in order to pay the principal and interest on the stormwater portion of the GO bond issuance.
Bonds are some of the best ways for local governments to finance capital projects for environmental initiatives such as lands purchases, internal energy revolving funds, or greening projects. Bonds can be a great method for financing environmental projects because they are structured so that those who benefit from the good or service pay for it. Property tax revenues or fees are used to pay back investors for the bonds. Who pays the property taxes? In this case, property owners or service consumers who benefit from stormwater abatement.
When a local government purchases some sort of capital good, it’s known that the project will A) take some time to construct and B) the capital good has a long life-span. Having to immediately pay for a capital project would put all of the financial burden upon the current residents, who might not even live there in 20 years when new residents could still be benefitting from the project. Having a repayment schedule allows local governments to spread the cost out, instead of frontloading the burden on current residents. This additional time leads to increased costs for the government via interest, but is not too much considering government bonds get some of the lowest interest rates due to their tax-free status. Therefore, intergenerational equity is something that needs to be considered when issuing bonds. Loading later generations with debt may be considered unfair if they don’t receive the benefits of the good or service. Discretion and consideration of the useful life of a good should be taken into account when creating and voting for a bond.
From the average citizen investor’s perspective, bonds can be a great addition to an investment portfolio. The low yielding interest is offset by the tax-free status and low risk of the investment, making it a reliable source for hedging more risky assets. To be clear, not all bonds are created equal; for instance, some municipalities’ bonds are riskier, for example Detroit, who has an A rating, (compared to Chapel Hill’s A AA rating). Overall, however, less than 1% of municipal bonds have defaulted. These attributes make GO bonds very enticing to the average citizen, and because of that make it a great option to fund environmental capital projects: everybody wins.
Griffen Rice is first year MPA student in the University of North Carolina’s School of Government and serves as a research assistant for the Environmental Finance Center. Griffen earned his B.A. in Political Science and Philosophy and B.S. in Economics from the University of North Texas.
The contents of all posts authored by students are solely the responsibility of the authors. Statements made and opinions expressed are strictly those of the authors and not the Environmental Finance Center or The University of North Carolina at Chapel Hill.
I am curious if you are advocating the use of General Obligation bonds in place of Revenue bonds, and if so, why?
I have a feeling Chapel Hill going to referendum had more to do with the size, assets and revenues of their Stormwater fund, and that they do not have a combined enterprise system.
I appreciate you writing about bonds, as it is a small piece of the government finance world, yet one that is all too often misunderstood, overlooked, and outright feared.
Hi Chris,
Thanks for the question. In short, it depends on what you are trying to accomplish. Revenue Bonds are funded by the project that it paid for so the revenue stream is narrower, while General Obligation Bonds are guaranteed by the municipalities taxing authority. Additionally, the voting characteristic of the General Obligation Bond adds a political dimension when dealing with finance.
In the case of Chapel Hill it is probable that they were looking for approval from their constituents, since increasing spending can be a controversial topic given the political climate. When the possibility of a Revenue Bond was considered the cost and interest rates were higher so Chapel Hill was trying to spend wisely. Lastly, issuing a Revenue Bond in some instances puts limitations of the utility’s ability to set rates, so I believe they were trying to prevent any possibility of a loss of autonomy.
Hope this helped, Griffen Rice