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The Story Behind Municipal Bonds

Wednesday, Aug 13, 2014

The concept of municipal debt has been around for centuries, dating back to the Renaissance period in Italy. However, the first official recording of a municipal bond in the United States took place in New York City in 1812, with the issue of a bond to fund a canal.

The practice spread rapidly throughout the US, with bondholders acquiring approximately $27.5 million in outstanding municipal debt by 1843 and over $200 million by 1860. Growth continued, spurred on by railroads and expansion, untilThe Panic of 1873 and the subsequent depression brought new restrictions on municipal bonds through state laws and constitutional amendments.

Since that time, there have been many cycles of expansion and contraction in the municipal bond market, but these vital investment vehicles remain the lifeblood of cities to this day.

Types of Municipal Bonds

The municipal bonds issued through the majority of the 1800’s were general obligation (GO) bonds – bonds that are backed by the full faith and credit of the issuing municipalityand their ability to raise revenue through property taxes and other levies.

However, in 1897 the city of Spokane, Washington issued a new style of bond to pay for an extension of their city water system. This new style of bond, known as a revenue bond, was backed solely by the revenues generated by the use of the water system. The concept of backing debt through revenue generated solely from the bonded project – or any source other than the traditional tax base of GO bonds – was challenged but upheld by the courts.

Eventually authorities and commissions were created to allow revenue bonds to be issued for areas that were not limited to a single municipality, such as the Port Authority of New York (now known as the Port Authority of New York and New Jersey) that was established in 1921.

Today there are thousands of both GO bonds and revenue bonds in current issue – ranging in size, scope, return, and subsequent degree of risk.

Municipal Bonds and Federal Taxes

The tax-exempt status of municipal bonds was derived from a Supreme Court decision that preceded the current tax code.

The 1894 Wilson-Gorman Tariff Act applied a federal tax on various types of income, including interest on municipal bonds. The act itself was declared unconstitutional in the 1895 case Pollock v. Farmers’ Loan and Trust Company, wherethe Court further ruled that interest on municipal bonds were exempt from federal taxes.

Citing “intergovernmental tax immunity” that prevents state and federal government intrusion on each other’s sovereignty via taxes, the Court reasoned that taxing municipal bond interest income would harm the ability of state governments to borrow money. Thus the Revenue Act of 1913 establishing the federal tax code (as allowed by the 16th Amendment) provided federal tax-exempt status for state and local bond issues.

Work with a municipal bond authority and put a municipal bond specialist to work for you today by contacting THE GMS GROUP. We have a number of municipal bond offerings as well as research and reports to provide our investors with the information they need to make smart investment decisions. Contact us today or call 877-467-0070.