Tax anticipation notes are used by state and local governments to obtain financing before tax revenues have been received. When the issuing government entity eventually receives tax revenues, the resulting funds are used to retire the tax anticipation notes. The funds received from issuance of the notes are useful for smoothing out the differences between the need to pay for obligations and the inflow of cash from tax receipts, and may be used to pay for capital improvements or to fund ongoing operations.
Investors obtain two benefits from investing in these notes, which are:
- The interest income earned on the notes is not taxable, which can be a considerable benefit for higher-income investors.
- The future revenue with which the notes are paired can be pledged to repaying the notes, so there is some degree of assurance regarding repayment of the notes.
Tax anticipation notes are typically issued at a discount. The difference between the discounted price and the face value of the notes represents the effective interest rate on the notes. The duration of the notes is usually no more than one year.