A municipal bond is a debt issued by a government authority, whether that be federal, state, local, or a municipality. Municipal bonds are considered low risk, which means they also pay low interest. These low-interest payments are advantageous to the issuing authority, as it reduces their cost of debt, compared to corporate bonds. The issuing authority uses its bonds to pay for capital expenditures. Non-capital expenditures (i.e., expenses) are paid for with revenue from taxes.
Most municipal bonds are exempt from federal taxes and some are exempt from state taxes. Because of these exemptions, high-income investors buy municipal bonds for their taxable accounts rather than retirement accounts. Municipal bonds are callable, which means the issuing authority can pay off the bond early, decreasing its overall yield.