Definition
The term tax-anticipation note refers to securities issued by municipal and state governments to finance a project prior to the receipt of tax revenues. Tax-anticipation notes (TAN) are short-term debt securities that will eventually use taxes to repay expenses associated with the project.
Explanation
When municipal and state governments have a near-term need to finance an emergent project, they will oftentimes issue tax-anticipation notes, which can be used to bridge the timing gap between the collection of tax revenue and an emergent expense. When taxes are eventually collected from citizens, the funds are used to retire the note.
Also referred to as tax-anticipation warrants, these securities are typically issued for 12 months or less, and carry relatively low interest rates since earnings are usually exempt from state and federal income taxes. The agreement between the issuer and investor typically includes:
First Claim: when taxes are collected, the funds will be used to retire the note before diverting the money to any other expense.
Project / Expense: the debt is collected for a specific purpose, and the funds cannot be diverted to pay for any other project or expense.
Maturity: the date on which the securities mature is typically fixed, and is not altered or revised.
Tax-anticipation notes are oftentimes used to fund road construction and building repairs. These notes are one of several options municipal and state governments have at their disposal to fund a short term need. Additional sources of funds include revenue anticipation notes and bond anticipation notes.
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