United States General Accounting Office

GAO Report to the Committee on

Transportation and Infrastructure,

House of Representatives

September 1995 PRIVATE PENSION

PLANS

Efforts to Encourage

Infrastructure

Investment

GAO/HEHS-95-173

GAO United States

General Accounting Office

Washington, D.C. 20548

Health, Education, and

Human Services Division

B-253598 

September 8, 1995

The Honorable Bud Shuster

Chairman

The Honorable Norman Y. Mineta

Ranking Minority Member

Committee on Transportation

 and Infrastructure

House of Representatives

This report responds to your request for information on the role that pension plans might play

in expanding public investment in infrastructure projects, in particular, by implementing the

proposals addressed in the 1993 report of the Commission to Promote Investment in America’s

Infrastructure.

As agreed with your office, unless you publicly announce its contents earlier, we plan no further

distribution of this report until 15 days from the date of this letter. At that time, we will send

copies to the Secretary of Labor; the Secretary of Transportation; the Director, Office of

Management and Budget; and interested congressional committees. Copies will be made

available to others upon request.

Please call Donald C. Snyder, Assistant Director, Income Security Issues, on (202) 512-7204 if

you or your staff have any questions regarding this report. Major contributors to this report are

listed in appendix III.

Jane L. Ross

Director, Income Security Issues
Executive Summary

Purpose The federal government invests billions of dollars annually in the nation’s

infrastructure—highways, mass transit, rail, aviation, water resources, and

wastewater treatment facilities. However, concern about the state of this

infrastructure and the need for additional spending in the face of federal

budget deficits has led to proposals to encourage the nation’s pension

plans to invest in infrastructure projects. The Congress responded to

concern about insufficient infrastructure investment by passing legislation

in 1991 that established the Commission to Promote Investment in

America’s Infrastructure. The Infrastructure Commission studied ways to

encourage infrastructure investment, in particular by pension plans, and

issued recommendations in 1993.

Given ongoing congressional interest in infrastructure and pension issues,

the Chairman and the Ranking Minority Member of the House Committee

on Transportation and Infrastructure asked GAO to (1) identify the role that

current federal policies play in providing incentives for private pension

plans to invest in infrastructure projects and (2) analyze the Infrastructure

Commission’s proposals relating to pension plan investment to determine

how pension plans might respond.

Background The federal government has long played a key role in financing

infrastructure projects through grants and subsidies to state and local

governments. In the 1980s and 1990s, trends such as federal spending

cutbacks, project backlogs, and increasing federal and state budget

deficits led to the perception that the nation had an infrastructure crisis.

While some analysts question the magnitude of the problem, recent studies

estimated that states and localities may need an additional $40 billion to

$80 billion annually to build, operate, and maintain infrastructure facilities.

To address the situation, the Congress created the bipartisan Commission

to Promote Investment in America’s Infrastructure when it passed the

Intermodal Surface Transportation Efficiency Act of 1991 (ISTEA). The

Infrastructure Commission’s task was to study the “feasibility and

desirability” of creating a type of security instrument that would permit

pension plans to invest in infrastructure projects and other methods of

encouraging investment in infrastructure.

Results in Brief Although pension plans constitute a vast pool of capital, they have not

been invested to any significant degree in domestic public infrastructure

because of the combined effects of federal law. Federal law requires

Page 2 GAO/HEHS-95-173 Pension Plan Infrastructure Investment
Executive Summary

pension plans to seek the highest risk-adjusted rate of return on

investments for the benefit of plan participants. It also encourages the

growth of pension plans by exempting their earnings from taxation. At the

same time, to encourage public investment in infrastructure, federal law

provides a tax exemption on interest income to those who invest in

municipal bonds. But pension plans have no incentive to invest in the

lower-interest, tax-exempt municipal bonds generally used to finance

infrastructure projects, since the plans’ earnings are already tax exempt.

To encourage greater investment, the Infrastructure Commission

recommended creating two new, federally sponsored financing entities to

assist projects and attract investors, including pension plans. In reviewing

the Infrastructure Commission’s recommendations, GAO found that

although the proposals might encourage pension plans to invest in

infrastructure projects, many analysts and market participants are

skeptical about whether they are the best way to encourage infrastructure

investment or whether they are needed at all.

The Infrastructure Commission’s proposals would expand federal

subsidies, which under current pension and tax law cost the U.S. Treasury

more than $60 billion in foregone revenue in fiscal 1994. Yet even if the

Infrastructure Commission’s proposals could induce pension plans to

invest, the share of pension plan assets that might go to infrastructure

projects would probably be small.

Given existing federal law on pension plans and municipal bonds, other

options, such as the federal capitalization of state revolving funds, could

be explored. While such options have limitations, they may offer an

alternative way to expand infrastructure investment without relying on

pension plans.

GAO’s Analysis

Federal Policies Create a

Disincentive to Pension

Investment in

Infrastructure and Involve

Large Subsidies

Not only do federal pension policy and the tax exemption for municipal

bonds create a fundamental disincentive for private pension plans to

invest in infrastructure projects, but these laws also involve large federal

subsidies in the form of foregone federal revenue, referred to as a “tax

expenditure.” In fiscal year 1994, exempting pension plan earnings from

taxation resulted in foregone revenue of about $48.8 billion. Nearly

Page 3 GAO/HEHS-95-173 Pension Plan Infrastructure Investment
Executive Summary

$12 billion in revenue was foregone by subsidizing interest on tax-exempt

bonds. The Infrastructure Commission’s proposals could add to these

federal subsidies.

Infrastructure Commission

Proposed New Federal

Incentives

In its 1993 report, the Infrastructure Commission proposed creating two

new entities to provide credit assistance to states and localities that would

make infrastructure projects more attractive to private sector investors.

One entity—the National Infrastructure Corporation (NIC)—would support

projects by purchasing debt securities of selected projects. NIC could

expand investment by creating securities backed by projects it had

supported. Another entity—the Infrastructure Insurance Corporation

(IIC)—would provide additional credit assistance by insuring projects that

could not obtain bond insurance from the private sector. The

Infrastructure Commission also proposed expanding tax incentives,

including the creation of a “public benefit bond” that would distribute

earnings tax free to participants in certain pension plans.

Establishing NIC and IIC would involve additional federal subsidies,

however. For example, the Infrastructure Commission proposed that NIC

and IIC be capitalized through a federal grant of $1 billion per year over 5

years and have a line of credit through the U.S. Treasury. Under current

budget rules, these new costs would have to be offset with spending cuts

or additional tax revenues to avoid increasing the federal budget deficit.

Proposals for Attracting

Pension Plans

The Infrastructure Commission identified three specific ways that pension

plans could participate in infrastructure projects generally through NIC and

IIC:

• Pension plans could invest in the equity of the proposed bond insurer, IIC.

• Pension plans could buy taxable project debt insured by IIC or purchase

securities directly issued by NIC.

• Pension plans could act as lenders directly funding project debt through

purchasing public benefit bonds.

The first two proposals would provide limited opportunities for pension

plan involvement. First, experience with another government-sponsored

bond insurance entity (the College Construction Loan Insurance

Association, or “Connie Lee”) suggests that the amount that would be

invested in the equity of IIC by pension plans would be small. Second, NIC’s

ability to create securities backed by infrastructure projects would take

Page 4 GAO/HEHS-95-173 Pension Plan Infrastructure Investment
Executive Summary

considerable time to develop. Moreover, some market participants doubt

whether securities backed by specific projects could be pooled to develop

the infrastructure securities NIC is supposed to issue. Third, creating a

public benefit bond that would provide tax benefits to pension plan

participants could be attractive as an investment for participants of

defined contribution plans, such as 401(k) plans, in which participants

choose their investment instruments. However, the proposal would

involve expanding tax subsidies and require new administrative

procedures.

Questions Raised About

the Infrastructure

Commission’s Approach,

Federal Role

GAO reviewed economic analyses and held discussions with market

participants in evaluating the Infrastructure Commission’s proposals.

While discussions with some market participants indicated some of the

Infrastructure Commission’s ideas might attract pension plan investment

to infrastructure projects, many economists and market participants were

skeptical. They raised questions about the goal of reallocating pension

capital as well as the need for the federal entities and incentives that the

Infrastructure Commission proposed.

Experts and market participants noted that alternative mechanisms, not

specifically targeted to pension plans, may increase infrastructure

investment. One proposed approach is to amend ISTEA to allow states to

create state transportation revolving funds similar to those established

under the Clean Water Act. While this approach has limitations that

require further study, it may be an alternative way of attracting new

sources of capital to infrastructure projects.

Recommendations GAO is making no recommendations.

Comments by Outside

Experts

Several outside experts reviewed a draft of this report and generally

agreed with GAO’s information. Their technical comments were

incorporated where appropriate throughout the report.

Page 5 GAO/HEHS-95-173 Pension Plan Infrastructure Investment
Contents

Executive Summary 2

Chapter 1 

Introduction

8

The Changing Federal Role in Infrastructure 8

The Infrastructure Investment Debate 9

The Infrastructure Commission’s Recommendations 11

Objectives, Scope, and Methodology 11

Chapter 2 

Federal Laws Create

Disincentives to

Pension Plan

Investment in

Infrastructure

13

Federal Pension Law 13

Tax-Exempt Municipal Bonds Lower Costs to State and Local

Governments

15

Tax Exemptions for Pension Plans and Municipal Bonds Involve

Large Subsidies

18

Chapter 3 

The Commission to

Promote Investment

in America’s

Infrastructure

Proposed New

Federal Incentives

19

Rationale for the Infrastructure Commission’s Proposals 19

Creation of a National Infrastructure Corporation and an

Infrastructure Insurance Corporation

20

Tapping Pension Plan Capital for Infrastructure Financing 22

Evaluating the Infrastructure Commission’s Proposals 23

Chapter 4 

Market Participants’

Perspectives on

Private Pension Plan

Investment in

Infrastructure

26

Private Pension Plan Managers Cite Disincentives to

Infrastructure Investment

26

Market Participants Express Concerns About an Increased

Federal Role

29

Alternative Financing Mechanisms Are Available 31

Page 6 GAO/HEHS-95-173 Pension Plan Infrastructure Investment
Contents

Chapter 5 

Concluding

Observations

32

Appendixes Appendix I: Scope and Methodology 34

Appendix II: Economic Perspectives: Is an Expanded Federal

Role in Attracting Pension Plan Investments in Infrastructure

Justified?

36

Appendix III: GAO Contacts and Staff Acknowledgments 42

Figure Figure 2.1: 30-Year Tax-Exempt Municipal Bond Yields Versus

30-Year Taxable Treasury Bond Yields, 1984-1994

16

Abbreviations

CBO Congressional Budget Office

DOL Department of Labor

DOT Department of Transportation

ERISA Employee Retirement Income Security Act of 1974

ETI economically targeted investment

FHWA Federal Highway Administration

IIC Infrastructure Insurance Corporation

IRA individual retirement account

ISTEA Intermodal Surface Transportation Efficiency Act of 1991

NIC National Infrastructure Corporation

Page 7 GAO/HEHS-95-173 Pension Plan Infrastructure Investment
Chapter 1 

Introduction

Concern over the state of America’s infrastructure—highways, mass

transit, rail, aviation, water transportation, water resources, water supply,

and wastewater treatment facilities1

—has become widespread. The

nation’s interstate highway system has nearly been completed, but

highway, air traffic, and other transportation and environmental problems

are mounting. However, the federal budget deficit has made it increasingly

difficult to fund infrastructure improvements either directly through

federal grants or indirectly through tax exemptions. Consequently, the

Congress and the administration have explored additional financing

methods—including some that involve America’s pension plans,2

 which

were estimated to have over $4 trillion in assets in 1994—to expand

federal, state, and local financing of infrastructure projects.3

The Changing Federal

Role in Infrastructure

Substantial grant funding for infrastructure projects, including highways,

wastewater treatment facilities, and mass transit began between 1956 and

1964.4

 Spending on these programs as a share of total federal spending

1

This is the definition of “infrastructure” suggested by the Congressional Budget Office (CBO).

2

Private pension plans are established by employers in the private sector. Some of these plans are

established under collective bargaining agreements with unions. Public pension plans are those

established by governments at the federal, state, and local levels. This report focuses primarily on

private pension plans.

3

The Department of Labor (DOL) includes infrastructure investment in its definition of “economically

targeted investment” (ETI). ETIs are defined as investments that are selected for the economic

benefits they create in addition to the investment return to the employee benefit (pension) plan

investor. These investments are defined to include infrastructure, job creation, housing, and

community development. While many of the issues concerning ETI and infrastructure investment

overlap, in this report we consider infrastructure investment in a separate manner from ETI. The main

reason for this is to narrow the scope of the issues we address. Another reason is that it is possible to

make a broad distinction between ETIs, which tend to involve issues more relevant to public pension

plan investments, and infrastructure investment, which tends to involve issues more pertinent to

private pension funds. We have issued a separate review of ETI issues. See Public Pension Plans:

Evaluation of Economically Targeted Investment Programs (GAO/PEMD-95-13, Mar. 17, 1995).

4

The Federal Aid Highway Act of 1956 authorized the development of the interstate highway system

and created the Federal Highway Trust Fund. The Federal Highway Trust Fund, which receives

revenue from federal fuel taxes and other highway-related excise taxes on items such as tires, is the

source of funding for highway grants to the states. However, the law did not allow tolls on federally

assisted highways other than those that were already in operation or under construction when the law

was passed.

The Federal Water Pollution Control Act Amendments of 1956 provided the first federal grants for

constructing wastewater treatment facilities. The initial federal commitment was relatively small, but

the Clean Water Act of 1972 increased federal grants to an unprecedented level—$18 billion from 1972

through 1976.

The federal government became heavily involved in supporting urban mass transit infrastructure

development through the Urban Mass Transportation Act of 1964, which provided grants for new or

enhanced rail or bus systems. Federal financing has also helped support the operation of mass transit

systems.

Page 8 GAO/HEHS-95-173 Pension Plan Infrastructure Investment
Chapter 1 

Introduction

peaked in the 1970s. But by the late 1970s, the growth of federal

infrastructure spending had slowed and continued to slow into the 1990s.

According to CBO, the share of all federal spending that was devoted to

infrastructure declined from over 5.4 percent in 1977 to less than 3 percent

in 1992.5

 For example, in the area of environmental infrastructure, the

Congress began to reduce funding for constructing wastewater treatment

facilities in the late 1970s and decided in 1987 to phase out federal

capitalization grants by 1995.

The Infrastructure

Investment Debate

The decline in infrastructure investment as a share of federal

spending—coupled with a growing backlog of infrastructure development

and repair projects, and federal, state, and local budget deficits—led to a

widespread perception of an infrastructure crisis in the 1980s and 1990s.

Estimates of how much investment was needed to resolve the crisis varied

widely. A 1991 Office of Technology Assessment study estimated that

federal, state, and local governments spent about $140 billion annually on

building, operating, and maintaining infrastructure facilities,6

 but others

estimated that $40 billion to $80 billion more was needed each year.7

However, some experts and economists believe that the infrastructure

problem has been overstated. They argue, for example, that the U.S. stock

of “public capital” (that is, infrastructure) rose steadily between 1949 and

1991. Some also contend that past spending on infrastructure means less

can be spent now; the interstate highway system is about 98-percent

complete, for instance, and Americans have the highest quality drinking

5

Total federal spending for infrastructure in fiscal year 1992 was $41.2 billion (in nominal dollars). See

CBO, Updating Trends in Public Infrastructure Spending and Analyzing the President’s Proposals for

Infrastructure Spending From 1994 to 1998 (Washington, D.C.: Aug. 1993).

6

Office of Technology Assessment, Delivering the Goods: Public Works Technologies, Management,

and Finance, OTA-SET-477 (Washington, D.C.: U.S. Government Printing Office, Apr. 1991).

7

National Council on Public Works Improvement, Fragile Foundations: A Report on America’s Public

Works, Final Report to the President and the Congress (Washington, D.C.: U.S. Government Printing

Office, Feb. 1988), pp. 59-73.

Page 9 GAO/HEHS-95-173 Pension Plan Infrastructure Investment
Chapter 1 

Introduction

water in the world. The debate over infrastructure investment has been

extensively explored in the economic literature.8

Policies to Expand

Infrastructure—A Role for

Pension Plans?

Although there is no consensus on the magnitude of any infrastructure

gap, federal, state, and local officials have begun seeking new and

innovative ways to finance development for the 1990s and beyond. For

example, the Congress included the “toll provisions” in section 1012(a) of

the Intermodal Surface Transportation Efficiency Act of 1991 (ISTEA) to

allow tolls to be charged on new, reconstructed, or renovated federal

highways other than interstates. The revenue streams from the tolls make

participating in financing highway projects more attractive to private

investors. Another provision of ISTEA, section 1081, established the

Commission to Promote Investment in America’s Infrastructure (the

Infrastructure Commission) “to conduct a study on the feasibility and

desirability of creating a type of infrastructure security” that would attract

pension plan investors.

Creating securities that would encourage pension plans to invest in public

facilities was a novel idea because private pension plans do not generally

invest in public projects within the United States. Public projects at the

state and local levels are commonly financed through bonds for which the

interest income is exempt from federal taxation. Tax-exempt bonds pay

lower interest rates and, thus, hold down the cost of borrowing for state

and local governments while providing a return to investors comparable

with the after-tax return of taxable securities. At the same time, to

encourage the development and growth of private pensions, the federal

government exempts pension plans’ earnings from taxation.9

 However,

since plans are subject to fiduciary rules under the Employee Retirement

Income Security Act of 1974 (ERISA), which obligate them to seek the

8

A number of researchers raised concerns in the 1980s over public investment in infrastructure. In

particular, estimates published by David Alan Aschauer implied that public capital investment

generates high rates of return, higher even than private capital investment. His work supported the

conclusion that public capital is undersupplied. See “Why Is Infrastructure Important?”, in Is There a

Shortfall in Public Capital Investment?, ed. Alicia H. Munnell (Boston: Federal Reserve Bank of

Boston, June 1990). Aschauer’s work lent strong support to calls for more infrastructure investment

and spurred a lively academic debate, much of it over technical issues of econometrics. Though

Aschauer’s critics acknowledged he had surfaced the importance of public capital, they concluded that

its impact on economic output was smaller than Aschauer found. In Is There a Shortfall in Public

Capital Investment?, see “Discussion” by Henry J. Aaron, pp. 51-63, and Charles Hulten, pp. 104-107.

For a comprehensive survey of the literature, see Edward M. Gramlich, “Infrastructure Investment: A

Review Essay,” Journal of Economic Literature, Vol. XXXII (Sept. 1994), pp. 1176-96.

9

When distributions from pension funds are made to retirees, the income received will generally be

subject to taxation, presumably at a lower tax rate. Thus, pensions represent a tax-deferred

arrangement.

Page 10 GAO/HEHS-95-173 Pension Plan Infrastructure Investment
Chapter 1 

Introduction

highest return (taking risk into account) on their investments, they do not

normally invest in lower-yielding, tax-exempt bonds.

The Infrastructure

Commission’s

Recommendations

The bipartisan Infrastructure Commission, which was appointed by the

President and congressional leadership, made three major

recommendations in its February 1993 report designed to increase

institutional investment, including pension plan investment, in

infrastructure projects:10

• Create a National Infrastructure Corporation (NIC) to leverage11 federal

dollars and boost investment in infrastructure projects; NIC would have the

capacity to become self-sustaining through user fees or dedicated

revenues.

• Create new investment options to attract institutional investors, including

pension plans, as new sources of infrastructure capital.

• Strengthen existing infrastructure financing tools and programs by making

federal incentives more consistent and by providing uniform treatment for

investment in infrastructure projects.

Objectives, Scope,

and Methodology

Given continuing congressional interest in infrastructure and pension

issues, and at the request of the Chairman and the Ranking Minority

Member of the House Committee on Transportation and Infrastructure, we

initiated a study to

• identify the role that current federal policies play in providing incentives

for private pension plans to invest in infrastructure projects and

• analyze the Infrastructure Commission’s 1993 proposals relating to

pension plan investment to determine how pension plans might respond.

In addressing these objectives, we reviewed relevant laws, policies,

reports, Infrastructure Commission hearing testimony, and various

economic analyses. We also interviewed former Infrastructure

Commission officials, corporate executives, government officials, and

experts on infrastructure financing or pension plan issues. For further

details on our scope and methodology, see appendix I.

10Financing the Future: Report of the Commission to Promote Investment in America’s Infrastructure

(Washington, D.C.: Feb. 23, 1993).

11Leveraging involves borrowing through the use of bonds that are guaranteed by the resources

available to a fund or, in this case, a corporation. By borrowing against its resources, the corporation

expands the amount of money available for the desired activities beyond what it could lend directly if

it relied only on its own resources.

Page 11 GAO/HEHS-95-173 Pension Plan Infrastructure Investment
Chapter 1 

Introduction

To ensure the accuracy of our information, we provided a draft of this

report to several outside experts, who generally agreed with our findings.

We incorporated their technical comments where appropriate.

We conducted our review between January 1994 and June 1995 in

accordance with generally accepted government auditing standards.

Page 12 GAO/HEHS-95-173 Pension Plan Infrastructure Investment
Chapter 2 

Federal Laws Create Disincentives to

Pension Plan Investment in Infrastructure

Current federal tax and pension policies are inconsistent with the goal of

having pension plans invest in infrastructure projects to any significant

extent. Fiduciary requirements state that pension plans must invest their

assets for the exclusive benefit of their participants by earning the highest

risk-adjusted return possible. Federal law also exempts the plans’ earnings

from taxation. At the same time, the Internal Revenue Code and current

federal grant and revolving fund programs encourage infrastructure

project sponsors to finance public projects at lower interest rates through

the municipal bond market. As a result, infrastructure projects do not

attract pension plan investment. However, the Infrastructure Commission

did not propose to substantially change the long-standing tax and pension

policies, which together translated into more than $60 billion in indirect

federal subsidies in fiscal year 1994.

Federal Pension Law Federal law does not prevent private pension plans from investing in

infrastructure, but the plans’ investments must meet certain standards.

Private pension plan managers may only make investments that comply

with various fiduciary standards found in ERISA, Taft-Hartley Act

restrictions, Internal Revenue Code provisions, and common law.12 These

fiduciary standards require plan managers to, among other things, carry

out their duties with the same care, skill, and diligence as a prudent

person. These standards have been interpreted to mean that managers

should obtain market-rate returns on their investments.13

DOL, which is responsible for enforcing the fiduciary standards in ERISA,

interprets the standards as permitting infrastructure investment. DOL’s

Solicitor testified before the Infrastructure Commission that nothing in

ERISA’s fiduciary provisions specifically prevents pension plans from

purchasing a security created to encourage investment in infrastructure

facilities. Specifically, a pension plan must

• act solely in the interest of the participants and beneficiaries, and for the

exclusive purpose of providing benefits and defraying reasonable

expenses;

• act prudently;

• diversify plan investments; and

12See Dan M. McGill, Fundamentals of Private Pensions, 5th ed. (Homewood, Ill.: Richard D. Irwin,

1984).

13Pension Plans: Investments in Affordable Housing Possible With Government Assistance

(GAO/HRD-92-55, June 12, 1992), pp. 2-3.

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Chapter 2 

Federal Laws Create Disincentives to

Pension Plan Investment in Infrastructure

• not engage in certain kinds of transactions that may create conflicts of

interests or result in self-dealing.

This guidance generally means that private pension plans may invest in

infrastructure projects only if the investments offer an equal or higher rate

of return, adjusted for risk, as other potential investments. However, a

pension plan can, according to the Solicitor’s statement, consider

“noneconomic” factors even though it is required to act solely in the

interests of its participants. For example, DOL advised a pension plan that it

could invest in a mortgage pool that included only construction projects

built by union labor because the mortgages had to meet rigorous financial

criteria, and the investment was competitive with comparable investments

available in the marketplace. However, according to the Solicitor’s

testimony, DOL has consistently opposed pension plan investments

designed to achieve socially beneficial objectives at the expense of yield or

security.

A key ERISA requirement is that pension plan managers “act prudently.”

Specifically, ERISA requires that a fiduciary use the care that “a prudent

man acting in a like capacity and familiar with such matters would use in

the conduct of an enterprise of a like character and with like aims.” In fact,

the Counsel to the Infrastructure Commission said that only large pension

plans are likely to want to bear the cost of the “due diligence” work to

determine whether an infrastructure investment is prudent.

In Interpretive Bulletin 94-1, issued on June 22, 1994, DOL reiterated its

position that the fiduciary standards applicable to infrastructure are no

different than the standards that apply to other investments. DOL stated

that it issued its bulletin because “a perception exists in the investment

community” that ETIs, including infrastructure, “are incompatible with

ERISA’s fiduciary obligations.” The bulletin stated that sophisticated

long-term investors, including pension plans, may invest in assets designed

to create benefits to third parties in addition to their returns to investors.

That would be possible even though less information about the investment

may be readily available and the investment may be less liquid, may

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Federal Laws Create Disincentives to

Pension Plan Investment in Infrastructure

require a longer time to generate significant investment returns, and may

require special expertise to evaluate.14,15

Tax-Exempt

Municipal Bonds

Lower Costs to State

and Local

Governments

Federal tax laws were designed to help lower the costs to states and

localities for developing and financing public projects. The Internal

Revenue Code exempts the earnings on municipal bonds from federal

taxation; thus, states and localities financing infrastructure projects can

hold down their costs by paying lower interest rates and still attract

investors who do not have to pay taxes on the interest they collect.

Typically, the interest rate paid on tax-exempt bonds is about 15 to

20 percent lower than that paid on taxable bonds of comparable risk and

maturity. Given the high capital costs of some infrastructure projects such

as environmental facilities, the interest savings can be considerable.16

Although tax-exempt bonds help states and localities hold down the cost

of public projects, the comparatively low interest rates they pay make

them relatively unattractive to pension plans, whose earnings are already

tax exempt. The difference between yields on tax-exempt and taxable

bonds changes over time, but we found that taxable bonds consistently

pay a higher rate of return. CBO, for example, found that the yields on

30-year AAA-rated17 tax-exempt general obligation bonds (or bonds that

are issued for state and local projects) have been an average of

1.4 percentage points lower than those on 30-year Treasury bonds since

1989. Our work shows that the yields on the tax-exempt bonds were lower

than those on the Treasury bonds every month during the 11-year period,

as shown in figure 2.1.

14As part of its effort to improve information on ETIs, DOL is creating a clearinghouse for pension plan

managers and other interested parties; it is expected to begin operating during 1995.

15Despite DOL’s clarification of fiduciary rules, ERISA’s diversification and conflict of interest

requirements could continue to make certain investments difficult for pension plans. ERISA requires

fiduciaries to diversify the investments of a plan to minimize risk. In fact, ERISA’s legislative history

cautions fiduciaries against investing an “unreasonably large proportion of plan assets” in securities

that are “dependent upon the success of one enterprise or upon conditions in one locality.” Also,

conflict of interest and “self-dealing” problems can arise if plan sponsors may benefit from an

investment. For example, a construction company’s pension plan could not invest in a public project

that the company itself is building.

16Environmental Infrastructure: Effects of Limits on Certain Tax-Exempt Bonds (GAO/RCED-94-2,

Oct. 28, 1993).

17Several private agencies such as Moody’s Investors Services and Standard and Poor’s rate bonds,

prior to sale, for their ability to pay interest and principal (that is, their “creditworthiness”). Investors

use the ratings as a guide to the investment quality of the bond. Bonds rated AAA are the highest

quality (least risky). Bonds rated below AAA, such as B, C, and so on, are considered lower quality.

Bonds issued by the federal government are not rated and are considered to be almost riskless.

Page 15 GAO/HEHS-95-173 Pension Plan Infrastructure Investment
Chapter 2 

Federal Laws Create Disincentives to

Pension Plan Investment in Infrastructure

Figure 2.1: 30-Year Tax-Exempt Municipal Bond Yields Versus 30-Year Taxable Treasury Bond Yields, 1984-1994

14


12


10


8


6


4


2


0

Jan


1984

Jan


1985

Jan


1990

Jan


1986

Jan


1987

Jan


1991

Jan


1988

Jan


1992

Jan


1989

Jan


1993

Percent Before-Tax Yields

Month/Year

Treasury Bonds


Municipal Bonds

Jan


1994

Dec


1994

Source: Salomon, Inc., Analytical Record of Yields and Yield Spreads, 1995.

The lower return on tax-exempt municipal bonds means that the securities

cannot compete effectively for pension plan assets. Consequently,

infrastructure developers have little incentive to seek financing from

private pension plans, and private pension plans have little incentive to

seek infrastructure investment opportunities. Only 0.1 percent of the

assets held in private pension plans were invested in such securities at the

end of 1992, according to CBO.

Federal Infrastructure

Financing Programs Take

Advantage of the

Tax-Exempt Market

Federal agencies assist infrastructure projects through programs that

involve direct, as well as indirect, federal expenditures. We reviewed

several recent initiatives that used federal funds to help infrastructure

developers obtain financing from traditional sources, such as tax-exempt

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Federal Laws Create Disincentives to

Pension Plan Investment in Infrastructure

bonds. Actions taken to increase private investment in infrastructure have

included

• establishing the State Water Pollution Control Revolving Fund Program

under the 1987 amendments to the Clean Water Act to leverage, and

eventually replace, federal capitalization grants;18

• permitting states to lend federal funds to toll road projects under section

1012(a) of ISTEA in 1991; and

• issuing Executive Order 12893, Principles for Federal Infrastructure

Investments, on January 26, 1994, which directed federal agencies to seek

private sector participation in their infrastructure programs.19

These initiatives generally use the tax-exempt market and do not target

pension plan investment.

18The program provides grants and a 20-percent state match through the Environmental Protection

Agency to state revolving funds. These revolving funds are loan programs that leverage their federal

and state dollars through the tax-exempt bond market and then make loans to local governments. As

the loans are repaid, the revolving funds are replenished, and additional loans can be made to local

governments for other eligible water pollution control projects. The program made the states, instead

of the federal government, responsible for managing the effort to subsidize local government projects.

19The Federal Highway Administration (FHWA) is responsible for two related efforts. First, it is

implementing section 1012(a) of ISTEA, referred to as the “Toll Provisions,” which permits tolls to be

charged on federal-aid highways (other than those in the interstate highway system). The provisions

are expected to encourage private sector investment in toll road projects because projects may earn a

reasonable return on their investment, and federal project funds may be commingled with revenue

bond proceeds backed by tolls and private capital. The toll provisions allow states to “recycle” their

federal highway grants by making loans to eligible state and local projects that can then charge tolls to

repay their state loans. When loans are repaid, the state can recycle the federal money to other eligible

projects. Projects may continue to charge tolls after their loans are repaid and use the money for other

debt service, operation, maintenance, construction, and renovation costs. Unlike the Clean Water Act

Amendments of 1987, ISTEA does not permit state revolving funds to use their federal money to

guarantee bonds.

Second, FHWA set up the Innovative Financing Test and Evaluation Project in March 1994 to

encourage states, localities, private investors, and the financial community to cooperatively increase

investment in transportation by using the funding flexibility permitted under ISTEA.

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Federal Laws Create Disincentives to

Pension Plan Investment in Infrastructure

Tax Exemptions for

Pension Plans and

Municipal Bonds

Involve Large

Subsidies

The tax exemptions for private pension plans and for bonds that finance

infrastructure projects involve large, indirect federal subsidies in the form

of foregone federal revenue, referred to as a “tax expenditure.” Recent

estimates20 show that exempting pension plan earnings from taxation

resulted in foregone revenue of about $48.8 billion in fiscal year 1994.21

Nearly $12 billion in revenue was foregone by subsidizing interest on

tax-exempt bonds.

Although current policies are costly and have the effect of discouraging

pension plans from investing in public projects, the Infrastructure

Commission did not propose changing these basic federal laws

substantially. However, research suggests that it might be less costly to

pay interest subsidies directly to state and local governments than it is to

exempt state and local bonds from taxes.22 Paying interest subsidies

directly to state and local governments might also eliminate the

disincentive for pension plans to invest in state and local government

bonds because the bonds would presumably pay investors competitive

interest rates. The Infrastructure Commission recognized, though, that

both the tax exemption for pension plan contributions and the tax

exemption for municipal bonds are long-standing federal laws.

20“Analytical Perspectives,” Budget of the United States Government, Fiscal Year 1996 (Washington,

D.C.: U.S. Government Printing Office, 1995), pp. 41-42.

21Additional estimates show that of the $48.8 billion in tax expenditures for pensions, about

$7.1 billion, or about 15 percent, are for private pensions. The remainder are for federal, state, and

local government pensions. See Joseph S. Piacentini and Timothy J. Cerino, EBRI Databook on

Employee Benefits, 3rd ed. (Washington, D.C.: Employee Benefit Research Institute, 1995).

22Tax Policy: Tax Expenditures Deserve More Scrutiny (GAO/GGD/AIMD-94-122, June 3, 1994), p. 26.

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The Congress tasked the Infrastructure Commission with conducting a

study on the “feasibility and desirability of creating a type of infrastructure

security to permit the investment of pension assets in funds used to

design, plan and construct infrastructure facilities in the United States,”

including examining other methods of encouraging public and private

investment in infrastructure facilities. In short, the focus of the

Infrastructure Commission’s inquiry was on developing a new investment

instrument that could attract private money, with a particular

concentration on pension plans. The Congress has not acted on the

proposals contained in the Infrastructure Commission’s 1993 report,

although a bill based mainly on the proposals was introduced in the 103rd

Congress.23

Rationale for the

Infrastructure

Commission’s

Proposals

The Infrastructure Commission found that there is a significant need to

facilitate investment in the repair, renewal, and development of domestic

infrastructure. The Infrastructure Commission’s report argued that

budgetary constraints will prevent federal, state, and local governments

from increasing either grant expenditures or tax subsidies sufficiently to

eliminate the nation’s projected shortfall in infrastructure investment. The

Infrastructure Commission’s Counsel told us that there is a “limited

appetite” for state and local tax increases to pay for roads, environmental

facilities, and other infrastructure projects. Furthermore, the

Infrastructure Commission’s report noted that the legal limits24 on federal

tax subsidies for municipal bonds, issued to finance projects that involve

private sector participation, constrain the availability of financing and

increase the cost of financing such projects. As grant funds from the

federal government decrease, states and localities need to find new ways

to leverage their limited resources.

23For a summary of the provisions of the bill (H.R. 5120) introduced by Representative Rosa DeLauro,

see Government Corporations: Profiles of Recent Proposals (GAO/GGD-95-57FS, Mar. 30, 1995). For

further discussion, see David Seltzer, “Reinventing Infrastructure Finance-An Inside Look at the

DeLauro Bill,” Municipal Market Finance (Oct. 1994).

24The Tax Reform Act of 1986 restricts the issuance of tax-exempt debt for financing infrastructure if

private businesses use more than 10 percent of the facility or service more than 10 percent of the debt.

Also, the law caps the volume of tax-exempt, private-activity bonds issued in a state at no more than

$150 million, or $50 per state resident annually, whichever is greater.

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Federal Incentives

Creation of a National

Infrastructure

Corporation and an

Infrastructure

Insurance

Corporation

The Infrastructure Commission’s 1993 report recommended that the

Congress establish two new corporations to provide credit assistance and

insurance to state and local issuers of debt to finance infrastructure. The

Infrastructure Commission recommended the establishment of a National

Infrastructure Corporation (NIC) that would purchase and bear the credit

risk of obligations issued to finance transportation and environmental

facilities, including both governmental and public-private sponsored

projects. NIC would also insure project sponsors against a portion of the

risk of developing new facilities. Also, the Infrastructure Commission

recommended the establishment of an Infrastructure Insurance

Corporation (IIC), initially an NIC subsidiary, that would insure

infrastructure bonds.25

In general, the Infrastructure Commission’s proposals are aimed at

providing credit assistance to public and private sponsors seeking

financing for infrastructure projects. Borrowers may have difficulty

securing financing because their projects may be judged as too risky given

the rate of return they promise to investors. When an entity assumes some

of this risk (that is, by providing credit assistance or bond insurance) the

investment becomes more attractive to the investor. At the same time, the

state or locality seeking to obtain financing may do so on more favorable

terms. The ability to bring borrowers and investors together by having an

entity assume risk may involve the provision of a subsidy on the part of the

federal government.

The Functions of NIC and

IIC

The Infrastructure Commission proposed that NIC and IIC provide three

forms of credit assistance. First, NIC would purchase “subordinated” bonds

sold by state and local governments to finance new infrastructure projects.

The payment on these bonds would be legally subordinated to, or not due

before, payments on the remainder of the debt, called “senior” debt. The

subordinated debt purchased by NIC typically would be for projects that

are not eligible for investment-grade credit ratings (ratings BBB and

above) in the marketplace.

25The Infrastructure Commission also made recommendations aimed at tax policy. It urged the

Congress to modify or repeal various federal restrictions on the use of tax-exempt bonds imposed by

the Tax Reform Act of 1986. The Infrastructure Commission proposed several options, including

(1) exempting from federal taxation any debt issued to finance new environmental and transportation

projects; (2) allowing municipalities to retain profits earned by investing funds borrowed at

tax-exempt rates in higher-yielding, taxable assets; (3) increasing from 10 percent to 25 percent the

proportion of the facilities financed with tax-exempt bonds that private businesses can use; and

(4) allowing banks to deduct the purchase price and carrying costs of tax-exempt infrastructure debt

issued for up to $25 million per year from the current legal limit of $10 million. However, since these

changes would tend to encourage tax-exempt financing, they would probably not increase pension

plan investment in infrastructure.

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Second, NIC would insure private firms against a portion of the risk

associated with developing new facilities, such as the risk of

environmental lawsuits and voter disapproval of the issuance of bonds to

provide long-term financing. NIC would be legally obligated to cover up to

70 percent of any losses incurred by developers if the projects were never

completed.

Third, IIC would bear a portion of a project’s credit risk by insuring or

reinsuring senior infrastructure bonds. IIC would insure or reinsure only

those bonds that private municipal bond insurers would not insure or that

could not obtain other forms of credit enhancement, such as a bank letter

of credit. It was also proposed that in the long run, NIC would purchase

senior infrastructure bonds, including bonds insured by IIC.

26

Financing and Organizing

NIC and IIC

The Infrastructure Commission proposed that the federal government

initially capitalize NIC and IIC through a grant of $1 billion per year over 5

years. Later on, NIC would raise additional funds by issuing debt to the

public and creating and selling securities backed by the infrastructure

bonds that it had purchased (that is, providing securitization).27

The Infrastructure Commission’s report did not specify the legal and

organizational status of NIC. It noted that NIC’s ability to borrow from the

public would benefit from a “limited line of credit” from the U.S. Treasury,

but it did not foresee a need for a “full faith and credit guarantee” from the

federal government. IIC would be established initially as an NIC subsidiary

and would operate as a private corporation similar to the College

Construction Loan Insurance Association (Connie Lee)—a private,

26In testimony before the Congress, Commission Chairman Daniel V. Flanagan, Jr., described a process

in which NIC would provide support to state revolving funds in the form of development risk

insurance for the preconstruction phase of projects. States and localities would establish projects as

well as a revenue stream in the form of user fees. NIC would reinsure the user fees to provide the

credit rating/credit enhancement for the project. According to the Chairman, this would attract the

interest of pension plan managers who are seeking diversification in their portfolios. In addition, he

believed this would add a “third leg” to the existing supports for infrastructure finance (that is, grants

and municipal bonds).

Once those functions were being carried out and projects were being completed, the Chairman

expected that the process would mushroom in terms of demonstrating the feasibility of various

projects and providing a security to the market. He noted that pension plans are large and are capable

of investing in infrastructure on their own, but they are also concerned about “political uncertainty” in

public projects. Consequently, the Chairman believed, the “government has to recognize this and

provide the tools to address this uncertainty.”

27Securitization is the creation of marketable securities that are backed by the receipts from a group

(pool) of individual loan or lease transactions. The sale of these asset-backed securities to a broad

range of investors with an extended geographic dispersion and a wide spectrum of portfolio risk

diversification provides capital to make additional loan or lease transactions.

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America’s Infrastructure Proposed New

Federal Incentives

for-profit municipal bond insurer that insures bonds for construction at

institutions of higher learning and teaching hospitals.28

Tapping Pension Plan

Capital for

Infrastructure

Financing

The Infrastructure Commission noted that pension plans historically have

not participated in financing infrastructure in the municipal bond market

because of their tax-exempt status as well as the relative complexity of

infrastructure credit. The Infrastructure Commission identified three

options to encourage pension plans to participate:

• Pension plans could invest in the equity of the proposed bond insurer, IIC.

• Pension plans could buy taxable project debt insured by IIC or purchase

securities directly issued by NIC.

• Pension plans could act as lenders directly funding taxable project debt

through purchasing public benefit bonds.

The first option would involve pension plans by having them provide

capital to start up IIC. Since it is assumed IIC would generate a revenue

stream of its own through fees paid by those seeking insurance for their

bonds, the pension plans could earn a return. The size of such a return is

not clear. Furthermore, the experience with Connie Lee suggests that

those providing capital typically would invest only modest amounts. Thus,

the potential equity participation in IIC by pension plans is likely to be of

limited magnitude.

The second option involves two parts. First, pension plans could directly

purchase taxable project debt insured by IIC. Second, NIC could use its

capital to purchase taxable project debt, some of which may have been

insured by IIC. When a large volume of debt has been acquired, NIC could

create a new security backed by the project debt that would then be sold

to the market with NIC’s guarantee. It is thought that this security would

create a secondary market for project debt and reduce the risks of

investing in specific project debt. Since it is presumed that this security

would offer a competitive, taxable, market rate and be more liquid than

specific project debt, pension plans might be attracted to it. Pension plans

might, for example, support pollution control projects that are not eligible

for tax-exempt financing because they benefit private businesses.

28Connie Lee was authorized by the Congress under title VII of the Higher Education Act of 1986 to

help address a need for investment in higher education facilities. Connie Lee provides assistance to

issuers of debt and carefully selects the issues it will insure. It is classified as a government-sponsored

enterprise, but it states that it maintains its AAA credit rating—the highest available—on the basis of

its credit criteria, management expertise, financial performance, and capital reserves. The federal

government contributed a modest amount of seed capital—15 percent of total equity investment—with

private organizations providing the remainder of the capital.

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However, this could only occur after some time, since NIC would need to

develop a quality portfolio of loans over time as a precondition to issuing

its own debt or securitizing its loans.

In its third option for increasing pension plan investment in infrastructure,

the Infrastructure Commission recommended modifying federal tax law to

allow all or part of the earnings on a municipal or “public benefit” bond to

be distributed tax free upon retirement to workers who participated in

defined contribution pension plans, such as 401(k) plans and individual

retirement accounts (IRA).29 Defined contribution plan participants would

be willing to invest in such a bond because its after-tax rate of return

would be comparable to a taxable market return. This would allow the

localities issuing the bonds to finance projects at rates comparable to

those in the municipal bond market while attracting direct investment

from pension plans.

The Infrastructure Commission’s Secretary told us that he considers the

public benefit bond proposal to be the “cornerstone of the Infrastructure

Commission’s proposals related to pension plans.” However, the

Infrastructure Commission’s Executive Director said that much of the

investment in infrastructure would come from public, and perhaps union,

pension plans—not from corporate pension plans. He estimated that about

1 percent of U.S. pension plan assets might be ultimately invested in

infrastructure.

Evaluating the

Infrastructure

Commission’s

Proposals

One approach to evaluating the proposals is to examine the economic

justification for an expanded federal role in establishing entities and

incentives to entice pension plan investment into infrastructure. We

reviewed a number of economic analyses related to the justification for a

federal role, and a discussion is contained in appendix II. Here, we

29A defined contribution pension plan or individual retirement account plan provides an individual

account for each participant and generally bases benefits upon the amount contributed to the

participant’s account and the accrued investment return. The 401(k) plans, which are codified in the

Internal Revenue Code, are a type of defined contribution plan in which an employee may elect to

contribute a portion of his or her own earnings to the plan on a pre-tax basis, with taxes on earnings

deferred until withdrawal. The employer may also make a matching contribution. IRAs allow

individuals to contribute to an account that may be tax-deferred subject to certain limitations and

restrictions. While defined contribution plans such as 401(k)s and IRAs are tax-deferred arrangements,

the public benefit bond proposal would make earnings on investments in these bonds tax exempt. In

contrast, defined benefit pension plans promise each employee a determinable monthly benefit at

retirement. Employers are responsible for adequately funding their defined benefit plans so that the

plans have sufficient funds to pay the promised benefits.

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Federal Incentives

summarize that discussion, focusing on a recent CBO analysis that

specifically addressed the Infrastructure Commission’s proposals.30

CBO made the following key points regarding the Infrastructure

Commission’s proposals:

• The premise that greater investment in infrastructure will increase overall

economic output is questionable, and only a few projects that would be

supported through NIC would have returns higher than alternative private

investments. The proposed new federal incentives may result in further

distortion of investment choices by displacing other investments, which in

turn could result in economic inefficiency.

• The municipal bond market already receives a large federal subsidy and is

generally considered to be functioning well. The market imperfections that

affect the municipal bond market were not addressed by the Infrastructure

Commission’s proposals.

• Measuring and controlling the impact of new federal financial entities are

influenced importantly by the organizational form of the proposed

corporations. Establishing NIC as a government-sponsored enterprise

carries high risk (through contingent liability) to the federal government.

Concerning the specific incentives for pension plan involvement

mentioned earlier, CBO made several additional points. With regard to

pension plans investing in IIC’s equity, CBO noted that the proposed IIC has

little justification on efficiency grounds since the municipal bond

insurance industry appears to be competitive. Hence, this first avenue for

pension plans may not be necessary or attractive.

The second avenue—having pension plans buy debt securities issued

directly by NIC—is problematic because infrastructure projects are

heterogeneous and, thus, are not likely to be easy to pool into securities to

create a secondary market.

The third avenue for pension plan investment—having pension plans

invest directly in funding infrastructure project debt through public benefit

bonds—also was questioned by CBO. It noted that the public benefit bonds

might subsidize projects that are not really public in nature. This provision

might circumvent the legal restrictions put in place during the 1980s to

prevent the excessive use of tax-exempt municipal debt to finance private

activities that were crowding out state and local spending and raising

30CBO, An Analysis of the Report of the Commission to Promote Investment in America’s

Infrastructure (Washington, D.C.: Feb. 1994).

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Federal Incentives

costs for public projects.31 CBO also noted that administrative costs may be

associated with implementing a public benefit bond that gives a tax break

to pension plan participants. Internal Revenue Service regulations would

have to be put in place to require individuals to separate income from

investing in infrastructure securities from other asset income.

The CBO analysis concluded that the interaction of existing federal tax

subsidies for pension plans and municipal bonds is the main cause of the

low level of direct investment in infrastructure. It noted that existing

subsidies for municipal debt could be reduced and that this could induce

pension plans to invest in infrastructure. A similar effect could result from

taking away the tax exemption for pension plans. However, the

Infrastructure Commission did not advocate either approach.

In reviewing other analysis and commentary on the Infrastructure

Commission’s proposals, we found substantial skepticism among

economists as well (see app. II). The basic view was that there seems to be

little reason to put new incentives in place to reallocate capital from its

existing uses. Moving beyond the economic analysis framework implies

that the issue becomes one of competing political values about how to

allocate resources. In our discussions with Infrastructure Commission

officials, it was noted that the rationale for the proposals was based more

on “policy” considerations than on a strictly economic justification. In this

regard, the Infrastructure Commission’s rationale seems more rooted in

the view that capital should be reallocated to public investment (in

infrastructure), and the proposed entities and incentives are justified as an

effort to implement that objective.

This means that the justification for an expanded government role to

encourage investment in infrastructure can depend on the values

expressed by the voters. In other words, if individuals perceive a problem

with infrastructure and want it to be addressed, then government may be

chosen as the means to meet this demand. The institutions and public

processes for making infrastructure investment decisions should then be

the focus of analysis and debate.

31There is some evidence that these restrictions have not reduced infrastructure investment at the state

and local levels. See GAO/RCED-94-2.

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Market Participants’ Perspectives on Private

Pension Plan Investment in Infrastructure

Private pension plan managers and financial market experts we spoke

with confirmed that private pension plans are not active investors in the

domestic infrastructure finance market for many of the reasons that the

Infrastructure Commission and others cited. For example, they noted the

lack of available investment opportunities at competitive rates of return.

Some market participants suggested a role for defined contribution

pension plans and the desirability of finding “niches” for pension plan

investment in infrastructure. Their points seem broadly in line with some

of the proposals that the Infrastructure Commission made.

Other market participants expressed concern about efforts to induce a

reallocation of pension capital. Some pension plan managers were

concerned that pressures to invest in infrastructure or other ETIs would

ultimately affect their ability to comply with their fiduciary responsibilities

under ERISA. They believed that even DOL’s Interpretive Bulletin 94-1 (which

states that the selection of an ETI will not violate ERISA rules if the general

fiduciary standards are met) did not provide any new information and that

DOL’s interpretation would simply subject the private pension plans to a

higher level of government scrutiny. Other experts noted there are

alternative mechanisms that do not involve pension plans but may help

increase infrastructure investment.

Private Pension Plan

Managers Cite

Disincentives to

Infrastructure

Investment

Earlier, we discussed the fundamental disincentive for pension plan

investment in infrastructure that results from the tax-exempt status of the

plans and the use of tax-exempt municipal bonds as a common vehicle to

finance infrastructure. The financial return to the pension plan is simply

too low, which leads to concerns, as the Counsel to the Infrastructure

Commission noted, in evaluating whether these investments meet

fiduciary standards. In our discussions with market participants, other

disincentives for pension plan involvement were noted. In many respects,

the Infrastructure Commission’s proposals attempt to respond to these

concerns.

While pension plan managers told us that they are unlikely to invest in

infrastructure projects, one investment manager noted that he could

consider including infrastructure projects in an “alternative investment

portfolio” if the projects provide a rate of return that is competitive with

taxable securities. However, he believed that managers of alternative

portfolios are still unlikely to invest pension plan assets in infrastructure

projects because alternative investments, such as venture capital and

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Market Participants’ Perspectives on Private

Pension Plan Investment in Infrastructure

foreign securities, are available. At any rate, alternative investment

portfolios are small.

Project finance experts told us that infrastructure projects are often large

and complex, with long development and construction phases. These

types of projects are not standardized and, thus, are difficult to make into

securities, in contrast to home mortgages. Unlike mortgage-backed

securities, pooling of infrastructure projects does not have a track record

that investors can assess. That situation is not advantageous to pension

plans, particularly in light of their fiduciary requirements concerning

safety, liquidity, and yield.

It is difficult for investors to estimate the rate of return or risk of a

proposed infrastructure project. The chief investment officer of a

communications firm that has a large pension plan told us that the pricing

of public infrastructure projects is not driven by cost of capital but by

political considerations. Predicting long-term cash flows is, therefore,

difficult. In addition, a project developer who served as Secretary of the

Infrastructure Commission said that he had been unable to attract pension

plans to proposed projects because of the difficulty in estimating the rate

of return. Proposed projects have not yet demonstrated competitive

returns.

Pension Plans Seek

Diversification, Liquidity

Our discussions with market participants highlighted several key points

regarding pension plan involvement in infrastructure. One is that pension

plans seek diversification in their portfolios but must have investments

that provide competitive returns within fiduciary standards. In addition,

liquidity and standardization of investments are important. The securities

that may be backed by infrastructure projects would not possess these

characteristics, and it may be more difficult to use information about them

in evaluating securities for future projects. Even if these problems could

be overcome, the potential amount of pension capital that could be

invested in infrastructure is probably significantly smaller than the vast

pool of available capital sometimes suggested.32

Defined Contribution Plans

May Play a Role

Defined contribution pension plans (primarily 401(k) plans) represent the

fastest-growing portion of pension plan assets. These plans, managed by

the mutual funds and life insurance industry, represent a potential source

32The estimate by the Infrastructure Commission’s Executive Director that 1 percent of pension plan

assets might ultimately be invested in infrastructure suggests a maximum available capital of roughly

$40 billion.

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Market Participants’ Perspectives on Private

Pension Plan Investment in Infrastructure

for financing infrastructure. According to data that an investment firm

provided to the Infrastructure Commission, private defined contribution

plan assets represented almost 47 percent of all privately sponsored

pension plan assets in 1991.

According to the chief economist at a private bond-rating agency, the

managers or the participants of these plans might not want to invest in

infrastructure bonds. However, if the same bonds were sold as part of a

“government bond fund” they might buy them, he said, because the public

thinks of government bonds as safe investments. Also, investing a small

portion of their assets in infrastructure might help diversify risks in a

defined contribution pension plan’s portfolio of investments if the value of

infrastructure assets goes up when the value of other assets is going down.

One mutual fund industry lawyer told us that defined contribution pension

plans cannot be expected to finance infrastructure projects since they do

not “pass through” the tax advantage to beneficiaries. Also, infrastructure

investments may lack the liquidity that defined contribution plans require

in order to repay beneficiaries.

These views suggest a possible role for the Infrastructure Commission’s

proposed public benefit bond, which would pass through tax benefits to

retirees. An advantage of tapping defined contribution assets is that a

portion of these funds are self-directed by workers and, hence, these

workers can make a voluntary choice to invest these funds in

infrastructure securities.

Need to Find Niches for

Private Pension Plan

Investment

Since pension plans, by virtue of their tax-exempt status, would prefer

fully taxable bonds over tax-exempt bonds, the way to entice them into

funding public projects, some experts suggested, is to find niches where

their capital can be put to fruitful uses at competitive rates of return.

Projects that meet this criterion might include “stand-alone” toll roads

constructed by private developers for which there is adequate demand and

that can generate identifiable revenue streams. Furthermore, according to

the Infrastructure Commission’s Secretary, toll roads that lacked a track

record when they were initially financed could attract pension plans when

they are refinanced based on a history of generating revenue.

Economic research suggests that user fees could provide a revenue stream

to finance a large share of many public works facilities such as

transportation, water supply, wastewater treatment, and solid and

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Pension Plan Investment in Infrastructure

hazardous waste systems.33 Because these facilities largely serve

identifiable consumers, their use can be measured and priced, and the

beneficiaries can be charged directly for the cost of services. If financing is

linked to use, revenue can become steadier and more predictable,

encouraging better maintenance, rehabilitation, and replacement.34

Unless these niches are found, pension plans will not be significant

investors in America’s infrastructure, according to a managing director of

a municipal bond-rating firm. Pension plans are not investing in

infrastructure because “the deals aren’t out there.” One way to identify a

niche, the managing director suggested, would be to establish a pilot

program on one kind of project, such as highways or mass transit, so that

pension plan managers would “learn to walk before they run.”

Once these niches are found, then government incentives—such as the

development of industrywide standards for evaluating projects, and tax

credits—might help attract private capital. A transportation consultant

said that any governmental actions to encourage investment in

infrastructure must move in the direction of assisting the private sector’s

efforts in infrastructure investment, establishing standards for project

evaluation, and pooling and securitizing private sector projects. We were

also told that while government guarantees, by reducing risk, enable state

and local governments to obtain lower interest rates, they also lower the

return to investors.

The view that niches must be found suggests the need for exploring

alternative financing schemes but also seems to be broadly consistent with

the notion of a government corporation that would work with localities to

find projects and help make them attractive to pension plans.

Market Participants

Express Concerns

About an Increased

Federal Role

Creating NIC and IIC to attract pension plan capital to finance public

projects may not be necessary, according to the pension plan

representatives and experts we met with. They pointed to the vast market

for privately insured tax-exempt municipal bonds that already exists for

financing such projects.

Other concerns included the potential for increased federal direction or

scrutiny of pension plan investments. Pension plan managers are

concerned about the possibility that the federal government will mandate

33See Gramlich, “Infrastructure Investment: A Review Essay.”

34Fragile Foundations, pp. 59-73.

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certain investments, or classes of investments, said a managing director of

a financial services company that manages assets for large corporate

pension plan clients. In addition, partners in a global investment

management firm that advises pension plans told us that they believed

DOL’s interpretive bulletin will subject private sector pension plans to a

higher level of government scrutiny than they receive now. They believed

that pension plan managers will become more circumspect about the

possibility of investment losses in ETIs.35

State and local officials are unlikely to seek investment from private

pension plans because it would increase their cost of borrowing, the chief

economist of a bond-rating agency told us. An official of a private bond

insurance company noted that NIC’s insurance proposals would also be

more costly than private insurance. Instead, she recommended that

projects obtain low-interest loans and grants from the federal government.

In financing infrastructure projects, pension plans would require a

competitive rate of return as well as a government guarantee backed by

the full faith and credit of the federal government. Thus, pension plan

capital would be expensive for states and localities to borrow.

Municipalities could finance their projects more efficiently by improving

their bond credit ratings instead of relying on government guarantees or

pooling of assets, according to a managing director responsible for

municipal bond ratings. In this view of the capital markets, plenty of

capital is available to finance creditworthy infrastructure projects.

Moreover, the bond insurance function envisioned for IIC would compete

with the functions currently being performed by private insurance

companies. One insurance industry official stated that IIC could not do any

more than the private insurance industry does. The managing director of a

bond-rating company told us that IIC may not significantly increase

infrastructure investment by offering bond insurance because municipal

bonds are already privately insured. A project finance expert at an

investment bank told us that by offering insurance to projects with more

risks than the private sector would normally accept, IIC would encourage

the development of financially infeasible projects.

35Union pension plans are more likely to consider infrastructure investments because they could

generate jobs for union members. A September 1993 survey of 118 union (multiemployer) pension plan

trustees, administrators, advisers, and consultants conducted by the International Foundation of

Employee Benefit Plans revealed that 73 percent of the respondents believed there is a shortage of

public money to finance infrastructure projects. Of these, more than half, or 58 percent, believed

pension plan investment is an appropriate way to make up for the shortfall. However, 95 percent of the

respondents believed that it is somewhat important or very important for infrastructure securities to

be backed by the full faith and credit of the federal government.

Page 30 GAO/HEHS-95-173 Pension Plan Infrastructure Investment
Chapter 4 

Market Participants’ Perspectives on Private

Pension Plan Investment in Infrastructure

Alternative Financing

Mechanisms Are

Available

We found that some market participants and experts were skeptical about

the need for the government to intervene by creating NIC to reallocate

capital. They were not sure whether the complex NIC mechanisms would

work in the marketplace and questioned whether specific incentives to

attract pension plans are the best way to spur infrastructure investment.

They pointed out that other mechanisms for infrastructure financing

already exist, such as municipal bonds, state revolving funds, user fees,

and private bond insurance for creditworthy projects.

In transportation finance, for example, some pointed out that ISTEA could

be amended to allow states to create state revolving fund loans or to

provide credit enhancement (such as guaranteeing local government

bonds) with federal highway money. Some state officials and industry

experts remain skeptical about the viability of state transportation

revolving funds.36 One concern, for example, is whether even densely

populated areas will generate many revenue-bearing projects with the

capacity to repay loans. Despite these concerns, however, state

transportation revolving funds could serve as an alternative to NIC and IIC,

and may help expand infrastructure investment if key barriers to their

effectiveness can be overcome.37

36See Surface Transportation: Reorganization, Program Restructuring, and Budget Issues

(GAO/T-RCED-95-103, Feb. 13, 1995).

37See Water Pollution: State Revolving Funds Insufficient to Meet Wastewater Treatment Needs

(GAO/RCED-92-35, Jan. 27, 1992), which concluded that state revolving funds are an efficient

alternative to grants for subsidizing local governments. However, the program will not generate

enough dollars to close the tremendous gap between wastewater treatment needs and available

resources. State revolving funds pose particular problems for small communities, many of which

cannot repay loan assistance at any interest rate and cannot compete with larger communities for

loans.

Page 31 GAO/HEHS-95-173 Pension Plan Infrastructure Investment
Chapter 5 

Concluding Observations

There has been long-established general agreement on the need for

infrastructure to be funded by tax dollars and on a federal role in

supporting infrastructure projects. Nevertheless, debate continues on the

amount of infrastructure investment that is needed, the role of

infrastructure in fostering future economic growth and higher

productivity, and the appropriate degree of federal involvement. There is

also a continuing effort to explore innovative and efficient ways to finance

projects. The idea of attracting a portion of pension plan capital to

infrastructure investment has become popular, and the proposals of the

Infrastructure Commission offer an ambitious attempt to put that idea into

practice.

Our review of the Infrastructure Commission’s proposals suggests that

they could play a role in encouraging more infrastructure investment by

pension plans. The government can foster marketplace innovations and

has done so in the past. But this comes at a cost to the federal government.

We found strong reservations among economists and market participants

about the need for new federal entities and subsidies to encourage a

reallocation of pension capital when significant existing tax subsidies

discourage pension plans from investing in infrastructure projects.

If the primary goal is increasing infrastructure investment, then there are

many ways, including initiatives currently under way, to address this goal.

Encouraging localities to make projects more creditworthy through the

provision of adequate revenue streams could foster investment that is

more in line with the demand from the public. Techniques to leverage

grants at the state level seem promising. Establishing NIC and IIC might aid

these efforts, but the evidence is insufficient to conclude that such entities

are required to attain an adequate level of infrastructure investment.

The goal of attracting pension capital to infrastructure is problematic.

Advocates for new federal entities to encourage direct pension capital

flows to infrastructure recognize that the subsidies accorded to pension

plans and municipal bonds are well established and serve important policy

objectives. Advocates also need to recognize that fostering significant

pension plan investment in infrastructure would probably require a

reevaluation of existing tax policy.

Page 32 GAO/HEHS-95-173 Pension Plan Infrastructure Investment
Page 33 GAO/HEHS-95-173 Pension Plan Infrastructure Investment
Appendix I 

Scope and Methodology

To determine the present involvement by private pension plans in

infrastructure finance and to analyze the role that current policies could

play in addressing the nation’s infrastructure needs through greater

pension plan involvement, we reviewed relevant laws, our previous

reports, reports by the Congressional Research Service and the

Congressional Budget Office, and the U.S. Department of Labor’s pension

plan policies. We also reviewed selected statistics on taxable and

tax-exempt bond interest rates from 1984 to 1994 and federal revenue

losses caused by granting tax exemptions.

We interviewed a judgmentally selected sample of corporate and other

officials along with experts on infrastructure financing or pension plan

issues. In selecting those to be interviewed, we consulted

• Standard and Poor’s Register of Corporations,

• Dun and Bradstreet’s Directory of Public and Private Corporations,

• Institutional Investor’s “List of Corporate Pension Funds,” and

• Pension and Investments’ “1,000 Largest Pension Funds.”

To identify and analyze the role that federal laws and policies play in

infrastructure finance, we interviewed two investment bankers, a

municipal bond dealer, officials of two bond-rating agencies, the director

of public policy for a municipal bond insurer, and the director of policy

analysis for a national organization that represents municipal bond

dealers. We discussed existing programs for attracting private investment

to infrastructure projects with officials at U.S. Department of

Transportation (DOT) headquarters, two Federal Highway Administration

field offices, and a private firm that was established to take advantage of

opportunities presented by these programs. We discussed methods of

leveraging federal grants with private funds with a DOT consultant and

officials of the New York State Environmental Facilities Corporation—a

state agency that finances water pollution control facilities. We also

reviewed our related work on infrastructure financing and public-private

partnerships.

To analyze the Commission to Promote Investment in America’s

Infrastructure’s proposals related to private pension plan investment and

whether pension plans would respond favorably, we reviewed the

Infrastructure Commission’s final report and testimony from

Infrastructure Commission hearings, and interviewed the Infrastructure

Commission’s Chairman, Executive Director, Secretary, Counsel, and key

witnesses at Infrastructure Commission hearings or their representatives.

Page 34 GAO/HEHS-95-173 Pension Plan Infrastructure Investment
Appendix I 

Scope and Methodology

We also interviewed or obtained information from officials at companies

that sponsor pension plans, invest assets on their behalf, and provide

investment policy advice. In addition, we reviewed relevant DOL

interpretations of the Employee Retirement Income Security Act of 1974,

related pension plan investment rules and regulations, and various

economic analyses, including CBO’s. We also interviewed a consultant who

prepared a report to DOT on the Infrastructure Commission’s proposals.

We discussed with the Special Assistant to the Assistant Secretary for

Pension and Welfare Benefits DOL’s interpretation of ERISA and its efforts to

assist pension plans that may wish to invest in infrastructure.

We performed our work at DOT and DOL headquarters in Washington, D.C.,

and FHWA field offices in Albany, New York, and Trenton, New Jersey. In

addition, we visited the New York State Environmental Facilities

Corporation headquarters in Albany, and infrastructure finance

consultants, pension plan consultants, and pension plan managers in

Chicago; New York City; Philadelphia; and Arlington, Virginia.

Page 35 GAO/HEHS-95-173 Pension Plan Infrastructure Investment
Appendix II 

Economic Perspectives: Is an Expanded

Federal Role in Attracting Pension Plan

Investments in Infrastructure Justified?

A fundamental theme in the Infrastructure Commission’s report is the

recommendation for a federal role in providing structures and incentives

to entice pension plan investment in infrastructure projects. One approach

to evaluating the proposals is to examine the economic justification for an

expanded federal role. We reviewed a number of economic analyses

related to this approach, including a recent CBO analysis of the

Infrastructure Commission’s recommendations.38

Justifying a Federal

Role: The Economic

Analysis Approach

Much of the debate over infrastructure is cast in terms of how much

infrastructure is “needed.” Various studies attempt to estimate this need,

but economists attempt to address this issue using economic analysis. This

economic analysis is focused mainly on macroeconomic considerations

relating primarily to the effect of greater infrastructure investment on

economic growth. But a related discussion of infrastructure investment

issues and government policy takes place in a more microeconomic

context, in regard to the operations of financial markets. Here the issue is

whether financial markets allocate funds to public investment projects

efficiently or, in more practical terms, whether particular projects will be

able to attract investors at rates of return acceptable to all parties involved

in the transaction.

Financial Markets and

Infrastructure

Investment

Generally, economists view financial markets as highly efficient. Investors

seek the highest return available, for comparable risk, and, in theory, the

markets will not leave any profitable alternatives unexploited. Rates of

return on various investments will tend to equalize, and differences among

the returns will be linked to different characteristics and risk. If an

individual or organization seeks to finance a given project, the project will

obtain financing only at an interest rate at which someone is willing to

lend. A certain number of projects will meet the market criteria and obtain

financing. Projects that do not will not be financed. In general, the source

of funds for financing projects (that is, pension plans, banks, corporations,

individuals) is of little importance because each source seeks only the

investment that meets its criteria, and the borrower seeks only to finance

the project as inexpensively as possible.

Economic theory recognizes that market institutions are not perfect and,

as a result, some projects may not be correctly evaluated. This may occur

if certain social benefits or costs of a project are not included in the

38CBO, An Analysis of the Report of the Commission to Promote Investment in America’s

Infrastructure (Washington, D.C.: Feb. 1994).

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Appendix II 

Economic Perspectives: Is an Expanded

Federal Role in Attracting Pension Plan

Investments in Infrastructure Justified?

evaluation, such as when there are “externalities,” or “spillover effects,”39

or if there are barriers preventing market participants from getting

information about projects or investments.40 These “market

imperfections,” or “market failures,” serve as a rationale for government

intervention in the marketplace, usually to correct these failures or to

regulate the activities of institutions. This is a standard justification for

much of government’s involvement in markets and applies as well to

public investment. The existing array of grants and subsidies to public

investment at various levels of government can be viewed as a response to

correct what are seen as market imperfections.

On a more practical level, much of the everyday activity in financial

markets is an effort to find financing for projects at favorable rates and to

do so by assuring investors of the creditworthiness of projects. In addition

to traditional practices, various sophisticated financing schemes or credit

enhancements—sometimes involving government subsidies—may be

offered to make projects viable. Many investments, particularly those in

infrastructure, are complex transactions requiring agreement among many

parties. It is not generally clear at the outset what will be necessary to

complete a project’s financing. While there are a variety of practices in the

marketplace, it is difficult to judge any particular set of institutional

arrangements as optimal from an economic perspective. What is clear is

that the choice of the institutions, rules, and policy by which decisions

about infrastructure financing are made is the result of the interaction of

individuals in both their market and political settings.

Assessing the

Infrastructure

Commission’s

Rationale for

Expanding

Government’s Role

In evaluating the proposals of the Infrastructure Commission and

determining whether a federal role is justified, it is useful to consider

economic rationales for a government role in credit markets. A 1987

Brookings Institution study noted three important objectives for

government credit programs:41

• to improve the efficiency of markets by correcting market imperfections

and encouraging innovations,

39Spillover effects can occur, for example, when a large infrastructure project in one state benefits the

residents of nearby states. The government of the state in which the project is located may not be able

to require the residents of other states to pay for their share of the benefits received from the project.

As a result, the project may not be approved.

40See Joseph E. Stiglitz, “The Role of the State in Financial Markets,” in Proceedings of the World Bank

Annual Conference on Development Economics, 1993 (Washington, D.C.: The World Bank, 1994).

41Barry P. Bosworth, Andrew S. Carron, and Elizabeth H. Rhyne, The Economics of Federal Credit

Programs (Washington, D.C.: The Brookings Institution, 1987).

Page 37 GAO/HEHS-95-173 Pension Plan Infrastructure Investment
Appendix II 

Economic Perspectives: Is an Expanded

Federal Role in Attracting Pension Plan

Investments in Infrastructure Justified?

• to reallocate resources toward activities that are judged to have a public

value greater than that reflected in private decisions, and

• to redistribute income by providing a transfer to selected firms and

individuals.

A recent CBO analysis of the Infrasturcture Commission’s proposals

employed those three objectives in raising questions about whether the

Infrastructure Commission’s recommendations were based on a

compelling case for government action. CBO made the following key points:

• The municipal bond market already receives a large federal subsidy and is

generally considered to be functioning well. The market imperfections that

affect the municipal bond market are not addressed by the Infrastructure

Commission’s proposals.

• The premise that greater investment in infrastructure will increase overall

economic output is questionable, and only a few projects that would be

supported through the National Infrastructure Corporation would have

returns higher than alternative private investments. The proposed new

federal incentives may result in further distortion of investment choices by

displacing other investments, which in turn could result in economic

inefficiency.

• Measuring and controlling the impacts from new federal financial

structures are influenced importantly by the organizational form of the

proposed corporations. Establishing NIC as a government-sponsored

enterprise carries high risk (through contingent liability) to the federal

government.

CBO noted that the proposed structures may play a role in producing

information about projects that may be useful in pricing future bond

issues. But CBO doubted the value of this information to the markets. One

of the rationales noted in the Brookings study concerns the government’s

possible role of introducing “innovations” in the marketplace. At one level,

this rationale can arise in a market failure context, in the sense that a lack

of certain information in the market can lead to inefficiency in resource

allocation. In this regard, the Infrastructure Commission’s recommended

structures and activities may play a role in demonstrating that certain

projects can be made viable when the government (through NIC) plays a

role as a catalyst in “getting product to the market place” as Infrastructure

Commission Chairman Daniel V. Flanagan, Jr., suggested.

This in turn raises a question: To what end would the government’s efforts

to introduce innovations be directed? Addressing this question involves

Page 38 GAO/HEHS-95-173 Pension Plan Infrastructure Investment
Appendix II 

Economic Perspectives: Is an Expanded

Federal Role in Attracting Pension Plan

Investments in Infrastructure Justified?

the second rationale—reallocating resources to activities that are judged

to have a public value greater than that reflected in private market

decisions. The Infrastructure Commission’s proposals are aimed primarily

at reallocating pension plan capital toward public investment and away

from private investment. As noted in chapter 1, some evidence suggests

that such a shift would “improve” the allocation of resources and might

increase economic output. But many economists disagree with this view

and suggest the effect may be the opposite.42 Essentially, it is difficult to

determine whether there is market failure and whether there is adequate

justification, from an economic analysis framework, for an expanded

government role as the Infrastructure Commission proposes.43

Moving beyond this economic analysis framework implies that the issue

becomes one of competing political values about how to allocate

resources. Some of our discussions with Infrastructure Commission

officials confirmed that conclusion. It was noted that the rationale for the

proposals was based more on “policy” considerations than on a strictly

economic justification. In this regard, the Infrastructure Commission’s

rationale seems more rooted in the view that capital should be reallocated

to public investment in infrastructure and that the entities and incentives

proposed by the Infrastructure Commission are justified as an effort to

implement that objective.

Hence, it would seem that the justification for an expanded government

role to encourage investment in infrastructure can depend on the values

expressed by the voters. In other words, if individuals perceive a problem

with infrastructure and demand that it be addressed, then government may

be chosen as one vehicle for providing an institutional framework to

satisfy this demand. Analysis should then focus on considering the

institutions and public processes for making infrastructure investment

decisions.

The Political Process and

the Demand for

Infrastructure

Some analyses extend the economic analysis framework to encompass the

public processes for making decisions about providing public goods,

including infrastructure. One perspective focuses on the incentives of

42See commentary by Bosworth and Charles Hulten presented at America’s Infrastructure Financing

Policies, a symposium sponsored by the Financial Guaranty Insurance Company (Washington, D.C.:

Sept. 27, 1993). Also see Keep Your Sticky Fingers Off My Pension, testimony by William Niskanen,

The Cato Institute, before the Joint Economic Committee (June 22, 1994).

43The rationales intersect in that the seemingly value-based rationale that capital should be allocated to

social purposes could be interpreted as a lack of information (informational inefficiency) on the part

of investors about certain projects. This point seems to be present in discussions of economically

targeted investments.

Page 39 GAO/HEHS-95-173 Pension Plan Infrastructure Investment
Appendix II 

Economic Perspectives: Is an Expanded

Federal Role in Attracting Pension Plan

Investments in Infrastructure Justified?

decisionmakers in the political process. At one level, this perspective is

closely related to the standard economic analysis approach previously

discussed. The existence of extensive market failures is questioned, which

reduces the scope for justifying government action to address alleged

market failures. The primary focus, however, is on decisionmakers in the

political process, who may have incentives to expand spending on public

goods and who may be subject to persuasion by those who may benefit

from public provision of such goods. In this view, “. . . the incentives faced

by political decision makers shows little resemblance to the incentives

necessary to provide an optimal supply of public goods.”44

A related perspective that focuses on the role of the political process in

gauging the demand for infrastructure and difficulties posed by existing

political mechanisms is found in an analysis by George E. Peterson.45

Peterson noted that individuals and households express their demand for

infrastructure through voting, either on bond issues or on the taxes or fees

assessed to recover investment costs. He provided evidence from bond

referendums to show that taxpayers have expressed a willingness to “buy”

more infrastructure than was actually provided by public authorities. This

is a paradox, in Peterson’s view, and one explanation is that political

leaders are risk averse and exhibit “fear of rejection at the referendum,”

which leads them to offer fewer infrastructure projects than voters would

be willing to pay for. He also suggested that “one man, one vote” schemes

fail because there is no mechanism for weighting votes by willingness to

pay or by economic stake in the outcome, as may be the case with

business interests. He concluded that

“[A]s a result, a good deal of political ingenuity in recent years has gone into inventing

institutions that can legally invest in infrastructure without submitting to the referendum

process. This strategy seems to be a mistake. The most striking cases of turnaround in . . .

infrastructure spending have occurred precisely where new business-consumer alliances

have taken their case to the public and asked for voter support. Typically, these proposals

have included a redesigned tax or fee package that targeted a greater share of costs to

business and users, thereby relieving the cost burden on the general taxpayer who must

approve the new spending.”

Analyses such as these place the focus on the individual’s role in deciding

about infrastructure spending and on the costs involved in the decisions.

44Tom G. Palmer, “Infrastructure: Public or Private?,” Policy Report, The Cato Institute, Vol. V, No. 5

(May 1983), pp. 1-3.

45George E. Peterson, “Is Public Infrastructure Undersupplied?,” in Is There a Shortfall in Public

Capital Investment?, ed. Alicia H. Munnell (Boston: Federal Reserve Bank of Boston, June 1990), pp.

113-30.

Page 40 GAO/HEHS-95-173 Pension Plan Infrastructure Investment
Appendix II 

Economic Perspectives: Is an Expanded

Federal Role in Attracting Pension Plan

Investments in Infrastructure Justified?

Proposals such as those made by the Infrastructure Commission imply

that infrastructure spending is insufficient and that a larger federal role is

justified to align infrastructure spending with voter preferences. But this

may not be the case if the Infrastructure Commission’s mechanisms move

the cost burden of greater infrastructure spending away from those who

directly benefit from it. Therefore, a key factor will be whether the costs of

the Infrastructure Commission’s proposals will be adequately evaluated in

comparison with alternatives. The proposals extend additional subsidies

to pension plans (and participants) to invest in infrastructure46 and

essentially spread this added federal cost to the general taxpayers. But a

number of analysts have suggested that changes to existing policy and

procedures would go a long way toward providing incentives to expand

infrastructure investment without significantly expanding the federal role

or federal subsidies: revising grant procedures, leveraging grants, making

innovations in asset securitization of municipal bonds, and encouraging

joint public-private ventures.47 While the Infrastructure Commission’s

proposals offer potentially viable alternatives to expand infrastructure

spending and pension fund involvement, it is important to weigh these

proposals against other policies in terms of which provides what the

public wants at the lowest possible cost in resources.

46The third rationale provided by Bosworth relates to the goal of redistributing income. Infrastructure

proposals will likely have redistributional effects. For example, the Infrastructure Commission’s

proposals may subsidize certain projects to attract pension funds, thus conferring additional subsidies

on pension plans. For example, see Scott M. Reznick, Innovations in Structuring Public and

Public-Private Investments in Infrastructure (Washington, D.C.: Volpe National Transportation

Systems Center, DOT, Dec. 23, 1993). A fuller treatment of such distributional considerations was not

within the scope of this study.

47Edward M. Gramlich, “How Should Public Infrastructure Be Financed?,” in Is There a Shortfall in

Public Capital Investment?, pp. 223-37; and “Infrastructure Investment: A Review Essay,” Journal of

Economic Literature, Vol. XXXII (Sept. 1994), pp. 1176-96.

Page 41 GAO/HEHS-95-173 Pension Plan Infrastructure Investment
Appendix III 

GAO Contacts and Staff Acknowledgments

GAO Contacts Donald C. Snyder, Assistant Director, (202) 512-7204

Kenneth J. Bombara, Senior Economist

Staff

Acknowledgments

In addition to those named above, the following individuals made

important contributions to this report: Anindya Bhattacharya, Senior

Economist, and Frank Grossman, Evaluator, conducted the data gathering

and analyses for the project and coauthored the report. Assisting in

various phases of the project were Robert Gentile, Evaluator; Robert T.

Griffis, Senior Evaluator; and Roy G. Buchanan, Evaluator.

(105664) Page 42 GAO/HEHS-95-173 Pension Plan Infrastructure Investment
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