Concern over the state of America’s infrastructure—highways, mass transit, rail, aviation, water transportation, water resources, water supply, and wastewater treatment facilities—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, which were estimated to have over $4 trillion in assets in 1994—to expand federal, state, and local financing of infrastructure projects. Substantial grant funding for infrastructure projects, including highways, wastewater treatment facilities, and mass transit began between 1956 and 1964. Spending on these programs as a share of total federal spending 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. 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 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, but others estimated that $40 billion to $80 billion more was needed each year. 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 water in the world. The debate over infrastructure investment has been extensively explored in the economic literature. 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. However, since plans are subject to fiduciary rules under the Employee Retirement Income Security Act of 1974 (ERISA), which obligate them to seek the highest return (taking risk into account) on their investments, they do not normally invest in lower-yielding, tax-exempt bonds. 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: Create a National Infrastructure Corporation (NIC) to leverage 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. 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. 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. 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 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. 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. 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 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 require a longer time to generate significant investment returns, and may require special expertise to evaluate. 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.