Private Pension Plans: Efforts to Encourage Infrastructure Investment
(Chapter Report, 09/08/95, GAO/HEHS-95-173).

Pursuant to a congressional request, GAO provided information on the
role that pension plans play in expanding public investment in
infrastructure projects.

GAO found that: (1) pension plans have not been investing in domestic
public infrastructure because of the combined effects of federal law,
which requires plans to seek the highest rate of return on investments
and encourages growth by exempting earnings from taxation; (2) to
encourage public investment in infrastructure, federal law provides a
tax exemption on interest income to those who invest in municipal bonds;
(3) pension plans have no incentive to invest in lower-interest
municipal bonds, since plan earnings are already tax exempt; (4)
although the Infrastructure Commission recommended creating two federal
financing entities to attract pension plans to invest, the share of plan
assets that might go to infrastructure would likely be small; and (5)
the federal capitalization of state revolving funds may be an option to
expand infrastructure investment without relying on pension plans.

--------------------------- Indexing Terms -----------------------------

 REPORTNUM:  HEHS-95-173
     TITLE:  Private Pension Plans: Efforts to Encourage Infrastructure 
             Investment
      DATE:  09/08/95
   SUBJECT:  Pensions
             Investments
             Revolving funds
             Tax exempt status
             Transportation industry
             Economic development
             Municipal bonds
             Employee retirement plans
             Pension plan cost control
             Investment planning
IDENTIFIER:  State Water Pollution Control Revolving Fund
             
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Cover
================================================================ COVER


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

Pension Plan Infrastructure Investment

(105664)


Abbreviations
=============================================================== ABBREV

  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

Letter
=============================================================== LETTER


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
============================================================ Chapter 0


   PURPOSE
---------------------------------------------------------- Chapter 0:1

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
---------------------------------------------------------- Chapter 0:2

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
---------------------------------------------------------- Chapter 0:3

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 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
---------------------------------------------------------- Chapter 0:4


      FEDERAL POLICIES CREATE A
      DISINCENTIVE TO PENSION
      INVESTMENT IN INFRASTRUCTURE
      AND INVOLVE LARGE SUBSIDIES
-------------------------------------------------------- Chapter 0:4.1

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 $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
-------------------------------------------------------- Chapter 0:4.2

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
-------------------------------------------------------- Chapter 0:4.3

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 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
-------------------------------------------------------- Chapter 0:4.4

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
---------------------------------------------------------- Chapter 0:5

GAO is making no recommendations. 


   COMMENTS BY OUTSIDE EXPERTS
---------------------------------------------------------- Chapter 0:6

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. 


INTRODUCTION
============================================================ Chapter 1

Concern over the state of America's infrastructure--highways, mass
transit, rail, aviation, water transportation, water resources, water
supply, and wastewater treatment facilities\1 --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


--------------------
\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). 


   THE CHANGING FEDERAL ROLE IN
   INFRASTRUCTURE
---------------------------------------------------------- Chapter 1:1

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 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. 


--------------------
\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. 

\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). 


   THE INFRASTRUCTURE INVESTMENT
   DEBATE
---------------------------------------------------------- Chapter 1:2

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 water in the world.  The debate over
infrastructure investment has been extensively explored in the
economic literature.\8


--------------------
\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. 

\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. 


      POLICIES TO EXPAND
      INFRASTRUCTURE--A ROLE FOR
      PENSION PLANS? 
-------------------------------------------------------- Chapter 1:2.1

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 highest
return (taking risk into account) on their investments, they do not
normally invest in lower-yielding, tax-exempt bonds. 


--------------------
\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. 


   THE INFRASTRUCTURE COMMISSION'S
   RECOMMENDATIONS
---------------------------------------------------------- Chapter 1:3

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 leverage\11
     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. 


--------------------
\10 Financing the Future:  Report of the Commission to Promote
Investment in America's Infrastructure (Washington, D.C.:  Feb.  23,
1993). 

\11 Leveraging 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. 


   OBJECTIVES, SCOPE, AND
   METHODOLOGY
---------------------------------------------------------- Chapter 1:4

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. 


FEDERAL LAWS CREATE DISINCENTIVES
TO PENSION PLAN INVESTMENT IN
INFRASTRUCTURE
============================================================ Chapter 2

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
---------------------------------------------------------- Chapter 2:1

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

  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.\14
\15


--------------------
\12 See Dan M.  McGill, Fundamentals of Private Pensions, 5th ed. 
(Homewood, Ill.:  Richard D.  Irwin, 1984). 

\13 Pension Plans:  Investments in Affordable Housing Possible With
Government Assistance (GAO/HRD-92-55, June 12, 1992), pp.  2-3. 

\14 As 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. 

\15 Despite 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. 


   TAX-EXEMPT MUNICIPAL BONDS
   LOWER COSTS TO STATE AND LOCAL
   GOVERNMENTS
---------------------------------------------------------- Chapter 2:2

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-rated\17

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. 

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

   (See figure in printed
   edition.)

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. 


--------------------
\16 Environmental Infrastructure:  Effects of Limits on Certain
Tax-Exempt Bonds (GAO/RCED-94-2, Oct.  28, 1993). 

\17 Several 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. 


      FEDERAL INFRASTRUCTURE
      FINANCING PROGRAMS TAKE
      ADVANTAGE OF THE TAX-EXEMPT
      MARKET
-------------------------------------------------------- Chapter 2:2.1

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 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. 


--------------------
\18 The 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. 

\19 The 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. 


   TAX EXEMPTIONS FOR PENSION
   PLANS AND MUNICIPAL BONDS
   INVOLVE LARGE SUBSIDIES
---------------------------------------------------------- Chapter 2:3

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 estimates\20 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. 

\21 Additional 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). 

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


THE COMMISSION TO PROMOTE
INVESTMENT IN AMERICA'S
INFRASTRUCTURE PROPOSED NEW
FEDERAL INCENTIVES
============================================================ Chapter 3

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


--------------------
\23 For 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). 


   RATIONALE FOR THE
   INFRASTRUCTURE COMMISSION'S
   PROPOSALS
---------------------------------------------------------- Chapter 3:1

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 limits\24 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. 


--------------------
\24 The 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. 


   CREATION OF A NATIONAL
   INFRASTRUCTURE CORPORATION AND
   AN INFRASTRUCTURE INSURANCE
   CORPORATION
---------------------------------------------------------- Chapter 3:2

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. 


--------------------
\25 The 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. 


      THE FUNCTIONS OF NIC AND IIC
-------------------------------------------------------- Chapter 3:2.1

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. 

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


--------------------
\26 In 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."


      FINANCING AND ORGANIZING NIC
      AND IIC
-------------------------------------------------------- Chapter 3:2.2

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, for-profit municipal
bond insurer that insures bonds for construction at institutions of
higher learning and teaching hospitals.\28


--------------------
\27 Securitization 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. 

\28 Connie 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. 


   TAPPING PENSION PLAN CAPITAL
   FOR INFRASTRUCTURE FINANCING
---------------------------------------------------------- Chapter 3:3

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.  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. 


--------------------
\29 A 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. 


   EVALUATING THE INFRASTRUCTURE
   COMMISSION'S PROPOSALS
---------------------------------------------------------- Chapter 3:4

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 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 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. 


--------------------
\30 CBO, An Analysis of the Report of the Commission to Promote
Investment in America's Infrastructure (Washington, D.C.:  Feb. 
1994). 

\31 There is some evidence that these restrictions have not reduced
infrastructure investment at the state and local levels.  See
GAO/RCED-94-2. 


MARKET PARTICIPANTS' PERSPECTIVES
ON PRIVATE PENSION PLAN INVESTMENT
IN INFRASTRUCTURE
============================================================ Chapter 4

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
---------------------------------------------------------- Chapter 4:1

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 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
-------------------------------------------------------- Chapter 4:1.1

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


--------------------
\32 The 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. 


      DEFINED CONTRIBUTION PLANS
      MAY PLAY A ROLE
-------------------------------------------------------- Chapter 4:1.2

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 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
-------------------------------------------------------- Chapter 4:1.3

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
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. 


--------------------
\33 See Gramlich, "Infrastructure Investment:  A Review Essay."

\34 Fragile Foundations, pp.  59-73. 


   MARKET PARTICIPANTS EXPRESS
   CONCERNS ABOUT AN INCREASED
   FEDERAL ROLE
---------------------------------------------------------- Chapter 4:2

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 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. 


--------------------
\35 Union 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. 


   ALTERNATIVE FINANCING
   MECHANISMS ARE AVAILABLE
---------------------------------------------------------- Chapter 4:3

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


--------------------
\36 See Surface Transportation:  Reorganization, Program
Restructuring, and Budget Issues (GAO/T-RCED-95-103, Feb.  13, 1995). 

\37 See 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. 


CONCLUDING OBSERVATIONS
============================================================ Chapter 5

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. 


Appendix I SCOPE AND METHODOLOGY
============================================================ Chapter 5

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.  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. 


ECONOMIC PERSPECTIVES:  IS AN
EXPANDED FEDERAL ROLE IN
ATTRACTING PENSION PLAN
INVESTMENTS IN INFRASTRUCTURE
JUSTIFIED? 
========================================================== Appendix II

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


--------------------
\38 CBO, An Analysis of the Report of the Commission to Promote
Investment in America's Infrastructure (Washington, D.C.:  Feb. 
1994). 


   JUSTIFYING A FEDERAL ROLE:  THE
   ECONOMIC ANALYSIS APPROACH
-------------------------------------------------------- Appendix II:1

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
-------------------------------------------------------- Appendix II:2

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 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. 


--------------------
\39 Spillover 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. 

\40 See 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). 


   ASSESSING THE INFRASTRUCTURE
   COMMISSION'S RATIONALE FOR
   EXPANDING GOVERNMENT'S ROLE
-------------------------------------------------------- Appendix II:3

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,

  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 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. 


--------------------
\41 Barry P.  Bosworth, Andrew S.  Carron, and Elizabeth H.  Rhyne,
The Economics of Federal Credit Programs (Washington, D.C.:  The
Brookings Institution, 1987). 

\42 See 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). 

\43 The 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. 


      THE POLITICAL PROCESS AND
      THE DEMAND FOR
      INFRASTRUCTURE
------------------------------------------------------ Appendix II:3.1

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 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.  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
infrastructure\46 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. 


--------------------
\44 Tom G.  Palmer, "Infrastructure:  Public or Private?," Policy
Report, The Cato Institute, Vol.  V, No.  5 (May 1983), pp.  1-3. 

\45 George 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. 

\46 The 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. 

\47 Edward 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. 


GAO CONTACTS AND STAFF
ACKNOWLEDGMENTS
========================================================= Appendix III

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. 

