Fixing Our Pension and Infrastructure Problems at the Same Time

Toll-financed replacement and modernization of major highways via P3 concessions would significantly assist under-funded pension funds to increase their returns.

Two of America’s largest public-sector problems are the massive underfunding of state and municipal employee pension systems and serious under-investment in transportation infrastructure, especially our aging highway system.

The vast majority of public pension funds have not set aside enough money to cover their obligations to retirees. As of 2013, the official figure for all U.S. public pension plans showed them to be only 71 percent properly funded. But according to finance expert Andrew Biggs at American Enterprise Institute, if those funds were required to calculate their liabilities under the same rules as corporate America, and if market values were used instead of “smoothed” values, the funded ratio would drop to just 41 percent, and their unfunded liability would be $2.6 trillion.

At the same time, we have any number of studies documenting serious shortfalls in needed highway investment. Unpriced and under-capacity urban expressways cost motorists and truckers $160 billion a year just in lost time and excess fuel consumption, yet very little is being invested in meaningful congestion relief. Our aging 47,000 miles of Interstate highways-the crown jewel of our highway system-will require between $1 trillion and $2 trillion to rebuild and modernize over the next few decades, yet no program exists to generate such funds.

Part of the answer to fixing under-funded pension systems is also a way to help solve the highway investment shortfall. A clue was provided by two of 2015’s least-appreciated highway finance transactions: the acquisition by major pension funds of the remaining years of the long-term concessions for the Chicago Skyway and the Indiana Toll Road. In each case, a consortium of public pension funds invested billions in an existing tolled Interstate. Unlike the highly leveraged original transactions from last decade, these new deals invested serious equity: 55 percent in the Skyway and 57 percent for the Indiana Toll Road. With those kinds of low-leverage deals, the pension funds expect to earn returns in the low double digits over many decades.

Public pension funds have been investing equity in large-scale public-private partnership (P3) infrastructure for several decades in Australia and Canada, but this trend has only gained legs in the United States in the last few years. Last decade, public employee unions actively opposed P3 deals, fearing that they would put union jobs at risk. But as the depth of the pension crisis has become more visible, those objections are fading away. Major U.S. public pension funds in Arizona, California, Florida, Illinois, New York, Texas, and elsewhere are starting to invest serious money in P3 infrastructure projects, initially mostly low-risk brownfield projects.

Portions of the P3 community tend to dismiss the recent Skyway and Indiana deals as boring “brownfield” (asset-shuffling) transactions. But that greatly underestimates their significance. Both of those highways are aging Interstates, built in the 1950s. Over the remaining 89 and 66 years of their concessions, both will require major reconstruction. So these deals are more accurately described as hybrid brownfield/greenfield concessions. As such, their risk profile is intermediate between a high-risk greenfield toll road and a low-risk existing toll road with a long traffic history.

The need to redesign, rebuild, and modernize the rest of the largely non-tolled 47,000 route-miles of Interstates is very real, and will need to be dealt with over the next two decades. That is the same time frame in which public pension funds must resolve the underfunding of their pension promises to the huge baby boom generation. To do that, they will need to diversify their investments by adding asset classes that can generate 9-to-12 percent annual returns. Replacement tolled Interstates can be a significant part of that diversification, if financed conservatively as the two public pension consortia have done with the Indiana and Skyway concessions.

Unlike several recent Interstate highway P3 projects (e.g., portions of the new I-69 in Indiana and the reconstruction of I-70 East in Denver), these replacement projects must be toll concessions, not availability-pay concessions. There is no way that existing federal and state fuel tax revenues could possibly generate enough revenues to pay for a $1-to-2 trillion Interstate replacement effort. This will only be doable with large additional investment in these corridors, and tolls are the obvious funding source.

Shifting 21st century Interstates from fuel taxes to all-electronic tolls will be a key building block in America’s overall transition from per-gallon taxes to per-mile charges. Just about everyone in transportation agrees that this transition will have to take place over the next several decades-the same time frame within which 20th century Interstates must be replaced. But to avoid concerns over “double taxation”-paying both fuel taxes and tolls on the same highway-the tolling algorithm must calculate a fuel-tax rebate at the same time it computes the toll for driving on the replacement Interstate. This is a basic premise of the mileage-based user fee pilot programs under way in several states, and is a key to getting motorist and trucker buy-in for this transition.

P3 toll concessions can also make credible a state’s promise that the per-mile tolls needed for Interstate reconstruction and modernization-which will generally need to be at least twice as much as current per-mile revenue from fuel taxes-will be genuine user fees, not an all-purpose transportation tax to be used for everything legislators can think of. Each state’s enabling legislation for toll-financed Interstate replacement should include language limiting the toll rates to the capital and operating costs of the new facilities. But since legislation can always be changed, the same provisions need to be included in the long-term P3 concession agreements and in the bond covenants for debt financing.

Pension funds (and other infrastructure investment funds) that provide the equity for Interstate replacement projects will want enforceable assurance that the tolls will not be excessive (as they would be if they became all-purpose transportation funding sources), since too-high tolls would divert many users to other routes and would not, therefore, maximize revenues for the equity investors.

In short, America could address three, not just two, pressing problems via what is proposed here. Toll-financed replacement and modernization of major highways via P3 concessions would significantly assist under-funded pension funds to increase their returns, provide much-needed increases in major-highway investment, and make a large contribution to the needed transition from per-gallon to per-mile highway funding.

Robert Poole is director of transportation policy at Reason Foundation. This column first appeared in Public Works Financing.

Robert Poole is director of transportation policy and Searle Freedom Trust Transportation Fellow at Reason Foundation.