Under the plans set out in a consultation document, councils could release as much as £22bn for construction work.
The Local Government Pension Scheme England and Wales is administered by 89 separate local funds that hold combined investment assets worth £150bn.
There are pension fund rules to make sure that investment risks are spread across different types of investments to give taxpayers long-term protection. Fund managers are currently limited in the amount they can invest via partnership arrangements, which includes many types of infrastructure investment.
The proposals published for consultation today include an option to increase the current limit of 15% to 30%. This would clear the barriers standing in the way of better council investment giving them the scope to inject up to £45bn in such arrangements.
Local government secretary Eric Pickles said:"Unlocking Town Hall pension pots so they can be used to invest in vital infrastructure projects is a common sense decision that will help this country complete on a global scale and get Britain building.
"By lifting the restrictions controlling local pension investments councils could pump a further £22bn directly into job creating infrastructure projects that will boost our economy.
"This is potentially a huge development and investment opportunity we simply cannot afford to ignore that also allows us to maintain long-term value for money for the taxpayer."
A recent report by the Future Homes Commission said council pension funds could be used to build key infrastructure projects like new homes in the UK without increasing the government deficit.
Investment decisions remain for individual local pension funds, which have a duty to protect the local council taxpayers, and local services and to ensure that there are no conflicts of interest.
The consultation applies to England and Wales only. It will run for six weeks until 18 December. The consultation document Local Government Pension Scheme: Investment in Partnerships can be found at: www.communities.gov.uk/publications/localgovernment/lgpsinvestmentpartnerships.
CBI director for business environment Rhian Kelly said of the proposals: “Unlocking pension fund investment is critical to improving the UK's infrastructure, so businesses will be heartened that government is listening to the recommendations of the CBI and others, and taking action to lift barriers and attract new sources of funding.
“Local government pension funds are some of the largest in the country and many already have experience of investing in infrastructure and housing. Infrastructure projects should be a natural fit for these funds, which have very long time-horizons and are looking for a healthy investment return. Lifting restrictions should allow them to take a more prominent role in deepening pension funds' involvement in infrastructure financing.
"But we cannot afford to rest on our laurels. More must be done to ensure we deliver a pipeline of investable projects and ensure that the real priorities – the projects of national economic significance – are given all possible support.”