Since Congressman Jay Inslee made his announcement Monday  that he would challenge Republican Rob McKenna in next year’s election for governor, conversation has been stuck on one point—his proposal to use state pension funds for private sector investment in start-ups—in Inslee’s otherwise vaguely-defined plan to correct the state’s economic course.

As reported by The Seattle Times:

One of Inslee’s chief ideas to spur job growth was to open up resources for start-up companies who are currently starved for cash. He suggested using a small amount of state pension money to support these businesses – an investment that is typically risky – and grow new industries. He declined to say how much money he would commit to such a program.

But ten minutes on an Internet search engine could have given Inslee an opportunity to make last-minute revisions to a plan that opponents suggest is at best risky and at worst a lurch toward European-style economic planning. No matter how many millions Inslee wants to borrow from state workers’ retirement pay, one research group came out Monday to say that pension funds like Washington’s are already stretched to the breaking point.

Just as Inslee was proposing to “invest” the retirement income of state workers into start-up firms—businesses in the highest category of risk—he may not have known the Institute for Truth in Accounting was releasing its 50-state study of worker benefit solvency, a report in which only four states were found to have sufficient assets to cover obligations for state workers for pensions and retirees’ healthcare. (Washington was not one of the four states in the black.)

The Institute’s study concluded that Washington State needs more than $14.9 billion to cover its current promised obligations, an amount that translates to a burden of $6,500 per taxpayer.

In light of the Institution’s findings, Inslee’s proposal seems more like a risky game of fiscal Jenga played on a crowded table. When the pieces of Inslee’s fantastic economic construction do fall, taxpayers will be forced to pick up the pieces from the inevitable failure of his experiment in merging bureaucracy and entrepreneurism. In all likelihood, the million dollar blocks will come crashing down not on the heads of retirees themselves, but on local governments as author and City Journal editor Steve Malanga, suggested Monday in The Wall Street Journal:

Earlier this year, California’s Little Hoover Commission, a government oversight agency, observed: “Barring a miraculous market advance and sustained economic expansion, no government entity—especially at the local level—will be able to absorb the blow [from rising pensions] without severe cuts to services.”

Inslee’s plan to use pension funds for economic experimentation is not a new one, even for the congressman. In the book Inslee co-authored in 2009, Apollo’s Fire: Igniting America’s Clean Energy Economy, he used California’s pension system (CalPERS) as an example of what government could do to spur growth in the so-called clean-tech sector:

At the same time, major public pension funds like that of the California Public Employees’ Retirement System, with $190 billion in assets in 2005, and other socially responsible investors are putting money into clean technology and finding that the new energy economy meets their social and environmental goals even as it makes a profit for their bottom line.

If there was laughter heard Monday in the Golden State when Inslee again suggested commandeering public pensions to be used as high-risk investment pools, it was because CalPERS—both in terms of its investment behavior and its overall financial stability is just one more example of the reverse Midas touch he inflicts when promoting organizations to the top of his hierarchy of success.

The current estimated 30% underfunding of CalPERS—an amount a March 2011 Los Angeles Times editorial stated was in the “tens of billions”— is due in large part to risky investing. The most recent problems at CalPERS stem from unsafe investing in exotic mortgage instruments, but the troubles are not the entity’s first encounter with red ink.

It is important to note that the fiduciary entity responsible for paying hundreds of thousands of California public employees in their retirement, had its own part to play in the first scandal of the 21st century that rocked the financial world—Enron.

One of the more notorious elements in the Enron scandal (oh, how a banking crisis will wipe the memory slate clean) was the joint venture between the energy giant and CalPERS known as Joint Energy Development Investments (JEDI). The purpose of JEDI was to seek out investments in energy companies. Is this what Inslee has in mind when he proposes diverting over-obligated pension funds to make investments in risky start-up companies? If Inslee opened the vault for the Democrats to begin using like a monthly investment club, what would stand between Washington State and the temptation that CalPERS succumbed to?

On the other hand, even seemingly prudent involvement in the market by government can go awry.

Using CalPERS as an example again (it’s the largest pension system of its kind in the United States), in 2002 the entity became part of the Asian banking contagion, reacting to fears of losses by yanking its investments out of Southeast Asia. Joining other skittish stockholders in a bolt for the exit, CalPERS caused a run on markets that eventually necessitated a full-scale banking bailout led by the United States. Analysts such as William Pesek Jr. writing for Bloomberg have argued that not only did CalPERS exacerbate what could have been a minor correction in Asian stocks, it swung so far in the direction of being risk-averse that it missed out on the resurgent growth in the same markets it abandoned.

In February 2002, CalPERS tried to stake out the moral high ground when it pulled out of stocks in Indonesia, Malaysia and Thailand. It cited concerns about corporate governance, political instability and labor standards. It turns out that those markets have been among the world’s top performers for two years running. …

The biggest losers weren’t the economies CalPERS vacated, but its shareholders. They missed out on a 17 percent rise in Thai stocks in 2002 and 117 percent jump in 2003. They also lost out on an 8 percent rise in Indonesian shares in 2002 and a 63 percent increase in 2003. Malaysian shares rose almost 23 percent last year.

What Inslee’s proposal to revive Washington’s economy fails to recognize is that in order to regain its potency—particularly in the area of its small and medium-size start-ups that Inslee correctly identifies as the drivers of the economy—a rethinking of the tax code is more likely to produce results than providing selective support to businesses chosen based on a narrow set of criteria.

When a new business has gathered the capital necessary to fledge from the nest of its innovation into the realm of competitive business, a chief obstacle it faces in Washington state is a regressive business tax structure. Washington’s business and occupation tax—one that taxes a business’ first dollar of income at the same rate manner as its one billionth—has been creating a formidable barrier for small businesses trying to compete with more established ones.

For Inslee, a career politician, concepts such as break-even points and economies of scale may be recognizable only as phrases to be emphasized forcefully when addressing large groups of corporate donors. Nevertheless, he should hear from small business owners on the issue of replacing the business and occupation tax and its complex system of preferential credits and deductions, perks lobbied into being by the big businesses. To do so could be the best way to restore fairness to the state’s economy and unleash the full potential of what the region has to offer.


[featured image credit: flickr; article image credit: flickr]