Arnold Is Hitting His Marks

The guv has plugged budget holes. But is he pushing the problems into the future?

From Hollywood action hero to Sacramento mover and shaker, Arnold Schwarzenegger has made the transition to politician look easy. Consider how he has handled California's longstanding fight with Indian tribes over tax-free gaming revenue. After months of battle, Governor Schwarzenegger won an agreement on June 21 that ensures five of the largest tribes will cough up 15% of their future slot-machine revenues to a badly depleted state budget. On top of that, they agreed to pay off a $1 billion bond that will help trim the $14 billion deficit. It's all part of what Schwarzenegger calls "a new battle plan for the state of California." At a signing ceremony with the tribes, Schwarzenegger proclaimed that "instead of divide and conquer, this is unite and conquer."

Scarcely eight months since winning a free-for-all recall election that booted former Governor Gray Davis from office, the one-time Terminator has energized a state capital that had been paralyzed for years. Campaigning as a tax-cutting friend to business, the 56-year-old Austrian-born Schwarzenegger has muscled through ballot initiatives that will restructure the state's debt with $15 billion in bonds and will force lawmakers to balance the budget. Using his charm -- and the threat that he would take ballot initiatives directly to voters -- the hugely popular celebrity pressured legislators to cut California's skyrocketing workers' compensation costs by overhauling medical coverage. Most surprising of all, Schwarzenegger submitted a budget to the legislature that eliminates this coming year's deficit and even leaves a $998 million surplus. Most expect it to be approved on July 1. Said Schwarzenegger in a recent press briefing: "Businesses are coming back to California, expanding in California, and creating jobs in California."

Well, maybe. But the Golden State and its popular new leader -- known around the state capital as both Conan the Republican and the Governator -- still face huge challenges. True, Schwarzenegger has done a brilliant job of dealmaking in refinancing the huge debt he inherited from Davis and in balancing the state's budget for the upcoming year. Problem is, those accomplishments could quickly unravel, since he balanced the budget largely by borrowing and by delaying promised funding for schools and local governments. What's more, he's counting on savings from government streamlining that he hasn't yet accomplished.

That's why critics see most of Schwarzenegger's hard work as little more than budgetary patchwork. A fresh deficit of nearly $8 billion is projected for the fiscal year starting in mid-2005 by the state Legislative Analyst's Office as California is forced to repay prior loans. On top of that, California will have to restore $2 billion in suspended education outlays and an additional $1.3 billion to local governments. "It's clear sailing now, but there's a storm out there in 2005 and 2006," says Pacific Investment Management Co. (AZ ) bond guru William H. Gross.

What's more, as Schwarzenegger expends his seemingly limitless political capital on state finances, other looming issues are going largely unaddressed. The state, which suffered through rolling blackouts in 2001, is again perilously low on electricity. Other states, which offer lower taxes and fewer environmental regulations, continue to lure businesses away from California. Indeed, California is the second-costliest state in which to do business, behind Hawaii, according to the Milken Institute, a nonprofit think tank.

Then there's the economy. The state's once superheated job market now trails the nation in jobs created. In the past, California tended to garner about 11% of all jobs created nationwide, according to a University of California at Los Angeles study. Yet in March and April, the state created only 5% of the country's 700,000 new jobs. Although that could soon change, a return to the go-go years of the late '90s appears unlikely. The UCLA study projects job growth in the state for 2005 at just 1.9%, a big improvement over the 0.8% expected this year but nowhere near the 3.6% growth seen at the end of the last decade. But the news isn't all bad. Personal income growth is projected to grow by 5.2% to 5.6%. That is slightly ahead of the national average and will provide much needed tax revenue.


As the governor waits for robust economic growth to replenish the state's coffers beyond 2005, he's using his special brand of high-voltage charm to win over Sacramento's Democratic-controlled legislature. In a town where Davis often warred with leaders of his own party, Schwarzenegger has become the great conciliator. Visitors to his office at the Capitol get to swing the sword from his Conan films and meet with Schwarzenegger pals Danny DeVito, Clint Eastwood, and Rob Lowe, who sometimes sit in on meetings. Often, he strikes deals with legislative leaders at the presidential suite at the Hyatt Regency, where he lives when he's away from Los Angeles, or in a smoking tent pitched on the Astroturf patio outside his office, where the governor likes to puff on cigars. "He has vigor, he has charisma, and he's committed to making this state work right again," says former Assembly Speaker Herb J. Wesson Jr., a Democrat who negotiated the workers' comp deal.

All well and good. But charisma only goes so far in a state where business still finds plenty of good reasons for leaving. On July 1, California will become the first state in the nation to mandate "family leave" for all workers, including fathers. And later this year, if it isn't overturned by a business-sponsored ballot initiative in November, businesses with 200 employees or more would be required to provide state-approved health-care plans for their employees -- a requirement that business groups estimate would cost $7 billion.


But the biggest business beef is with a workers' compensation package that doesn't seem to save money the way Schwarzenegger had hoped. The legislative fix was designed to reduce workers' compensation costs, which have tripled for some companies in recent years, by establishing HMO-like networks of insurer-approved doctors. The rules also provide incentives for getting workers quickly back on the job.

Schwarzenegger figures the changes should cut premiums by 25% to 30%. But insurers, including the state insurance commissioner, figure the savings at far less than that. "What the governor and legislature passed were just words," says Stanley R. Zax, chairman of Zenith National Insurance Corp. (ZNT ), the state's sixth-largest insurer. It says it will cut rates just 10% starting in July.

That makes Arnold's job all the tougher. Although the governor has made calls to businesses thinking of blowing town -- he sweet-talked Genentech Inc. into expanding its Vacaville plant and got Virgin Atlantic Airways Ltd. to put a new facility in San Francisco -- other companies are heading out. Amy's Kitchen Inc., a maker of organic foods that is considering moving a third of its 750 workers to Oregon, got a call from Schwarzenegger asking the company to stay put. "We like it here in California, but we're on the fence because it's so darn expensive here," says co-founder Andy Berliner.

In Sacramento, Schwarzenegger can rely on a combination of clout and Hollywood charm to help push his agenda. With the statewide Field Poll estimating that 65% of California voters approve of the job he's doing -- higher than the 60% Ronald Reagan got in 1969 -- he isn't afraid to go "over the heads of the legislature," as he said the day after his election. When the workers' comp bill stalled in April, he headed to a local Costco to help sign up voters for a ballot initiative to roll back rates. To help fund the initiative, Schwarzenegger's political action committee, the California Recovery Team, gave more than $1 million. Earlier, the group funded his campaign to pass the $15 billion bond deal.

Everyone, of course, loves hanging with a movie star. And Arnold plays his role to the hilt. To promote tourism, he recently spoke to a group of travel agents -- preceded by a stunt double zooming through the audience on a motorcycle and dressed like a leather-jacket-clad Terminator. It's great theater. But the show's not over, and the Golden State needs a big second act.

By Ronald Grover in Sacramento and Christopher Palmeri in Los Angeles

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