Deal Breaker

Joe Mathews covers labor and politics for The Times. This article is adapted from Joe Mathews' upcoming book "The People's Machine: Arnold Schwarzenegger and the Rise of Blockbuster Democracy" (PublicAffairs), Copyright 2006 by Joe Mathews.

Arnold Schwarzenegger entered the Sheraton conference room with an unlit stogie in his mouth. On this day in November 2004, his concession to the Sacramento hotel's smoking rules was the only one he would make to limits set by others. After a string of victories in his first year in office, the governor believed that he had a once-in-a-generation opportunity to overturn California's political order in 2005.

Although Schwarzenegger often oversold even his modest achievements as historic reforms, in private he talked about his frustration with the slow pace of change in the state, and about how the political reality stymied major progress. He wanted to invest billions in repairing California's infrastructure, but the budget, though far healthier than when he took office, was still unbalanced. As the governor tried to make political history, his own political history boxed him in. He knew it would be a struggle to reconcile his campaign promises to reduce the state budget deficit, avoid a tax increase and protect popular public spending, particularly the school funding guarantee known as Proposition 98.

Much has been said and written about the supposed reasons for the governor's slide in the polls during his second year in office, including his fight with a nurses union and the rhetorical misstep of calling legislators "girlie men." But the real story of his political rise--and the subsequent decline from which he has only partially recovered--centers on his relationship with the 335,000-member California Teachers Assn. and a deal that he and his closest advisor, Bonnie Reiss, negotiated with the union shortly after his election in the waning days of 2003. That agreement reflected his stated desire to protect Prop. 98 and education funding. During an interview at Riverside's historic Mission Inn in the midst of the campaign to recall his predecessor, Gray Davis, I had asked Schwarzenegger if he would suspend the Prop. 98 guarantee to balance the budget. "Not over my dead body," he replied.

But a year later, as he contemplated using ballot measures and a special election to fix the state's stubbornly out-of-balance budget, the governor began to see Prop. 98 as a target. The meeting at the Sheraton in November 2004, a year and a day after his inauguration as governor, was Schwarzenegger's belated attempt to force his team to plan for such an election. More than two dozen advisors showed up, including pollster John McLaughlin, who flew out from New York to give a presentation. There were a few warning signs, particularly the governor's relatively low approval rating on education (43%). But the good news outweighed the bad. Seventy-one percent of the voters surveyed had a favorable opinion of Schwarzenegger. "Enjoy it," McLaughlin said as his client chomped on his cigar. "We have no place to go but down."

Bonnie Reiss got a look at her future boss in action in 1979 when she and her friend Maria Shriver were trying to whip up interest in a Teddy Kennedy for President event at a roller-disco club in Hollywood. The two women coaxed Shriver's bodybuilder boyfriend into taking a stroll along Venice Beach. "He let us walk 20 feet behind him and try to sell fundraiser tickets to the people following him down the beach," Reiss recalled.

In 1994, Schwarzenegger asked Reiss, by then an entertainment lawyer and environmental activist, to lead the national expansion of his foundation, the Inner City Games. The two were a good match in part because they were so different; the Republican Schwarzenegger projected Austro-Californian cool, while the Democrat Reiss talked and moved like a New York express train. Under their guidance, the Inner City Games evolved from a sporting event in L.A. into a collection of after-school programs in 15 cities. It also became Schwarzenegger's springboard into politics when he decided to sponsor a 2002 ballot initiative to fund programs like his.

The star's political consultants advised him then that CTA was the most politically powerful organization in the state, and that the union could sink the initiative by opposing it. To avoid that prospect, he reached out to the CTA's political director, John Hein, and invited a lawyer who did work for the union to help write the after-school initiative, Proposition 49, so that its funding stream would not interfere with Prop. 98.

The CTA knew how to use direct democracy. In 1988, the union had sponsored Prop. 98, which established a three-part formula involving tax revenues, school enrollment and per-capita income growth to determine how much money the schools should receive. As each factor changed, the funding guarantee could go up or down, depending on the day it was calculated.

If the amount spent on education in a given year fell short of Prop. 98's guarantee, the difference would be paid off in the future. Because the state almost always owed money under Prop. 98, the education lobby, and the CTA in particular, held a political sword over the governor and the Legislature.

Accepting this reality, Schwarzenegger in his first weeks in office approached Hein again and, with Reiss handling much of the negotiating, cut an extraordinary deal that gave him a one-year cushion as he tried to reduce a $16-billion deficit. Under the agreement, the schools would receive whatever the Prop. 98 guarantee was eventually calculated to be in his first budget year--minus $2 billion in savings that Schwarzenegger sought.

The CTA provided political cover. The union sold the deal to other education associations and backed the Republican governor's budget with the Democratic Legislature. And throughout much of 2004, relations remained warm. Schwarzenegger taped a message praising the CTA for the National Education Assn. convention. He settled a class-action lawsuit brought by the American Civil Liberties Union against the state for failing to provide equal opportunity for low-performing school districts. The CTA was included in discussions about reform spearheaded by Schwarzenegger's education secretary, Richard Riordan.

By the fall, the teachers union began making plans to endorse Schwarzenegger for reelection. But the governor knew nothing of the possible endorsement. And he had begun to feel trapped not only by his deal with the union, but also by the Prop. 98 formula. With the economy recovering and unexpected revenues flowing into the state, the guarantee was projected in late 2004 to be $1.8 billion higher than it had been estimated when Schwarzenegger made the deal. Under Prop. 98 and the legislation that formalized the accord, he was obligated to give the schools the extra money. And if the guarantee continued to grow as expected, the state would be on the hook for an additional $1.3 billion in Prop. 98 funds in the following budget year.

The governor was in a jam. State revenues were up $5 billion, but state spending formulas required Schwarzenegger to boost the budget by $10 billion. If he tried to stop the increases, he would be accused of cutting programs even as the budget expanded.

"You have to understand, it's nothing personal with me," Schwarzenegger recalled in an interview this year. "Gray Davis could not make it manage. No one could have made it manage under the political and budget system that we have. The system itself is dysfunctional."

Meanwhile, the Legislative Analyst's Office--the nonpartisan California equivalent of the Congressional Budget Office--produced a report that all but invited the governor to back away from his deal with CTA. Instead of funding the full growth in Prop. 98, the LAO suggested, Schwarzenegger could cut the deficit by boosting the education budget only enough to reflect increases in the cost of living and enrollment.

Schwarzenegger believed he had three options, all loaded with political peril. He could take the legislative analyst's advice, thus risking a fight with the CTA and hurting his public standing on the very issue--education--on which his own polling showed him to be weak. Or he could keep the deal and slice into the rest of the budget, which would mean cutting the health and human services programs that his wife's family had long championed. Or he could raise taxes and violate another promise, jeopardizing the political support of Republicans.

Schwarzenegger's economic advisors urged him to honor the education deal. So did Schwarzenegger's new finance director, Tom Campbell, and Reiss, who argued that he would then be in a stronger position to reform Prop. 98. The governor could say: I hate this budget and its cuts to human services, but it's what Prop. 98 requires. Yet Reiss and Campbell were in the minority. The conservatives on Schwarzenegger's staff warned that paying back the Prop. 98 growth would encourage a tax increase. The liberals worried about the program cuts.

Kim Belshe, the health secretary, argued that if Schwarzenegger provided the additional billions in Prop. 98 growth, the state would have to deny government-sponsored health insurance to tens of thousands of poor children. The health secretary played yet another card. As a decision on the budget approached, Belshe called Shriver to warn her of the possibility of cuts in health programs. The first lady was soon on the phone to her friend Reiss. Why aren't you protecting these programs? Shriver demanded.

"I said, 'Maria, in a zillion years, I couldn't advocate, nor could your husband, the governor, sign a budget that had those kinds of health and human service cuts,'" Reiss later recalled. But she explained to Shriver that by putting the cuts in the January budget proposal and fully funding the Prop. 98 growth, the governor would make the case for budget reform. He would still have time to restore the money to health programs when he revised his budget in May.

Shriver's views did not sink the education deal, but they indicated the direction the governor was heading. Schwarzenegger was not inclined to take Reiss' and Campbell's advice, concerned how it would look if he took $1.8 billion out of health and put it into Prop. 98 in January, only to reverse himself in May. "There would have been a huge thing about 'the governor flip-flops again,'" he said in the interview. "'Once again, he's changing his mind, and he's under pressure and all that.'"

"I had a choice," Schwarzenegger said. "If we want to give education the $2 billion more they say they are owed, we have to take the $2 billion out of health care, and that means we would have to take it out of vulnerable citizens. I was not willing to do that." And there was no justification for raising taxes, the governor believed, when revenues were up $5 billion.

In different circumstances, Schwarzenegger might have approached the CTA earlier in the fall and tried to fashion a compromise. But if the governor chose to amend Prop. 98 as part of his budget reform for the special election, he would be in a fight with the teachers union anyway. In addition, he was looking at possible education reforms, including lengthening the probation period for new teachers and a "paycheck protection" initiative to restrict the ability of unions that represent public workers to use their members' dues on politics. As his media strategist said in a Dec. 9 memo to the governor and a top staffer, "We are going after CTA with a vengeance."

On Dec. 15, three top Schwarzenegger aides, including Tom Campbell, told John Campbell (no relation to Tom), a Republican legislator who was drafting a budget reform initiative, that the governor wanted to amend Prop. 98 as part of the measure.

The next day, Schwarzenegger invited CTA President Barbara Kerr, a Riverside schoolteacher, to a meeting inside the governor's Capitol offices. Schwarzenegger and his team had decided to make no mention of the budget reform proposal. Instead, he used the meeting to try to figure out if there was any way he could renegotiate his original budget deal with CTA.

I'm having some trouble, Schwarzenegger confessed to Kerr. I can't keep the deal this year without hurting health care and other programs. Is there anything you could do to help us?

We have a deal, Kerr bluntly replied. We expect you to honor it. The CTA had agreed only to the one-time, one-year savings of $2 billion from the Prop. 98 guarantee, she said. If Schwarzenegger didn't give the schools the full Prop. 98 guarantee, including the growth, he would be taking more money from education. "I think he was startled that I didn't just say, 'Oh, OK.' I don't think he likes to be told no," Kerr said. There was discussion but no resolution. Kerr and the CTA officials left after 90 minutes.

The following week, CTA leaders held a conference call. No one, least of all Kerr, could believe the governor would break such a high-profile deal.

Schwarzenegger would wait until immediately before the State of the State speech to break the bad news, and he wouldn't do the job himself. Instead, Reiss invited education groups to a conference room inside the governor's office at 3:30 p.m. on Jan. 5, 2005, less than two hours before the address. Tom Campbell greeted the guests before taking his seat alongside Reiss and Riordan. Riordan made remarks. Then Campbell spoke: The governor, he said, would not provide the education money in the budget that was dictated by Prop. 98. There were a few moments of stunned silence.

Let me get this straight, asked Glen Thomas, who represented county school superintendents. You're breaking the deal?

"I'm not going to argue with you over that characterization," Campbell replied.

Kevin Gordon, executive director of the California Assn. of School Business Officials, followed up. Campbell had said in his talk that Schwarzenegger would be "modifying Prop. 98." It wasn't clear whether he meant the terms of the funding deal or Proposition 98 itself, which was part of the California Constitution.

Are you amending the Constitution? Gordon asked.

Yes, Campbell replied.

One education advocate asked Campbell, Reiss and Riordan if they understood the size of the fight they had just picked. The entire education lobby would attack Schwarzenegger.

You have to do what you have to do, replied Reiss, looking grim.

Barbara Kerr watched the speech in her office at CTA headquarters near San Francisco. After the governor declared that, on the budget, "we must have a new approach that overrides the formulas, that overrides the special interests," she was sure that he was coming after Prop. 98. Kerr sent out an e-mail: "I guess I'm a wartime president."

Reiss says none of Schwarzenegger's advisors were ready for the coming attack on school funding and the governor's agenda. "I think--and I put myself as part of that group--his political team and his senior staff didn't do what we should have done. You have a governor who has told you he's declaring war on three continents, and you don't have a plan on where your forces are."

Schwarzenegger believed he was merely making the opening offer in what he expected would be months of talks on a grand compromise deal with the Legislature. But the governor had kicked off a bid to reform education, the budget and California politics by breaking a deal on education funding with the most politically powerful union in the state. Why would the Legislature, why would the CTA, why would anyone make a deal with Schwarzenegger after watching him break the biggest deal of his political career?

When he looked back at this momentous set of decisions, Schwarzenegger believed he was a victim of his own impatience. He should have taken more time, perhaps a year or two, to lay the groundwork before pushing for reforms and a special election. That was true, but there was more to his troubles than that.

Rather than facing the fact that he had made a bad deal with the CTA, Schwarzenegger embraced a budget reform measure to change the very basis of the deal. The budget reform, which became Proposition 76, was less a proposal to improve the governance of the state than a method to rescue the governor from an agreement that was no longer useful. Direct democracy was a fantastic tool for many things: for telling a story to the public, for leveraging public opinion to force the Legislature to act, for building coalitions. But the ballot initiative system was not a magic elixir for politicians to drink when they got into jams.

By biography and profession, Schwarzenegger was a manufacturer of magic. The governor thought that he could conjure a compromise with legislators and the teachers union. And he said that he always intended to provide the schools with the Prop. 98 growth, but he simply couldn't do it in this particular year and under this budget. "I always recognized that we owed them money," he would say. "The question is how do you pay it back." He believed that, too, with all his heart. "He never wanted to break that deal," said Reiss. "He never intended to break that deal."

But the fact was that the delay he wanted in funding Prop. 98 growth was not part of his original agreement with the CTA. Schwarzenegger was slow to recognize how a broken deal based on Prop. 98 could combine with a budget reform amending 98 to produce a climate so toxic that it could poison all of his plans.

Two weeks after the State of the State speech, the CTA began its campaign against Schwarzenegger and his special election. In the CTA, the governor, for the first time, faced an opponent that knew him well. The union's chief tactic was to attack him for his "broken promise" on education funding, and Prop. 98 TV ads even quoted Schwarzenegger's "dead body" pledge from the Mission Inn. These attacks destroyed the governor's popularity, dropping his job approval rating by 30 points over the first six months of 2005. His other ballot measures were collateral damage. All four of the initiatives he backed would go down to defeat in the November 2005 special election.

Afterward, Reiss and Schwarzenegger reached out to representatives of the teachers union. By this May, those conversations had produced a new agreement between the governor and the CTA that, over several years, promises to give the schools the growth in Prop. 98 funds--now estimated at just less than $3 billion--that were due under the terms of the original deal. Education is also slated to get an additional $2 billion upfront. But the political damage has been done. And the California Teachers Assn. is supporting Phil Angelides for governor.

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