JOURNAL EDITORIAL REPORT

Can California tax its way back to fiscal health?

Gov. Jerry Brown's strategy for growing deficit woes

 

This is a rush transcript from "Journal Editorial Report," May 19, 2012. This copy may not be in its final form and may be updated.

PAUL GIGOT, HOST: This week on the "Journal Editorial Report," fresh from a high-dollar private equity fundraiser, President Obama attacks Mitt Romney for his ties to private equity. When will Romney fight back?

Plus, Greece on the brink. What its exit from the Euro would mean for the U.S. economy.

And as California's deficit woes broke, can Governor Jerry Brown tax his way back to fiscal health?

Welcome to the "Journal Editorial Report." I'm Paul Gigot.

Fresh from a fundraising swing through Manhattan, which included a stop at Part Avenue apartment of private equity big wig, Tony James, President Obama rolled out a long expected attack on Republican rival Mitt Romney's ties to, well, private equity. The campaign released an ad blaming Romney and his former firm, Bain Capital, for the 2001 closing of GST Steel in Kansas City.

(BEGIN VIDEO CLIP)

MITT ROMNEY, R-PRESIDENTIAL CANDIDATE: I know how business works. I know why jobs come and why they go?

DAVID FOSTER, LOCAL NEGOTIATOR FOR GST STEEL WORKERS: Bain Capital was the majority owner. They were responsible. Mitt Romney was deeply involved in the influence that he exercised over these companies.

UNIDENTIFIED MALE: They made as much money off it as they could and they closed it down and they filed for bankruptcy without any concerns to families or to the communities.

JACK COBB, STEELWORKER: He was like a vampire. He came in a sucked the life out of us.

(END VIDEOTAPE)

GIGOT: Joining the panel this week, Wall Street columnist and deputy editor, Dan Henninger; assistant editorial page editor, James Freeman; and Washington columnist, Kim Strassel.

Kim, you spent all week looking into the story, the closing of that steel plant in Kansas City. Why don't you tell us what the facts are? The reality of what really happened?

KIM STRASSEL, WASHINGTON COLUMNIST: It's not really the ad. You have -- 1993, the steel industry is a wreck. Hundreds of thousands have been laid off. Companies losing billions of dollars. And you have this plant in Kansas City -- which I spoke to someone who was vice president at the business before and after the Bain acquisition. This plant was going to be closed back in 1993 unless they found a buyer. Bain came in. They felt there were some product lines that might give it a competitive edge. They invested more than $100 million. In the end, it didn't work out. This was a heavily unionized business and they could not compete on the world market when prices plunged again in the 1990's. They ultimately went bankrupt. What Bain did do was gave it an extra eight years of life.

GIGOT: So this plant would have closed without the investment from Bain Capital?

STRASSEL: That's the argument of the vice president, who was there, of the business, who was there before Bain came in. He said, the decision had already been made, if we couldn't sell it, we were going to closer.

GIGOT: What about the larger story of Bain. You spent months looking into it, the overall portfolio and investment, how well they did. Is this a success story or a story of rapacious vulture vampire?

(LAUGHTER)

Pick your adjective of capitalism.

JAMES FREEMAN, ASSISTANT EDITORIAL PAGE EDITOR: They are capitalists who want to make money. But it is a good story. This is kind of the story of the campaign. There is a good story for Romney if he wants to tell. You keep waiting for him to come out and --

(CROSSTALK)

GIGOT: What is the story?

FREEMAN: The story is, by any measure, this is a wealth and a job creator over time. They backed Staples early on. 90,000 people work there now. Thousands work at a company called Bright Horizons, the child care center. Even the steel industry. Steel Dynamics, they basically created - - now employs thousands of people.

GIGOT: Another steel company.

FREEMAN: Another steel company. Even within the steel industry, Bain appears to be a net job creator, which -- how many people can say that in the steel industry?

GIGOT: One of the things that private equity does, it investigates in companies that are down on their luck, that have maybe poor management, that aren't doing well, and tries to turn them around.

FREEMAN: Right.

GIGOT: Sometimes it works, sometimes it doesn't work.

DAN HENNINGER, COLUMNIST & DEPUTY EDITOR: So what does this ad tell us about the Obama campaign? That ad -- after listening to Kim describe what actually happened -- that ad is a piece of propaganda. OK? And he's talking about an event many years ago because he cannot talk about the economy we have in the here and now. The Obama campaign is essentially going to be five months of propaganda.

Now, the thing about that, it can work. And if Mitt Romney doesn't provide the facts and answer to this, he's going to be spun in a way he will not realize is happening to him.

GIGOT: Well, Kim, it's pretty clear that the Obama campaign is trying to define Romney right now, in this early stage of the general election campaign, and go after him on the strength that Romney claims for his campaign, which is, I know how to create private-sector jobs. This ad goes right to the heart of that claim. How -- how much impact could it have?

STRASSEL: Well, it's huge. And you're right. He's invited it. What he's done is say, I can do this. And the Obama campaign is saying, actually, look at your experience and you've taken the wrong lessons from your experience. You know how to shut plants down and extract capital from them.

The problem that Mr. Romney faces, he's not engaged on this. He seems to know they want to touch this issue and he's going to have to defend himself. The problem is he may not want to get into a back and forth about the details of GST Steel, but what he needs to do is talk about the value of private capital, the facts behind risk taking and how an economy works and makes the case. If he doesn't, it's a huge claim left unanswered and it goes to the heart of his credibility.

GIGOT: Let's show the ad that Romney is running. This is their first big ad of the general election campaign. Let's watch.

(BEGIN VIDEO CLIP)

AD NARRATOR: What would a Romney presidency be like? Day one, President Romney immediately approves the Keystone Pipeline, creating thousands of jobs that Obama blocked. President Romney introduces tax cuts and reforms that will reward job creators, not punish them. President Romney issues an order to begin replacement of Obama-care with common-sense health care reform. That's what a Romney presidency will be like.

ROMNEY: I'm Mitt Romney and I approve this message.

(END VIDEO CLIP)

GIGOT: James?

FREEMAN: That would be a good day.

(LAUGHTER)

GIGOT: Don't answer -- the strategy, let's not answer the Bain Capital. Let's not go in that debate. Let's go after Barack Obama on the economy and going off on the economy. Smart strategy or not?

FREEMAN: Well, I think it's a good message for him. At some point, he's going to need to defend his business career. And I think he's got something there worth defending. And for the community of organizers -- the goal is not to destroy the company. You want to create that asset value, just like if you're in private sector.

(CROSSTALK)

HENNINGER: Obama is going to be running against banks, JPMorgan, the financial industry. There is no way to hide from that subject --

(CROSSTALK)

GIGOT: Dan, why play that game? Why not do this and -- the campaign would argue, the Romney campaign, we're going on offense and take it to him. And Independents want to hear that positive message. They don't want to get into a tit for tat about Bain.

HENNINGER: The nature of the campaign will be he'll have to do both. He'll have to stand next to Barack Obama, who is going to shove the financial system down his throat. He better have an answer.

GIGOT: OK, Dan.

When we come back, Greece on the brink. Will the debt-strapped country exit the Euro after next month's election? And will that take down the U.S. economy?

(BEGIN VIDEO CLIP)

(SHOUTING)

(END VIDEO CLIP)

(COMMERCIAL BREAK)

GIGOT: U.S. and European stocks were down sharply this week in growing concerns over the Greek debt crisis. Fears that the country will soon leave the Eurozone caused a near run on banks in Greece as Greeks withdrew almost $900 million in a single day. A caretaker government was sworn in and a new election called for June after no party could put together a majority after this month's splintered election.

We're back with Dan Henninger. And joining us, Wall Street editorial board member, Matt Kaminski; and foreign affairs columnist, Bret Stephens.

Matt, Greek economy, the size of New York, Buffalo.

(LAUGHTER)

New York, perhaps.

GIGOT: Why is everybody so concerned its collapse?

MATT KAMINSKI, EDITORIAL BOARD MEMBER: Or Dallas --

(CROSSTALK)

KAMINSKI: It's like $350 million. It's a very small economy. The worry is about contagion, that if Greece does have to leave the Euro because it cannot pay its debt and cannot meet the terms of this huge bailout package, $170 billion Euros from Europe, they will have to go back to the drachma. And that has an immediate knock-on effect on Spain, Portugal, perhaps on Italy, which are also suffering from a lot of the same problems that Greece has too.

GIGOT: Will those knock-on effects be because suddenly the markets would say, OK, we're going to turn on the debt, Portugal and Spain, because if one country can leave the Euro, anybody can leave the Euro.

KAMINSKI: Exactly.

GIGOT: Or is it a banking system problem?

KAMINSKI: It's both, in fact. Obviously, the market's going to say, aha, now we see how to do this. There will be pressure on the bond market, to the bond market. But the other problem is that people that have -- you know, if you're Portuguese and you have your money in a Portuguese bank account and you see what happens in Greece, where they go to a drachma and dump the Euro, they'll forcibly convert the Euro accounts into drachma. The drachma will drop in value and it will wipe out the savings of millions of people.

(CROSSTALK)

KAMINSKI: The people will be trying to do the same thing in Portugal and Spain.

BRET STEPHENS, FOREIGN AFFAIRS COLUMNIST: Look, this is a tragedy. What's happening is a tragedy for the Greeks and may also be the salvation of the rest of Europe. If I were Angela Merkel, chancellor of Germany, I would secretly be wishing for a Greek exit from the Euro.

GIGOT: Explain that.

STEPHENS: First, it's a small economy, two percent of the overall Eurozone.

GIGOT: We've got that.

STEPHENS: The problem is the demonstration effect of Greece. If Greece leaves the Euro and converts to drachma, the economy goes into freefall. Governments in Spain and Italy, hopefully, in France, where you have a new socialist president, Francois Hollande, are going to take a look at what happens.

GIGOT: It will be ugly.

STEPHENS: It will be ugly when countries leave the Eurozone, when they try to sort of float on air and ignore fiscal restraint, and it will care them. And that's what the rest of these countries need. You know, in Italy, you have a trillion-dollar economy under Mario Monti and he's desperately trying to put together labor market reforms and other reforms and he's getting a lot of push back from Italian politics. They may look at what's happening in Greece and say, we don't want to go there. We do not want to become third-world countries inside of Europe.

HENNINGER: Well, we should not believe or think that we're going to be disinterested observers to this process. We're going to get hit. Europe has to go down before it can go up. It's probably on the brink of recession right now. France's economy grew not at all in the first quarter. Germany only .5 percent. Those Germans -- western banks -- western European banks hold Greek debt. If that Greek debt flattens, they're going to have all the credit insurance. The default swaps are going to come into play. We don't know who holds those. It'll probably affect some American banks as well.

GIGOT: Barack Obama and Tim Geithner, the treasury secretary, say Europe should use the tools they have available to them. That's their term of art, to solve the problems. They have them there, they said, solve it. What does that mean?

KAMINSKI: They want to do a stimulus, an Obama-type stimulus in Europe. Angela Merkel who --

(CROSSTALK)

GIGOT: More government spending?

KAMINSKI: Especially more government spending, trying revive growth through inflation.

(CROSSTALK)

GIGOT: That's the European central bank, also, inflating.

KAMINSKI: Well -- Germany isn't going to go for this for political and economic reasons. But the impact on the U.S. can also be overstated here. The banks have written off a lot of their Greek debts already. You know, there's sort of the market reaction on Wall Street. I think you'll see these tremors to be felt. But there are healthy economies in Europe. In fact, the biggest economy is Germany, a fairly healthy economy. Central Europe is doing fairly well. So I think the trade, yes, maybe some American experts pay fall, but I don't see a dramatic impact on the U.S.

GIGOT: Briefly, Bret.

STEPHENS: What's missing here is nobody in Europe is talking about the Thatcher solution. They're talking about the tools, which is inflating their way out of the debt, more stimulus spending. They're not talking seriously about labor market reform, breaking the backs of their over unionized labor forces, cutting taxes. Taxes have been going up in nearly every country in Europe. And giving their entrepreneurs a reason to start businesses in Europe. That solution is missing. And until you get the Thatcher/Reagan formula, Europe is going to continuing to slide.

GIGOT: Austerity for governments, not for the private sector. All right.

Still ahead, is California heading down the Greek path? News this week that its debt woes are worsening. Will Governor Jerry Brown's solution drive more of the middle class from the Golden State?

(BEGIN VIDEO CLIP)

GOV. JERRY BROWN, D-CALIF.: I don't like to tax anybody, but you've got to go where the money is.

(END VIDEO CLIP)

(COMMERCIAL BREAK)

(BEGIN VIDEO CLIP)

BROWN: We don't want to be a Greece, Portugal, Italy, Ireland, or an England. They all borrowed too much and they got too deep into their hole.

(END VIDEO CLIP)

GIGOT: Well, it may not be Greece yet, but California's fiscal problems are getting worse, with Jerry Brown announcing this week that he faces a state budget deficit of $16 billion, almost twice the $9.2 billion he predicted in January. Along with a new round of spending cuts, the governor is calling for a temporary increase in the state's sales tax and a seven-year surtax on Californians earning $250,000 or more a year. Will that fix what ails the Golden State?

Joel Kotkin is a demographer and urban studies professor at Chapman University in California. He joins me now.

Welcome to the program.

JOEL KOTKIN, DEMOGRAPHER & URBAN STUDIES PROFESSOR, CHAPMAN UNIVERSITY: Nice to be here.

GIGOT: So other states have seen revenues grow in this economic recover. What is wrong with California? Why can't they do the same?

KOTKIN: Well, California has a very top-heavy economy. It got a lot more top heavy with Facebook. You have a relatively small number of people earning phenomenal amounts of money, but the general middle class, the small business economy is struggling. And even today, Facebook goes public and H.P, Hewlett Packard, announces 30,000 layoffs. The fact is that you have very high-end success, but the middle class has been hollowing out and has been hollowing out now for at least a decade. And frankly, as Governor Brown said, that's where the money is. There's only so much money you can take from the very rich. They're good at hiding it. As you know, Apple has moved a lot its financial reporting to other states and other places where they don't have to pay the taxes. And so, you know, the middle class is a sitting duck. But the problem is that sitting duck is also the key thing that drives the economy.

GIGOT: I want to ask you about that because, the governor says, look, we're just taxing the risk. We're not hitting the middle class. And you're saying it's not the rich, despite the high tax rates, that are leaving this state and putting it in such bad condition. It's the middle class. Why is there so much pressure on the middle class in California that they're fleeing?

KOTKIN: Part of it has to do with costs, particularly on the coast. If you make $250,000 and have a family in California, you're not rich. Even $500,000 in San Francisco, Los Angeles, very expensive places to live. And a lot of these people run small businesses, are individual proprietors. They are-- they are a group that's very, very vulnerable to these high tax rates and they're the ones who drive the economy. I don't see any way that we're going to make our economy better by continually raising taxes on middle class Californians. And so what we're -- we are evolving to, and I wrote about this in the "City Journal," is we are moving increasingly to a bifurcated society, much more so than the rest of the country. And this step by Governor Brown will probably make it worse.

GIGOT: When you say bifurcated, you mean the rich will do well. They'll stay. And the relative poor can depend on government benefits. But it's that middle part of the economy, the people who make average salaries, upper middle class salaries, they're the ones who are fleeing to Nevada and Texas and Idaho and Arizona. Is that the point you're making?

KOTKIN: Yes, I think that's basically what's happening. I mean, and then what's happening, what we see in the population profile, particularly on the coast, an aging population, not a lot of young people, not a lot of young families. And L.A. in particular suffered a huge out-migration of families. Basically what's happening is we see people coming to California, sometimes when they're young, but leaving when they get a little bit older. And frankly, people aren't coming. our last year, according to the IRS, we were right around where Michigan is in terms of people -- as a percentage of people coming in.

Now, think about this. This is California, the most beautiful state in the union. We have the best weather. We still have some of the great universities. We have great infrastructure. We're right on the Pacific Rim.

GIGOT: Yes, beautiful.

KOTKIN: All the things that should count for an upwardly mobile economy are here. And we're gradually destroying it. And by the way, I would say taxes are not the biggest problems. The biggest problem is our regulatory environment which enough to drive almost anyone crazy.

GIGOT: That's regulation on the environment, regulation on energy. They have a cap-and-trade, state cap-and-trade program, which imposes those burdens on companies in the state, even though the rest of the country doesn't have it. Briefly, you voted for Jerry Brown. Has he been a disappointment?

KOTKIN: I -- I didn't -- I was somewhat misquoted. I didn't vote for him last time.

GIGOT: Oh, OK.

KOTKIN: I didn't vote for either of them.

(LAUGHTER)

But I have voted for Jerry many times. I've known Jerry for a long time, longer than I care to admit. But I thought he'd be more innovative and tough. And he's at the end of his career. He should be able to risk things right now. And instead, he's playing it, you know, really much more like a conventional Democratic politician. And I don't think it's going to get us where we want. I think a lot of us thought, Jerry is smart, he's innovative, he's willing to take risks. He did it when he was a young man. For whatever reason, he's not doing it as an older man.

GIGOT: OK. All right, Joel Kotkin, thanks very much for being here.

We have to take one more break.

KOTKIN: Thank you.

GIGOT: When we come back, "Hits and Misses" of the week.

(COMMERCIAL BREAK)

GIGOT: Time now for "Hits and Misses" of the week.

Kim, first to you.

STRASSEL: This is a hit for the GOP voters in Nebraska who, this week, went their own way in choosing their candidate for U.S. Senate. This had turned into a classic primary, Paul, and groups like the Club for Growth, who flooded the state. they didn't like the front runner, the attorney general. They backed their own guy, Don Sandberg (ph). But the voters knew him. He was a three-time loser for the Senate and had his own baggage. In the end, they said, we want none of them and they went for a fresh face, State Senator Deb Fischer. They sent a message, if you're coming into the state with primary drama, you better have somebody worth backing or we'll ignore you, too.

GIGOT: OK.

Bret?

STEPHENS: Ninety-nine-0, that was a recent Senate vote and it wasn't to name a post office after Bob Hope or some other kind of easy vote. This was the Senate's unanimous rejection of President Obama's 2013 budget. That is a big miss for the president and an indication of a lack of seriousness of his governance. Unfortunately, they rejected four other Republican budgets as well. That's a miss for Congress, too.

GIGOT: OK.

Matt?

KAMINSKI: Here is a "like" to the Facebook IPO on Friday, the biggest IPO of a new company in history. They raised about $18 billion, and valued the company at $100 billion only eight years after Mark Zuckerberg famously started this company in his college dorm room. It shows that American animal spirits are alive and well. Now whether the stock does well is a different question.

GIGOT: Do you have any shares, Matt?

KAMINSKI: I haven't gone to the computer yet.

(LAUGHTER)

GIGOT: OK.

That's it for this week's edition of the "Journal Editorial Report." Thanks to my panel and to all of you for watching. I'm Paul Gigot. We hope to see you right here next week.

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