How can Judaism say people are innately good if Judaism also recognizes that there is a distinct difference between good and evil?
Man essence is his soul, also called a "spark of God". We believe that the objective "good" is the eternal ideals and actions as done and suggested by the Perfect God and His Torah, and that they are natural for man [our conscience naturally identifies the good]. God created a perfect world, which obviously includes challenges enabling us to be independent and have free-will to develop our nature to be good, godly and productive, or the opposite (=to choose against our nature, and do bad, evil, wrong, not beneficial in the long-range). In other words part of man's "good" (=his free-will), is the possibility to be counterproductive, and opt for short-term pleasure (sometimes cruel) over long-term pleasure (our conscience), and receive the ramifications. Nevertheless, even if man chooses "bad", in the end, the Perfect God, similar to a wise chess-master, can turn every bad or "wrong" decision into a positive one. In addition, we can always turn around and improve, and this is the natural process of "trial and error" and spiritual evolution, called Teshuva [= to return to one's idealistic self].