(FORTUNE Magazine) – to trim without hurting the poor. WASHINGTON'S deficit fighters have directed most of their firepower this year at such politically palatable targets as defense. But if Congress is truly going to get spending under control, it must turn the budget ax on the most untouchable target of all, America's middle class. Ronald Reagan's fiscal 1986 budget takes a step in that direction. By paring back such predominantly middle-class benefits as Medicare, federal pensions, and student aid, the President would save $8.9 billion in 1986 and about $91 billion over five years. FORTUNE believes Congress should cut middle-class benefits much more, upping the savings by about $120 billion over the next five years. FORTUNE's deficit reduction plan, spelled out in this series of articles, would balance the budget in six years or so by holding the overall increase in federal spending to the rate of inflation. Previous articles have argued that defense spending needs to rise--at a 3% annual rate after inflation, vs. the 7% increases that the President wants--while many subsidies to business, farmers, and state and local governments should be eliminated entirely. Individuals, who got $399 billion in payments and subsidies last year, must also take their lumps. Significant deficit reduction will be all but impossible without some cuts in Social Security, which will cost $202 billion in 1986, more than one-fifth of the President's budget. Any cuts in Social Security would reduce the deficit by boosting the surplus in the Social Security trust fund and lowering the government's borrowing requirements. Economists and many thoughtful politicians recognize that Social Security has grown far too generous. Elderly families now have per capita incomes about equal to the rest of the population, and the poverty rate among older Americans is actually lower than the rate for people under 65. The average retiree gets back more than twice as much as he and his employer put in--plus interest--and 70% of the benefits go to middle- and upper-income Americans. The Senate Budget Committee and Majority Leader Robert Dole hope to restrain Social Security outlays by imposing a one-year freeze on cost-ofliving adjustments, or COLAs. Since 1975, benefits have marched upward each year with the consumer price index. A gutsier un-COLA strategy would be to reduce cost- of-living adjustments to three percentage points less than the increase in the CPI. The savings in fiscal 1986 would be about $4.3 billion, less than a freeze would yield. But the savings over five years would total $80.7 billion, almost double what a freeze would achieve. Critics contend that cutting the cost-of-living adjustments would exact too great a toll from the elderly. A study commissioned by the American Association of Retired Persons concluded that CPI-minus-3 would push almost 427,000 elderly people below the poverty line in 1986. But that's only a little more than 1% of all recipients, and Congress could protect them by paying full COLAs to people with low incomes. Such a targeted approach would be a lot cheaper than showering benefits on all the elderly in order to reach the needy few. What's more, all Social Security recipients would still have protection against rampant inflation. If inflation hit, say, 10%, pensioners would get a 7% cost-of-living increase. A retiree now getting $450 a month would see his check increase to $481.50, only $13.50 less than under a full COLA. Individually, such sacrifices are small. But they add up to real money when multiplied by 36 million recipients. Congress might want to consider raising the payout at some point in the future when the country's finances are in better shape. But even if it didn't, retirees would continue to receive far more in benefits than they and their employers paid for. Next to Social Security, the biggest target for domestic spending cuts must be Medicare, the health insurance system for the elderly and disabled. When Congress created Medicare in 1965, Lyndon Johnson's actuaries predicted that the hospital insurance program would cost a modest $8.2 billion in 1983. They were off by $30 billion. Unless Congress takes some bitter medicine soon, the Medicare bill could top $100 billion by 1990. Congress put a tourniquet on Medicare in 1983 with a new hospital reimbursement system. The old cost-plus system encouraged ever more expensive care--the higher the costs, the higher the profits for the hospital. The new program, which pays flat fees for various treatments, reversed the incentives. Suddenly, lower costs meant higher profits. The growth in hospital expenditures tumbled from 12.6% in 1982 to 7.6% last year. President Reagan wants to tighten the tourniquet. He proposes freezing payments to doctors and hospitals for one year and increasing the portion of costs paid by patients. In addition, he calls for a voluntary ''voucher'' system under which Medicare would pay a fixed amount per person to a private insurer or health plan. The projected savings are $4.2 billion in 1986 and $42.9 billion over five years. Congress is apt to go along with a freeze, but not with fee hikes for patients or vouchers. VOUCHERS, however, are the best long-term prescription for rising health bills. They would put an upper limit on federal health costs. They would also get government out of the business of regulating prices. Instead, competition for Medicare dollars among insurers and providers would help exert downward pressure on costs. Also in dire need of pruning are the government's incredibly generous retirement systems. In an earlier article in this series, FORTUNE recommended major cuts in military pensions. The $23-billion civil service retirement system cries out even louder for reform. It's the ''Cadillac of pension / plans,'' to use the words of Donald Devine, director of the Office of Personnel Management, the agency that oversees the federal work force. Government employees can retire after 30 years of service with full benefits at age 55, and their pensions are fully indexed to inflation. Some 100,000 federal retirees are getting more than they would earn if they were still on the job. The Reagan Administration wants to trade in the Cadillac for a Chevy. The President has proposed increasing the retirement age, paring back basic benefits, eliminating the cost-of-living adjustment next year, and then reducing it permanently. Congress should go further and abolish the annual COLA. Defenders of the present system argue that federal workers deserve the same protection against inflation that private sector workers get with Social Security. But 75% of federal retirees collect both indexed Social Security and indexed civil service pensions. Why not let Congress exercise its discretion, as private employers do, and vote ad hoc increases from time to time? In addition, Congress should increase employee contributions from 7% to 11% of salary. Such reforms could save as much as $25 billion over five years. The gold-plated benefits now heaped on America's veterans also need cutting. The Veterans Administration's 80,000-bed hospital system was created primarily to care for veterans with service-connected disabilities, but it now provides free care to any veteran who is disabled, poor, or over 65. Only 10% of all treatment is for service-connected problems. This year VA medical care and hospital construction will cost almost $10 billion. The President has proposed limiting free care to service-connected disabilities, low-income veterans, and other special groups like former prisoners of war. All others would have to pay for a portion of their care. The Administration also wants the VA to recover costs from private insurance plans, now held by an estimated 89% of all veterans. Those reforms would save $361 million in 1986 and $5.8 billion by 1990. The $10-billion-a-year veterans' compensation program, which provides disabled veterans with monthly payments ranging from $66 to $1,295, also begs for reform. The notion of compensating veterans wounded or injured in the line of duty is unassailable. But the VA compensates veterans for any disability diagnosed while on active duty--including hereditary diseases such as diabetes. An incredible 35,000 vets got $108 million in disability payments for diabetes last year. REAGAN hasn't proposed cuts in veterans' compensation, but the facts call for a frontal attack. Just as worker's compensation limits benefits to employees injured on the job, veterans' compensation should limit payments to veterans hurt in the line of duty. That would eliminate payments to about two million vets and save about $3 billion a year, according to Ronald Eisenberg, a former VA doctor and author of Veterans Compensation: An American Scandal, a book on the excesses of the system. The VA's most flagrant boondoggle is its home-loan guarantee program. In 1983 the recession and high interest rates pushed many VA borrowers into default. By 1984 foreclosures were running at 2,500 a month, and costs began skyrocketing. Instead of swallowing its losses, the VA bought 90% of the defaulted properties, hoping to resell them. To attract buyers, the agency offers anyone--veteran or draft dodger--no-down-payment loans at about 13% interest. The VA sells these loans to investors with the promise to buy back any that default. The repurchase rate on the loans averages an astronomical 14%. Meanwhile, the VA is sitting on a mind-boggling inventory of 21,000 houses, valued at $885.5 million, and is about to buy 11,000 more. The cost of VA home ownership is $425 million this year. Congress should also take a sharp pencil to student aid programs, which will provide $13 billion in grants, subsidized work, and direct and guaranteed loans in the 1985-86 school year. Of college freshmen receiving federal aid, 25% come from families with incomes above $25,000. Clever students can pyramid $15,300 a year in grants and guaranteed loans. Defaults on guaranteed student loans will hit $3.4 billion this year, double the figure in 1981. The Administration wants to tighten the eligibility standards for aid and trim the effective subsidies to banks that make guaranteed loans. That would save $736 million in 1986 and $7.3 billion over five years. So-called Pell grants, originally designed by Democratic Senator Claiborne Pell of Rhode Island to assist poor students, would be limited to families with incomes below $25,000. Guaranteed loans would be limited to families with incomes below $32,500. In addition, the government would establish a cap of $4,000 in aid per year for each student. Asks Education Secretary William Bennett: ''Why should the lower two-thirds of taxpayers be supporting college expenses for the upper third?'' Using the same criterion of need, there is good reason to trim food subsidies for children at schools and day-care centers. The government pays a minimum of 24 cents for each school lunch, no matter how wealthy the student's family. Day-care centers also get food subsidies even though many of the children attending them come from well-to-do families. The President has rightly proposed eliminating food subsidies for children from families with incomes greater than 185% of the official poverty line. The savings would be $648 million in 1986 and add up to $4.8 billion by 1990. Other subsidies are less direct but equally difficult to justify. The national park system, for instance, cost $616 million to maintain last year. Entrance fees, most of which haven't changed since 1979, covered only 3.4% of those costs. It seems eminently reasonable to expect campers to pay more than 50 cents for a day's hike through Yosemite or $7 a night for a campsite. The higher fees the President proposes would generate $40 million in 1986 and $225 million over five years. MANY MIDDLE-CLASS subsidies are specks of dust in the cosmos relative to $200-billion deficits, but they ought to be eliminated on principle. The National Endowment for the Arts provides a smorgasbord of such excesses. Some morsels: A $10,000 grant ''to research, design, and test a new bathtub for the elderly and disabled.'' (The arts folks apparently concluded that the plumbing industry wasn't coming out with the right designs, and that the legions looking out for the elderly at the Department of Health and Human Services had missed a crucial need.) A $5,000 grant to explore ''the use of worked sheet metal and cast metal as integrated elements of clothing.'' A $10,000 music composition grant for a work combining the ''ambiance of large underground caverns'' with the ''sounds of high tension wires and the earth vibrations of pylons.'' A $5,000 grant to explore the relationship between women writers and their gardens. Every program in the federal budget could be trimmed if Congress and the White House were committed to austerity. In this series, FORTUNE has presented an array of savings proposals that stretch from the MX missile to farm subsidies, from the Export-Import Bank to student aid. Taken together, they would be more than enough to eliminate the seemingly inexorable growth of federal spending and balance the budget without raising a dime in new taxes. For all the wailing and gnashing of teeth in Washington these days, no special interest would be ruined. And the public interest would be well served.