(FORTUNE Magazine) – IN THEIR Report to the Forty-First President of the United States of America, Gerald R. Ford, President No. 38, and Jimmy Carter, No. 39, offer this observation: ''Americans are ready to do what has to be done; all they want is leadership.'' George Bush must provide a vision of a nation that is strong diplomatically, militarily, and economically, and is, at the same time, compassionate toward the poor, the undereducated, the homeless, and the hopeless. But the President-elect's task is different from that of those who have gone before him: He has to achieve these lofty goals in the face of a $148 billion budget deficit. In his mission the new President is likely to rely most heavily on the counsel of James Baker, campaign chairman, former Treasury Secretary, and Bush's choice as Secretary of State. The two will not lack advice: Recommendations and briefing papers on issues from agriculture to welfare are flooding Washington. ^ After plowing through many of them and after consulting legislators, budget experts, and academics, Fortune has arrived at its own concise agenda for the incoming Administration. Its first aim: to bring the budget into balance. In doing so, we will not hew to the targets in the Gramm-Rudman-Hollings law, which would cut the deficit to zero by 1993. We would get there one year later. Why delay? This is a case where too much haste would unacceptably raise the risk of recession. And remember, Gramm-Rudman is not Holy Writ -- the goals have been finessed before. Our plan calls for cutting expenditures and raising revenues by a total of $100 billion by 1994, which will produce a small surplus (see page 92). That computation excludes the hole, $100 billion or so deep, that some reckless entrepreneurs have drilled for the thrift industry; fortunately, this can be handled off budget (see Markets, below). Balancing the budget is sure to cause anguish for many; only the poor should be spared the pain. We also examine five broad areas of public policy important to business and suggest new ways to think about them, not spend money on them. FORTUNE began its attempt to eliminate the deficit with the general philosophy that it is better to reduce spending than increase taxes. We don't believe Bush can do the job while sticking to his no-tax-increase pledge. We did hope to cancel $2 in outlays for every $1 in new revenues raised. But we couldn't do that without seriously diminishing military prowess or returning many to poverty. Cuts and taxes came out fairly even -- about $50 billion by 1994 for each.

SPENDING Congress and the President should freeze spending for one year on defense and most civilian programs, excluding Social Security, Medicare, and other entitlements from farm loans to aid to dependent children. Candidate Bush proposed only a flexible freeze, which would provide federal agencies an inflation allowance. Better would be a rigid freeze for fiscal 1990 (starting in October) on defense and nonentitlement programs, with no provision for inflation, and only a gradual thaw thereafter. Here's how the plan to gradually balance the budget by 1994 would work. DEFENSE ($14 billion in savings in 1994). Retiring Defense Secretary Frank C. Carlucci, commendably modest in his requests, nonetheless wants an increase of 2% a year beyond inflation simply to pay for programs the department has promised to carry out. To meet the Fortune budget, some will have to be junked, some postponed, and others, like Star Wars research, trimmed. Bush should: -- Cancel additional purchases of the F-15E, the advanced Air Force fighter built to destroy airfields, tank depots, and similar targets behind enemy lines. Cruise missiles can do the job about as well. -- Pack the aircraft carriers Coral Sea and Midway in mothballs and thus reduce the number of carrier task forces to a dozen, plenty for patrolling the sea lanes and exporting American air power to the world. -- Buy few, if any, Stealth bombers ($500 million each) for now. B-52s equipped with nuclear cruise missiles and the B-1s, for all their engineering troubles, still present a formidable threat to the Soviet heartland. -- Eliminate thousands of jobs. President Reagan, while promising to reduce the size of government, added 90,000 or so civilians to the Pentagon payroll. Many who served usefully during the military buildup are now supernumeraries. -- Close dozens of unnecessary bases; cancel the Navy's program for adding nine American home ports to the current list of 35, plainly no more than pork barrel afloat; cut back purchases of noncombat equipment, such as staff cars.

CIVILIAN AGENCIES ($6 billion in savings). Like many corporations in difficult times, the FBI, foreign service, Bureau of Indian Affairs, and dozens of other agencies would have to quit hiring, eliminate marginal travel, and repair rather than replace equipment. But the President should not try to cut across the board. The IRS, in fact, should hire more auditors and lawyers, an expansion that is likely to increase income.

RETIREMENT, UNEMPLOYMENT, AND DISABILITY INSURANCE ($6 billion in savings). While Fortune does not want to touch cost-of-living adjustments (COLAs) for Social Security recipients, some federal pensioners should have theirs cut. When a typical military man retires in his 40s, he immediately receives his pension and the right to annual cost-of-living increases. Yet he is young enough to take a civilian job as protection against inflation. A lieutenant colonel who retires at the age of 47 after 25 years in the service now receives about $2,400 a month, rising annually by about as much as the consumer price index goes up. The government should hold off on the COLA until the colonel reaches 62. At that time his pension should be adjusted to reflect the 15 years of inflation. If applied to all federal employees, a pause before COLAs would save a refreshing $3 billion a year. / The government would also save $1.5 billion a year if it required workers to endure the first two weeks after losing a job without unemployment insurance. It could pocket a similar amount by not giving disability benefits to veterans who left the service with minor ailments, such as flat feet.

MEDICARE AND OTHER HEALTH PROGRAMS ($16 billion in savings). The cost of Medicare, which provides health insurance for those over 65, is growing at such an astounding rate that it will exceed defense in 20 years. Still, Medicare has done a reasonable job of tightening hospital costs over the past few years. The program should put the squeeze on doctors by slicing reimbursement fees, especially for surgery. Doctors have turned learning curve economics upside down. Twenty years ago it took a surgeon all day to perform a coronary bypass, and he charged $1,200, about $4,000 in 1988 dollars. Today a surgeon can do three a day, at $4,500 a snip. Nothing will prevent patients who can afford it from paying more than the Medicare cutoff, but many doctors will settle for the Medicare rates. Now is the time to take advantage of the hospital bed surplus. Bush should stop the Veterans Administration from remodeling and expanding hospitals, which will cost $500 million this year, a waste when the average hospital occupancy rate is an inefficient 68%. The deficit makes it hard to solve the nation's two big remaining health needs: coverage for the 37 million people now uninsured and long-term care for the very old and the disabled. But President Bush should find some way to bring more prenatal care to poor women; this would cost an estimated $700 million a year. Charge it to investment, for without such care women are more likely to give birth to sickly babies, costly to care for and difficult to educate.

AGRICULTURE ($3 billion in savings). In 1986 agricultural policies that encourage overproduction cost taxpayers a record $26 billion. The drought shrank the size of the crop in 1988 and with it the cost of financing the farm surplus to about $12 billion. But when good weather returns, the corn will stand tall and government spending will stretch skyward with it. Bush should pull down the costs from the outrageous to the merely expensive. With the Reagan Administration's blessing, Congress has guaranteed farmers certain prices. For example, the target price for 100 pounds of rice is now $11.15. The grower can get only half that on the market; the government pays him the difference. Knocking down target prices by one penny on all products saves an astounding $100 million. Let's chop them by 5%. Also, the government should stop offering farmers crop insurance below cost. They should buy protection on the market.

DEAD PROGRAMS ($5 billion in savings). A variety of support systems have outlived their usefulness. The Rural Electrification Administration, for example, nobly underwrote the stringing of power and phone lines to isolated farms in the 1930s. But these days suburbanites around Atlanta and Minneapolis are among the customers who benefit from the program's cheap, taxpayer- subsidized loans. The school lunch program could trim its budget by $500 million a year by letting children from families well above the poverty level brown-bag it. Amtrak, the government-owned rail system, transports passengers way below cost; most can afford to pay more.

TAXES FORTUNE's call for increased revenues should not be taken as an excuse to spend more or to raise individual and corporate income tax rates. Lower rates, the spoils of the 1986 tax reform war, have helped rev the country's economic engine, and increasing them would threaten growth. Besides, a bump-up in marginal rates would break the government's compact with the American people -- low rates in exchange for fewer loopholes -- and scramble individual and corporate spending, savings, and investment plans. Instead of taxing income, the Bush Administration should put the touch on consumption, mainly by increasing excise taxes and user fees. In the spirit of reform, the tax base should also be broadened to include income not now subject to tax, most notably employee fringe benefits. Altogether these changes would raise about $56.5 billion and help produce a small budget surplus in 1994. A good use for the surplus: Give it back to the poor, who will be hit hardest by the excise tax increases, in the form of a tax credit.

GASOLINE TAXES ($18 billion in revenues in 1994). The politicians lining up behind this powerful money raiser include: House Ways and Means Committee Chairman Dan Rostenkowski, former Labor Secretary William Brock, and National Economic Commission Co-Chairmen Robert Strauss and Drew Lewis. Congress should increase the federal gas tax 20 cents per gallon over the next five years. That's only 4 cents a year, but it would raise $18 billion by 1994. (The usual formula of one penny of tax yielding $1 billion in revenues works only for the . first few cents of increases. After that, the higher price cuts the amount of gas guzzled.) The federal government levies taxes of 9.1 cents per gallon on gasoline, and 15.1 cents per gallon on diesel fuel. (In addition, states hit gas from 7.5 cents per gallon in Georgia to 20.9 cents in Wisconsin.) Even with the proposed increases, motor fuel taxes would be considerably lower than those in most other countries. But higher pump prices would spur conservation and help reduce the carbon dioxide levels that have led to the greenhouse effect.

SIN TAXES ($7.5 billion in revenues). What's that? First take some of the pleasure out of driving, then clamp down on these other all-American activities? That's right. So-called sin taxes on beer and wine have not gone up since 1951, and on cigarettes only once since then. These taxes have actually declined after adjusting for inflation. Says Harvard economist Lawrence Summers: ''The real taxes on cigarettes are half what they were before the Surgeon General determined that cigarettes are hazardous to health. Real taxes on wine and beer are half what they were before states began tightening drunk-driving laws.'' FORTUNE would double the cigarette tax to 32 cents per pack and raise taxes on beer and wine to the equivalent of distilled spirits, $12.50 per proof gallon. That means beer drinkers would see taxes on a six-pack go from 16 cents to 63 cents. The Brie and Chablis crowd would find levies on a 750 milliliter bottle of wine rise from 3 cents to 54 cents. Still, inflation- adjusted tax rates for beer and cigarettes would remain below those of the 1950s.

USER FEES ($6 billion in revenues). Even top Bush advisers support raising the prices the government charges for such services as maintaining national parks and managing federal loans. Opening Alaska's Arctic National Wildlife Refuge to oil exploration would also generate increased leasing revenues.

EMPLOYER-PROVIDED HEALTH BENEFITS ($14 billion in revenues). During the tax reform debate, powerful business and union lobbies succeeded in preserving the tax-free status of health insurance benefits to corporate employees. But in a broad-based, low-rate system, health insurance should be taxed as income. A good start would be to tax employees on the amount of employer-provided premiums that exceeds a reasonable average, say $225 a month for families and $90 a month for individuals. The thresholds, of course, should be indexed for inflation. Taxing health premiums would put corporate employees on a more even footing with the self-employed, who must buy insurance mainly with after-tax dollars. It would also discourage companies from buying expensive additional coverage, which has helped fuel the explosion in health care costs.

SOCIAL SECURITY ($11 billion in revenues). Many state and local government employees are not covered by Social Security. Still, they may qualify for benefits at retirement either because they later worked at jobs covered by Social Security or because their spouse is eligible for the federal retirement program. These employees tend to get more benefit for less payroll tax than workers elsewhere. Including state and local government employees in the Social Security system would correct that inequity and boost payroll taxes by $6 billion in 1994. It would also assure people who spend their whole careers in state and local government of Social Security as well as their pension. Though most civil service and private pensions are taxable, Social Security benefits are completely tax-free for couples with adjusted gross incomes under $32,000 and individuals under $25,000. Even those above the thresholds pay taxes on no more than 50% of their benefits. Congress should continue to protect lower-income recipients from taxes but increase the taxable portion of Social Security to 85% for people above the cutoff. (The remaining 15% should remain untaxed; it represents a return of the capital that employees contributed to the system and paid taxes on during their working years.) Taxing the Social Security benefits of upper-income retirees would increase income tax revenues by $5 billion.

EDUCATION A top priority for the self-described ''education President'' should be to get more disadvantaged youngsters into preschool. While not a panacea, studies show that reaching these children early reduces the need for remedial help and may keep them from dropping out of school later. Bush's solution is to expand Head Start, the highly acclaimed 24-year-old preschool program for lower-income youngsters, to include all eligible 4-year- olds. Bush should also put a large chunk of the $1 billion he plans to spend over four years into salary increases for Head Start supervisors and teachers -- average teacher pay is now only $9,600 a year. Where would the money come from? Eliminating the child-care tax credit for families with adjusted gross incomes over $50,000 would save an estimated $1 billion a year. To take care of children under 4, candidate Bush proposed another, refundable, tax credit, to be phased in over four years, of up to $1,000 per child for families with incomes of $20,000 or less. Cost: $1.5 billion. The problem is, some families will spend the money on child care; others will use it for food, shelter, luxuries, even cocaine. A far wiser idea would be to give the money to the states to expand their early-childhood programs for the disadvantaged. Another must: addressing America's critical shortage of math and science teachers. Over the next five years, 20,000 new ones a year will be needed, ten times more than are expected to enter the profession. Bush wants to give the states $50 million a year to create more magnet schools, specialized learning centers. While magnet schools do provide choice for students in big-city systems, which unquestionably need fixing, they may hurt the average public schools by robbing them of their most promising students and teachers. That money would be better spent on forgiving loans to college students who agree to teach math and science: For every year of teaching, a part of the debt could be wiped clean. Other items on the education agenda require not more but smarter spending. Support for vocational education, which will be up for reauthorization in the 1990 budget, heads the list. Uncle Sam contributes close to $1 billion a year to this seriously flawed program. The money is sprayed across thousands of secondary and post-secondary schools, regardless of quality. Since the states already spend over $10 billion a year on voc ed, the federal money should be used to set up a venture capital fund to foster new approaches to vocational training. Additional assignments for Bush: First, provide remedial help to all disadvantaged youngsters who need it. Second, crack down on student loan defaults, which will cost the government $1.8 billion in 1989. Third, develop more effective methods to assess the nation's students. By depending on multiple-choice tests, the educational establishment has inadvertently developed a test-driven curriculum. Children should learn to think well, not just test well.

THE ENVIRONMENT Blood vials washing onto Eastern beaches, rainless days drying up Midwestern farmland, nuclear weapons facilities contaminating Western ground water -- all these make the environment a hot priority. The trouble is that the pressure for action -- any action -- may rush the President and Congress into expensive but not necessarily effective programs. The best thing for George Bush to do is name a strong, knowledgeable leader to head the Environmental Protection Agency, someone who would help fashion sensible legislation and administer present laws effectively. Bush should also deliver on such campaign pledges as calling for an international conference on global warming.

The next EPA administrator should work with Congress to set general antipollution goals, provide incentives for reaching them, and leave the polluters free to find the best way to get there. That would encourage innovation rather than erratic adherence to the complicated, costly, and technically inferior solutions often mandated by Congress. Instead of ordering coal-burning plants to install billions of dollars' worth of soon-to-be- obsolete scrubbers, as some legislators have advocated, the Administration should propose legislation to allow utilities to choose how to cut the pollutants that cause acid rain. Though the laws on hazardous-waste disposal are quite strict, the U.S. government has not been abiding by them. The Department of Energy has simply released radioactive and toxic materials near its nuclear weapons plants. The result: contamination of air and water. The Energy Department figures it will take decades and cost up to $110 billion to clean up these sites. Those estimates are probably too low.

MARKETS The savings and loan crisis gives the Bush Administration an opportunity to overhaul the nation's antiquated system for regulating financial institutions. With 500 bankrupt S&Ls and nearly as many at the brink of insolvency, the Administration must act swiftly. The walking dead must be closed and the wounded sold to other thrifts with more capital. Paying off depositors of liquidated S&Ls and arranging the marriages of healthier ones will cost at least $50 billion. To avoid this budget-buster, the Bush Administration should use a special government agency to guarantee bonds that would be repaid in part by fees charged to borrowers and financial institutions. The government can then use that money to clean up the industry. This plan would leave general revenues alone and would not worsen the budget deficit. In addition to collapsing S&Ls, banks are failing at a record rate. No surprise, then, that the insurance system designed to protect depositors is about to crack. The Bush Administration should consider merging the Federal Savings & Loan Insurance Corp. (FSLIC), which is bankrupt, with the Federal Deposit Insurance Corp. (FDIC), which is solvent and protects bank deposits up to $100,000, to form a single, independent provider of federal insurance. But strings should be attached. The problem with FSLIC and FDIC has been that they so protect the thrifts and banks that these institutions can make risky investments without fear. One simple change to put the industry more in tune with the market would be to require banks to find their own insurance for part of the $100,000 in deposits. Bush should also push for repeal of the Glass-Steagall Act, which would promote competition by removing artificial barriers between investment and commercial banks, the thrift industry, and the insurance business. Accusations of greed and the fear of huge corporate-debt burdens have catapulted takeovers and leveraged buyouts onto the agenda of the 101st Congress. But Bush should resist efforts to slow the buyout boom and monkey with free markets. Especially worrisome: proposals to eliminate the deductibility of interest on debt used to finance LBOs and takeovers. True, high-interest bonds are a boon to acquirers, but they are also needed for run- of-the-mill corporate borrowers. Besides, curtailing interest deductibility would put U.S. bidders at a substantial disadvantage to foreign acquirers, who could still deduct loan interest.

HOUSING With several hundred thousand homeless Americans crammed into drab emergency shelters or huddled against sidewalk steam vents, can anyone with a shred of humanity object to spending a lot more on low-income housing? Yes. Spent wisely, the Department of Housing and Urban Development's outlays of $14 billion in fiscal 1989 will be adequate to meet the housing needs of America's poorest citizens. The Bush Administration should resist pleas for more public housing. For one thing, the national vacancy rate for low-cost housing that meets HUD standards was 8.7% in 1988, vs. 5.1% in 1980. Besides, a building program would not deliver much relief to the homeless for years. A better option is to stretch available funds to serve more citizens in need. Over the past eight years HUD has shifted away from subsidizing public- housing construction in favor of issuing vouchers to needy recipients to help them pay the rent. Vouchers cover the difference between the local fair- market price and 30% of eligible renters' incomes. Since vouchers cost the federal government $4,800 a year for each household, vs. about $7,000 for the same family in a newly built project, HUD has been able to provide for 1.2 million new families since 1981. But HUD's rental-assistance programs now cover only about one-third of the more than 13 million low-income households. Small changes could extend benefits to more needy families and make the system more equitable. Edgar O. Olsen, an economist at the University of Virginia who studied the actual rents paid by low-income families for apartments that meet federal quality standards, calculates that HUD is overestimating fair-market rents by as much as 60%. HUD should review its methods: Fairer fair-market prices would greatly increase the number of recipients. The government could raise the proportion of total income poor families pay out of pocket from 30% to 35%. This would lessen the government's contribution to each family, providing funds to reach more people. The 35% is still far less than the average of 50% low-income families pay if they receive no benefits. To expand the stock of low-income housing in areas where supply is tight, Congress should extend the life of a tax credit due to expire in 1989. Under the program, corporations and individuals who build, buy, or rehabilitate low- income housing can take up to 9% of the cost of the low-income units off their federal tax bill each year for ten years. This is an approach to affordable housing that taxpayers can afford.

TRADE Even though the trade deficit is still about $130 billion a year, Bush should resist the temptation to build higher barriers to the U.S. market. That would only provoke retaliation. Policy should focus on spurring exports, not restricting imports. The new President need not solemnly forswear the use of tariffs and quotas. But he should employ these cudgels only to secure access to foreign markets, not to protect domestic industries. Bush must take a forceful lead in the Uruguay Round of the General Agreement on Tariffs and Trade (GATT) talks, which stalled at December's session in Montreal. He might, for example, strike boldly and propose the elimination of all tariffs on industrial trade. Though that goal cannot be realized anytime soon, such a rallying cry would keep discussion moving in the free-trade direction. To show that he means what he says, Bush should reverse his pledge to renew the voluntary restraint agreements due to expire in September, which restrict steel shipments from 28 countries, including Japan and South Korea. Another priority at the talks: drawing up guidelines for trade in services and intellectual property. The U.S. International Trade Commission estimates that piracy of know-how costs Americans up to $61 billion a year. Bush should suggest legislation to close a loophole in U.S. law that allows foreigners to use patented production processes without the approval of the patent holder. In the Uruguay Round, the Administration should push for an end to counterfeiting through more effective international protection of patents and copyrights. In addition to the multilateral GATT negotiations, the U.S. should seek bilateral trade arrangements with Japan and other industrialized Pacific Rim countries. An excellent model is the U.S.-Canada Free Trade Agreement, though it is unlikely that any other trade deal can be as far-reaching. During the period leading up to its economic unification in 1992, the European Community may try to keep foreign companies out. Bush must make it clear that he supports European integration but not at the expense of American trading rights. One thing Bush will not have to worry about: foreign investment in U.S. assets. For all the xenophobia that flowered during the presidential campaign, American businesses have a far greater presence in the rest of the world than foreign companies have here. U.S. direct investment abroad stood at an estimated $323 billion at the end of the third quarter of 1988, while foreign assets in the U.S. were about $290 billion. The American profit advantage is even bigger: an estimated $33 billion for U.S. owners overseas through September 1988, vs. $14 billion for foreign companies in the U.S.

In their report Presidents Ford and Carter advised the new President not to send too many bills to Congress (that causes confusion) or too few (that creates a vacuum). ''Congress needs to know your priorities,'' they said. So do the American people. In that spirit Fortune has put forth its proposals. Over the next four years we will be measuring George Bush's response.

CHART: NOT AVAILABLE CREDIT: NO CREDIT CAPTION: STEPPING ON THE GAS