(FORTUNE Magazine) – WANT TO PIN a face on America's persistent deficit and savings crisis? Forget those hoary cliches -- the welfare queen, lazy bureaucrat, greedy businessman, weapons-crazed general, or rich Third World potentate living off U.S. aid. Reach instead for a photograph of your mom and dad. That's because the main engine driving federal spending ever upward is the explosive growth in entitlements, programs that churn out benefits aimed mostly at older middle- and upper-class Americans. Indeed, you could eliminate all discretionary spending right now -- shut down Congress, the federal agencies, the national parks, the Pentagon; wipe out waste, fraud, and abuse -- and, thanks to the spending programmed to pour automatically through the entitlement spigot, the budget would be gushing red ink again by 2012. * No, you won't hear that harsh truth uttered many places on the campaign trail this fall. But on December 15, safely after the congressional elections, a group called the President's Bipartisan Commission on Entitlement and Tax Reform will issue its final report on this dangerous trend. As its name suggests, in addition to suggesting how to slow entitlement spending growth, the commission -- appointed by Bill Clinton after the 1993 budget fight -- will also propose ways to reduce the heavy burden the U.S. tax code imposes on savings and investment, a change FORTUNE has long advocated. The most promising: possible cuts in Social Security and Medicare that will hit wealthier taxpayers hardest, and a call for a new, broad-based consumption tax. "I'd prefer not to tinker," says commission co-chair and Democratic Senator Bob Kerrey of Nebraska. "It's time for real change." Is it? The consensus inside the Beltway deems such talk political lunacy. Doesn't Social Security, ardently defended by the 33 millionstrong American Association of Retired Persons, remain the political equivalent of a subway track's third rail -- instant death for all who touch it? Consider the "Contract with America" that Georgia's Newt Gingrinch persuaded 366 Republican congressional candidates to sign. It pledges support for a balanced-budget amendment but says nothing about the only action that could deliver on that promise -- cutting entitlement spending. No wonder Kerrey's co-chair, retiring Republican Senator Jack Danforth of Missouri, will bet only a stick of chewing gum that the President and Congress will confront the problem. "And some days," says Danforth, "the bet goes down to a Chiclet." But despite the prevailing silence, there's growing evidence that, this time, the conventional political wisdom is wrong. Among the experts -- the kinds of people serving on the Kerrey-Danforth commission, plus most business leaders, economists, and policy analysts -- broad agreement already exists on the need to tackle entitlements. Now public opinion is catching up. In a new survey by the opinion research firm Mathew Greenwald & Associates, 72% of respondents said it was unrealistic to believe the deficit could be cut without reducing entitlements, 78% backed major Social Security and Medicare reforms now, and 74% said they'd think better of politicians who addressed the issue openly. To Paul Hewitt, executive director of the National Taxpayers Union Foundation, an antideficit group, such data confirm his suspicion that "disaffection with Congress arises in part out of its refusal to acknowledge such problems." Generational change is fueling this new sentiment. Baby-boomers, the largest block of voters in U.S. history, are increasingly skeptical of Washington's ability to keep its promises for their retirement and are more open to reform than their parents. Behind them, a fast-growing crowd of twentysomethings known as Generation X are even more ready for change. A recent poll by an X-er advocacy group in Washington called Third Millennium turned up this striking, if somewhat tongue in cheek, fact: Americans between 18 and 35 are far more likely to believe in UFOs than to believe that Social Security will be there when they retire. Concludes Robert Lukefahr, 30, co-founder of Third Millennium: "Doing the right thing is fast becoming politically expedient." Already this pending seismic shift is sending tremors through the political landscape. During the 1993 budget wars, Bill Clinton consistently underestimated the willingness of younger Democrats, partly emboldened by Ross Perot's antideficit campaign, to attack spending. Last spring a constitutional amendment to balance the budget fell short of the two-thirds needed for enactment by only four votes in the Senate, 19 in the House. In the November 8 elections, the latest insider predictions are that the Republicans will pick up 20 to 30 seats in the House and three to seven in the Senate. Whether or not the GOP regains control, the center on Capitol Hill is clearly moving rightward. In such an atmosphere the Kerrey-Danforth commission's report just might provide bipartisan cover for the opening shot in a real battle to change the way the U.S. government taxes and spends. That battle clearly needs to be waged. Although Congressional Budget Office projections show the deficit hitting a seven-year low of $166 billion in fiscal year 1996, the red ocean quickly rises again, reaching a record high of $324 billion by 2003. As a result the national debt, which has ballooned from less than half a trillion dollars in the late 1970s to $3 trillion today, could more than double again by the year 2000. The problem is not a dearth of revenues. Indeed, the total federal tax take currently amounts to almost 19% of GDP, the peacetime average since the end of World War II. Nor is it defense, which has been pared to $274 billion, or 3.9% of GDP, the lowest level since 1948. The problem is that nonstop spending . machine loosely labeled entitlements. Back in 1963 these programs claimed, along with interest payments on the national debt, just 29% of federal spending, which left 71 cents of every federal dollar free for productivity- boosting investments in education, technology, roads, bridges, and the like, as well as defense. By 1993, however, entitlement spending plus interest hit $864 billion, or 61.4% of the budget. By 2003 it will top 72%, reversing the ratio that prevailed during the Kennedy years. The result, notes Mark Weinberger, staff chief of the Kerrey-Danforth commission, is that "government has lost its ability to prioritize." Many Americans associate the term "entitlements" with programs for the poor like welfare and food stamps. In fact, growth in such means-tested entitlements was largely contained during the Reagan years and has since stabilized. The big exception: Medicaid, which provides health insurance for the poor. Besides Medicaid, the prime engines of entitlement growth are non- means-tested programs, particularly Social Security and Medicare, which go to virtually every citizen over 65 regardless of income. What's behind this torrid growth? Its expansion, particularly in coming years, mainly reflects the aging of America's baby-boom generation. Today there are almost five working Americans for every retiree. But by 2030, when all the boomers have retired, there will be fewer than three if current birth and immigration rates hold. Moreover, people are living longer. The average life expectancy at age 65 has risen from 12.6 years in 1940, when the first Social Security check was mailed, to 18 today, and is conservatively expected to hit 21 by 2040. Americans are also retiring earlier. The average age for men has declined steadily from 69.1 in 1942 to 63.7 in 1992. Meanwhile, health care price inflation, though it slowed mercifully last year, has been rising at double-digit rates for more than a decade. Combine these demographic and social changes with funding formulas based on age and indexed to inflation, and you get a sure-fire recipe for massive and growing federal deficits. Economist Eugene Steurle of the Urban Institute calculates that total lifetime Social Security and Medicare benefits for a couple that retired in 1970 at age 65, having collected average earnings during their working years, were worth $250,000. By 1995 the value of such benefits, in inflation-adjusted dollars, will approach $500,000; by 2030, a dazzling $800,000. This generosity is, of course, great news if you're already retired. Virtually everyone who turned 65 between 1940 and today will receive considerably more from Social Security and Medicare than he or she put in (and that's including a credit for interest on these contributions). But it would be crazy for any boomer or buster to count on the level of Social Security and Medicare benefits now promised. Under current projections the Medicare trust fund will go bankrupt in 2001, and Social Security in 2029.

COULD MORE TAXES alone ensure those programs' solvency? Only if Congress acted quickly -- and the pain would surely be too high. Boston University economist Laurence Kotlikoff calculates it would take an immediate increase in the combined 15.53% payroll tax paid by employers and employees of between five and 15 percentage points. Waiting until 2029 would require tax rates as high as 40%. For children born today, that would translate into an unconscionable and politically unimaginable lifetime tax burden of 82% of earnings -- vs. 33.2% for people born in the 1950s. Couldn't we grow our way out of this mess? Not likely. Remember that government's role as an active investor in productivity-boosting activities has already pretty much been curbed. As for the private sector, big deficits inevitably crowd out savings and investment, and put upward pressure on interest rates. And spending growth dominated by entitlements is particularly pernicious. "What government is doing," says Kotlikoff, "is taking money from the young who save and giving it to the old who spend." Today the average 70- year-old man spends one-quarter more per year than the typical 30-year-old, whereas he consumed one-third less than his younger counterpart in the early 1960s. Says Kotlikoff: "This explosion in entitlements is at the very heart of our savings crisis." So is a tax system that is decidedly anti-savings and anti-young. Right now workers are taxed on their wages. Then, if they save anything, their earnings are taxed again. By contrast, the elderly get most of their Social Security and Medicare income tax-free. Result: a young couple with one child earning $30,000 a year pays $7,103 in taxes, while a retired couple with the same income, assuming 40% of that money comes from Social Security, would pay only $855. Small wonder that young families have so much trouble saving, which in turn helps explain why net national savings in the U.S. -- private savings minus government deficits -- grew a meager 3.7% a year in the 1980s and under 2% in the early 1990s, down from an annual average of 7% during the 1970s and 8% in the 1960s. The price for this is high. With real national income per worker rising an average of only 0.3% a year since 1973 -- partly because of that paltry savings and investment -- it will take 222 years to double America's standard of living, vs. just 32 years at the 2.2% rate prevailing from 1947 to 1973. How does the country climb out of this pit it has dug for itself? The road back begins with Social Security. The Concord Coalition, a fast-growing grassroots group launched by former Senators Paul Tsongas and Warren Rudman and investment banker Peter Peterson to focus public opinion on the deficit, favors imposing a comprehensive means test on all entitlements. Families with incomes over $40,000, for example, would see their benefits reduced by 10% for every additional $10,000 in household income they collect up to $120,000. Above that level, they'd get only 15% of their promised benefits. The budget savings: $5 billion in the first year, $52 billion a year by the fifth year.

BUT SUCH draconian cuts at the top could backfire politically. Cautions Brookings Institution economist Henry Aaron: "Ultimately, support for the program would collapse, and the real losers would be the poor." Most worrisome would be the strong antisaving signal that means-testing would send: don't save and you collect Social Security; save and the feds will take it away. A sounder approach would be simply to subject Social Security and all other entitlements, including the imputed insurance value of Medicare and Medicaid, to full federal taxation. Since the U.S. income tax system is already progressive, low-income retirees would pay little or no additional tax. And middle- and upper-income recipients would simply have to pay the same rates as working people with comparable incomes. "Why should a 65-year-old be taxed differently than a 27-year old?" asks CBO director Robert Reischauer. "There is no logical reason except that the elderly once had an income disadvantage, and members of Congress were moved by stories of their pitiful condition." Those were tales from the old economy. Today the poverty rate among the elderly is the lowest of any age group. For every poor American over 65, there are about seven under age 25, and five between 25 and 64. Fully taxing all entitlements would raise $18 billion the first year it was imposed and $68 ! billion by year five. Anxious pols, take note: according to Greenwald's survey, 60% of Americans support fully taxing Social Security benefits to households with incomes over $50,000. Congress should also consider accelerating a planned increase in the retirement age from 65 to 67, which currently phases in over three decades. This would be most unpopular with Americans nearing retirement, and with employers who'd rather make room for younger workers more up to speed on new technologies and management techniques. Still, in a largely white-collar economy, 67 ain't what it used to be. Most retirees are hale, hearty, and plenty able to put in a few more years rather than lay a bigger bill on their kids and grandkids. Even so, such reforms would fall short of ensuring the long-term solvency of Social Security. To really manage the boomers' retirement, more and more experts are exploring the possibility of splitting the program into two parts: a minimal basic benefit and a mandatory retirement savings account that individuals could manage much like a private mutual fund. Under such a system the government might say to workers: we'll contribute 1% of your payroll tax to a private retirement account if you and your employer each contribute an additional 1%. The public benefit would guarantee against poverty in old age, but the private portion would give individuals an opportunity to earn bigger returns. No group is higher on such proposals than Generation X. A Third Millennium poll found that an astonishing 82% of those born after 1960 backed the notion of reducing their Social Security benefits in exchange for allowing them to put part of their current payroll tax into an individual retirement account. Boomers, too, should prove enthusiastic, particularly once they realize their only alternatives are to pay higher taxes now or accept lower benefits later. Says Bill Beaman, vice president of the Committee for Economic Development, a business-backed think tank: "Mandatory savings that you can manage yourself are a lot more attractive than mandatory taxes that go straight to Uncle Sam." In addition to reforming Social Security, Congress must rethink Medicare and Medicaid, which together represent the single fastest-growing portion of the federal budget. Last year Clinton tried to convince Congress that a grandiose combination of universal coverage, price controls, and new incentives for cost-conscious buying would hold down health care prices in both the public and private sectors. He failed utterly. What might fly in an even more conservative Congress? At a minimum Washington should help individuals and small businesses band together in voluntary purchasing pools to negotiate lower costs. More boldly, it should spur cost-conscious buying by limiting the tax deductibility of employer- provided health plans to the level set by the lowest-cost plan in any region. Projected savings: as much as $7.8 billion in the first year and $16.3 billion in the fifth. At the same time Congress needs to extend such market pressures to Medicare and Medicaid. Last session many solons were already poised to ratchet down further the reimbursement rates the government pays under these programs to doctors and hospitals. Problem is, such a move would simply encourage health care providers to make up their losses by raising the prices they charge privately insured purchasers. "It's like squeezing down on a balloon," says Sylvester Schieber, vice president of Wyatt Co., a Washington consulting firm: "One side shrinks but the other explodes." The better course, as with Social Security, is to rely on the market to hold down costs by making beneficiaries, particularly upper-income ones, more price-sensitive. A first step, which already has broad political support, would be to increase the premiums paid by upper-income retirees for Medicare Part B, the voluntary program that covers visits to the doctor's office. Originally the program was financed fifty-fifty by government and individuals. But inflation changed the ratio, over time, to 75% government financing regardless of income. Reversing it to 25-75 for families with incomes over $55,000 would raise $6.2 billion in the first year and $9.4 billion a year by the fifth. Long term, though, the only way to control rising federal health care costs is to move toward a voucher system under which retirees and the poor covered by Medicaid get a fixed monetary grant from the government. Then, like most workin Americans, they would have to choose each year whether to use that voucher to buy pricier fee-for-service insurance or to opt for more economical managed-care plans. Finally, as Congress cuts consumption by holding down entitlement spending growth, it should encourage savings and investment through fundamental tax reform. Business, with the exception of retailers that fear a drop in sales, is increasingly supportive of this idea. Indeed, the American Business * Conference, which represents 100 fast-growing, medium-size companies, is lobbying all out for a progressive income tax plan devised by Senators Sam Nunn and Pete Domenici that would tax consumption and exempt most savings and investment. The National Association of Manufacturers has long advocated a European-style value-added tax (VAT), which imposes a levy on the "value added" to goods and services by businesses at each stage of production. More surprising is the growing support among elected officials. Since former Ways and Means Committee chairman Al Ullman of Oregon was defeated in 1980 after advocating a VAT, the conventional wisdom in Washington has been that broad-based consumption taxes are political suicide. But today congressional advocates range from conservatives like Domenici to liberals like Ways and Means Chairman Sam Gibbons. Top White House officials are also sympathetic. In the past, Chief of Staff Leon Panetta advocated a broad-based consumption tax for deficit reduction, and Budget Director Alice Rivlin wrote a book promoting a national sales tax. Indeed, in an interview with FORTUNE last year, Clinton himself voiced interest in a VAT. What has changed? First, there's a growing appreciation of the huge economic costs imposed by the overly complex and often irrational U.S. tax code. Last year the simple cost of complying with that code tallied $192 billion. Of that sum, individuals paid $65 billion and business $127 billion -- $10 billion more than companies forked over in corporate income taxes. In addition, policymakers increasingly realize it's folly to continue taxing savings and investment if the goal is a national revival of productivity. And while there's zero political support for further increases in income or payroll taxes, a low-rate, broad-based consumption tax could generate big money with relative ease. For example, a 6% VAT would raise $166.2 billion -- enough to do any one of the following: eliminate the corporate income tax, cut payroll taxes in half, remove 40 million low- and middle-income Americans from the tax rolls, wipe out the 1995 deficit, or do a little of each. Ideally, what Clinton and Congress should do is begin a serious debate on how to move toward a simpler, more efficient tax system that discourages consumption and encourages savings and investment. They could take a comprehensive approach, by replacing the current income and payroll tax systems with a progressive consumption-based income tax like the Nunn-Domenici plan or by implementing a VAT and using the revenues to reduce income and payroll taxes. Or they could take an incremental approach -- cutting back on tax subsidies for health care, mortgage interest, and other forms of consumption while increasing incentives for savings and investment, say by lowering taxes on long-term capital gains, expanding savings incentives like IRAs and 401(k) plans, and making it easier for companies to fully fund their pension plans.

WHATEVER the precise tradeoffs, Congress should above all keep its eye on the goal of long-term deficit reduction. "We know this is the surest way to boost national savings and investment," says Brookings' Henry Aaron. "So just do it!" In FORTUNE's view, the best bet would be to start next year with a package that slows the growth of Social Security and Medicare for upper- and middle-income elderly and offers working-age Americans new incentives to save and invest. That's the kind of middle-class tax cut the U.S. really needs. For Bill Clinton, backing such an approach just might prove a winning strategy, especially if a renewed assault on the deficit once again helped spark a decline in long-term interest rates and prolonged the economic expansion into 1996. On the political front, moving in this direction should help Clinton co-opt ornery Republicans in the next Congress and enable him to attract younger voters and Perotistas. What's certain is that if this President doesn't take up the challenge, someone else eventually will. Nothing else will do so much to keep the American dream from morphing into a fiscal nightmare and ensure that when Clinton and his fellow boomers retire, we'll all be a lot better off.

CHART: NOT AVAILABLE CREDIT: FORTUNE CHART/SOURCE: BIPARTISAN COUNCIL ON ENTITLEMENTS AND TAX REFORM CAPTION: DEVOURING THE BUDGET ON AUTOMATIC PILOT

CHART: NOT AVAILABLE CREDIT: FORTUNE TABLE/SOURCE: CONGRESSIONAL BUDGET OFFICE CAPTION: THE SIX LARGEST ENTITLEMENTS