Note to Congress: Compromise; There are only two options: cutting benefits or committing resources.

After 15 years of being largely off the national policy agenda, Social Security came back with a vengeance in 2001. President Bush established the Commission to Strengthen Social Security, giving it a clear mandate to propose a way of incorporating optional individual accounts into the system. Critics denounced the commission as a stacked body and individual accounts as the first step in a long-term plot to do away with the program. The stage was set for some difficult but important negotiations.

Then came a series of events that changed the equation. Budget surpluses that might have helped lubricate an agreement on Social Security between conservatives and liberals vanished in the aftermath of Sept. 11. The president’s commission issued a report that, instead of recommending a specific plan, outlined several options for reform, thereby earning denunciations from both proponents and opponents of privatization. And the Enron scandal—or, more particularly, the retirement-savings losses of Enron employees—dimmed some of the enthusiasm for privatization. It all has made the prospects for an agreement on major substantive reform of Social Security, not especially bright before Sept. 11, seem very dim indeed in 2002. This is a shame. If we want to avoid truly draconian policy changes in the long run, Social Security’s very real long-term funding problem must be addressed quickly.

Finding a long-term solution will require both liberals and conservatives to make compromises they find unpalatable. Both sides must start by abandoning their most extreme positions. Liberals will not accept reforms that appear likely to undermine the current system of guaranteed benefits as the core of retirement-income policy by undermining its fiscal base of support over time. In particular, they will not accept the redirection of current Social Security payroll taxes to fund individual accounts. Conservatives will not accept putting any more payroll tax resources into the current Social Security program. Nor will they accept injecting significant general revenues into the current Social Security program, except perhaps for very narrow, carefully defined purposes.

Both sides also need to alter their rhetoric. Conservatives need to drop the shrill cries that we’re in the midst of a severe crisis, while liberals must acknowledge there is a real long-term financing problem that must be solved. Both sides need to admit that investing in equities—either through individual accounts or collective investment of current trust fund surpluses—is not a free lunch that will solve Social Security’s financing problem, but at best a healthy snack that will make it more manageable. In the long term, there are only two options: cutting benefits for retirees or devoting more resources to retirement income security.

Liberals and conservatives must accept this simple fact: The concerns raised by the other side about some of their favorite proposals are probably legitimate and need to be addressed. Specifically, liberals must agree to strong safeguards to protect against political interference in investment decisions if Social Security trust-fund money is invested in corporate equities and bond markets. Conservatives must accept limitations on administrative costs so that savings in mandatory individual accounts, especially the accounts of low-wage workers, are not eroded by high fees charged by fund managers. Eligible funds would have to be diverse in their holdings across firms and sectors of the economy to prevent a repeat, on a much larger scale, of the Enron retirement-savings debacle.

And one other thing: While we are fixing Social Security’s fiscal situation, we must guard against making existing social problems worse. Despite major progress over the past 40 years, the United States still has many seniors in poverty, especially elderly widows. Many privatization proposals could make this vulnerable group even worse off.

Assuming that the two sides of the ideological divide are willing to attempt an agreement rather than trying to bash each other for fun and political profit, here are some specific ideas for bridging the Social Security divide:

* Increase the Social Security payroll tax by 2% of total earnings, split equally between employers and employees. All the new contributions would go into mandatory individual accounts. Workers would have a wide choice of privately managed funds, but all funds would have to have diverse holdings. Caps would be placed on the fees of account managers to hold down administrative costs. Funding mandatory savings accounts through payroll taxes, rather than general revenues, provides a stable income stream that is essential if mandatory savings accounts are to be a major part of seniors’ retirement incomes, given that partial privatization will increase their risk in depending on market investments.

* Gradually reduce initial benefits for future cohorts of Social Security recipients as new individual accounts are phased in. Replacement rates would be set so that the combined “old” Social Security benefits and new mandatory savings accounts would roughly equal current benefits, given conservative estimates on rate of return for the mandatory savings component. Benefits would continue to be fully adjusted for inflation after retirement.

* Begin investing part of current Social Security trust-fund surpluses in equity and corporate bond markets through multiple funds. The size of individual funds would be limited to prevent any disruption of capital markets. These funds would have a strict legislative mandate to maximize return for retirees, rather than to serve social ends, and they would be privately managed. A major advantage of such an approach is the potential for increasing returns on Social Security contributions. Even more important, it would ease the cash-flow transition expected to occur around 2016 as Social Security shifts from serving as a source of financing for the federal government to being a drain on government revenues.

* Create a more generous minimum benefit for retirees, paid for out of general revenues. The current Supplemental Security Income (SSI) safety-net program for the elderly serves few people because its benefit levels are minimal and its assets tests are absurdly low. International experience suggests that it is almost impossible to eliminate poverty among the aged without increased reliance on some form of means-tested program. A new income guarantee within Social Security should have higher benefits and less stringent assets tests than the current SSI program, but not carry with it automatic eligibility for Medicaid, which would raise program costs substantially. Seniors who could meet SSI asset tests could still get Medicaid. To assuage concerns about high benefits luring immigrants, benefit guarantees should be prorated based on the years that a recipient spent in the United States as an adult—one-fortieth of the full monthly pension for every year of residency. Recertification for eligibility should occur automatically through filing an income tax return, as is done in Canada.

None of these proposals, individually or collectively, is a panacea for Social Security’s problems. But they do form a balanced package that has elements appealing to both sides of the ideological divide. Seeking a middle-of-the-road solution on Social Security is not easy. But failure to reach an agreement now will pose an unacceptable burden on future generations of retirees and their children.