One of the chief casualties of the Republican drive to impeach President Clinton may be any hope of "saving Social Security" in 1999. It's difficult to see who other than Clinton can broker an agreement between the two main camps in the debate: traditionalists and modernizers.

The traditionalist camp includes organized labor, minority and liberal interest groups, and many if not most congressional Democrats. While acknowledging that the system faces a big funding shortfall as the baby boom generation retires, traditionalists are determined to preserve Franklin D. Roosevelt's 1935 handiwork more or less intact. They say government can insure Americans against unforeseeable economic risks and guarantee everyone a decent retirement only by maintaining the original structure of intergenerational transfers and "defined benefits."

Modernizers, who span the spectrum from center-left to center-right, hold that Social Security's problems can't be fixed with the usual tucks and tweaks. Most favor some version of the "two-tiered" approach that would divert a small portion (usually 2 percentage points) of payroll taxes into personal retirement accounts for every worker. This group includes prominent Democratic senators such as Daniel Patrick Moynihan of New York, Bob Kerrey of Nebraska, and John Breaux of Louisiana; most moderate Republicans; small-business groups; and young people worried that without basic changes, the system will either impose crushing tax burdens on them or go belly up before they reach retirement.

A third group lies farther to the right. It consists of the libertarian Cato Institute, Wall Street financiers, and GOP presidential aspirant Steve Forbes, and it demands complete privatization now. The group has found few takers in Congress, whose members are reluctant to hurl themselves on Social Security's "third rail." However, the program's liberal guardians suspect that many modernizers are closet privatizers who seek to establish a beachhead they can expand tomorrow.

In any case, full privatization will be off the table in 1999. Passing a major Social Security overhaul this year will require a political deal that can satisfy the core concerns of modernizers and traditionalists. Can President Clinton define a "third way" on Social Security that breaks the left-right deadlock, just as he has on welfare reform, public education, reinventing government, and other issues?

The Golden Age Is Over

It's possible, but "saving Social Security" is different in one key respect from the President's previous New Democrat innovations. While most Americans think our welfare and education systems are broken and need basic repair, few believe Social Security has failed. On the contrary, the system has unquestionably succeeded in its basic mission of reducing poverty in old age and insuring Americans against losses stemming from disabling accidents or the death of a working spouse or parent.

No "reform" that threatens to undo these historic achievements will get very far. Yet opinion polls also register growing public doubt about the program's ability to honor its future commitments. Most Americans realize that changing demographics dictate that things cannot go on as they have.

Put simply, the growth in the number of elderly people in the population will far outstrip the growth of the work force whose taxes support them. By 2030, one in every five Americans will be old, while the ratio of workers to retirees will fall to an all-time low of 2-to-1 by 2030. In the past we've compensated by bringing more occupations into the system, but today more than 90 percent of working Americans are covered by Social Security.

Nor can we rely on the usual quick fix of jacking up the payroll tax. Just 6 percent in 1960, that tax was raised seven times in the 1980s alone and today, at 12.4 percent, takes a bigger bite out of most workers' paychecks than the federal income tax. Thus, the conditions that since 1940 have allowed each generation of retirees to draw much more from Social Security than they put in -- a fast-growing work force and public willingness to accept higher payroll taxes -- no longer exist. Further straining the system are advances in health and longevity that mean that today's workers can expect to spend nearly a quarter of their adult lives in retirement. Congressional Budget Office Director Rudolph Penner put the matter succinctly at a White House conference in December: "The golden age of Social Security is over."

Who Invests?

To renew Social Security's promise for the 21st century, we have to find a new way to finance the system. By 2032, the program's trust fund will be exhausted and tax revenues will only cover 75 percent of promised benefits. Where will the money come from to pay for the retirement of 77 million boomers who on average will live from five to seven years longer than their 1940 counterparts?

Almost everyone is looking to the market. The reason is simple: By tapping financial markets' high rates of return, lawmakers can avoid or at least mitigate such politically unpalatable steps as slashing benefits, hiking payroll taxes, or borrowing more and returning to large government deficits.

By law, Social Security must invest its reserves (totaling about $760 billion) in safe but low-yielding government securities. If some portion of current reserves and future revenues were instead invested in stocks and corporate bonds, returns over time would be far higher. Over the last 40 years, for example, real (after-inflation) returns on stocks have averaged 8.2 percent annually. That looks a lot better than returns on Social Security, which are projected at about 1 percent per year over the next 35 years.

Even many traditionalists lately have warmed to the notion of moving to a "funded" system, that is, one financed at least partially by market earnings rather than simple tax transfers. Where they differ from modernizers, however, is on the question of who does the investing. Traditionalists want the government to invest and control the money; modernizers want individuals to manage and own their own retirement accounts. While endorsing market-based reform, President Clinton thus far has refrained from taking sides on the question of means, leaving himself free to act as an honest broker.

The dispute centers mainly on risk. Traditionalists note that while average returns on equity investments are high, by definition lots of people must fall below the average. They fear that people with spotty work histories who make bad investments could do worse in a two-tiered system than in the current one. Moreover, because markets fluctuate, returns will vary no matter how wisely people invest. Two people who invest the same amount of money in the same stock index fund could get drastically different returns if one retired in a falling market and the other retired during an upturn.

For these reasons, economists Henry Aaron and Robert Reischauer of the Brookings Institution propose that government invest some portion of Social Security's reserves, thereby spreading market risks among the whole population. In this way, everyone would be guaranteed a secure and decent fixed benefit, albeit one that for many might be less than if they had invested the money themselves.

Critics of "collective investment" charge that it would create enormous political risks by making government a major stockholder in America's largest companies. Aaron and Reischauer maintain that a Social Security version of the Federal Reserve Board could be set up to insulate investment decisions from politics.

But modernizers raise a more fundamental objection: In the name of protecting individuals from market risks, collective investment would deny them the opportunity to build personal wealth and take greater responsibility for managing their retirement security. This runs counter to important trends in the rest of society -- a shift from employer-sponsored "defined benefit" to employee-controlled "defined contribution" pension plans in the private sector and an unprecedented surge in mutual fund investments. Thanks to these developments, nearly half of the public now has some investment in the stock market. By diverting even a small portion of the payroll tax into personal retirement accounts, we could make stock ownership a near-universal experience. This would give millions of low-income workers the same chance affluent families have to harness the power of compound interest over the course of their careers.

Personal accounts would refashion Social Security from a system of wealth transfer into one that also promotes individual wealth creation and broader ownership. Workers would own their accounts and could pass on any assets they didn't use to their heirs. This approach would address a prime source of economic inequality in old age: relatively low savings among poor minority families. According to Rand Corporation economist Jim Smith, the median black or Hispanic older household has no financial wealth at all, making those households utterly dependent on Social Security. Indeed, most economists believe that Social Security's progressive benefit structure dampens low-income workers' incentive to save.

In addition to market risk, traditionalists marshal other arguments against partial privatization. The most convincing is that the costs of administering millions of small accounts would be much greater than for one mammoth fund invested by the government. Least convincing is the liberal claim that low-income Americans simply aren't competent to manage such accounts and must therefore delegate that task to a wise and paternal government.

In a recent speech to the Democratic Leadership Council, Kerrey pointed out that such paternalism is at odds with his party's Jeffersonian faith in the capacities of ordinary people. "There is a particular irony to me that this view comes from quarters that are described as representing the traditional Democratic point of view," the senator said. "I am a Democrat because I believe in the dignity, not the density, of every American."

Elements of the "Grand Bargain"

Despite his impeachment ordeal, President Clinton still can make a vital contribution to breaking the impasse on Social Security. As the centerpiece of his 1999 State of the Union Address, he could offer a "grand bargain" that addresses the traditionalists' legitimate qualms about market risk and overhead costs and the modernizers' equally valid desire to empower workers.

In such a bargain, the President could reaffirm his commitment to preserving the system's social insurance for the disabled and survivors, for which there remains no plausible private alternative; and challenge the modernizers to back reforms aimed at strengthening Social Security's basic guarantee against poverty, both by raising the minimum benefit all retirees get and changing outdated formulas that produce high poverty rates among elderly women, especially widows.

By lifting the "floor" for everyone -- and thereby guaranteeing that no low-wage worker would be made worse off by market-based reform-- the President would stand on solid ground in challenging the traditionalists' premise that only by investing the money itself could government shield individuals from undue market risk. Washington can provide further safeguards by emulating the Federal Thrift Savings Plan, which limits federal workers' choices to rule out investments that are overly conservative or too risky. The plan also offers a model for keeping overhead down: Have Social Security continue to collect all payroll tax revenue and transfer some portion to individual accounts designated by workers.

Finally, the President should challenge both sides to ensure the system's solvency while also financing the transition to a partially funded system. It makes sense to dedicate a healthy chunk of future fiscal surpluses to this purpose. In addition, Congress should embrace a gradual increase in the retirement age to 70 by 2030, in keeping with advances in the average life span of older Americans. The best way for boomers to help solve the problems their retirement will create is to work longer, keeping the work force from shrinking as rapidly and boosting payroll tax revenues. Less dramatic but still important ways to close the funding gap include bringing state and local employees into the system and adjusting the Consumer Price Index downward.

Among the welter of reform proposals crafted in recent years, the one that comes closest to embodying such a "grand bargain" is the 21st Century Retirement Security Plan issued last summer by the National Commission on Retirement Policy. The plan also has the crucial virtue of being bipartisan-- the commission's congressional co-chairs were Democrats Breaux and Rep. Charles Stenholm (Texas), and Republicans Sen. Judd Greg (N.H.) and Rep. Jim Kolbe (Ariz.).

Renegotiating the Social Compact

The grand bargain sketched here would renegotiate, not abandon, the social compact implicit in Social Security. It would offer working Americans new opportunities to build personal wealth while asking them to take greater responsibility for their retirement security. It would convert Social Security from an entitlement based on the false promise that everyone can consume more than they produce to a system that promotes savings, investment, and greater economic self-reliance. And it would embody a new approach to governing based on a key New Democrat insight: That in the Information Age, government's role is not to take care of us, but to give us the tools we need to take care of ourselves and each other.

Will Marshall is president of the Progressive Policy Institute.