Social Security plays an important role in the lives of all Americans. But in order for it to continue, it must be reformed. Social Security must be redesigned to recognize the demographic, economic and social changes in our society since the program was put in place. A new, strengthened system can continue to provide essential retirement, survivors and disability benefits. It also can contribute to capital formation, improve savings, and reinforce individuals' responsibility to plan for and contribute to their own retirement. The current system is simply not sustainable without harm to the economy and future generations of workers and retirees. It's not a question of whether to reform the system. It's a question of how and when to do it.

There are only three ways to fix the Social Security system: increase revenues; adjust benefits; or earn a higher rate of return on invested assets. The magnitude of the problem effectively requires the adoption of some combination of at least two of the three options.

Revenue enhancement: If the current 12.4% payroll tax was increased to 14.6% immediately, the system would be solvent for 75 years. To keep the system balanced in perpetuity, however, would require a tax rate of 17-18% of payroll. This does not include payroll taxes that support Medicare. Seventy-five percent of the population already pays more in payroll taxes than it does in income taxes. Payroll taxes are regressive and have a negative effect on cash wages and jobs. Higher payroll taxes would reduce the rate of return individuals receive on their contributions and undermine support for the system.

Benefit adjustments: Possible benefit adjustments include increases in the retirement age, changes in the benefit formula, modifications to the Consumer Price Index so that it more accurately reflects inflation, and means-testing of benefits. To solve the problem solely through adjustments in benefit levels, however, would require a 25 percent across-the-board reduction if current retirees were included. If those in or near retirement are held harmless, younger workers would face benefit reductions of 30 to 35 percent. This level of benefit reduction is neither feasible nor desirable unless the current system is reformed to include a mechanism that allows individuals to save for their own retirement and replace those benefits.

Increasing the rate of return: Lack of enthusiasm for increasing taxes and/or reducing benefits has spurred interest in ways to improve the rate of return earned on Social Security's assets.

Government investment of the trust funds: One approach would maintain the current structure of the Social Security system and have the government invest the trust fund assets through a newly- created federal agency. Supporters argue that sufficient protections can be put in place to minimize government influence over the investments. This approach, however, raise a number of concerns. It would create the potential for social investing - basing investment decisions on criteria other than financial risk and return. Would the federal government be willing to invest in tobacco stocks? Would Social Security money be invested overseas? Would organized labor want to invest only in companies with unionized workforces? Would retirees sacrifice return in order to support political objectives? If the market dropped, would the government intervene to prop up share prices?

Investments of large amounts of capital by the government also could interfere with the efficient operation of markets. Assets could be concentrated in certain market segments, leading to distortion in the price of certain investments. The government would own substantial portions of private companies, raising significant concerns about interference with the operation of private companies. Government investing could improve the financial status of the Social Security trust funds but would not create new savings in the economy. If the trust fund buys up equities to boost its rate of return, other investors will be left with lower-performing investments. Individuals may see lower returns on their 401(k) plans and IRAs and the overall economy would be no better off .

Government investment of the trust fund assets is too dangerous a path. Even if protections are put in place, future Congresses can undo them. Even Federal Reserve Chairman Alan Greenspan has said that this option must be rejected.

Individual accounts: An alternative to investing the Social Security trust funds in the private capital markets is to redesign the Social Security system for future retirees so that it is made up of two components: 1) a defined benefit plan similar to the current Social Security system that pays smaller benefits to middle- and upper-income people; and 2) individual accounts owned and invested by the individual participants.

A reformed Social Security system that includes individual accounts has many advantages over the current system. It would maintain the current safety net, and even improve it for lower- income workers. Similarly, disability and survivors benefits would continue as under current law. Individual accounts would move us from the current system, where payroll taxes are used to pay current retirees' benefits, to a partially funded system where workers would start to save for their own retirement. It would replace a system that shifts costs to future generations with one in which each generation saves for its own retirement, thus reducing burdens on our children and grandchildren.

Workers would have real ownership of their accounts. No politician could take that benefit away. Individual accounts would be easily understood by workers. There would be a direct link between taxes paid and benefits earned and workers would receive a better rate of return on their contributions. Workers at all income levels could accumulate assets that could be passed on to their heirs, thus giving every American a greater stake in our nation's economy. Finally, individual accounts could increase national savings and lead to a stronger economy - one better able to support an aging population.

Unlike the government investing in private companies, individual accounts can be designed in a manner that minimizes the potential for social investing and negative effects on the capital markets. There are issues that must be addressed when designing a new Social Security system with individual accounts. There are difficult administrative challenges that must be addressed. There may be limits on investment options. There will need to be strict oversight of investment advisors. The public will need to be educated about investments and risk.

Despite these challenges, individual accounts give us an opportunity to create a retirement system for the 21st century. The current system has served us well but it cannot be sustained by our aging population. We should take a lesson from those who dared to create a universal retirement system in 1935. We need that same kind of vision and creativity. We should take advantage of the maturation of our capital markets and the advances in technology that allow us to build on the success of the past and create a stronger Social Security system for the future.