(FORTUNE Magazine) – THE GREAT DEBATE OVER SOCIAL SECURITY IS SO CLOUDED with hype and misinformation from each side that only one thing is perfectly clear: It's shaping up to be the landmark political issue of 2005. Now that President Bush has pushed this explosive debate to center stage, the parties are sowing confusion by taking highly polarized, exaggerated positions. The Democrats are in ostrich mode, claiming that Social Security faces no crisis at all, while Republicans are swearing that the program is going bankrupt and can be saved only by a revolutionary--and they claim relatively painless--switch to private accounts.

But both sides are peddling myths: Social Security's problems are real and pressing, and a shift to private accounts would prove as risky as it is radical. If you believe, as FORTUNE does, that the best solution would fully fund future promises yet avoid job- and pay-killing tax increases, here's what we know for sure.

● The crisis is real. Liberals, from the New York Times columnist Paul Krugman to House Minority Leader Nancy Pelosi, counter that Republicans are using scare tactics to invent a crisis and that the program is in no immediate danger because it can pay full benefits for 37 more years. But without a radical fix, the damage to the U.S. economy will start long before 2042. Right now Social Security is still collecting far more in taxes than it pays out in benefits; the government is using that entire surplus, around $100 billion a year, to fund the budget. It's actually borrowing the money by issuing bonds to the Social Security trust fund. But that borrowing doesn't raise interest rates because the government gets the cash from itself, without competing for savings in the capital markets. All that changes in 2011, when the surplus starts dropping sharply. If the U.S. doesn't cut spending or raise taxes, it will have to start borrowing the shortfall--the difference between the $100 billion and the dwindling Social Security surplus--from the private markets. That will pull more and more of America's meager savings into government bonds, potentially forcing companies to pay higher rates to raise capital.

It doesn't improve matters that America is already facing massive annual deficits of $300 billion to $400 billion--and hence huge borrowing--as far as the eye can see. The scenario gets much bleaker in 2018, when Social Security starts taking in less money in taxes than it pays out in benefits. From then on, the system needs to cash in its government bonds to keep paying benefits. According to the Social Security trustees, the U.S. will have to raise an additional $255 billion a year in today's dollars by 2030 to pay off the bonds coming due that year alone.

● Raising payroll taxes is a bad idea. Though the Democrats have yet to introduce Social Security legislation, leading liberal academics are praising the ideas behind a proposal from the Brookings Institution that would levy a new 3% to 4% tax on earnings over the current cap of $90,000. (Today the payroll tax is 12.4%; income over $90,000 isn't taxed at all.) But higher payroll taxes would cut take-home pay and kill jobs by raising the cost of hiring workers. As a result, they'd make it far harder for Americans to bank their own retirement savings.

● Privatization: a fig leaf for giant benefit cuts? The administration hasn't offered a Social Security bill either. But in the 2004 report from the President's Council of Economic Advisors, it analyzed a potential plan that may give an indication of what's to come. Bush's trial balloon--and it's by no means his final proposal--wouldn't raise payroll taxes, and on the surface it looks like a manifesto for personal accounts. But far and away the leading feature is a benefits cut that's unprecedented in U.S. history--for any federal program. In 2011 the administration wants to stop indexing benefits to wages, which grow far faster than prices, and tie them to prices instead. That would reduce future benefits so drastically that the system would shift over to generating huge surpluses starting around 2050--money that could be used to pay soaring Medicare benefits, for example. By the turn of the century, Social Security benefits would absorb just 2% of GDP, vs. about 7% if the current system is left unchanged. (For a different take on indexing, see Matt Miller's column in this issue.)

The plan sounds too good to be true, and it is. Because benefit increases won't outpace inflation, retirees would get a lousy return on their tax contributions. Amazingly, the personal accounts don't help much because they would allow Americans to stow away only $1,000 a year.

● Bigger personal accounts would be better, but ... Legislation sponsored by Representative Paul Ryan (R-Wisconsin) and Senator John Sununu (R-New Hampshire) creates big personal savings accounts that in theory could do the seemingly impossible: Offer a good deal for workers and also put Social Security on a strong footing. Ryan-Sununu wouldn't cut promised benefits at all. Instead, it would deliver those benefits by allowing workers to divert more than 6% of their pay to personal accounts --up to $5,000 a year, five times the figure in the Bush proposal. Over long periods those accounts should generate the same returns investors now get on a conservatively managed portfolio, around five points more than inflation. The personal accounts alone could pay virtually all benefits by around 2024; the remaining 6% in payroll taxes would then gradually pay down the debt needed to finance the transition to the accounts by 2062.

The problem is that the government would need to borrow even more massive amounts under Ryan-Sununu than under the Bush plan because the accounts are so much larger. Without big spending cuts, Ryan-Sununu would require an additional $200 billion in annual borrowing above the amount needed to pay down the bonds and finance the deficit. Is it realistic to think that financial markets could look beyond such massive debt? It's highly possible we'd see foreign investors flee and interest rates soar.

Bottom line: For now there's still no easy solution to the Social Security mess. But at least Washington is finally grappling with the problem.