I have a similar problem:
OS X Server 10.3.9 running on a G3; clients running OS X 10.4.8.
I used Server Admin to set up the server with L2TP and set the shared secret[1]; I used Internet Connect to try to get a client to connect to the server. The result is always the same: The client says "Authentication Failed" and the server's logs record the conversation (Here's the relevant part):
...Tue Jan 16 15:55:08 2007 : sent [CHAP Challenge id=0x1 <c9af9d6375c13e5657d49c44c6ab8259>, name = "inside"]
Tue Jan 16 15:55:08 2007 : rcvd [LCP EchoReq id=0x0 magic=0x9101c22f]
Tue Jan 16 15:55:08 2007 : sent [LCP EchoRep id=0x0 magic=0xf01aa2]
Tue Jan 16 15:55:08 2007 : rcvd [LCP EchoRep id=0x0 magic=0x9101c22f]
Tue Jan 16 15:55:08 2007 : rcvd [CHAP Response id=0x1 <f27c5a611e1e9cf68c17d04d37448b6d00000000000000000f035bba35b5a714589e7292c1fba0 78d57fb3640b62a08e00>, name = "timberwoof"]
Tue Jan 16 15:55:08 2007 : sent [CHAP Failure id=0x1 "E=691 R=1 C=C9AF9D6375C13E5657D49C44C6AB8259 V=0 M=Access denied."]
Tue Jan 16 15:55:08 2007 : CHAP peer authentication failed for remote host timberwoof
Tue Jan 16 15:55:08 2007 : sent [LCP TermReq id=0x2 "Authentication failed"]
Tue Jan 16 15:55:08 2007 : rcvd [LCP TermReq id=0x2 "Failed to authenticate ourselves to peer"]
...
The user 'timberwoof' exists on the server. I tried changing password type to Advanced, but there's a catch-22 situtation: no user is set up with Advanced password, and it can only be changed to that by a user using Advanced password.
[1] Has anyone else noticed that the dialog box for setting this in Server Admin 10.4.7 is broken? It always forgets the shared secret and then complains that none has been entered.