An important part of the Chicago Revolution in antitrust was the argument that no monopoly is forever. Eventually, someone will innovate and offer a superior product that the monopolist cannot match. And, just like that, the monopolist will be history.
Microsoft’s lock on operating systems looked assured in 1998 when the Justice Department tried to break the company up. But that remedy was never ultimately imposed. And in the end it didn’t matter. For, less than ten years later, smartphones arrived, and now most people do most of their computing on operating systems not made by Microsoft.
It seems to follow that antitrust action is a waste of time.
So interesting, then, to hear all the talk of late about how, despite its best efforts, China won’t be able to catch up with the West in chip production.
Not for decades.
Maybe never.
We are told that chip production relies upon an entire ecosystem of designers and suppliers. That experience matters. And so on.
But if that’s right, then the view that no monopoly is forever must be wrong—or at least not absolutely true in all cases. If the Western chip fabs have a near-permanent lock on the market, then it can’t be the case that we can always rely on markets to erode monopoly power. It can’t both be true that China can never catch up with the West on chips and that no position of market dominance is forever.
So which is it?
I suspect that those who think China can never catch up are wrong.
It may well be the case that the learning curve on chip production is such that a latecomer will never be able to catch up with a first mover absent technology transfer. But the argument about the impermanence of monopoly power has never been that newcomers will one day master the incumbent’s technology. It has always been that newcomers will one day introduce a completely different technology that carries out the same tasks as the old technology, only ten times better.
To this day, Microsoft continues to dominate the market for PC operating systems. What eroded Microsoft’s power was the introduction of a different technology—smartphones—that required a different kind of operating system. Microsoft didn’t start out with a lead in mobile operating systems, and, in the event, Microsoft lost the race.
So the question about whether China can overcome her lack of cutting edge chip supply and find a way to go head to head with the West as computing revolutionizes everything from military equipment to passenger vehicles is really the question whether China can come up with different technologies that do computing better—not just more semiconductors.
I don’t know the answer to that question. But it is perhaps useful to note that while China is not a leader in the design and production of conventional chips, China is a leader in quantum computing—which promises vastly greater processing speeds—and in artificial intelligence.
Indeed, it is worth asking whether TikTok’s success at challenging both Google’s dominance in search and Facebook’s dominance in social media doesn’t contain a lesson. At the same time that at least some Americans were quaking in their boots regarding these American tech giants’ size—and calling for antitrust enforcement—TikTok was quietly applying superior artificial intelligence to revolutionize the core functionality of both companies. TikTok is a Chinese company.
The view that technological advance always ultimately erodes dominant positions is perhaps most closely associated with Joseph Schumpeter, who called this process “creative destruction.”
The question, then, is whether the West should worry that creative destruction will erode its dominant positions.
If the Chicago School of antitrust is right, the answer is “yes.”
The West has careened from fear to confidence in Ukraine.
The fear may well return.
On February 25, 2022, the day after the present Russian invasion of Ukraine commenced, the West feared Russia.
The West feared escalation.
The West feared nuclear war.
And so the West would commit only to very limited supply of arms to Ukraine. Antitank small arms. But no tanks. No artillery. No big missiles.
Then Russia’s conventional forces struggled in the field. Russia withdrew her forces from the north and gave up on the reduction of Kyiv.
Now the West’s confidence grew. Russia appeared to be a paper tiger. And now the arms poured in. Artillery. Missile systems. Tanks.
But it was unclear why Russia’s poor showing as a conventional military so stoked Western confidence, because the threat to the West had always been a nuclear threat.
On February 25, 2022, no one thought that Russia might retaliate against the Western arming of Ukraine by undertaking a conventional invasion, of, say, Britain.
What the West feared was that Russia might respond by using battlefield nuclear weapons according to her doctrine of escalating to deescalate. She might drop a nuclear weapon on Kyiv.
And then what?
For the West not to respond by dropping a nuke on Russian forces would be to condone Russia’s use of the weapons. But to respond in that way might draw a nuclear response from Russia.
There would be nuclear war.
The peculiar thing about the resurgence of Western confidence after Russia’s conventional forces struggled is that Russia’s poor performance with conventional arms didn’t change the nuclear calculus.
Unless one wished to infer from Russia’s difficulty hitting Ukrainian targets with her long range missiles, or her inability to achieve air superiority, that Russia was in fact incapable of using her nuclear weapons at all, there was no basis in Russia’s weakness in conventional arms to support the view that Russia was not a threat to the West after all.
Indeed, as we have been reminded by Russia’s renewed threats to use nuclear weapons in response to her loss of the city of Izium, her conventional military failures made her more likely to resort to nuclear war.
If the West feared nuclear war with Russia on February 25, 2022, the West ought to have feared nuclear war with Russia even more on April 2, 2022, once Russia had retreated from Kyiv. If the West thought it unwise to supply Ukraine with weapons on February 25, 2022, then the West should have thought it even less wise to supply Ukraine with weapons in April 2022.
Instead, the West sent more.
I do not mean to say that the West should not have sent more weapons. But I do mean to say that the West ought to have been aware, in sending them, that the West was increasing the risk of nuclear war. The arming of Ukraine ought to have been carried out with a sense of courage—with an awareness that great and increasing risks were being undertaken in the interest of winning a struggle with a nuclear adversary.
Instead, it was undertaken with a sense of relief and confidence. It was undertaken out of the irrational belief that Russia’s conventional military weakness meant that supplying the weapons would not be as dangerous as had at first appeared.
Which is a problem, because it suggests that West will not be ready when, as is increasingly likely, Russia uses nuclear weapons in Ukraine.
For if Russia were to do that, the West would find itself right back in the scary world of February 25, 2022, a world in which the West’s first instinct was not courage but rather fear and paralysis.
If the West’s basis for standing up to Russia over the past six months has been the belief that Russia is no real threat, then when Russia demonstrates that she remains a threat—indeed an existential threat—the West’s basis for standing up to Russia will disappear.
If it seemed obvious to the Biden Administration in the lead-up to the invasion that drawing a red line and committing to arm Ukraine would be unwise, because it could lead to nuclear war, then it will seem equally obvious to the Biden Administration on the morning after a nuclear attack by Russia on Ukraine that responding in kind would be unwise, because it could lead to nuclear war.
But if the Biden Administration does not respond, then the West will lose.
The problem with the past six months of Western policy toward Russia is that it has been built on the fantasy that Russia’s inability to get tanks to Kyiv means that she is not a nuclear threat.
In fact she remains a grave nuclear threat, and the West has been fighting a proxy war against her. And not just any proxy war, but the supremely dangerous form in which only one side believes that there is a proxy involved. Russia does not think this is a proxy war. She thinks that Ukraine (unlike, say, Afghanistan) is hers.
When the West decided in April to arm Ukraine in earnest, the West decided to escalate a conflict between the West and a nuclear adversary. The West can only win such a nuclear struggle if the West knows that it is in fact a nuclear struggle.
And only if the West is willing to risk the West’s annihilation in order to win.
On February 25, 2022, the West was not prepared to take such a risk.
It has been a common progressive move for more than a century to argue that property rights are not sacrosanct because the government creates them. Government creates them and government can take them away. I heard this in seminars in law school. And I recall Elizabeth Warren making this argument on the campaign trail in 2020. And Morris Cohen said it in 1927.
But I do not understand why this argument has so much appeal to progressives, because it does nothing more than assert a contrary position to that taken by libertarians. It does not prove anything in favor of government intervention.
The question, after all, is how the government should use its power. Should the government use it to protect and expand property rights? Or should the government use it to dissolve and restrict property rights?
The libertarian asserts that the government should protect property rights because these are in some sense prior or fundamental.
And the progressive, in arguing that the government giveth and so can taketh away, asserts no more than that government action—regulation—is in some sense prior or fundamental.
There is no more substance than that to the government-giveth argument.
It resolves nothing, just as libertarians’ assertion that property rights are prior and fundamental resolves nothing. It merely asserts the opposite of what the libertarians assert.
The fact that government is needed to enforce property rights does not in itself imply that government need not enforce them. It does not imply that property rights are not in some sense prior or fundamental. It may well be that property rights guaranteed by government are prior and fundamental in relation to all things. And that government elimination of property rights is posterior. I do not personally believe this to be so, but I do not see why the fact that government is needed to guarantee property rights implies that property rights need not be fully and absolutely guaranteed.
And that is before we even get to social contractarian arguments that claim that government is no more than a mutual defense pact between prior possessors of things that come to be called property under the terms of the social contract.
Moreover, as a historical matter, it is not clear to me which side has the better of the argument. On the one hand, government enforcement does reduce outside interference with one’s possessions, and one cannot speak of property in the legal sense without assuming the existence of a legal authority committed at least in principle to recording and enforcing such rights.
On the other hand, it is the case that people living in places that have no central government possess things and enjoy them quietly for long periods of time, so long as they are individually powerful enough or in sufficient harmony with their neighbors to protect their possession of the things.
The only thing that progressives’ assertion that the government giveth really does is to demonstrate to progressives that there is an alternative to the view that property is fundamental—namely, that government regulation is fundamental.
But it does not answer the question how much to protect property and it does not even establish that the libertarian view is necessarily wrong.
There is a tendency among free marketers to say: “if markets are bringing it about, it is necessary.” And the big insight on the left for at least the past fifty years has been to say: “ah, but the market is shaped by the law, so if we pass a law preventing it from happening, then markets won’t bring it about after all.”
So, in the context of the influx of American digital nomads to Mexico City, and the opposition to gentrification they have aroused, the free marketer says: “locals are getting rich selling to the Americans, and the Americans clearly believe they are getting something of value, so this is natural; it’s going to happen; if you try to stop it you might as well try to use your pinky to dam the Nile.” And the left winger replies: “the only reason the Americans can move here is that Mexico permits them to stay for six months without a visa. Change the rule, and this goes away. Mexico has a choice.”
The free marketer seems to espouse market naturalism: society is self-organizing and policymakers have little choice regarding outcomes. The most they can do is create a temporary disequilibrium—a dam that will break. By his reply, the left winger restores the policymaker’s freedom to decide social outcomes.
Both the free marketer and the left winger miss the point.
The proper argument for free markets is not that market outcomes are natural. The left winger has the better of the debate on that score: the state does in fact come first, then the market. That is why free marketers fear Communism. Because the state really can shut down the market—and, by extension, use a lighter touch to shape the social outcomes to which the market leads.
A proper free market argument accepts that policymakers can channel or override market outcomes but the argument holds that policymakers shouldn’t do that, because the people speak clearest through markets. That is, the only really coherent argument for free markets is that markets are more democratic than the electoral process. When people buy and sell, they vote, and the free market position is that un- or lightly-regulated markets process those votes in a way that is more faithful to the preferences of the voters than are the institutions of representative democracy that process the votes that people cast in electing the policymakers who would otherwise regulate market outcomes.
So, the argument would go, while activists might not like the fact that Americans are moving to Mexico City, the fact that Mexicans themselves are willing to rent them places to live and sell them tacos is the clearest possible indicator that Mexicans want the Americans to come.
The left winger’s response that the state comes first is not a good rejoinder to this proper form of the free market argument. For the free marketer can argue that the state ought to embrace the system that most faithfully reflects the will of the people, and that markets, in his view, are that system. The only way for the left winger to strike back is to argue that the electoral process, through which people can choose to alter market outcomes, does an even better job of reflecting the will of the people.
That might be true—and I tend to think that it is. But unlike the question whether the law is prior to the market and can influence market outcomes, the answer is easier to contest, as several generations of public choice theorists have done.
In the market, one’s ability to speak is mediated by wealth—more money and more ownership means more votes. But even were it possible to keep money out of politics—and if not, then elections are mediated by money, too—elections would still be prone to distortion by small, highly-organized interest groups. Many voters don’t show up to the polls, and their representatives don’t always do what they want even when they do.
Indeed, it is difficult even to compare outcomes under these approaches because they represent, in effect, different social welfare functions. Are the sale decisions of landlords and street food vendors a more accurate expression of the abstraction that is the “will of the people” than the decisions of representatives elected by the subset of the population that showed up to vote in the last election?
The debate over regulation of markets is really a debate over norms—and specifically democratic legitimacy—not market naturalism.
It won’t be resolved until both sides start acting that way.
The principal problem with liberal gun rights policies in the modern age is the same problem that has bedeviled all modern warfare: firepower. What do you do when a single rifleman with enough ammunition can wipe out hundreds of people per minute?
This was, of course, a problem with which militaries were much concerned between 1914 and 1918 in particular. One might have expected that the principles that they developed in response would have been put to use already by school defense planners, especially since those principles govern the way all armies today deal with the same problem of firepower that schoolchildren now face.
But they have not been applied.
To my knowledge, the principal principle employed today by schools is that of concealment. If a shooter enters the building, classroom lights are to be turned off, doors are to be locked and barricaded, and children are to hide.
Concealment is, indeed, one of the methods that World War One tacticians identified as a means of dealing with firepower.
But it’s just one, and far from the most important—especially when the enemy has a rough sense of where you are. If he knows you’re behind a wall, or a door with a few chairs and desks up against it, he doesn’t need to know exactly where you are. With enough firepower, he can shoot up the entire wall or the entire door, and everyone behind. Just so, the modern soldier is taught to distinguish between concealment and cover.
Cover as in armor or concrete: stuff that stops bullets and negates firepower.
Cover is another method that World War One tacticians identified as a means of dealing with firepower. But it, too, is not enough. Cover works, but only if you can prevent the enemy from closing with you and pulling you out of your cover. In war, that is done by marrying cover with firepower of your own. You can close on a tank that has no gun, but not so easily on a tank that has a gun.
But it’s hard to marry a school with firepower of its own. The trouble has to do with the element of surprise. You need to have a lot of guards on duty at any given moment in order to minimize the advantage an attacker gets from surprise. Guards get bored and fail to notice things. They panic. They run. And they get shot before they can reach for the arms that they have careless cast aside. You would need a garrison effectively to support an armored school.
Absent such a garrison, you can armor your doors and make desks and chairs from concrete, but all the enemy needs to find is one unlocked classroom door and he’s in—and will have plenty of time to step behind every concrete desk or chair therein.
Cover, too, does not exhaust the principles developed by World War One tacticians.
Another is: dispersion.
Modern weapons can bring astonishing amounts of firepower to bear on discrete areas, but they can’t bring astonishing amounts of firepower to bear on everything at the same time. That is especially true for a lone rifleman.
The more dispersed the targets, the longer it takes to hit all of them.
Which brings us to one of the principal school design flaws from the perspective of modern defense: schools concentrate students. Once the shooter has entered a classroom, the walls of the classroom corral his targets whereas modern tactics demand that targets disperse in order to defend successfully.
But the most important lesson that tacticians learned in World War One was something else: combination.
A successful defense cannot be mounted using any one of these principles alone. Concealment alone won’t do it (the enemy will just shoot all the concealed places). Cover won’t do it (the enemy will just close with you and pull you out). Dispersion won’t do it (given enough time, the enemy will find a bullet for every target).
If you disperse and conceal yourself behind cover, the effects of the enemy’s firepower are much reduced. It will take him longer to find you, make it harder for him to hit you, and take him longer to hit all of you.
This was the rationale behind the defense in depth developed by the Germans toward the end of the war.
Rather than concentrate thousands of defending troops in a frontline trench against which the allies could bring to bear massive firepower, the Germans created a deep patchwork of trenches, lightly manning each. They took advantage of natural obstacles, like hills, by stationing troops on reverse slopes. And they devolved authority onto commanders of small teams of defenders whose job was to adjust their positions dynamically as the battle evolved to maintain dispersion. This approach soon became a staple of modern tactics.
Modern militaries deal with firepower by deploying cover, concealment, and dispersion in combination. The least schools can do for their students is to deploy same.
The first and most important change that must be made to school defense is to eliminate the corralling effect of classroom walls. As soon as an attacker is known to be inside a school, the walls separating the classrooms from the outside world must disappear. Make them garage doors, say, and program them to spring up at the first sign of trouble. (A more fanciful approach is illustrated below.)
Interior walls should be armored and stay in place, as one doesn’t want temporarily to increase the number of available targets—concealment and cover still matter within the building—but the exterior walls should disappear, allowing students and teachers to disperse as fast as their legs will carry them.
But that, alone, is not good enough.
Rather than disperse into open fields enabling our rifleman to mow down fleeing students like a World War One machine gunner overlooking no-man’s land, students must disperse into concealment and cover.
To achieve this, schools must be ringed by concrete blocks in irregular patterns (irregular to deny the shooter an unobstructed field of fire in any direction). (Even better, they should be great concrete busts of historical figures, so that they both teach and protect.) As soon as the outside walls go up in response to a threat, students must be able to flee into cover and concealment of this kind. The blocks must be spaced closely enough to conceal and cover, but not so closely as to prevent students from continuing to run and run and run; for they must not stop behind these blocks, but weave through them, continuing to disperse (according to arrows conveniently painted throughout this field of cover) until they have arrived behind the cordons set up by first responders.
Here the box-like outside walls of a schoolhouse are tethered to a boom which jerks the walls away at the first sign of trouble. Students are then free to flee to safety in all directions using the cover and concealment provided by a dense assemblage of irregularly-spaced concrete blocks.
In this way, the rifleman’s firepower is almost completely negated. In seconds, his targets disappear behind cover and concealment. He must chase them down on foot, close with them, one by one, and each time he pauses, all the other targets recede further from him. He cannot see them. He cannot shoot them from afar.
A country that gives each person a right to that hallmark of modern warfare—firepower—must give its students the benefit of modern defensive combat tactics. It must give them the defense in depth.
Of course, another approach would be not to honor an individual right to modern firepower in the first place.
I still remember well when we retreated from Buna. It was the night of 20 January 1943. . . . There were many soldiers wounded, or too sick to retreat. Five or six of us were standing around with Captain Kondo when he said to one of the wounded, ‘We are going to leave now. But there is no one who can carry you. It would be a big problem if a soldier like you, who is still clear in his mind, should become a prisoner of war. So, you should kill yourself here.’ The wounded soldier said, ‘Yes sir. I will die here, sir.’ Kondo said, ‘I’ll give you my pistol. Please die now.’ But the soldier didn’t have enough strength to pull the trigger of the pistol. He told Kondo that. The Captain said, ‘Alright. Give it to me. I’ll shoot you.’ The soldier pleaded with Kondo to wait. Kondo said, ‘Now what! Are you scared?’ The soldier asked if he could call out to His Majesty, the Emperor. He shouted ‘Long Live the Emperor,’ then the Captain shot him in the head and killed him. It was the first and last time I saw someone calling out the Emperor’s name before he died. We all knew that it was not his real feeling, because everyone else called out for their mother. To call out ‘long live the Emperor’ was just for show.
Peter Williams, Japan’s Pacific War: Personal Accounts of the Emperor’s Warriors 62-63 (2021).
The Americans on Guadalcanal:
I was passing a line company when I heard the company commander berating a Marine for walking along the top of the ridge. Because of sniper fire it was against regulations. I knew this captain was a Reserve officer, and stopped to watch. The Marine on the skyline did not immediately come down as ordered. The captain proclaimed that he had one minute or the captain would shoot him on the spot for refusing a direct order. He looked at his watch and placed his right hand on his sidearm, a showy, chrome-plated, ivory-handled, Smith and Wesson revolver. A few yards behind, a Marine was cleaning his rifle and seemed to be paying no attention. He replaced the bolt, loaded the magazine, and put a round in the chamber. Then he cradled the rifle in his arms and gazed off into the distance. I noticed that the piece just happened to be pointed right at the captains back. The Marine on the ridge ambled down, the captain took his hand off his revolver, the rifleman took the bolt out of his rifle, and I continued on my way.
Eric M. Bergerud, Touched with Fire: The Land War in the South Pacific 437 (1997).
In both of these stories there is abuse. In the Japanese story it is from the top and in the American story it is from the bottom.
I find the American story more frightening, I think.
For there is nothing more frightening than resentment.
All the more so, here, because, fifty years later, the American historian who recounts the tale, Eric Bergerud, remarks that the officer was inadequate—because he tried to exercise authority.
I am struck by how different the American experience was, also, from another army that, like the Japanese army, was authoritarian—that of Germany in World War One. Here is Ernst Junger:
As we hurried on, I called out for directions to an NCO who was standing in a doorway. Instead of giving me an answer, he thrust his hands deeper into his pockets, and shrugged his shoulders. As I couldn’t stand on ceremony in the midst of this bombardment, I sprang over to him, held my pistol under his nose, and got my information out of him that way. It was the first time in the war that I’d come across an example of a man acting up, not out of cowardice, but obviously out of complete indifference. Although such indifference was more commonly seen in the last years of the war, its display in action remained very unusual, as battle brings men together, whereas inactivity separates them.
Ernst Junger, Storm of Steel 194-95 (1961) (M. Hoffman, trans. Penguin Books 2004).
Junger fought almost continually from 1915 to 1918.
Authority means freedom from resentment—you accept your position.
On the other hand, the Americans came out on top in both wars.
Many have drawn the conclusion from Russia’s failures in Ukraine that the United States would have been more successful—because the United States were more successful in their own most recent military adventure against a functioning state: the invasion of Iraq.
To see whether such a conclusion is sound, it is useful to consider whether the Iraqis took the same steps as the Ukrainians to defend their country—and if they did not, whether those steps would have been effective in Iraq.
If Iraq did take the same steps, or they would not have been effective, then the comparison between Ukraine and Iraq is a good one: if America beat Iraq it could probably have beaten Ukraine as well.
But if Iraq did not take those steps, and they would have been effective, then American success in Iraq may not tell us much about how America would have fared against Ukraine.
A RAND post-mortem on the Iraq War is most helpful in this regard. It suggests that Iraq, unlike Ukraine, failed to mount a basic defense of its territory—one that would have seriously hampered the American invasion—which in turn suggests that American success in Iraq tells us little about whether America would have been more successful than Russia in Ukraine.
The report points out five basic mistakes that Iraq made, which would have slowed the American advance, and which Ukraine has not made.
First, on the eve of the American invasion of Iraq in 2003, much of the Iraqi military was stationed in the north or the east of the country—the opposite of where they needed to be to counter a massive, well-publicized American buildup of troops to the south and west.
No one seems fully to understand why Iraq did this. But it is as if Ukraine had stationed all of its units on its borders with Romania, Slovakia, Hungary, and Poland prior to the Russian invasion.
Ukraine did not, of course, do that; on the eve of the invasion, its troops were stationed in the east of the country, where the Russian invasion force was massed. If Iraq had deployed its forces to the south and west, American forces would have faced a much more numerous and concentrated enemy during the Iraq War.
Second, Iraq failed systematically to prepare to blow up ports, bridges, dams and oil fields to slow the American advance.
This was not because American planes or special operations forces had prevented demolition plans from being carried out. There simply were no plans.
As RAND puts it: “Even though the Iraqi strategy was to impede the U.S. march toward Baghdad, measures that could have slowed the American advance, such as the systematic mining of roads, destruction of bridges, and flooding of choke points, were not part of the Iraqi defense scheme.”
Ukraine has not made this mistake—at least not entirely. While Ukraine failed to scuttle ships in the Port of Mariupol in advance of the Russian invasion, she did mine the port. And she did blow bridgesanddams, slowing the Russian advance on Kyiv and forcing Russia to engage in costly bridging operations in the east of the country.
If Iraq had done the same—in particular, if she had blown the Hadithah Dam, flooding the Karbala gap, which was the main bottleneck along the American line of advance—the invasion would have been slowed.
According to RAND, “[t]he gap to the west of Karbala was the only feasible route of advance as the area to the east of Karbala and around the Euphrates River crossing was a ‘nightmare of bogs and obstacles.’ . . . Had the dam been breached, the resulting flood would have made an armored movement through the gap impossible.”
The report continues: “However, there is no evidence that the Iraqis ever intended to breach the Hadithah Dam, as they had ample opportunity to do so before the Rangers seized it.”
Third, Iraq made virtually no effort to defend against the American advance on the most defender-favorable terrain in the country: its cities, which offer excellent concealment from air attack, among other advantages.
RAND reports: “According to [an American researcher], the [Iraqi] Regular Army and Republican Guard commanders his team interviewed [after the war] found the entire concept of city fighting unthinkable. [The researcher] quoted one Iraqi colonel as saying: ‘Why would anyone want to fight in a city? Troops couldn’t defend themselves in cities.’”
Indeed, almost none of the Iraqi army had trained for urban combat and its leaders hardly considered the option. And the sole Republican Guard unit stationed inside Baghdad failed to prepare any serious strong-points in the city. According to RAND:
A survey of Iraqi defenses in Baghdad found no defensive preparations, such as barricades, wall reinforcement, loophole construction to permit firing through walls, or wire entanglements, in the interiors of buildings and few, if any, obstacles, minefields, and barriers on the streets. What prepared fighting positions existed were typically outdoors and exposed. The protection surrounding such positions was often one sandbag deep. As a consequence, the militias and Special Republican Guard units often fought in the open or from easily penetrated defensive positions.
Stephen T. Hosmer, Why the Iraqi Resistance to the Coalition Invasion Was so Weak 51, 71 (2007).
Iraq did plan on using militias to defend cities using small arms. But instead of using the urban terrain to their advantage, these units engaged in suicidal frontal assaults on armored vehicles.
Ukraine has not made these mistakes. While it is difficult to judge the preparations made by Ukraine for the defense of downtown Kyiv—which seemed to be ad hoc at best—the urban defense of Mariupol appears to have been well executed. It slowed the Russian advance for three months despite heavy bombardment from both Russian strategic bombers and artillery.
A bit of arithmetic suggests that if Iraq had taken urban defense seriously as well, American casualties would have been very high and the Iraq War—which lasted six weeks—would have been greatly prolonged.
While the ratio of Iraqi to American casualties in the invasion was 40 to 1 (according to calculations based on numbers supplied by Wikipedia), virtually none of that fighting involved urban combat. The following year, however, when the United States spent another six weeks wresting control of a single small Iraqi city–Fallujah—from lightly-armed Iraqi insurgents who used the urban terrain to advantage, the ratio of Iraqi to American casualties fell nearly to parity: 4.45 to 1 (again based on casualty figures in Wikipedia). (The Iraq War, like the earlier Gulf War—which I touch upon below—was an American-led coalition affair; the numbers I report for “American” troop strength and casualties in these wars are coalition-wide numbers.)
If Iraq had concentrated its 1.3 million combatants in its cities, 292,000 American casualties—approximately the size of the entire American invasion force—would have been required to kill or wound them all. (And, if the numbers in Wikipedia are any guide, virtually all of the Iraqi combatants in Fallujah did have to be killed or wounded before the United States were able to declare victory in that battle.)
Even if we reduce the number of casualties required for victory by 75% to make liberal allowance for desertions and the application of measures not employed in Fallujah—such as the carpet bombing of Iraqi cities—America would have needed to sustain about 50,000 casualties to take Iraq via urban combat—roughly the level of casualties that Russia has sustained so far in the invasion of Ukraine (assuming 15,000 Russian dead and a 3-to-1 ratio of wounded to dead).
Moreover, the amount of time required to reduce Iraqi cities would have been great. American forces entered the Battle of Fallujah with the 3-to-1 ratio of attackers to defenders generally thought required for a successful advance. But at the beginning of the invasion of Iraq, Iraqi combatants outnumbered American combatants by more than four to one—1.3 million Iraqis under arms to about 300,000 Americans.
It would not, therefore, have been possible for American forces to reduce every Iraqi urban area at the same time. Instead, America would have had to proceed piecemeal—perhaps even city-by-city—in order to achieve favorable attacker-to-defender ratios, greatly increasing the duration of the campaign.
Fourth, apparently few in the Iraqi military could hit a target. As RAND puts it with endearing understatement: “Coalition forces were also fortunate in that Iraqi shooting accuracy was so poor. This bad marksmanship was apparent in both Iraqi regular military and militia units, and it was frequently commented on by U.S. forces.”
Many Iraqi units had no live fire training in the year before the invasion and units that did allocated four or ten bullets per soldier for target practice.
The marksmanship problem extended to elite Iraqi tankers. According to the report:
At Objective Montgomery west of Baghdad, an elite Republican Guard tank battalion fired at least 16 T-72 main gun rounds at ranges of as little as 800-1000 meters at the fully exposed flanks of the U.S. 3-7 Cavalry’s tanks and Bradley fighting vehicles—with zero hits at what amounted to point[-]blank range for weapons of this caliber. In fact, the nearest miss fell 25 meters short of the lead American troop commander’s tank. Similar results are reported from American and British combatants throughout the theater of war, and across all Iraqi weapon types employed in [the war].
Stephen T. Hosmer, Why the Iraqi Resistance to the Coalition Invasion Was so Weak 72–73 (2007) (quoting Congressional testimony).
Ukraine has not had this problem.
One of the success stories of the Ukrainian defense against Russia has been the accuracy of her soldiers’ fire, particularly artillery. This has, of course, been greatly aided by the use of drones. But for coordinates relayed by a drone to be useful, an artillery team must be able actually to hit them. The large number of Russian armored vehicles and soldiers destroyed by Ukraine further testifies to the Ukrainian military’s overall competence at aiming and shooting a variety of different weapons.
If the Iraqi army had actually been able to hit American tanks at point blank range, American losses during the invasion would have been rather higher than they were.
Fifth, the Iraqi army apparently made no attempt to attack lightly-armored American supply lines during the initial invasion itself. (That changed during the insurgency that followed.)
Indeed, Iraqi units purposely bypassed supply vehicles to mount suicidal assaults on armored vehicles instead. This inattention to supply is striking because American supply lines were stretched very thin during the invasion, as commanders chose to bypass numerous cities in their sprint to Baghdad.
As RAND puts it:
The fast-moving Coalition combat forces depended on extended supply lines through areas that had not been fully cleared of enemy forces. However, the Iraqis apparently had no plan and made little or no attempt to interdict those lines of supply by having militia and other forces attack the thin-skinned tankers and other supply vehicles supporting the U.S. advance. Instead, the militia forces were directed to attack U.S. combat elements, particularly the tanks and APCs leading the U.S. advance.
Stephen T. Hosmer, Why the Iraqi Resistance to the Coalition Invasion Was so Weak 55 (2007) (quoting Congressional testimony).
The Ukrainian military has not made this mistake. A successful Ukrainian campaign against Russian supply lines, which, like American supply lines in Iraq, were seriously stretched because Russia bypassed cities on the way to the capital, helped win Ukraine the battle for Kyiv.
Had the Iraqi military targeted American supply lines, the American invasion would have been delayed. Indeed, it is striking that Russia, like America in Iraq, gambled that she could achieve capitulation via a sprint to the capital despite the rear-area vulnerability this creates. America won her gamble. Russia lost hers.
Overall, then, Russia has faced a much different foe from the one the United States faced in Iraq.
Ukraine had forces stationed roughly where she needed them to mount a defense, denied Russia infrastructure, used urban terrain to her advantage, showed competence in the use of her weapons systems, and attacked supply lines. And several of these actions—denial of infrastructure (e.g., bridges), accurate fire, and attacks on supply—have been credited as reasons for Ukraine’s success thus far in the war.
Iraq did none of these things. Indeed, Iraq was incompetent, whereas Ukraine has proven at least minimally competent.
Had Iraq been a minimally competent opponent, the results of the Iraq War might have been very different—and the image of American invincibility might have been tarnished in the way that Russia’s military image has been greatly tarnished by Ukrainian resistance.
(Of course, America’s struggles responding to the subsequent Iraqi insurgency demonstrated the limits of of the American military as an occupying force. But my interest here is in the ability of the military to prosecute a successful invasion rather than in its ability to prosecute a successful occupation—if successful occupations are ever possible in the absence of genocide.)
Russia’s failure to achieve air superiority in Ukraine has been striking, and it does seem reasonable to assume that America would have achieved air superiority—and would have carried out vastly more devastating air assaults in Ukraine than has the Russian Air Force.
But it is not clear that air superiority would have won the war for Russia so much as shifted the battlefield from the countryside and the suburbs to Ukraine’s cities.
Indeed, the American experience in the first Gulf War (as opposed to the Iraq War), suggests that air superiority is no silver bullet against a minimally competent defender such as Ukraine even outside of cities.
The Gulf War of 1991 was a contest between thousands of tanks and armored vehicles on both sides undertaken in the deserts of Kuwait, Iraq, and Saudi Arabia. It was preceded by six weeks of continuous air attack conducted by the United States on Iraqi forces, during five of which American planes had air superiority.
Despite this, many Iraqi armored units remained near full strength when the ground invasion began, forcing American ground units to destroy thousands of Iraqi tanks and armored vehicles in combat.
According to a researcher:
The Iraqi armor force that survived the air campaign was still very large by historical standards, and many of these survivors fought back when attacked by Coalition ground forces. It is now known that about 2000 Iraqi tanks and 2100 other armored vehicles survived the air campaign and were potentially available to resist the Coalition ground attack . . . . By contrast with these . . . Iraqi armored vehicles, the entire German army in Normandy had fewer than 500 tanks in July 1944.
Moreover, simulations conducted by the American military after the Gulf War showed that if Iraqi armored units had been minimally competent—that is, had they bothered to dig trenches for their tanks instead of hiding them behind sand berms and had they posted sentries to alert them when the invasion started—they would have inflicted more casualties on American invasion forces than American forces would have been able to inflict upon them, notwithstanding the inferior range and target acquisition systems of Iraqi tanks.
As the same researcher recounts:
Western armies dig their fighting positions into the earth below grade, and hide the soil removed in excavation. The [elite Iraqi Republican] Guard, on the other hand, simply piled sand into loose berms, or mounds, on the surface of the ground around combat vehicles and infantry positions. This gave away the defenders’ locations from literally thousands of meters away, as the berms were the only distinctive feature of an otherwise flat landscape, without providing any real protection against the fire this inevitably drew. Loose piles of sand cannot stop modern high-velocity tank rounds. In fact, they barely slow them down. U.S. crews in [one battle] reported seeing 120 mm tank rounds pass through Iraqi berms, through the Iraqi armored vehicle behind the berm, and off into the distance. No U.S. tank crew would leave itself so exposed.
Iraqi covering forces systematically failed to alert their main defenses of the U.S. approach, allowing even Republican Guard units to be taken completely by surprise. Going back at least as far as World War I, all Western armies have used covering forces—whether observation posts, forward reconnaissance screens, or delaying positions—to provide warning to the main defenses that they are about to be attacked. Ideally, these covering forces serve other functions as well (such as stripping away the opponent’s recon elements, slowing the attacker’s movement, or channeling the assault), but the minimum function they must perform is to notify the main defense of an attacker’s approach. This is not difficult. A one-word radio message is enough to sound the alarm. Even less can work if commanders agree in advance that failure to check in at specified times will be taken as warning of attack. The brevity of the message makes it virtually impossible to jam; the procedural backup of interpreting silence as warning means that even a dead observer can provide an alert. Yet at [the Gulf War battle known as] 73 Easting, for example, the Iraqi main position received no warning of the [American tanks’] approach. A few observation posts were deployed well forward of the main defenses, but these were evidently destroyed without sending any messages, and without the local commander interpreting silence as evidence of attack.
If, as those simulations showed, a minimally competent Iraqi army not making such basic mistakes and fielding mid-twentieth-century-vintage Soviet armor could have made the Gulf War a costly affair for the United States military, notwithstanding American air superiority over a desert terrain affording nowhere to hide, then a minimally competent Ukrainian military operating in Ukraine’s rather more defender-friendly terrain of farms and forests would likely be able to inflict substantial losses on an American invasion force having air supremacy.
And that’s before the fight would even make it to the cities.
The fact is that, against a minimally competent foe, even one with somewhat inferior technology and no air defenses, attacking is hard.
One gets a hint of this when one considers that the great advances of World War Two were, for the most part, executed only with the aid of staggering amounts of men.
To dislodge the 100,000 German soldiers holding the Seelow Heights on the route to Berlin, for example, the Soviets flung a million men at them and took thousands of casualties.
By contrast, both the American invasion force in the Iraq War and the Russian invasion force in Ukraine were smaller in size than the forces mustered by the defenders (300,000 against 1.3 million in Iraq and 225,000 against 300,000 in Ukraine according to Wikipedia).
One should expect, then, difficulties for the invader, regardless how competent the invader may be—or how advanced its weaponry. America was fortunate enough to dodge these difficulties by picking a foe that was not minimally competent.
The lesson of Iraq was not American invincibility but rather that the most important choice to make in planning a military adventure is whom to fight.
The difference between American success and Russian failure in these conflicts may be due to no more than that the United States chose wisely—and Russia poorly.
In what was, I think, the only math course I took in college, the professor said: “when you are trying to solve a problem, look for the asymmetries and ask: why? Asymmetries happen for a reason, and if there is no reason, then the asymmetry shouldn’t be there.”
It is a staple of tax theory that the income tax touches both labor and investment income whereas the consumption tax touches only labor income.
Why this asymmetry?
The Conventional Account
The standard explanation sheds no light on the question. It goes like this.
Suppose that you work for a period l at wage w, invest the resulting income of wl at interest rate r, and then spend the proceeds.
Under an income tax of rate t, you will pay twl in tax on your labor income, leaving you with wl-wlt=wl(1-t) remaining to invest. Your investment will grow to wl(1-t)+wl(1-t)r=wl(1-t)(1+r), but the interest earned on the investment, wl(1-t)r, counts as income as well, so it, too, will be taxed at rate t. You will therefore pay twl(1-t)r in additional tax, leaving you with wl(1-t)(1+r)-twl(1-t)r=
to spend after all taxes have been paid.
By contrast, under a consumption tax, you will be able to invest all of your labor earnings, wl, to obtain wl(1+r) after your investment pays out. Assuming that the income and consumption tax rates are the same, you will then pay tax twl(1+r) when you go to spend your income on consumption items, leaving you with a total of wl(1+r)(1-t)=
The expressions for the income tax and the consumption tax both have a tax term, 1-t, applied directly to labor income, wl, suggesting that they both tax labor income in the same way. But the expression for the income tax also applies the same 1-t term to the rate of return on investment, r, which the expression for the consumption tax does not. This suggests that the income tax taxes investment returns whereas the consumption tax taxes only labor income.
Indeed, if we construct an expression for an income tax that applies to labor income but not to investment income, we end up with our expression for a consumption tax.
We start with labor income wl and then apply a tax of twl, as we did in analyzing the original income tax, to obtain wl(1-t). This amount is again invested to obtain wl(1-t)(1+r). But now we are done—we do not apply a tax on investment returns. The result,
is identical to the expression that we obtained for the consumption tax.
We must, then, conclude that a tax on consumption taxes only labor income whereas the income tax taxes both labor income and investment income. (The table at the end summarizes after-tax value under this and a number of other scenarios that I will discuss.)
Why this asymmetry?
It is not intuitive.
A consumption tax is a tax on money going out, whereas an income tax is a tax on money going in. If everything that comes in must eventually go out, should not the income tax and the consumption tax be identical?
If the money the worker spends on consumption was generated in part through financial investments, shouldn’t a tax on everything he spends (i.e., on consumption) end up taxing the return on investment as well as labor income?
If there is no good reason for an asymmetry, then it should not be there.
If it should be there, then we have not really understood tax policy until we have understood why the asymmetry is there.
It turns out that the conventional account of the difference between consumption and income taxation both ignores a broader symmetry between the two approaches and is equally mum regarding a good reason for the asymmetry.
A Latent Symmetry
Let’s start with the broader symmetry that the conventional account omits.
Our method will be to try to find—or construct—symmetry between the income and consumption taxes. If we can figure out what we need to make the treatments symmetrical, we can then ask whether the absence of the things that are needed for symmetry is justified.
Comparing Workers with Rentiers
The first thing to realize is that the conventional account jumbles the tax treatment of labor income together with that of investment income. It tells the story of a laborer who starts with labor income and then invests it, suggesting that all income originates in labor. It starts with wl.
But not all of us are so unfortunate.
Some people don’t work—don’t have to work—because they get all of their income from financial investments.
The money they invest is so great that the return it throws off is large enough to make them prefer not to work for labor income.
There’s an old word for such people: rentiers. As Piketty has shown, they are making a comeback.
To avoid any quirks in tax treatment created by jumbling the experience of the rentier together with that of the worker, let’s consider the worker who gets all of his income from labor and the rentier who gets all of his income from investments—rather than consider a worker who plays rentier with his labor income, as in the conventional account.
Let’s look first at the rentier and the income tax.
The rentier has some financial endowment—call it p for property—which he grows to p(1+r)=p+pr through investment. At this point, the income tax is applied to his interest income, pr, and he is taxed the amount tpr. This leaves him with p+rp-tpr=
We see that the effect of the application of the income tax to investment returns reduces the after-tax growth rate of the investment from r to r(1-t).
Now let us consider the experience of the workers under the income tax when he does not invest his earnings in financial assets.
In that case, the worker earns wl, pays tax on it, and does not invest, ending with
The income tax treatment of the worker clearly differs from that of the rentier. We should be surprised that they do.
The income tax taxes both labor income and investment income at the same rate t, and here we have a rentier who has generated only investment income and a laborer who has generated only labor income. Shouldn’t the two be taxed in the same way?
The answer holds the key to our problem.
We can find it by continuing to try to construct symmetry between the treatment of the rentier and the worker.
One way to do that would be by eliminating the 1 term in the parentheses in our expression for the rentier’s after-tax income. That would give us pr(1-t), which is analogous to the expression for the worker’s after-tax income, lw(1-t).
But doing that would not make any sense. Eliminating the 1 is equivalent to making the claim that when you invest an amount p you obtain interest on your investment, pr (which is then taxed to obtain pr(1-t)), but not the return of the amount you invested, p.
But that’s not how finance works. When you invest an amount, you don’t lose your capital and gain only the interest paid on it. Instead, you get your capital back, plus interest.
We can also create symmetry by adding a 1 to the expression for the worker’s after-tax income, to obtain
Here is where things get interesting.
Labor as Capital
Adding that 1 in makes the claim that labor income, wl, is equivalent to the interest paid on an investment of working hours l. The worker invests l by working, and that investment grows into l(1+w)=l+wl, the worker’s l hours of work plus labor income wl.
But the “labor capital” that the worker has invested, l, is not taxed, only the return on that capital, wl, is taxed, just as, in the case of financial assets, the capital, p, is not taxed, and only the return on capital, pr, is taxed. As a result, the worker pays twl on value of l + wl, and ends up with l+wl-twl=l(1+w(1-t)), our symmetrized expression for labor income.
That is, with this change, the wage, w, becomes the analogue of the interest rate, r—it becomes the rate at which labor is compensated, just as r is the rate at which investment is compensated. And the number of hours worked, l, becomes the analogue of the dollar amount invested, p—it becomes the amount of labor with which the worker is endowed, just as p is the amount of investment capital with which the rentier is endowed.
But what does it mean to say that a worker invests l hours of labor and receives those l hours plus a return equal to labor income in exchange?
Of course, if one works l hours, one never gets those hours back again. Perhaps one receives the satisfaction of having worked l hours of honest labor alongside one’s income on that labor.
Or the l hours represent one’s ability to work over a given period of time, and, as this ability does not diminish from one period to the next, at the end of each period one starts over afresh with the same amount of hours on hand to invest in labor.
We do not need to resolve this question, however, because, for purposes of comparing consumption and income taxation, the nature of a labor hour matters only to the extent that this affect’s the hour’s exchange value. But labor hours have no exchange value.
Labor hours cannot be transferred.
One’s labor time is personal to oneself.
Only I can can expend my hours on work because only I have those hours.
You can pay me for my work—that’s the return that you pay me on my investment of my time in laboring for you—but you yourself cannot work my hours. If I could transfer my hours to you, then you could work 24 or 48 or 72 hours in a single day, for you could work my hours and your own ours and the hours of others.
But that, of course, is impossible.
I am a capital asset that only I can use.
Because labor hours cannot be transferred, they have no price. They cannot be exchanged for cash, cannot be spent on consumption goods or services, and cannot be taxed.
When we speak of financial investment, we speak of p(1+r) and when we speak of labor, we ought to speak, analogously, of l(1+w).
That is, we should think of labor hours in the same way as we think of financial assets, and we should therefore think about the taxation of labor income in the same way as we think about the taxation of investment income.
When we tax investment income, we don’t tax the financial asset that is invested—we don’t tax “savings”—but only the interest on that asset—the return on investment.
Just so, when we tax labor income, we don’t tax the labor asset that is invested—those labor hours—(how can we?) but only the interest on that asset, which is the interest rate—here called the wage—applied to the asset in the form of hours worked. That interest on the labor asset is otherwise known as labor income.
Thus the rentier’s after-tax investment value is p(1+r(1-t)) and the worker’s after-tax investment value is, similarly, l(1+w(1-t)).
But in the case of the worker we don’t write down l(1+w(1-t)) and instead write down wl(1-t) because the fact that l is not transferable, has no cash value, can’t be spent on consumption, and can’t be taxed causes us to forget that it is there.
Financial capital is a transferable thing—it’s dollars and cents, or things that can be exchanged for them—-and we can and do tax it and consume it. The existence of p is therefore constantly before our mind’s eye and we do not omit to write p(1+r(1-t)) rather than, analogously to the worker’s case, pr(1-t).
But what does this hidden symmetry between the income tax as applied to the rentier and the income tax as applied to the worker tell us about the asymmetry that we set ought to conquer, which is the asymmetry in the consumption tax treatment of labor and (financial) investment?
That answer is: a lot.
It shows why the asymmetry exists.
Eliminating the Asymmetry by Treating Labor as Capital
For if we acknowledge that labor income is the return on an investment of labor time, and if it were possible to transfer one’s endowment of labor hours, l, so that it could be taxed or consumed, just one’s endowment of financial assets, p, can be taxed or consumed, then the consumption tax would no longer be equivalent to a tax on labor income; it would differ both from a tax on labor income and from a tax on investment income and would differ from both in the same way.
Thus the asymmetry between the consumption tax treatment of labor and investment income would be eliminated.
If we acknowledge that labor income is the return on labor hours, and if one’s labor endowment were transferable—and so taxable and consumable—then a worker who generates labor income but does not invest in financial assets would generate value equal to l(1+w) from working and then pay tax tl(1+w) on this value, leaving the worker with consumption equal to
But, as we have already seen, under the income tax, the worker’s after-tax value would be l(1+w(1-t))—it would differ from value under a consumption tax in that the factor 1-t would be applied to the wage instead of to the entire investment.
And precisely the same would be true of the income and consumption taxes with respect to financial investments.
We have already seen that under an income tax the rentier’s after-tax value would be p(1+r(1-t)). Under a consumption tax, the rentier would invest p, obtain p(1+r), and then pay the consumption tax on that amount, leaving p(1+r)(1-t). Thus, here again, the difference would lie in the application of the factor 1-t to the interest rate (the analogue of the worker’s wage) in the case of an income tax. The table at the end summarizes these results.
It follows that, as a general matter, we cannot say that the consumption tax taxes labor income but not financial income.
The conventional account is not generally true.
The consumption tax is neither a tax on labor income nor a tax on financial income.
Rather, in principle, it is a tax on wealth—it taxes both the return on capital and the capital itself, whether that capital is labor capital or financial capital.
Because all wealth—the capital and the return on capital—must, ultimately, be consumed.
We also see from this analysis that the income tax and the consumption tax are not the same, whether applied to labor income or financial income. The income tax taxes the return on capital whereas the consumption tax taxes both capital and its return.
The answer to the question how a tax on what goes in can differ from a tax on what goes out is that what goes in is not just income but rather wealth—capital plus returns thereon—and so an income tax will not fully cover it. Thus the tax on what goes out—the consumption tax—which does cover everything that goes out, will differ from the income tax.
The Untransferability of Labor Hours as the Source of the Asymmetry
So much for the general structural symmetry of the income and consumption taxes. We must now ask why the conventional account finds asymmetry.
Is the conventional account simply mistaken, or is there a reason why, in practice, we must depart from the general structure?
It turns out that we have already encountered the answer. There is a good reason why, in practice, there is asymmetry. That reason is the untransferability of labor hours.
We cannot, in fact, say that under a consumption tax the after-tax value enjoyed by a worker is l(1+w)(1-t), because that equals l(1-t)+w(1-t), implying that the tax authority taxes tl labor hours, and the worker consumes l(1-t) labor hours.
But that’s impossible, because those hours can’t be transferred, either to the government or anyone else.
Unlike the rentier, who, at the end of the day, spends both his investment capital and his returns on consumption, the worker cannot spend his labor hours on consumption because he cannot trade them. He generates cash for consumption only through the returns he generates on his labor, which are paid to him in dollars or other tradable commodities.
His value after application of the consumption tax is, therefore, his labor income—his return on his labor hours—wl, less a tax twl on those returns, or wl(1-t), plus his labor capital, l, which he still holds, even if he cannot trade or consume it. So it is l+wl(1-t)=l(1+w(1-t)).
But that makes the consumption tax identical to the income tax—the same identity found by the conventional account. For we have already seen that under the income tax, he is left with l(1+w(1-t)), and as the income tax touches only labor income, wl, the fact that he cannot transfer his labor hours does not change the analysis.
Financial assets are consumable, however, and so the nonconsumability of labor hours counsels no change to our expression for the rentier’s value after application of the consumption tax. It remains p(1+r)(1-t) and so remains different from the expression for the rentier’s value after application of the income tax, p(1+r(1-t)).
So far from failing to tax financial capital, the consumption tax in fact does tax it—p(1+r)(1-t)=p(1-t)+rp(1-t), so financial capital, p, is reduced by 1-t—and it is the fact that the consumption tax taxes financial capital, while not taxing labor capital, that accounts for the difference in the way the consumption tax treats the two forms of endeavor.
Thus the nontransferability of labor introduces the asymmetry between the treatment of labor and investment income by the consumption tax that we see in the conventional account—and this is evident even without telling the story about the reinvestment of labor income in financial assets through which the conventional account makes this point.
The conventional account does not, of course, say that the worker’s after-tax value is l(1+w(1-t)), but rather that it is wl(1-t)(1+r). That is because the conventional account doesn’t recognize that labor hours are labor capital—or doesn’t care whether they are, because they are nontransferrable—and so doesn’t bother to write down the 1 in l(1+w) when it writes down the worker’s starting income. The conventional account omits the 1 and writes down wl instead. According to the conventional account, the worker’s wealth is exclusively his return on labor capital.
And, as already noted, the conventional account goes on to imagine the worker playing rentier and investing his labor income in financial assets. Thus, in the case of the consumption tax, the worker’s income is invested in financial assets and grown to wl(1+r) before being taxed down to wl(1+r)(1-t). So, in the conventional account, wl is in effect substituted for p in our expression for the rentier’s after-tax value of p(1+r)(1-t).
Similarly, in the income tax context, we have labor income of wl that is taxed down to wl(1-t) and then ploughed into financial investments. So wl(1-t) is substituted for p in our expression for the rentier’s after-tax income, p(1+r(1-t)), to obtain wl(1-t)(1+r(1-t)), the familiar result of the conventional account in the case of an income tax.
We can now restate what we have learned in terms of the conventional account.
The fact that after-tax value under a consumption tax in the conventional story has the same form, wl(1+r)(1-t), as a tax on labor income (that is then invested tax free), wl(1-t)(1+r), is not due to any failure on the part of a consumption tax to tax investment returns. After all, wl(1+r)(1-t)=wl(1-t)+wlr(1-t), so investment returns wlr are taxed down to wlr(1-t).
Rather, it is due to the fact that labor time, l, is not taxed under a consumption tax. If it were, then, adding 1+r terms (to reflect financial investment) to the expressions we generated for the worker above, we would find that the after-tax value expression under a consumption tax would be l(1+w)(1+r)(1-t), whereas the expression for a tax on labor income that is then invested tax free would be l(1+w(1-t))(1+r), which is a different quantity. It is only by deleting the first 1 to be found in each expression that they collapse into each other. (Equivalently, we could render labor hours untaxable—pulling the first 1 in the case of the consumption tax out of the parentheses—as we did above, and achieve the same result.)
Taxing Capital Would Restore Symmetry
Let us return to our simpler comparison of the tax treatment of worker and rentier in which the worker does not plow his earnings into financial assets.
Our understanding of the source of the asymmetry in consumption and income taxation helps us see how to eliminate it.
We have seen that the key to the asymmetry is that the consumption tax taxes capital and the income tax does not, but labor capital is untaxable, so the consumption tax and the income tax collapse into each other in the case of labor income—but not in the case of financial income.
The way to make the income tax equivalent to the consumption tax is, therefore, to redefine the income tax to apply to financial capital.
Make the income tax a wealth tax.
That would make the consumption tax as applied to investment income the same as the income tax, and the consumption tax and the income tax would, then, be equivalent both when applied to labor income and when applied to investment income.
Because no amount of redefinition of tax rules can make labor hours transferable, such a wealth tax would not apply to labor capital, and so the income tax as applied to labor income and the consumption tax would continue to be identical for practical purposes.
But now the income tax as applied to financial investments would be identical to the consumption tax, for now the rentier would pay tax both on p and his return rp, and so he would have his investment outcome, p(1+r) less tax tp(1+r), or p(1+r)(1-t), and the consumption tax on the rentier’s investment outcome would be the same as the income tax that he pays—tp(1+r)—leaving the rentier with the same after-tax value of p(1+r)(1-t).
This situation is slightly more complicated when we translate this insight back into the conventional account, because in the conventional account the worker is also the financial investor.
The conventional account’s expression for the income tax applied both to labor and financial income, wl(1-t)(1+r(1-t)), differs from that for the consumption tax, wl(1+r)(1-t), in two ways.
One is that the second 1-t term is applied directly to r rather than to the entire expression. The fix of taxing financial capital solves this problem. The worker’s financial capital—wl(1-t)—would, then, be taxed alongside the return on that capital, rwl(1-t), and so we would have after-tax value of wl(1-t)(1+r)(1-t), bringing the expression closer to that for the consumption tax.
But that still leaves the first 1-t term as an extraneous term. That term is present because the worker uses his labor income for purposes of financial investment and his labor income is taxed when it is earned. In effect, the worker who invests would be taxed twice under a wealth tax. Once when he generates labor income and again when he converts that labor income to financial capital and invests it.
This is the sort of problem we were able to ignore in comparing the experience of the worker with that of a separate rentier.
The income and consumption taxes can be brought into equivalence by recognizing a deduction for labor income that is invested in financial markets, in which case the worker will invest wl instead of wl(1-t), and the worker’s after-tax income will therefore become wl(1+r)(1-t)—identical to that for the consumption tax.
Labor income that is earmarked for investment is properly treated as investment capital, and so it should be taxed after it is invested, not when it is first acquired. If we tax labor income that is earmarked for investment, then we should tax all financial assets at the time that they are acquired—that is, before they are invested—and then again when the investment pays out.
The proposed fix to the asymmetry in consumption taxation—taxing financial capital and deducting labor earnings that are invested in financial markets—has a name: it is called a “cash-flow consumption tax.” The fact that it is called a consumption tax and not a wealth tax, even though it is collected when cash flows in rather than when it flows out, is an acknowledgement that this sort of tax on inflows is equivalent to a tax on outflows.
The Radicalism of the Consumption Tax
Defenders of the income tax (as presently defined) like it because it taxes more. Under the conventional account, after-tax income under the income tax is wl(1-t)(1+r(1-t)), which is less than after-tax value wl(1+r)(1-t) under a consumption tax because an additional 1-t term is applied to the interest rate, r, under the income tax.
But after-tax income is lower under the income tax only because, under the conventional account, labor income is taxed once before it is invested, and that happens only because the conventional account assumes that a financial investor’s source of income is labor.
For the rentier, the situation is reversed. We have already seen that the rentier subject to an income tax ends up with p(1+r(1-t)) in after-tax income whereas the rentier subject to a consumption tax ends up with p(1+r)(1-t). In the latter expression, the 1-t is outside of the parentheses—reducing the entire magnitude contained in the parentheses—and so after-tax income is lower than in the case of the income tax. That is because the rentier pays tax on his financial capital, not just his returns.
Because the consumption tax is a wealth tax; it is more radical than the income tax.
The truly rich, who do not work but live off of their financial assets, do worse under a consumption tax than under an income tax.
It is only the worker, who scrapes together savings to invest in financial markets, who ends up being taxed more heavily under the income tax than under the consumption tax.
That same math teacher who taught me to question asymmetries also liked to call out students who weren’t paying attention in class. “Are you an angry young man?”, he would ask.
I’m not.
But I would like to tax the rentier’s capital.
Scenario
Income Tax
Consumption Tax
Worker income invested (conventional account)
wl(1-t)(1+r(1-t))
wl(1+r)(1-t)
Worker value (transferable labor)
l(1+w(1-t))
l(1+w)(1-t)
Rentier value (transferable labor)
p(1+r(1-t))
p(1+r)(1-t)
Worker value (untransferable labor)
l(1+w(1-t))
l(1+w(1-t))
Rentier value (untransferable labor)
p(1+r(1-t))
p(1+r)(1-t)
Worker value (labor capital ignored)
wl(1-t)
wl(1-t)
Rentier value (labor capital ignored)
p(1+r(1-t))
p(1+r)(1-t)
Worker income invested (conventional account with cash-flow consumption tax instead of income tax)
It is common in the study of corporate governance to worry about the conflict of interest between shareholders and managers. Managers are supposed to run the firm to maximize shareholder value, but because they run the firm on a day-to-day basis, not the shareholders, they have plenty of opportunity to enrich themselves are shareholder expense. Others worry that the power of shareholders and managers over firm governance enables them to cheat creditors, workers, and sometimes even suppliers.
But there is another interest that no one ever talks about, and which is even less able to defend itself than are shareholders against managers, or creditors, workers, or suppliers against shareholders and managers.
That is the firm itself.
The firm is not its shareholders. It is not its managers. It is not its workers, creditors, or suppliers.
It is a fiction in the sense that a firm always is a fiction, a thing that exists only because shareholders, managers, workers, creditors, suppliers, and the government act like it exists. It has no flesh and no blood. It cannot be found anywhere; or, rather, it is located wherever the law says that it is located rather than where the laws of physics place it.
But it has a name: the name of the business.
It can open bank accounts.
It can own property.
It can sue.
It even has a right not to be deprived of life, liberty, or property without due process of law.
The firm exists in the way that the mime’s wall exists. There is nothing there, but his hand stops as if it were there.
Just so, the corporation exists because we speak as if it exists. Because we find all of our legal institutions bending around its form as if there were something there to bend them.
And yet, despite all the care that we take to act as if there really were an independent, living, breathing thing that is the firm, when it comes time to count up conflicts of interest, we never talk about the conflict between the interests of shareholders, managers, workers, creditors, and suppliers—and the firm itself.
We recognize that there must be such a conflict, and we even have an entire body of law—agency law—devoted to protecting the firm itself against managers and employees who put their interests before the firm’s. We say that managers and employees have duties of loyalty and care to the firm.
And yet we seem hardly able to take such duties seriously, or, at any rate, fully to appreciate that they are owed to the firm—to the mystery, to the fiction, to the hollowness beneath the mime’s hand.
We say that the board of directors owes a duty to the firm, but we think that the duty is really owed to the firm’s shareholders, or to its workers, or to whatever set of actual, living, breathing persons are ultimately harmed by the cupidity of the firm’s agents.
We comply with the fiction that managers and employees owe their duties to the firm by describing the shareholders who sue careless or disloyal managers as filing a “derivative” lawsuit on behalf of the firm. The shareholders have no direct claim against the wrongdoers, we say, because the wrong was done to the firm and not directly to the shareholders.
And we comply further by asking that any recovery be paid first to the firm as compensation for harm to the firm and only thence to shareholders.
But we experience this part of the fiction of the corporate person as unnecessary. Nothing would be lost were shareholders to be permitted to sue managers directly.
We are wrong to do that.
If we were actually to take conflicts with the firm seriously, we would come to a very troubling thought indeed: that the mute, defenseless fiction that is the firm is surely the worst victim of self-interested behavior of all.
Conflicts run deepest not between shareholders and managers, or even between managers and workers, but between all of these groups and the firm, because of all of these groups only the firm lacks a physical presence and hence even the slightest semblance of autonomy. The firm exists entirely in the unseen world behind the world, and speaks only through the very groups—the shareholders, managers, workers, and so on—from which the firm needs protection.
And the firm does need protection because the firm’s interests are necessarily always in conflict with those of shareholders, managers, workers, and all the other counterparties of the firm.
Because the firm never dies. It alone is in business for the long term and the long term interest is almost always in conflict with the short term interests of mere mortals.
Imagine that a firm generates a billion dollars in net income and that maximizing the long-term—as in over the course of the next two centuries—profits of the firm can be achieved only by investing that billion in clean energy technology.
It is easy to imagine that no flesh and blood humans associated with the firm might be interested in actually investing the money. The shareholders might want it paid out as dividends (they want to party). The managers might want it paid out in executive compensation (they want to party). The workers might want it paid out in retirement benefits (they want to party). The creditors want their debts paid. The suppliers want higher contract prices.
The the profit-maximizing firm—yes, the firm, that metaphysical life force, that abstract interest—would want the money invested and, if all the assumptions of general equilibrium theory hold, the fact that the profit-maximizing firm would want the money invested implies that investing it is necessary for the efficient operation of the economy. It is required to maximize economic growth and otherwise to launch society forward to the greatest extent possible.
But the firm with not invest the money. Because the flesh and blood humans who control what the firm does, who are agents to the firm’s fiction, mimes to its hollowness, don’t want that to happen. The door might want to be opened, but the mime will shut it.
The money will be spent instead on shareholders, managers, workers, creditors or suppliers, and both the firm and the economy will be smaller for it in the long run.
What’s more—and this is important—legal duties will have been breached by this failure to invest. Management will have violated the duty of care, which requires managers to operate the firm with a view to maximizing the firm’s long-term profits.[1]
But no one will sue.
Shareholders will not bring a derivative suit on behalf of the corporation—they wanted to be paid.
Competition will not force the firm’s agents to behave—lest competitors take the firm’s market share and put the agents out of their jobs—because the consequences of a failure to invest for the long term manifest in the long term.
One can only imagine how much bigger the economy would be, and how much more successful the firms in it, if the conflict of interest between the firm itself and its agents were not to exist. Or if there were some way of protecting firms against it.
Imagine all the investments that have not been made throughout history because those in control of firms preferred consumption to saving.
One gets the barest hint of how bad the problem must be in the hysterical objection of business elites to mid-20th-century price regulation in industries such as telecommunications, air transport, and energy distribution. Or the hysterical objection of business elites today to attempts to limit the scope of patent grants in order to prevent windfall gains from intellectual property.
The government, businessmen argue, systematically sets prices—or, in the intellectual property context, rewards—too low, because it fails to take into account all of the investment that must be made in the future of a business.
Firms must invest in research and development.
They must insure against risk.
And so, businessmen argue, what looks like profit really is not profit, but rather a cost of long-term survival and flourishing of the firm.
Ah, but if that is the case, if we cannot trust rate regulators adequately to determine how much must be spent for a firm to flourish, why should we be able to trust shareholders or managers to do that either?
It is not, after all, in their interest to carry out that analysis faithfully, for they can never have an outlook quite as long as the firm’s.
If we think that rate regulation was bad for American business in the mid-20th century, or that stinginess with the patent grant is a big problem for the dynamism of the American economy, we must—must, must—wonder just how bad the totally unaccountable dominance of flesh and blood over fiction, of the agents over their dumb master, must be for American business.
How much less is invested than optimally should be?
This, it seems to me, explains much—not just about a structural inefficiency in the economy but also about the structural maldistribution of wealth.
Why is it that the captains of industry are so rich? Is it just that they control scarce resources? Or that they have some monopoly power? Those are, to be sure, causes.
But I wonder whether the most important is not, quite simply, that they underinvest—and keep the difference for themselves.
When I was in high school, I ran an assassin game with a classmate. I ordered some very cheap waterguns direct from China. We asked every student to pay $30 to participate in the game. We gave each student a cheap water gun and the winner $200 as reward.
There were perhaps thirty participants, which made the game very profitable.
I was so embarrassed about this windfall that I let my surprised coventurer keep all of the profits, which he used to take a trip to Europe.
I was afraid to profit and he rejoiced in it. But the point is that both of us thought of the windfall as profit.
But was it? Neither he nor I thought for minute about the interests of the business.
Perhaps the best thing for our assassin business would have been for us to invest that money in the following year’s game. We could have increased the reward, attracting more participants. We could have ordered better guns. We could have organized a joint game with another school. Whatever.
But while these were the interests of the business, they were not our interests. The business was mute; and so we ignored it.
One sees this also, I think, in how homeowners treat their houses. It is very often the case that a person will buy a house that he would not be willing to rent because the rent would be too high.
Perhaps the house is very large, or there is a shortage of rental units in the area. Whatever the case, when a person owns and lives in a house that he would not be willing to pay to rent, he is putting his own interests as a customer and indeed shareholder (i.e., owner) of the space-selling business that is his home before the interests of the business itself.
His home could generate greater profits by being rented out and indeed those profits could be invested to improve the home or expand the business to include other properties, making the business and the economy better off.
But none of this happens because the flesh and blood person who controls the business would rather forego (read: consume) the profits that could otherwise be generated by renting to others—and which would lead to long-run profits—in order to enjoy the pleasure of living in a big house, or in the right neighborhood, or what have you, right now.
Once you understand the problem, you see it everywhere.
The owner of my car repair shop was kind enough to give me a lift in his personal, very expensive vehicle while I was getting my oil changed. What portion of the purchase price of that car should he have reinvested in his business? We will never know.
Indeed, one wonders what proportion of all the executive compensation, all the share buybacks, and all the dividends paid out to owners over the past few decades—payouts that turned an L-shaped postwar inequality curve into the U-shape of Piketty fame—should optimally have been reinvested in the firms themselves.
That is, one wonders whether, if the fiction that is the firm were real and could defend itself, captains of industry would be no richer than the rest of us, and the economy a whole lot larger.
One might think that the solution is for the state to step in to protect business fictions against their flesh and blood agents.
And perhaps that is right. We need regulation not just to protect consumers against grasping firms, or shareholders against grasping managers, but to protect firms—those helpless fictions—and indeed the economy entire, against all of the grasping human agents that constitute the sum total of a firm’s human capital.
But it might just as easily be right to say that unregulated firms produce more even after taking into account how much less they produce than they might thanks to the cupidity of their agents and the helplessness of the firm.
Regardless, we must see firms as almost always victims of their human controllers. And the wealth of those controllers as almost always funded in part not just by rents—revenues in excess of costs—but by theft in the form of underinvestment in their businesses.
It might well be that, in an optimally efficient world, every businessman would eat one meal a day and darn his own socks, for that is the real minimum that a businessman would accept in exchange for doing business.
And the profits that remain are best reinvested by firms in their own futures.
Notes
[1] Yes, the duty of care is subject to the business judgment rule, which means that courts defer to the judgment of managers regarding what actions will maximize profits, and so, in practice, even were shareholders to sue, it would be very difficult for them to win such a case. But the business judgment rule is meant only to give managers the benefit of the doubt. It does not make legal actions that are known in advance to fail to maximize profits. Indeed, in a world in which there were never any doubt regarding what course of action would maximize profits, the business judgment rule would count for nothing and a manager’s failure to take the known profit-maximizing course of action would give rise to immediate liability.
