History of The English Fiscal System - Income Tax

Income Tax

The revolutionary and Napoleonic wars mark an important stage in English finance. The national resources were strained to the utmost, and the whip and spur of taxation was used on all classes. In the earlier years of struggle, the expedient of borrowing enabled the government to avoid the more oppressive forms of charge but, as time passed, every possible expedient was brought into play. The class of taxes organized during peacetime had been those on houses, carriages, servants, horses, plate, etc., these being raised by successive steps of 10% each until, in 1798, their total charge was increased threefold – four or fivefold for the rich – under the plan of a triple assessment.

The comparative failure of this scheme (which did not produce the estimated yield of £4.5 million) prepared the way for the most important development of all – the introduction of income tax in 1798. Though a development of the triple assessment, income tax was also connected with the permanent settlement of land tax as a redeemable charge. Indeed, it is possible to trace the progress of direct taxation from the scutage of Norman times through to the tenth and fifteenth, the Tudor subsidies, the Commonwealth monthly assessments and the 18th century land tax, to the income tax as applied by Pitt which, after an interval of disuse, was revived by Peel in 1842. However, its immediate yield was rather less than was expected – £6 million out of £7.5 million. Nevertheless, by altering the mode of assessment from that of a general declaration to returns under several schedules, the tax became, at first 5%, and afterwards at 10%, the most valuable part of the revenue. In 1815 it contributed 22% of total receipts – i.e. £14,600 million out of £67 million – and, had it been employed at the beginning of the war, it would almost certainly have obviated much of the government's financial difficulties.

The window tax, which continued throughout the 18th century, had been supplemented during the American War by a tax on inhabited houses (one of Adam Smith's suggestions). Again, probate duty had been gradually raised during the 18th century, the legacy duty being introduced in 1780, which was moderate and did not affect land. Though direct and quasi-direct taxes had been dramatically increased, their growth was eclipsed by that of excise and customs. With each succeeding year of war, further articles attracted duty whilst tax rates were raised.

The maxim, said to have guided financiers in other countries, to the effect that wherever you see an object, tax it, fairly expressed the guiding policy of the early 19th century. Eatables, liquors, the materials of industry, manufactures, and commercial transactions had in to pay toll in almost all their forms. For example, salt attracted 15s. per bushel, sugar 30s. per cwt., beer 10s. per barrel (with 4s. 5d. per bushel on malt plus a hop duty), tea 96% ad valorem. Timber, cotton, raw silk, hemp and bar iron were also taxed as were leather, soap, glass, candles, paper and starch.

Despite the need for revenue, many customs duties were framed on protection thereby producing relatively small returns. For example, import duty on salt in 1815 produced £547, as against £1,616,124 from excise; pill-boxes brought in 18s. 10d., saltpetre 2d., with 1d. for the war duties. The course of war taxation was marked by varied experiments. Duties were raised, lowered and raised again, or given some new form in an effort to raise more revenue. Some duties, i.e. that on gloves, were abandoned as unproductive but the conclusion is irresistible in that the financial system generally suffered from over-complication and absence of principle. In the period of his peace administration, Pitt was prepared to follow the teaching of The Wealth of Nations. However, the strain of war forced him and his successors to employ whatever heads of taxation were likely to bring in funds without violating popular prejudices. Along with taxation, debt increased. For the first ten years additions averaged £27,000,000 per annum, bringing the total to over £500,000,000.

By the close of the war in 1815, the total reached over £875 million, somewhat smaller annual increases resulting from the adoption of more effective taxes, particularly income tax. Increasing trade levels also helped and the import of articles such as tea advanced in proportion with the growing population. Thus, tea duty of 96% yielded no less than £3,591,000 in 1815. It is, however, true that by that time, the tax system had reached its limit. Further extension (except by direct property confiscation) was hardly possible so that the war closed victoriously at the moment when prolongation seemed unendurable.

A particular aspect of the English financial system is its relation to the organization of the finance of territories connected with the English crown. The Exchequer may be plausibly held to have been derived from Normandy, and wherever territory came under English rule the methods familiar at home seem to have been adopted. With the loss of the French possessions the older cases of the kind disappeared. Ireland, however, had its own exchequer, and Scotland remained a distinct kingdom. The 18th century introduced a remarkable change. One of the aims of the union with Scotland was to secure freedom of commerce throughout Great Britain, and the two revenue systems were amalgamated. Scotland was assigned a very moderate share of the land tax (under one-fortieth), and was exempted from certain stamp duties. The attempt to apply selected forms of taxation custom duties (1764), stamp duties (1765), and finally the effort to collect the tea duty (1773) to the American colonies are indications of a movement towards what would now be called imperialist finance.

The complete plan of federation for the British empire, outlined by Adam Smith, is avowedly actuated by financial considerations. Notwithstanding the failure of this movement in the case of the colonies, the close of the century saw it successful in respect to Ireland, though separate financial departments were retained till after the close of the Napoleonic War and some fiscal differences still remain. By the consolidation of the English and Irish exchequers and the passage from war to peace, the years between 1815 and 1820 may be said to mark a distinct step in the financial development of the country. The connected change in the Bank of England by the resumption of special payments supports this view. Moreover, the political conditions in their influence on finance were undergoing a revolution. The landed interest, though powerful at the moment, had henceforth to face the rivalry of the wealthy manufacturing communities of the north of England, and it may be added that the influence of theoretic discussion was likely to be felt in the treatment of the financial policy of the nation. Canons as to the proper system of administration, taxation and borrowing come to be noticed by statesmen and officials.

These influences may be followed out in their working by observing the chief lines of adjustment and modification that followed the conclusion of peace. Relieved from the extraordinary outlay of the preceding years, the government felt bound to propose reductions. With commendable prudence it was resolved to retain the income-tax at 5% (one-half of the former rate), and to join with this reduction the removal of some war duties on malt and spirits. Popular feeling against direct taxation was so strong that the income-tax had to be surrendered in toto, a course which seriously embarrassed the finances of the following years. For over twenty five years the income-tax remained in abeyance, to the great detriment of the revenue system. Its revival by Peel (1842), intended as a temporary expedient, proved its services as a permanent tax; it has continued and expanded considerably since. Both the excise and customs at the close of the war were marked by some of the worst defects of a vicious kind of taxation. The former had the evil effect of restricting the progress of industry and hampering invention.

The raw materials and the auxiliary substances of industry were in many cases raised in price. The duties on salt and glass specially illustrated the bad results of the excise. New processes were hindered and routine made compulsory. The customs duties were still more restrictive of trade; as they practically excluded foreign manufactures, and were both costly and in many instances unproductive of revenue. As George Richardson Porter showed in Progress of the Nation (1851), the really profitable customs taxes were few in number. Less than a score of articles contributed more than 95% the revenue from import duties. The duties on transactions, levied chiefly by stamps, were ill-graded and lacking in comprehensiveness.

From the standpoint of equity the ground for criticism was equally plain. The great weight of taxation fell on the poorer classes. The owners of land escaped giving any return for the property that they held under the state, and other persons were not taxed in proportion to their abilities, which had been long recognized as the proper criterion.

The grievance as to distribution has been modified, if not removed, by the great development of:

1. The income-tax
2. The death or inheritance duties.

Beginning at the rate of 7d. per pound (1842–1854), the income-tax was raised to 1s. 4d. for the Crimean War, and then continued at varying rates reduced to 2d. in 1874, it rose to 5d., then in 1894 to 8d., and by 1909 appeared to be fixed as a minimum at 1s., or 5% on income from property. The yield per penny on the has risen almost uninterruptedly. From £710,000 in 1842, it now exceeds £2,800,000, though the exemptions and abatements are much more extensive. In fact, all incomes of £3 per week are absolutely free (£160 per annum is the precise exemption limit), and an income of £400 derived from personal exertion pays less than 5½d. per pound, or 2¼%. The great productiveness of the tax is equally remarkable. From £5,600,000 in 1843 (with a rate of 7d.) the return rose to £32,380,000 in 1907-1908, having been at the maximum of £38,800,000 in 1902-1903, with a tax rate of 6¼%. The income-tax thus supplies about one-fifth of the total revenue, or one-fourth of that obtained by taxation.

Several fundamental questions of finance are connected with the taxation of income and have been dealt with by English practice. Small incomes claim lenient treatment; and, as mentioned above, this leniency means in England complete freedom. Again, earned incomes appear to represent lower ability to pay than unearned ones. Long refused on practical grounds (as by Gladstone and Lowe), the concession of an abatement of 25% on earned incomes of £2,000 and under was granted in 1907. The question whether savings should be exempt from taxation as income has (with the exception of life insurance premiums) been decided in the negative. Allowances for depreciation and cost of repairs are partially recognized.

Far more important than these special problems is the general one of increased tax rates on large incomes. Up to 1908-1909 the tax above the abatement limit of £700 remained strictly proportional but opinion showed a decided tendency in favour of extra rates or a super tax on incomes above an assigned amount (e.g. £5,000), and this was included in the budget of 1909-1910.