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The Wartime Revenue Squeeze

World War I began under a minority Liberal Government elected in 1910 and dependent on Irish nationalists for parliamentary support. At first that government expected the war to be short and its costs limited, with the UK using its navy to blockade Germany but the land war waged mainly by France and Russia. Further, fearing that tax increases might provoke popular resistance, the government decided to fund the war from borrowing to a much greater extent than in the Napoleonic or Crimean Wars in the previous century—a policy that continued even after it became clear that those initial expectations of a short, cheap war were utterly mistaken (Daunton (2002): 38).

As the war continued, electoral competition was effectively suspended and replaced by two successive war coalition governments. The first comprised Liberals and Conservatives led by the Liberal Prime Minister Herbert Asquith from May 1915 to December 1916. The second, after the Conservatives withdrew their support for Asquith as war leader, was led by the Liberal David Lloyd George from 1916 to the end of the war and included Conservative, Labour, and some Liberal MPs (the remaining Liberals formed the Opposition under the former leader Herbert Asquith). Those three wartime governments imposed exchange controls that weakened the Gold Standard fixed-exchange rate system for the currency (without formally suspending it) and probably contributed to inflation during the war, and they imposed conscription as well as other deprivations, so there was certainly some non-fiscal austerity accompanying fiscal squeeze in this case. Although overall public spending rocketed during the war, as we saw in the previous chapter, that increase was concentrated on military activity, not civilian public services, so in effect there was a squeeze on civilian spending that accompanied the hard revenue squeeze imposed during the war.

But that revenue squeeze did not comprise extra taxes on the bulk of the population through higher indirect taxes and taxes on lower incomes (despite calls from John Maynard Keynes and others for such taxes), because, as already mentioned, the governing politicians seem to have feared such taxes might fuel industrial unrest or even Bolshevik-type revolution (Daunton (2002): 42-3). Instead, extra taxes were levied almost exclusively on middle and higher incomes, business profits, and inheritance, and war spending was funded mostly by borrowing, creating a huge debt overhang after the war. The wartime revenue squeeze included a fourfold increase in the standard rate of income tax between 1913 and 1919 (to 30 per cent), together with a reduction in tax thresholds that targeted middle and upper middle earners. Taxes on profits were also sharply raised during the war, with an Excess Profits Duty (EPD, a form of corporate tax based on the extra profits earned by each enterprise above their pre-war levels) levied at a rate that rose from 13 to 26 per cent between 1916 and 1918. Two successive wartime Chancellors of the Exchequer declared EPD to be an 'emergency tax' that would apply only during the war.[1]

  • [1] The Liberal Chancellor Reginald McKenna declared in 1915 (House of Commons debates,Hansard [hereafter 'HC Deb'] 13 November 2015, c.1397) 'This is.. .only a temporary tax, during
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