The Cash Nexus: Money and Politics in Modern History, 1700-2000

by Niall Ferguson

  As the eighteenth-century Austrian Chancellor Wenzel Anton von Kaunitz-Rittberg observed:

  It does not require much reflection or any profound insight to invent all kinds of ways and means of squeezing money out of our subjects. He who wishes to do so in a manner both reasonable and beneficial to the monarch and the state, however, must first, or at least at the same time, devote an equal measure of zeal to increasing his subjects’ wealth so that they might bear this additional burden.2

  The history of taxation is best understood as a quest for an elusive juste milieu: a system that extracts the maximum revenue while at the same time imposing the minimum constraint on the growth of the economy, for that is the proverbial goose which lays the golden eggs.

  FAMILY SILVER

  State assets have long been a source of government revenue. Ancient Athens had silver mines of Laureion.3 Rome derived around a sixth of its income from state-owned land.4 Renaissance Genoa had its alum mine at Phocea.5

  The great European monarchies started life with large royal domains which were for a time their principal source of revenue. In England the parliamentary catch-phrase of the fourteenth century – a reaction to royal requisitions known as ‘purveyances’ – was that ‘the king should live of his own’. This was in fact an almost universal European notion: in France the king was exhorted to vivre du sien, in Spain to conformare con lo suyo. Few kings could. The temptation to sell assets for the sake of ready cash – or to use grants of land as a form of payment in kind for loyal servants – was too powerful.

  This was especially true in France. By 1460 the French royal domain accounted for less than 3 per cent of total royal revenues;6 and though it rose to around a tenth in the 1520s, within fifty years it was back to around 4 per cent.7 By 1773 the royal lands brought in less than 2 per cent of total revenue.8 Not even the revolutionary confiscation of aristocratic estates and Church lands did much to replenish the assets of the state, as they were soon sold off to raise cash: the sale of Church lands alone accounted for 12 per cent of ordinary revenue in the Napoleonic period.9

  For a time, the English crown was somewhat better off than the French. In the 1470s Sir John Fortescue estimated that Edward IV received a fifth of the total yield of temporal property in his kingdom, though by the end of his reign this no longer sufficed to cover royal expenditure.10 Henry VII was so successful in raising domain revenue that he had to turn to parliament for taxation only once, in 1504, while his son gave a brief boost to the royal balance sheet by seizing the lands of the monasteries. However, most of these were quickly sold off to finance wars against France and Scotland: by the last years of Edward VI, seven-eighths had gone.11 His sister, Elizabeth I, could not hope to live of her own. Indeed, the crown’s lack of independent means was the main reason for the growth in the power of parliaments in the late sixteenth and seventeenth centuries. Although the restored monarchy recovered extensive lands after the Civil War, it was henceforth dependent on parliament for additional funding. In 1760 George III made over the revenues of the royal estates to parliament; since then the monarchy has largely been financed out of taxation through the Civil List and other subsidies.12

  Further east, the ‘domain state’ persisted for longer. In 1630 the Swedish royal domain, which included silver, iron and copper mines, accounted for 45 per cent of royal revenues and the Danish for 37 per cent; though by 1662 the Danish proportion was down to just 10 per cent, and by the end of the eighteenth century the Swedish royal domain had all but disappeared.13 Prussia was perhaps the longest-lived domain state, and among the most entrepreneurial. In 1740 revenue from the royal estates accounted for around 46 per cent of total revenue, and this fell only slightly in the subsequent fifty years. Even in 1806 its share was still as high as 30 per cent, and the development of a state railway network and other industrial concerns in the nineteenth century led to a slight increase.14 In 1847 more than a third of revenues came from state enterprises; ten years later 45 per cent; and in 1867 slightly more than half.15 This upward trend continued after German unification. Total entrepreneurial revenues rose as a proportion of total (ordinary and extraordinary) income from 48 per cent in 1875 to 77 per cent in 1913. Of course, these gross figures exaggerate how much disposable revenue the enterprises generated. But even when the costs of running the state enterprises are deducted, their importance was considerable: they covered 16 per cent of total ordinary and extraordinary expenditure in 1847 and 1857, 25 per cent in 1867. However, the net revenue declined steadily in importance after unification, from 6 per cent in 1875 to less than 2 per cent on the eve of the First World War.16 In Britain, by contrast, the railway system had been built almost entirely with private finance.

  Prussia was not unique, however. Other German states in the eighteenth and nineteenth centuries were also entrepreneurial: Württemberg, for example, or Hesse-Cassel – though the principal source of the latter’s entrepreneurial income was the state’s mercenaries, which paid for roughly half of all government spending between 1702 and 1763. As Landgrave William VIII put it: ‘These troops are our Peru.’17 By the turn of the century, his son was one of the richest men in the world: managing just a part of his huge investment portfolio started the Rothschilds on the road to banking greatness.18 Russia too had a substantial royal domain, to which was added a large railway network and heavy industrial sector in the later nineteenth century. By 1913 net receipts of the railway network accounted for around 8 per cent of total public revenue.19 Even nineteenth-century Britain, for all its reputation as a ‘night-watchman state’, derived an average of 20 per cent of its gross revenues from the postal, telephone and telegraph services which the state monopolized.20 This was much more than in France, where state properties declined as a proportion of total revenue from more than 10 per cent in 1801–14 to just over 3 per cent under the Bourbon and Orléanist regimes, and less than 2 per cent from 1848 until 1914.21

  State monopolies have also been established on the production and sale of commodities. The T’ang dynasty in China introduced a salt monopoly in 758; by 780 it accounted for half of all central government revenue. Salt monopolies were also introduced in Venice, Genoa, Siena, Florence, France and Austria, and were often linked to a tax (usually called the gabelle). Russia too introduced a salt monopoly, though its monopoly on vodka after 1895 was more lucrative: by the eve of the First World War the latter was providing just under a fifth of total revenue – an astonishing figure.22 The French monopoly on tobacco accounted for over 7 per cent of revenue at its peak in the eighteenth century.23 One of Bismarck’s abortive schemes to free himself from partial dependence on the democratic German parliament he had called into being was to create a similar tobacco monopoly. State monopolies on alcohol sales are still to be found in many countries. Around 5 per cent of American state and local government revenue comes from state utilities and liquor stores.24 State lotteries play a similar role: in each case the state monopolizes the gratification of a particular vice. The profits such monopolies make are essentially taxes on drinkers or gamblers. And like the vices themselves, the revenues they generate can be hard to give up. One of the greatest blunders of Mikhail Gorbachev was his campaign against alcohol abuse in the Soviet Union: the reduction of vodka consumption led to a drastic drop in revenue from this source.25

  Spending on infrastructure by states is sometimes portrayed as developmental: the state substitutes for insufficient private sector investment in strategically important sectors. In fact, most state enterprises have generally had a narrower, revenue-raising purpose. In undemocratic regimes, such public enterprises were indeed capable of making money, or at least of breaking even. But in many democratic states and in the planned economies of the twentieth century the public sector soon turned into a channel for covert subsidies to the poor and, at the same time, a sponge for soaking up surplus labour. Concealed unemployment, and the attendant stagnation or outright decline of productivity, meant that state enterprises after 1914 were more often net recipien
ts of state funds than revenue generators. A good illustration of this point is the way the German railways went from being a substantial source of revenue before the First World War to being a vast job-creation scheme in the Weimar Republic and the Third Reich.26 On average, 30 per cent of the Reich deficit between January 1921 and November 1923 was accounted for by net expenditures on the Reichsbahn. A substantial part of the railway deficit was due to over-manning, as well as to the government’s failure to index passenger fares.27 This policy was continued by the Nazis, who increased the number of railway employees by nearly a million. The contrast with the pre-war position in Prussia could hardly be more stark.

  The British nationalized industries provide another melancholy example. Nationalization in fact predated 1945: Churchill had brought the Thames dockyards into public ownership in 1908, while the Forestry Commission, the Central Electricity Generating Board, the British Broadcasting Corporation, the London Passenger Transport Board and British Overseas Airways were all inter-war creations. Between 1945 and 1951, however, state ownership was extended to coal, aviation, roads, railways, gas, electricity and steel. Whatever the motives behind these decisions – and the desire to avoid job-losses or wage cuts undoubtedly took precedence over boosting productivity or net revenue – the losses subsequently incurred were colossal. In 1982 the total cost in capital write-offs and grants was estimated at around £40 billion. The £94 billion of public money invested in the nationalized industries was ‘yielding an average return to the Exchequer of minus 1 per cent’. The car manufacturer British Leyland alone cost the taxpayer close to £3 billion in the space of a decade.28 It is not surprising, in the light of these figures, that the Thatcher government was attracted to the possibility of ‘privatization’: sale of these and other state-owned assets raised around £100 billion. This income should not have been, but generally was, counted as current revenue, allowing the government to paint a rosier picture of its finances than was justified. On the other hand, there was little substance to the former premier Harold Macmillan’s complaint that the ‘family silver’ was being sold off cheap.29 The shares in the privatized utilities were not systematically undervalued by the Treasury; and the productivity improvements subsequently achieved in most of the privatized industries have amply justified the policy, since widely imitated.30

  ‘TAXES ON EVERY ARTICLE’

  The simplest taxes to levy are those on easily monitored transactions: partly for that reason, customs duties on imports have been a source of revenue since ancient times. Ancient Athens imposed an average duty of 1 per cent on all imports.31 Rome too had its portoria, which accounted for around a quarter of revenues in the reign of Augustus.32 In medieval England, King John set a precedent by collecting a general ad valorem duty of 16 pence in the pound on a wide range of imports and exports. Although this was initially imposed with the consent of merchant assemblies, the duty gradually came to be regarded as part of the ordinary revenue of the crown (hence ‘customs’). After 1294, the crown also imposed extraordinary taxes on wool exports; and these too became customary: from 1398, life grants of the wool tax were made to the monarch along with the subsidy on wine and other merchandise (tunnage and poundage).33

  Yet the taxation of trade has its disadvantages. If taxes on commerce are set too high, they may have the effect of reducing the volume of trade and hence the amount of revenue. The high duty on English wool exports in the fourteenth century may well have been a factor in the sector’s slow decline.34 High import duties, on the other hand, encourage smuggling. Even an island state like Britain found it impossible to prevent large-scale evasion of duties in the eighteenth century, when the figure of ‘Smuggler Bill’ attained heroic status and as many as 20,000 people were involved in illegal trade. More importantly, import duties discriminate against foreign goods which might otherwise be cheaper than those which are domestically produced. From a liberal perspective, tariffs are not only a burden on consumers (here was the electoral appeal of ‘Free Trade’); they also diminish the efficiency of the international economy as a whole by sheltering from competition mediocre firms that happen to be on the right side of a national border. It was the practical argument that lower tariffs would increase trade volumes, allied to a distinctly Protestant view of the economy as a divinely ordained and self-regulating mechanism, which converted the majority of the British political élite to free trade, beginning with the Liberal Tories in the 1820s.35 In the event, duties were reduced so much that when trade dipped and military expenditure rose, Sir Robert Peel had to accept (in 1842) the necessity of a peacetime income tax to balance the budget.

  Continental states followed the British example of free trade to varying degrees, a process of trade liberalization that culminated in the early 1870s. However, the decline of agricultural and industrial prices in the course of the 1870s (due in large part to steep reductions in rail and sea freight rates) soon precipitated a revival of protectionism. ‘Manchesterism’ had been criticized since the 1840s by economists such as Friedrich List, who realized that infant German textile firms stood little chance of competing with superior British mills in the absence of protective tariffs. But the protectionist revival owed more to the fundamental political utility of tariffs as a way of buying support from biddable interest groups such as farmers.36 Protective tariffs on agricultural and industrial imports were restored by Bismarck in Germany in 1878 and reached a pre-war peak in 1902: not only did they benefit his own social class, the landowning Junker, they also had the merit of dividing his liberal opponents. On the eve of the First World War, according to League of Nations figures, average German tariff rates had risen to 12 per cent, compared with 18 per cent in France (the figure for Britain was still zero). Continental tariffs on wheat had risen to 36 per cent in Germany and 38 per cent in France; in Italy, Spain and Portugal the rates were higher still. In Russia and the United States, by contrast, it was imported manufactures that were heavily taxed; the same was true in Latin America.37 Between 1861 and 1871 the ratio of American duties to imports rose from 14 per cent to as much as 46 per cent, before levelling off at around 30 per cent.38 The 1902 Fordney–McCumber Act empowered a new Tariff Commission to impose duties on a case-by-case basis; of course, once a tariff had been introduced, it tended to remain in place regardless of changes in relative prices.39

  In the aftermath of the First World War, protectionism continued its upward drift. In the major industrial economies, the value of customs collected as a proportion of total imports rose from 11 per cent (1923–6) to 18 per cent (1932–9).40 A crucial factor in the Great Depression was the plodding passage between October 1929 and June 1930 of the American Smoot–Hawley tariff bill, which specified duties on no fewer than 21,000 items.41 Even Britain, the erstwhile champion of free trade, opted for protection, imposing a 10 per cent ad valorem duty in March 1932 and finally adopting Empire-wide protection (‘Imperial Preference’) in July 1932.42 As in the nineteenth century, protectionism had articulate defenders. In a lecture he gave in Dublin in April 1933, Keynes declared that he ‘sympathise[d]… with those who would minimise rather than with those who would maximise economic entanglement between nations’.43 Only gradually did economists and politicians come to see that this was a destructive game of ‘beggar-my-neighbour’. While it undoubtedly made more sense to impose tariffs than unilaterally to pursue a free trade policy in a protectionist world, it made even more sense to reduce trade barriers collectively, first by bilateral agreements, then, after the Second World War, through the multilateral General Agreement on Tariffs and Trade. The lesson first taught by Adam Smith in the eighteenth century – that lower import duties would lead to higher revenues by boosting trade – had to be painfully re-learned.44

  There is, of course, no reason in logic why a transaction that involves moving goods across a border should be treated differently from a transaction within a border. Throughout history, states have also had recourse to taxes on domestic transactions. Ancient Athens had an excise on sale
s of slaves.45 Rome had a similar 4 per cent sales tax, as well as a tax on the manumission of slaves and a 1 per cent sales tax on other goods.46 In medieval France the Ordnance of December 1360 ‘revolutionized’ royal finance by imposing a duty (the gabelle) on salt and aides of 5 per cent on the sale of most commodities apart from wine, which was taxed at a higher rate (at first 8, later 25 per cent).47 Renaissance Florence depended for a fifth of its revenue on a similar salt duty, levied at the city’s gates.48 Habsburg Castile had the alcabala, a 10 per cent sales tax.49 Even before the introduction of the vodka monopoly, the excise on spirits was one of the Russian state’s principal sources of revenue, accounting for as much as a third of the total in 1815.50

  Few states in history have relied as heavily on the taxation of domestic consumption as Hanoverian Britain; and this is of particular interest as it was the regime which presided over the first industrial revolution.51 In fact, the excise – defined succinctly in Dr Johnson’s dictionary as ‘a hateful tax levied upon commodities’ – had its origins in the Stuart period: Charles I had levied duties on cloth, starch, soap, spectacles, gold and silver wire and playing cards; and in 1643 parliament had introduced excises on tobacco, wine, cider, beer, furs, hats, leather, lace, linen and imported silks.52 By 1660 excises were also being levied on salt, saffron, hops, lead tin, iron and glass. In the course of the next hundred years, these taxes became the British state’s principal source of revenue.53 To help finance the war with revolutionary France, the Younger Pitt added hats, gloves, mittens, perfumery, shops and female servants to the list of dutiable goods, to say nothing of bricks, horses and hunting.54 By the end of the Napoleonic Wars, it seemed that scarcely anything in Britain was not taxed. Writing in the Edinburgh Review in 1820, Sidney Smith bemoaned: