by Hew Strachan
What mattered as much as anything else was the perception that Britain was taxing effectively. It was important for the control of domestic inflation; it reassured international credit. The belief that Britain had got it right, primarily through its income tax but also through the excess profits duty, acted as a benchmark for the other belligerents.
In practice, only the United States followed the lead. The incidence, distribution, and yield of federal taxes were all transformed by the war, and because the period of active American belligerency was so short it is not unreasonable to call the effects revolutionary. Nonetheless, as in the British case, the practice fell short of the declared intentions. In April 1917 McAdoo announced his belief that taxation was the main method to finance war, and that he hoped in this way to cover half the war’s costs. So vociferous was the response from those who argued that such rates would reduce the incentives to investment that McAdoo reduced his target to one-third. Moreover, he was too optimistic with regard to outgoings. He budgeted for total expenditure of $8,400 million in 1917/18; in reality federal spending was $13,000 million, and in 1918/19 it reached $18,515 million, twenty-four times its 1916/17 level.194 The ratio of budgeted war revenue to war expenditure fell continuously between 1917 and 1919, averaging below 29 per cent. The actual ratio of war revenue to war expenditure was only 23.3 per cent.195
In 1916 74.8 per cent of total revenue was raised through customs and excise. The latter, increased by the Emergency Revenue act of October 1914 to compensate for the loss of the former, accounted for 47.6 per cent of the whole. By contrast, only 16 per cent was derived from taxes on incomes and profits. Income tax, levied on net receipts over $3,000 per annum or $4,000 for a married person, supertax, which began on incomes over $20,000, and corporation income tax, charged on net profits over $5,000, were all introduced in 1913 at a rate of 1 per cent. Supertax rose to 6 per cent on incomes over $500,000, producing a maximum combined rate of 7 per cent. There was therefore plenty of slack in the system.196
Although in 1915 the new excise duties only produced $52 million against an anticipated $100 million, Wilson’s initial preference was to increase them rather than to move to direct taxation. Congress disagreed. Therefore, the Revenue act of 8 September 1916, designed to cover the defence programmes of that year, marked a significant shift in principle. Income tax and corporation tax were raised to 2 per cent. The top rate of supertax was set at 13 per cent (i.e. 15 per cent when combined with income tax) on incomes over $2 million per annum. Inheritance tax, hitherto levied by forty-two states, was appropriated for federal purposes. Beginning on estates of over $50,000, it was charged on a scale rising from 1 per cent to 10 per cent on $5 million or more. The final major innovation was a form of excess profits duty, a tax on munitions’ manufacturers of 12.5 per cent of the entire profit for 1916. In aggregate, federal receipts were increased 70 per cent and exceeded the budget forecast of $975.5 million by $142.4 million. But their incidence was borne chiefly by the wealthy, and (in the case of the munitions levy) the Entente. In 1913 49.7 per cent of the tax yield was paid for by those whose incomes exceeded $20,000. Under the terms of the 1916 act this same group paid 95.4 per cent of the yield. The government was therefore appropriating savings, not purchasing-power, and so failing to deter consumption.
On the other hand, the United States had made effective the two major taxes of war finance, income tax and excess profits duty, in advance of its actual entry to the war. The Revenue act of 3 March 1917 never became operational, but it serves to underline the point. It proposed a duty on the excess profits of all companies, at a rate of 8 per cent on profits of over 8 per cent.
Not until 3 October 1917 was the United State’s first War Revenue act passed, six months after its entry and at a stage when the monthly deficit was already over $400 million. The delay was less attributable to the fact that the system of war finance had been anticipated before April 1917, and more due to the pleading of special interests. The casualty was the rate of excess profits duty, which, although a great fiscal success ($2,227.6 million was raised in the year ending 30 June 1918), was insufficiently severe. Net profits equal to between 7 and 9 per cent of the capital invested in 1911, 1912, and 1913 were exempt. Thereafter 20 per cent was payable on the first 15 per cent of profits, 25 per cent on the next 5 per cent, 35 per cent on the next 5 per cent, 45 per cent on the next 7 per cent, and 60 per cent on the remainder. The tax on munitions’ manufacturers was reduced to 10 per cent, and this, together with a generous depreciation policy, halved its yield in 1918.
That McAdoo’s taxes were failing to anticipate new areas of liquidity was reflected, as in Britain, by yields over budget. The year ended 30 June 1918 showed a surplus of nearly $300 million on a budget of $3,400 million. Furthermore the taxes lacked simplicity. Their temporary nature was emphasized by dubbing each of the new direct levies a war tax, and they operated alongside the existing bands. Thus, the war income tax was superimposed on the prevailing income tax. The new threshold was fixed at $1,000 for a single person and $2,000 for a married person, and was charged at 2 per cent. The surtax liability was also lowered, beginning at $5,000, not $20,000. The initial rate remained 1 per cent, but those earning $20,000 or more were liable to pay a rate of 8 per cent. Somebody earning $2 million paid 13 per cent under the old surtax arrangements plus 50 per cent under the new. A war estate tax was added to the existing inheritance tax to give a maximum rate of 25 per cent on estates over $10 million, but estates worth under $50,000 were exempt from the old duty and paid only the new one at a rate of 2 per cent.
The combined effect was to continue to load the burden onto the rich and so to tax savings rather than purchasing power. Seventy-seven per cent of taxpayers earned less than $3,000 per year, but they contributed only 3.6 per cent of income tax. Indirect taxes targeted luxuries, including cars, jewellery, cameras, cosmetics, and boats, not major consumer items. By 1918 customs and excise contributed 22.3 per cent of federal revenue, as against 67.8 per cent generated by incomes and profits.
McAdoo’s proposals for 1918 included increased taxes on lower incomes and a maximum rate of 80 per cent on war profits. If the latter had been passed on to consumers it could have operated to curb demand and so check inflation. But Congress was more worried about the elections impending in November 1918, and preferred to meet a deficit—accumulating at over a $1,000 million a month by July—through reducing expenditure. The debate dragged on in the Senate until February 1919, and the War Revenue act of 1918 was therefore not effective until 1920.
Thus, even though the United States swung the balance of its revenue from indirect to direct taxation during the war, it found itself unable to effect major changes during the period of its active belligerence. An addition to the principles on which taxation rested proved extraordinarily difficult in wartime. No country demonstrated this more graphically than the third major financial power of the Entente—France.
In June 1914 France was poised to introduce individual income tax. For the radicals it was the denouement to a struggle begun by Caillaux in 1909 but prolonged by the recourse of successive governments to loans and deficit financing. In 1913 Barthou had promised income tax as the corollary of the three-year service law. He then did nothing. The success of the left in the 1914 elections put the three-year law under sufficient threat to make tax reform the quid pro quo of its retention. However, what followed was a feeble response to the length and depth of the debate. Eligibility for the tax, introduced on 15 July 1914, began with incomes of over 5,000 francs, but allowances for spouses of 2,000 francs and for each child of 1,000 francs raised the practical threshold to that comparable with supertax across the Channel. The full rate of 2 per cent was only applicable to incomes over 25,000 francs. Moreover, the opportunity to overhaul the existing tax structure was spurned. Four taxes—the ground tax, the door and window tax, the personal furniture tax, and the business tax—dated from the Revolution and were to a large extent dependent on regional variations in prope
rty values. They rested on the principle of equality of incidence rather than on social progressivism. Although a fifth, taxing the income on capital, had been added in 1872, whole areas of wealth and actual incomes were untouched.197
Almost immediately, the entire economic life of France was thrown into disarray. The implementation of a new tax seemed impossible when so many tax collectors were ordered to report for military service. Those that remained were instructed not to prosecute the families of servicemen. Tax collection never recovered from the initial disruption of invasion and mobilization. In 1913 10 million Frenchmen paid personal taxes, however low and however antiquated. During the war only 557,000 paid income tax. About 2.5 million were taxed on industrial and commercial profits in 1913, but only 1 million between 1914 and 1919. Certain classes were almost entirely exempt: only 120,000 farmers paid tax and only 32,000 members of the liberal professions (of four times that number practising) paid duty on their profits198.
Administrative confusion was not the only cause of falling revenue. Military service and the loss of north-eastern France also reduced France’s fiscal base. The moratorium cut off rental income, rendering landlords unable to pay taxes. Import duties on foodstuffs were suspended. The return on customs, which had increased sixfold between 1870 and 1913 to produce a total of 777.9 million francs, fell to 548.3 million francs in 1914. Between August and November 1914 yields on indirect taxes and monopolies were 43 per cent below their total for the first six months of the year; they were still 35 per cent down in December and only recovered to 22.21 per cent below in the first half of 1915. Indirect taxes did not rise significantly above their 1914 total until 1916, and monopolies not until the following year. In fact 1917 was the first year in which the revenue raised through France’s existing taxes exceeded its prewar level.199
The appointment of Alexandre Ribot as finance minister on 26 August 1914 was not calculated to reassure the radicals. An opponent of income tax, he proposed to delay its introduction from 1 January 1915 to 1 January 1916. The practical impediments to change gave legitimacy to his argument that France had more than enough problems to cope with. His preference was to wait until economic activity had recovered sufficiently to enable the new tax to be the basis for a balanced budget. As an interim measure he offered to double existing taxes. But the budget commission of the chamber was concerned that by doing so he would entrench the old system and provide an excuse for further procrastination on the new. France went into 1915 without any significant increase in its rates of tax.200
The problem for both Ribot and the budget commission was that the situation was no more settled by the end of the next year. In December 1915 Ribot proposed once again to postpone the introduction of income tax. This time he argued that the yield would be too low to warrant the trouble of change, as the richest part of France remained in enemy hands. He was voted down in the chamber. In response, Ribot not only introduced income tax, albeit at the low rate of 2 per cent and at the unnecessarily high starting point of 7,000 francs for a married man, but he also promised a war profits tax.201
Ribot modelled his war profits tax on Britain’s. As on the other side of the Channel, agriculture was excluded. But France’s tax, unlike its ally’s, made some effort to target the profits of individuals as well as those of companies. The average of the last three years of peace was to form the basis for judging the profits gained between 1 August 1914 and 31 December 1915. Those who refused to supply information to enable assessment were to have their normal profits assessed as thirty times the yield of the business tax. The first 5,000 francs of profit were to be exempt.202 In practice, the spectacular yields on the war profits tax were retrospective. A law of 1920 providing for the revision of all contracts formed during the war, and establishing 10 per cent as a reasonable profit, netted 2,937 million francs in 1920 and 3,313 million in 1921.203 But in the war itself 10 per cent was the effective rate of the tax. Fear of the moratorium’s effect on banking activity and the latter’s support for business were partly to blame. The government was too fearful of reducing output by removing the profit incentive. Thus Citroen, who showed a profit of 6.1 million francs between 1914 and 1917, paid only 60,000 francs in tax.204 Fiscal lag did the rest. The tax was enacted on 1 July 1916, and produced a mere 192.5 million francs in 1917 and 521.5 million in 1918.205
In May 1916 Ribot sounded a more robust note. He proposed to double all the existing direct taxes, except the door and window tax, and to increase income tax to 5 per cent. Although an attempt at last to recognize the mismatch between France’s outgoings and her declining revenues, the positive effects on revenue would have been minimal and the fiscal implications regressive. The inadequate levels of new taxation were being compensated for by the perpetuation of the old. As a result, the system was becoming more complex at a time when the tax authorities were understaffed, and individually each tax was producing a return too small for the effort required to collect it.
The law of 30 December 1916, therefore, seemed a better answer to the problem. Income tax was raised to 10 per cent, and liability was to begin on incomes of 3,000 francs. Furthermore, the rates were progressive, rising in steps of 10 per cent so that all income over 150,000 francs was forfeit. A war tax, modelled on that adopted by Napoleon, carried a further 25 per cent surcharge on income tax (or a flat rate of 12 francs per annum for those not liable for income tax) payable by men of military age not in the services. The war profits tax was raised to 60 per cent of profits over 500,000 francs. But total receipts in 1916 did little more than match those of 1913, and even in 1917 the yield on direct taxes only exceeded its 1914 total by a third. The effect of the new rates of income tax was moderated by exemptions. Duties on consumption—on beverages, sugar, alcoholic drinks, and tobacco—were raised and an entertainments tax introduced. Therefore, of the extra revenue for 1917 206.5 million francs derived from direct taxation and 379.6 million from indirect.
The fundamental reform of direct taxation, repeatedly postponed since 1914, was finally effected by Thierry on 31 July 1917. Thierry established seven schedules which combined to levy taxes on capital (on property and mobile capital), on capital and income combined (on business and agriculture), and on income (pensions, wages, and profits on trade). By including farming, Thierry closed the obvious loophole for evasion. But the rates, although progressive, were not high. Agriculture was assessed on half the annual rental; rates in other areas began at 3.75 per cent over 3,000 francs or 4.5 per cent over 5,000 francs, with reductions for income below these levels and exemptions according to the size of family. The new taxes, which came into force on 1 January 1918, brought in 411 million francs of additional revenue. But, as the old system was finally abandoned, income of 325 million francs was simultaneously forfeited.
France, therefore, entered the final year of the war at last possessed of a machinery for taxation appropriate to the undertaking. But the levels of tax were still low. Thierry anticipated increasing the rates of income tax, making the war profits tax truly progressive, and introducing a turnover tax. Klotz, his successor, was reluctant to increase income tax. However, in February he raised the rate from 12.5 per cent to 14 per cent. In December 1917 he adopted an estate tax and increased rates of inheritance tax. But France’s preoccupation with its declining birth rate once again moderated a tax into virtual ineffectiveness. Only an owner of an estate of over 50 million francs with no children faced a significant burden, fixed at 24 per cent. The owner of a similar estate but with three children paid only 3 per cent. A comparable fate overtook Thierry’s plan for war profits, which Klotz also accepted. He established a rate of 50 per cent on profits under 100,000 francs, rising to 80 per cent on those over 500,000 francs. But he then introduced lower rates for newly established war industries, for businesses in war areas, and for companies in which workers held up to a quarter of the total capital. Postponements of the tax were so freely given that of 720 million francs owed up to November 1918 only 24 per cent had been collected.206
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Thus Klotz, like his predecessors, could not escape an excessive reliance on indirect taxation. A turnover tax of 2 per cent was charged on all payments of more than 10 francs if a receipt was issued, and of more than 150 francs if not. Luxuries, including first-class hotels and restaurants, were subject to a 10 percent levy. The tax was pointless. In wartime the yield was small: by definition, luxuries found few markets in the conditions of1918. In peacetime, industrial interests argued, the duty would hamper France’s post-war recovery, since French exports were led by luxury products.207
Therefore, the profile of French taxation during the war changed remarkably little. It was still heavily weighted towards indirect duties. In 1913 27.8 per cent of taxation was direct, in 1918 39.1 per cent; indirect taxation stood at 53.5 per cent in 1913 and 43.1 per cent in 1918. Income tax raised less than 1,000 million francs by the war’s end.208 A distinctive feature of France was the relatively high burden of trade taxes (including the post and railways), which, at 18.7 per cent of the whole in 1913 and 17.8 per cent in 1918, remained virtually unchanged.209
After the war France’s defenders would argue that the taxes on consumption and the registration and stamp duties constituted not-ineffective substitutes for income tax.210 The former depressed the demand generated by rising nominal incomes; the latter represented a levy on cash as it circulated. If the population of France was characterized by a mass of small-income earners, rather than by great concentrations of wealth, and if the retrospective purpose of war taxation was the control of inflation, not the covering of war costs, then French policy was not as ill-conceived as its critics sometimes maintain. But the problem for France after the war remained that of paying for the war. France spent 223,000 million francs in the years 1914–19. It raised 32,000 million through taxation: this was not enough to cover its normal peacetime budget, let alone the servicing of the war debt. By November 1918 France had yet to pay for a single centime of its direct war costs.211