by Hew Strachan
France’s problems were more those of forwardness than of backwardness. Its old tax structure, hallowed by the triumphs of the Revolution and of Napoleon, was the product of a transformation in the power of the state over a hundred years earlier. Administrative innovation had therefore preceded rapid economic growth. Its principal continental ally, Russia, confronted a range of issues that superficially were similar. Like France, Russia was considering the introduction of income tax in 1914; like France, Russia saw its tax yield decline in 1914/15; and, like France, it planned major reforms, embracing income tax and a war profits tax, in 1916/17. But there was a cardinal difference. Russia was backward, in an administrative as well as in a fiscal sense. It lacked the developed economic base possessed by its major Entente partners. It then compounded its weakness by decisions calculated to worsen its position. By the time of the Bolshevik revolution, it had—again like France—failed to cover any of its war costs, including the servicing of its debt, through taxation.
In 1911 76.8 per cent of Russia’s revenue was derived from indirect taxation, and only 13.7 per cent from direct. By 1913 the latter figure had fallen to 8 per cent.212 The principal sums were raised through excise rather than customs, the latter being designed principally to protect Russia’s nascent industries rather than to contribute to the exchequer. Of 1,606.9 million roubles generated by customs and excise in 1913, only 352.9 million came from customs. The impact of the war on overseas trade was therefore less burdensome than for other powers. The main sources of excise duty were sugar, beer, tobacco, petrol, matches, and—above all—spirits. In 1912 the combination of the duty on spirits and the state’s monopoly of their sale produced net profits of 626.3 million roubles, or about a quarter of all state revenue.
Direct tax was levied on land, on urban property, and on commerce and industry. The yield of all three doubled between 1903 and 1913. But the total, 272.4 million roubles, remained low. Russia was too predominantly agricultural for the increases in commercial and industrial taxation arising from urbanization to have significant effect. Land values were falling. Estate duties, levied on the transfer of land, including death, were minimal: the top rate was 12 per cent and the bottom (for a widower or for children) only 1.5 per cent.
A bill for the introduction of income tax was drafted in 1905 and introduced in 1907. In 1914 it still languished in committee. The case against its implementation in peace was real enough. Russia was not a rich country; its geographical size and its population density would make assessment and collection complex. A low threshold would therefore be difficult to administer and possibly not very productive. A high threshold (the 1907 bill planned to exempt incomes below 1,000 roubles per annum) would discourage the accumulation of capital and its subsequent investment. Thus, the possible net returns on income tax were murky. Moreover, Russia before the war did not need direct taxation to soak up surplus cash. During the war it did.
On 28 July 1914 the state liquor shops were closed as a temporary measure to expedite mobilization. On 3 September the Duma extended the closure for the duration of the war, and a month later authorized local governments to intensify the ban. Temperance, it was hoped, would help the war effort by raising standards of public health and boosting industrial productivity. But it had two fiscal disadvantages. First, it contributed to monetary overhang, increasing the quantity of unspent cash in private pockets. Secondly, it diverted the trade in alcohol into illicit channels, so passing profits from the state to speculators. The gross loss to governmental revenues was 432 million roubles in 1914 and 791.8 million in 1915.
Even without such self-administered wounds, the war eroded Russia’s fiscal base. Loss of territory accounted for a decline in revenue of 69 million roubles in 1914 and 226.7 million in 1915. Customs receipts were hit by the closure of the western land frontier and of the Dardanelles. Railway traffic in the combat zone fell by two-thirds (and by a quarter elsewhere), so reducing returns on the railway tax. The budget of June 1914 had assumed an income for that year of 3,585.5 million roubles. In practice it sank to 2,898.1 million, and receipts for the second half of 1914 totalled 1,130.5 million roubles as against 1,804.8 million for the comparable period in the previous year. Revenue for 1915 continued at a similar level, 2,827.6 million roubles, when a rise to 3,132 million had been forecast.
The growth in income budgeted for 1915 rested on increases in almost all Russia’s existing taxes in 1914. The most contentious of these was the railway tax, whose abolition had been anticipated as part of an effort to encourage trade. As a result of its intensification, it became cheaper to move cargo on passenger trains and humans on freight trains. The only significant innovation of 1914 was a tax on the carriage of goods. Calculated by weight, it was particularly designed to restrict the movement of raw materials, so curbing demand which was exceeding supply. In practice, both the railway tax and the duty on the carriage of goods formed the beginnings of a vicious circle in which the government levied taxes on itself. The increase in military transport more than compensated for the loss in volume of civilian railway traffic; the ministry of war therefore paid the railway tax, albeit at half rates. The carriage of goods tax fell on materials destined for the production of munitions, and its burden was therefore passed on by industry in the price paid by the government for the finished article. A related point could be made about customs duties, which were revised in February 1915: 25 per cent of customs were paid by the Ministry of Finance for imports for military purposes.
The full force of this bogus income was revealed in the 1916 budget. Only minor changes were made to taxation in 1915, and the revenue anticipated for 1916 was 2,914 million roubles, a level comparable with the previous year. In the event, receipts totalled 3,974.5 million. The depreciation of the rouble played its part in creating a nominal increase. But that, in its turn, was partly fostered by the government’s taxation policy which was stoking cash inflation. About 70 per cent of the total revenue for 1916 was contributed by the state itself.
The 1916 budget, unlike that of 1915, did, however, recognize the need to plan for a long war followed by a sustained period of post-war recovery. The burden of indirect taxation had been significantly reduced by the ending of the monopoly on spirits, and it was proposed to continue the trend to direct taxation by the establishment of progressive income tax and of an increased tax on industrial profits. The target was not only to cover Russia’s ordinary expenditure during the war, but also to establish its taxation system on a new permanent basis appropriate to peace.
In the event, less was achieved than Bark’s ambitious programme promised. He wanted to exempt incomes below 700 roubles, recognizing that Russia’s population was becoming increasingly wealthy in nominal terms, and was being spared a significant burden of indirect tax. The Duma, arguing that Russian workers were poor and their cost of living high, was more concerned with the social than the inflationary implications. Its members pushed for a threshold of 1,000 or even 1,500 roubles. A compromise was struck at 850 roubles. Depreciation did mean that this level embraced about half the households of Russia, and its progressive effects put the top level of taxation higher than that of any other European country except Britain. But the tax was not to come into force until 1917. And the yield budgeted for that year, 178 million roubles, was still small alongside the forfeited spirit revenue.
The same point could be made in even stronger terms in relation to the new levels of tax on industrial profits, scheduled to produce only 55 million roubles in 1917. Companies whose profits exceeded 8 per cent of their invested capital and of their average profits for 1913/14 were liable for tax on sums over 2,000 roubles. Individuals were taxed on emoluments over 500 roubles. The bottom rate of tax was 20 per cent; the top rate, including the existing direct tax and income tax, was not to exceed 50 per cent.
In many ways the fiscal policy of the Provisional Government of March 1917 built on the programme developed by the Tsar’s ministers in the previous year. Nor was what it proposed dissi
milar to the thinking displayed by the other Liberal governments of the Entente at this stage of the war. It planned to increase rates of income tax, setting a combined top level of 90 per cent. As the assessment was based on 1916 incomes, which in some cases had fallen in 1917, the new taxes could in theory have exhausted a taxpayer’s total salary. The war profits tax was to be subject to progressive rates, so that individuals were liable to a maximum of 60 per cent and publicly audited companies to one of 80 per cent. The maximum combined level of tax on businesses was again 90 per cent. Speculators and middlemen, who had effectively escaped the 1916 legislation, were liable to be taxed on income rather than on profits from capital. Plans were also afoot to increase indirect taxes and establish new state monopolies.
But the Provisional Government was the victim of its predecessors’ weaknesses, of fiscal lag, and of its own flabby-mindedness. It increased salaries and allowances, promising to pay them out of its tax reforms. But taxation was too slow in its effects. In the short term it could only do so through monetary inflation. Between January 1917 and the Bolshevik revolution in November Russia’s note issue doubled. Little of this additional cash could be soaked up by the fiscal structure inherited from the Tsarist government. Thus the Provisional Government contributed to the very process which its harsh fiscal policy was designed to check. Inflation was not the least of the factors making Russia ungovernable in the autumn of 1917.
Russia had only a limited fiscal base. The increased money supply generated by the war, therefore, bore less and less relationship to the availability of goods and services. But a limited fiscal base did not mean that a state had to wave farewell to an efficient system of war finance. Good administration could in theory—by tight control of the money supply and by severe taxation—compensate for limited wealth. During the war and after the commentators of the major economic powers of the Entente, including Keynes, remarked approvingly on the performance of Italy. In 1914 Italian taxation drew off a higher proportion (about 10 per cent) of the gross national product than that of any other major European power.213 Throughout the war, Italy made, it was maintained, a real effort to service its war-related borrowings from current revenue. Some thought it had succeeded.214 It had not, but E. L. Bogart’s 1921 calculation of Italy’s deficit on normal expenditure plus interest charges for the war, $786.5 million, compared favourably with his reckonings for France ($3,346 million) and Germany ($4,180 million).215
Economic growth had enabled Italy to generate budget surpluses between the financial years 1897–8 and 1910–11. But the campaign in Libya then combined with Giolitti’s social reforms to push the national account into deficit. Although Italy did not join the Entente until April 1915, the burden created by military expenditure was exacerbated by preparations for war from 1914. Thus, Italy had been living with some of the features of a war economy for three years before it commenced active belligerence. Like France and Germany, it entered hostilities with an exchequer already encumbered by pre-war debt.
The period of budget surplus was, with hindsight, an ideal opportunity to restructure Italy’s taxation system. Taxes were levied under three heads—direct taxes on land, buildings, and mobile capital; transaction taxes (including inheritance duty); and consumption taxes. In 1913 only 27 per cent of Italy’s revenue was generated through direct taxation, as opposed to over 40 per cent in the 1870s. Fifty-eight per cent derived from the taxes on consumption, and 15 per cent from transaction taxes. Personal income tax was advocated, but as a measure of social justice, not as a means to increase revenue.
Italy’s tax structure remained unreformed in 1914. Its post-war critics would accuse it of inflexibility. But as serious as its increasingly antiquated structure was the fact that its stringency was more apparent than real. A powerful argument against personal income tax and in favour of the high rate of indirect tax was the relative poverty of Italy compared with its western European neighbours. The difficulties generated by relatively low incomes and high rates of taxation were resolved by the Ministry of Finance in a series of personal negotiations between individuals and the state as to their commitments. Published rates, therefore, did not reflect actual payments. Nor was the system of assessment only unfair, it was also inefficient. The direct tax on land was levied on the basis of an incomplete land register. Italy had voted to draw up a national register in 1886. Those provinces which expected their assessments to fall as a result co-operated in its establishment; the majority did not. Thus the yields on land tax fell. Thus too the tax on mobile capital became a proportionally greater element of direct taxation. However, this latter tax assessed each source of income separately, rather than considering each person’s total holdings. A taxpayer who divided his wealth over several heads therefore paid less on the same income than a taxpayer who concentrated his investments.216
Italy entered the war with much trumpeting about fiscal rectitude. Unable to claim that its purpose was defensive, it could harbour no latent hopes for an indemnity, and had therefore to confront its own capacity to pay for what it was about. But by the end of the war the structure of its taxation was little changed. In 1917/18 direct taxes still only contributed 36 per cent of total revenue, transaction taxes remained virtually constant at 14 per cent, and consumption taxes had yet to fall below 50 per cent. By the same year the burden of taxation, expressed as a proportion of gross national product, showed no more than a marginal increase to 10.9 per cent (expenditure rose from 11.2 per cent in 1913/14 to 36.7 in 1917/18).217 The accusation of inflexibility was justified.
The rates of direct tax were, of course, increased. Indeed, the three permanent direct taxes carried a 5 per-cent surcharge from October 1914, and a 10 percent increase followed in December of the same year. But these rises were low compared with the increased liquidity created by the war. Efforts to introduce progressive taxation, in November 1916 and September 1917, foundered on the illogicalities of the basic structure. Property in different regions continued to be assessed separately; distinctions as to earned, unearned, and mixed income persisted; investments in different businesses were not aggregated. Evasion was simple. Like France, Italy fell into the trap of an excessively diverse structure, complex and confusing in its administration, and with each tax generating only small returns. Like France, these pinpricks included a levy on those of military age not in the services (introduced in November 1916), and taxes on luxuries that were in limited demand.
Italy’s reputation for fiscal prudence was, nonetheless, sustained by its early introduction of a war profits tax. Indeed, the Italian duty actually became law in November 1915, ahead of the British scheme. Its basic structure aped the British proposal. Profits over 8 per cent of invested capital were defined as excessive, unless firms could prove that they had made higher profits in the three years preceding the war. The basic rate of tax was 20 per cent, rising to 60 per cent on profits over 20 per cent. As at first in Britain, the duty was not accompanied by a policy of price controls. Potentially, therefore, the tax operated not as direct tax on industry but as an indirect tax on the consumer. But, unlike Britain, the profits subject to assessment were not all the profits generated during the war but only those profits derived from the war. The excess profits duty adopted by Westminster did not have the munitions firms as its primary target; that embraced by Rome did. Therefore, the consumer which would bear the indirect burden would be the state. In Britain the excess profits duty had at least some impact in the battle to absorb private purchasing power. In Italy it did not.
A tax regime favourable to heavy industry was justified on strategic grounds and on Italy’s need to compensate for its economic backwardness by an accelerated programme of investment. War profits were therefore seen as an opportunity to write off debts and to develop fresh plant. State controls on industry were reduced, not tightened. Fiscal privileges were extended to equipment which did not necessarily need to be written off during the war but which could be used for peacetime purposes. To achieve all this, the state took, i
n the form of increased prices for war goods, the burden of its own excess profits duty. Similarly, a tax on all payments of the state to private parties (the centesimi della guerra introduced at 1 cent in November 1915, and then raised to 2 cents in July 1916, and 3 in June 1918) could be reflected back in the form of prices. The Italian exchequer’s creation of fictitious revenue bore at least a passing resemblance to that of Russia.218
Italy’s failure to control costs meant that, although during the war 23 per cent of its expenditure was nominally covered by revenue, the wholesale price index stood at 364 in 1919, if 1913 is taken as 100.219 But what, of course, is surprising in the Italian story is the reputation for fiscal rigour, not the fact of post-war inflation. The Liberal government of Italy was weak, its foreign policy misguided and unpopular, and its economy ill-developed. Italy was the least of the great powers of Europe in 1914.
Much more complex, and much more alluring to scholars in the 1920s and ever since, was the failure of Germany to manage its war finances. In 1919 its wholesale price index was 415, and it would quintuple by the end of 1922. Germany was not only the mainstay of the Triple Alliance, it was also, in economic as well as in military terms, the greatest of the continental powers. And yet, if the existing deficit in 1914 is included, German revenue between 1914 and 1918 met only 13.57 per cent of expenditure220. Its total tax yield from all sources throughout the war was less than Britain’s revenue from its excess profits duty alone.221 It thus failed to cover not only the servicing of its war-related debt but also its ordinary peacetime outgoings.