To Arms

by Hew Strachan

  Industry successfully resisted government management. Only one company in Germany became subject to direct state control: on 6 March 1918 the Daimler motor works were placed under the oversight of the army. Daimler’s shares, which had stood at 317 at the end of 1913, rose to 630 by 1916 and 1,350 in 1917: in 1916 and 1917 dividends of 35 per cent and 30 per cent were distributed. In the financial year 1916/17 the firm wrote off 100 per cent of the book value of its plant. Such accounting practices and their consequent profits did not prevent Daimler’s management from asking the War Ministry for a 50 per cent increase in the prices of automobiles and spare parts for aero-engines at the beginning of 1917, and threatening to suspend night shifts and overtime if its demands were not met in February 1918.242

  The difficulty in assessing the impact of the war profits tax is knowing how far a firm like Daimler was typical. Industries that were not benefiting from army orders were likely to experience decline; dividends as a whole, if related to the movement of prices, fell.243 But many firms kept both their dividends and their balances low in order to avoid tax demands from the government and increases in pay for their workers. Their profits were hidden in increased capital and reserves. The sixteen most important steel and mining firms in Germany—admittedly businesses likely to benefit from the war—entered net profits of 285 million marks over its first three years. The dividends of iron-processing firms rose on average 175 per cent when allowance is made for inflation, and those of the chemical industry 200 per cent. The most successful heavy industries showed an eightfold increase in profits even against 1912/13, itself a peak year, and Rheinmetall a tenfold increase.244

  But Rheinmetall’s major rival, and Germany’s principal armaments firm, Krupp, displays the danger of snap judgements. Shortly after the war’s outbreak Gustav Krupp von Bohlen und Halbach declared to the firm’s directors that he did not intend the company’s profits to be any greater than was normal in peace. The firm’s accounts suggest that this was not the empty rhetoric it was long assumed to be. In the immediately pre-war years average net profits had been 20 per cent of turnover; during the war they ran at 8.4 per cent, much lower than those of other major companies. Furthermore, Krupp’s dividends, which had averaged 12 per cent in the three years up to and including 1915/16, fell to 10 per cent in 1916/17, and no dividend was paid in 1917/18. The key to the question as to whether Krupp made vast profits from the war but hid them lies in its depreciation policy. During the course of the war it wrote off 85 per cent of its plant. But factory space increased 170 per cent, and housing was provided for the workforce, which tripled. So, writing off assets was not simply an accounting device. Munitions production constituted about 80 per cent of its business, and drastic depreciation was its only protection against the end of the war. Even so, its reserves were not sufficient to prevent the firm confronting crisis in 1919/20245.

  Krupp’s ability to carry through such accounting policies was enhanced by the fact that, after the efforts of 1915/16, the fiscal grip of the state on war industry relaxed. Helfferich, enamoured of the workings of the free market, used his shift to the Ministry of the Interior to make sure that the apparent rigour of his 1916 budget was not sustained. He was to be counted among Groener’s opponents in 1917.246 When Hindenburg took over at OHL in August 1916 he set a programme of increased munitions production which effectively elevated output over price control. The conservative instincts of Bethmann Hollweg’s government, reflected in economic liberalism, had been a partial restraint on costs; they were elbowed to one side by radical militarism. Because firms were left to bear their own investment costs in order to create sufficient plant for war needs, the state was required to be generous in the matters of depreciation and capitalization. Munitions manufacturers, like Krupp, aimed to write off their equipment costs in one or two years. But indulgence became laxity, and even collusion. Businesses could evade taxes, a once-and-for-all loss, by subscribing to war loans, a temporary sacrifice compensated for by the government. The obstructiveness of war industry in revealing the details of its accounts was borne with unreasonable patience by the War Ministry. Firms got into the habit of not operating to fixed prices, but of setting the final cost after delivery. The raw materials section of the War Ministry made allowances to employers for wage increases.247 Thus the state, as the principal consumer, became the main bearer of the burden of the war profits tax. Germany had embraced the principle of price control, albeit unevenly in 1914; as its effectiveness waned after 1916, so the real returns on the war profits tax fell. Without price control, taxation—and certainly taxation levied at a lower rate in 1917 and 1918 than in 1916—was stoking inflation, not retarding it.248

  The failure of the Reich to tax real incomes directly was made more severe by a shift in the financial policies of local governments. During the war they multiplied their spending four times (as opposed to five times for the Reich). They covered 35 per cent of it through borrowing, despite possessing the power to impose direct taxation, and, moreover, they moved from long-term debt to short-term. The federal states between 1914 and 1923 raised 6.1 billion marks through taxation, but required 3.5 billion of it to service their debts.249 Thus, it was not only the company but also the individual for whom the impact of taxation was loosened in the war, rather than tightened. The legacy of Germany’s failure to tax directly was not, therefore, the amount by which it failed to cover its war costs but the degree to which it bequeathed the post-war government with the problems of monetary overhang.

  The post-war focus on Germany has, however, served to obscure the even more dire position of Austria-Hungary’s revenues. In Austria itself, the reluctance to introduce new taxes was not the consequence of a lack of pre-war powers or of a pre-war infrastructure. In 1913 total net revenue was 3,122.9 million crowns. Direct taxes on property and income produced 431.5 million crowns, customs 199.9 million, excise duties 418.1 million, charges on stamps and railways 265.5 million, state monopolies 433.1 million, state-run businesses (including the roads) 1,208.1 million, and income from administration 166.7 million. By the end of the war current prices had risen fifteenfold, but ordinary revenue in 1917/18 had only increased by a quarter in current prices, to 4,194 million crowns. Furthermore, Austria stubbornly maintained the fiction that the war was working no change in the value of money. If the crown was held at its pre-war value, the net revenue for 1917/18 fell to 417.7 million crowns. By the same token, government spending also fell. If war costs for 1914/15 stood at 100, the ratio in peace prices was 77 for 1915/16, 46 for 1916/17, and 36 for 1917/18. The proportions for the armed services were even more alarming: 100; 74; 41; and 27. Austria was spending less in real terms on the war at the end than it was at the beginning.250

  The suspension of parliamentary activity in Austria until 1917 proved both a blessing and burden. On the positive side, government by decree removed the problems of parliamentary obstructionism and delay. On the negative, any new taxation lacked the imprimatur of popular approval and thus threatened to exacerbate internal tensions. The effect was to encourage the government to build on existing patterns of tax, but to fail to tap new sources. The first additional taxes of the war, not introduced until September 1915, were increases to existing levies—an addition to the duty on beer, and to the charges for inheritances, gifts, and social welfare. But these were not prompted by the war: they had been long debated in parliament and could now be imposed because of the latter’s absence. They were therefore irrelevant to Austria’s new circumstances. The yields on beer and spirits fell in line with the fall in consumption: indeed, because 77 million crowns of beer duty had to be passed over to the provinces, this particular account moved into deficit by the end of the war. The September 1915 increases netted a paltry 23 million crowns of additional income.

  The decline in consumption, therefore, rendered indirect taxation an inadequate tool with which to tackle the government’s target of covering the interest charges on war debt. But the principle of building on the existing system p
ersisted. In September 1916, citing the precedent of the Italian war of 1859, the government introduced special war surcharges on existing direct taxes. Overtly, these struck at the wealthy and relieved the less affluent: the threshold for liability to personal income tax was raised from 1,600 crowns to 3,000 crowns. With indirect duties failing to tax lower incomes because of falling consumption, this was not a route to social harmony but to monetary inflation. Moreover, the new rates appeared fiercer than they were. The surcharges were expressed as percentages on the existing levels of taxation, not on the principal to be taxed. The surcharge on incomes between 3,000 crowns and 20,000 crowns was only 15 per cent. But the scale after that rose with apparent steepness to 100 per cent on incomes over 140,000 crowns, 120 per cent on incomes over 200,000 crowns, and 200 per cent over 1 million crowns. However, all these percentages were the supplements applied to existing (low) rates of tax, not to the income itself. Thus, the net additional yield remained relatively small. The tax on interest payments was expressed as a 300 per-cent surcharge; in practice this meant an increase in the basic rate from 2 per cent to 8 per cent, which was—furthermore—to be levied only when the money was withdrawn. The surcharge on the duty on share dividends was 20 per cent, raising the rate from 10 per cent to 12 per cent—with a complicated additional scale graduated according to the level of profit on the invested capital. The tax on business profits suffered a 100 per-cent surcharge when the tax yield exceeded 60 crowns, and 60 per-cent when it was below that. The only group for whom the real burdens increased were landowners, whose effective rate of tax had fallen by half between 1898 and 1914. The 80 per-cent surcharge imposed on ground tax bit more deeply because the basic rate was 19.3 per cent, and the new effective rate became 34.7 per cent.251 But the empire’s agricultural heartland, Hungary, was left unaffected for fear of antagonizing Magyar farmers: throughout the war there was virtually no change in Hungary’s fiscal policies.252 In 1917/18 Austria’s yield on direct taxation had risen to 676.8 million crowns, but that was expressed in current values: in peace crowns it had fallen to 67.4 million.

  The difficulties of genuine innovation, directed at new areas of liquidity, were amply illustrated by the travails of Austria’s efforts to milk war profits. A royal decree of April 1916 aimed to tax the increased profits of all companies (not just companies benefiting from war industries) generated in the war years 1914, 1915, and 1916. When parliament reconvened in 1917, its deputies argued that the provisions of April 1916 were insufficiently rigorous. They wanted severer rates to be incorporated in a new scale which subsumed individuals as well as companies. However, the Upper House construed the proposals of the Lower as a socialist-inspired attack on productivity and capital formation. Conscious that a simple rejection of the deputies’ proposals would give time for profits to be dissipated before legislation was in place to tax them, the Upper House proposed a short-term solution—which was promptly rejected by the Lower House in case it transmogrified into a long-term arrangement. The final result was compromise. For public companies, the basis of comparison was the average of the highest and lowest profits in the years 1909 to 1914; the first 10,000 crowns of war-related profit was not liable for tax, and thereafter a levy on a scale of 10 to 35 per cent was applied. For private firms and individual businessmen 1913 was the point of comparison, the first 3,000 crowns were not liable, and the rate was 5 per cent on the next 10,000 crowns, 10 per cent on the next 10,000, 15 per cent on the next 20,000, and 20 per cent on the next 20,000. But the law only applied to 1916 and 1917, and the whole debate was therefore rerun in 1918. On this occasion the scale for private firms was widened, so that profits over 300,000 crowns were taxed at 60 per cent—a ceiling set by the Upper House. The Lower House wanted the same principles applied to public companies, but the Upper House insisted that account should be taken of the profitability on capital investment, and the scale was set at two-thirds that of private firms in order to allow the creation of reserves. The effect of all this parliamentary rancour was inefficiency. Many profits earned in 1914 and 1915 escaped entirely; the yield for 1916/17, budgeted at 169 million crowns, proved to be 90 million; an anticipated return of 300 million crowns for 1917/18 came in close to target, but this was only 29.9 million peace crowns. Austria’s hope was that it would make up the leeway—to the tune of 2,000 million crowns—after the war was over.253

  Parliament’s inability to embrace innovation was clearly recognized in Austria’s first proper war budget, introduced in September 1917 and designed to cover the year July 1917 to June 1918. It revealed that normal receipts had risen (in current crowns) from 3,080 million in 1913 to 4,062.6 million in 1917, and that the surcharges and war profits tax added a further 720 million crowns. But normal expenditure had outstripped the additional yield, jumping by 2,220 million crowns to 5,681 million. Furthermore, the interest charges on the war debt—which Austria had previously hoped to cover through the surcharges of 1916—were running at 1,795 million crowns. Despite this clear evidence that Austria was no longer even covering its peacetime costs, the budget did no more than reiterate the policy of surcharges on existing sources of revenue. A suggestion that a property tax be introduced was crushed with the observation that the idea was ‘not yet topical’.254 So palpable was the budget’s failure that new taxes had to be introduced long before the planned date of June 1918. These measures—adopted in January 1918—continued the notion of wartime supplements to existing direct taxes. The main novelties—a coal tax modelled on that of Germany, and a railway tax—had the effect of driving up production costs, and therefore committed the error of indirectly taxing the state itself. By these means the January 1918 interim budget added 820 million crowns to the existing total for war-related taxation of 720 million. But such figures were doubly insignificant—meaningless in the context of a total state expenditure for 1917/18 of 22,169 million crowns, and expressed in a currency that to all intents and purposes was fast becoming valueless.255

  When Bulgaria entered the war in 1915 its Finance Ministry had succumbed to pressure from both left and right and accepted the principle of progressive direct taxation. But the government’s enthusiasm for the idea was distinctly limited, not least because the bulk of foreign loans it had contracted in 1904, 1907, and 1909 were secured on the receipts from indirect taxation and from customs and excise. Between 1889 and 1911 Bulgaria’s yield from direct taxation remained roughly constant, totalling 38.2 million gold leva in 1889, peaking at 49.1 million in 1905, and falling back to 41.6 million in 1911. By contrast, indirect taxation grew from 9.3 million leva to 83.6 million over the same period. The government used its entry into the war to argue that any change in the balance should be postponed until the return of normal conditions. Although a war profits tax was proposed in December 1916, it was not adopted until May 1919. Direct taxation produced 24 per cent of Bulgaria’s revenue in 1914, and 21 per cent in 1918.

  A significant pressure against radical change was Bulgaria’s reliance on agriculture, and the effect on it of war. The mobilization of the army drained the land not only of men but also of draught animals and vehicles. In 1912 17 per cent of the land was fallow; in 1917 29 per cent. Grain production fell from 2,876,000 tons in 1911 to 1,065,000 in 1918. About half of Bulgaria’s direct taxation was derived from land tax. It netted 17.33 million leva in 1911, but under the impact of the First Balkan War slumped to 4.54 million in 1913.

  By 1917 its yield had recovered to 13.96 million leva, and in 1918 to 19.26 million. The growth was principally due to depreciation. But it also highlighted a shift to so-called industrial crops, and particularly tobacco. Bulgaria’s production of tobacco multiplied 3.5 times between 1912 and 1918. In meeting the cravings of the soldiers of the Central Powers, Bulgaria ensured that its balance of trade moved from deficit in 1914 to surplus in 1915,1916, and 1917. By the latter year tobacco accounted for 70 per cent of Bulgaria’s exports, as opposed to 9.9 per cent in 1909. Thus, the government could offset its reluctance to move on the issue of dir
ect taxation by focusing on customs and excise, as well as its own monopolies, including patents for the production and sale of tobacco.

  Total tax income, which stood at 120 million leva in 1914, fell to 97 million in 1916, but recovered to 151 million in 1917 and 278.7 million in 1918. In real terms, however, the tax yield was a third that of 1914, and thus made no contribution to the costs of the war. Nor did it soak up the increased money supply, which saw the note circulation rise from 226.5 million leva to 2,298.6 million. Peasant debt was reduced, and bank deposits rose.256

  If any of the belligerents had a weak administrative structure accompanied by a limited fiscal base, it was Turkey. When the tax on cattle was quadrupled, Kurdish breeders simply moved beyond the reach of the Turkish army.257 On the other hand, the abrogation of the capitulations did create the opportunity, previously denied the Sublime Porte, to levy customs and excise. However, the tariff structure, designed on a provisional basis before 1914, charged imports according to weight, not value. During the war the latter rose while the former fell, but the Turks were reluctant to change for fear of trade suffering even more than was already the case. More successful were domestic taxes on non-essential items of consumption imposed in 1916/17. These included sugar, petrol, matches, coffee, tea, and playing-cards. The duty on alcoholic drinks was revised in 1918.

  Arguably, the empire’s most effective direct tax was the power to requisition goods in kind. A war tax for those of military age but exempted from service was a failure. The idea of war profits tax was canvassed by Djavid, the finance minister, in a budget speech on 3 March 1917. But he then affirmed his defence of the rights of private property and reassured his listeners by emphasizing his belief that in war as in peace personal profits added to the nation’s wealth. His budget for 1917/18 assumed that outgoings of £T52 million would be offset by receipts of up to £T23 million, but it also reckoned on peace within six months. At that point the tax system would be revised to raise the state’s income to £T35 or £T36 million. In November 1917, when it was clear that the war would not end as he anticipated, income tax was introduced, but it was not effective during the war itself.