The World War II Revenue Squeeze

World War II saw a perhaps unprecedented (and certainly unrepeated) revenue squeeze, greatly exceeding that of World War I, with both tax rates and tax coverage dramatically increased. Martin Daunton (2002:176-7) points out that whereas the main features of what he calls the 'fiscal constitution' survived in World War I—that is dependence on progressive direct taxation and rejection of both a general sales tax and regular taxes on business profits—and that war had been funded largely by borrowing rather than by tax increases, the relative share of loans and taxes was reversed in World War II. The share of indirect taxation started to rise in 1942 for the first time in a century, with higher rates on existing indirect taxes and a broader sales tax (Purchase Tax, collected from wholesalers) with rates ranging from zero per cent on some goods to 100 per cent on others. But those tax increases were partly offset— particularly for those on lower incomes—by food subsidies introduced at the start of the war.

The numbers paying income or surtax rose from ten to fourteen million between 1939 and 1945, the standard rate of income tax rose from 29 to 50 per cent, and surtax rose from 41 per cent on incomes over ?50,000 to 48 per cent on incomes over ?20,000, amounting to nominally confiscatory rates of taxation (98 per cent) for top earners. As in World War I, an Excess Profits

Tax on companies was introduced early in the war (before the formation of the Churchill coalition in 1940), levied on the difference between wartime profits and pre-war or 'standard' profits, but at even higher rates than those imposed in World War I (the tax was initially levied at 60 per cent and later at 100 per cent). In addition, a completely new administrative system, 'Pay as You Earn' (PAYE) was introduced in 1944 for collecting income tax from millions of employees by obliging their employers to deduct tax at source from each wage payment through a coding system updated through the year instead of the previous system of annual or twice yearly lump sum payments from each income tax payer. Many have described this system as the major tax invention of World War II and see it as having enabled governments long after the war to tax earnings more heavily than would otherwise have been possible (for example, Houghton (1979): 97).

Along with that extreme revenue squeeze during World War II went a squeeze on civil expenditure that is concealed in the aggregate numbers shown in Chapter Two. Those aggregate numbers for total government spending reflect a huge spike in defence expenditure partly funded by borrowing (including the wartime 'Lend-Lease' scheme begun in 1941, under which the United States supplied the UK, along with other Allied countries, with food, oil and military materiel in exchange for use of military bases) and producing massive, off-the-scale budgetary deficits. Little or no investment took place throughout the war in domestic public services (such as schools, hospitals, roads, housing), and in many cases staffing in these services was severely run down as well, for example through the conscription of many doctors of military age into the armed forces, creating a major shortage of doctors for the civilian population.

These huge tax hikes and the accompanying squeeze on civilian spending took place at a time when, as noted earlier, mainstream party competition for votes was effectively suspended, under a wartime coalition government. All the political parties in that coalition consequently shared the blame for the wartime fiscal squeeze and the non-fiscal austerity that accompanied it. But the three parties also combined to make big promises to the voters for 'jam tomorrow' after the war. One such promise comprised 'post-war credits' for both income and corporate taxes. These credits (a unique policy innovation, not having applied to World War I) were in effect post-dated cheques in the form of a promise to repay that part of the extra tax paid as a result of the reduction of personal tax allowances. But of course it was not specified precisely when after the war that repayment would occur.

A second was the famous 'Beveridge Plan' for expansion of the welfare state (incorporating new family allowances, an extension of social insurance, and plans for free public health care), which was agreed in principle by Parliament in 1943. As with post-war credits, this promise was not fully specified—the

Lord President of the Council (later to be Chancellor) said on behalf of the government in 1943 that there could be no final commitment to the Plan until after a comprehensive review of the financial situation.[1] A third major promise made in the following year was the1944 Butler Education Act which provided for free secondary education combined with a higher school leaving age (implying educational expansion of the kind that had been hit by the cuts of the 1920s). In all of these cases (and for other less expensive promises made during the war, for example, for the development of town and country planning), there was scope for delay and modification of details, but it would have been politically difficult for any of the three parties to have reneged completely on these promises.

An exchange of correspondence in 1944 between the Chancellor, Sir John Anderson, and the wartime prime minister Winston Churchill (who was alarmed about the likely cost of the coalition government's commitments to extra public spending after the war) shows what those promises were expected to cost at that time.[2] The extra costs of the National Health Service and family allowance scheme involved in the Beveridge Plan were then estimated at some ?239m per year, with ?147m of that amount being met through extra compulsory 'insurance' contributions from employees and employers (public and private), and the other ?92m per year to be raised through higher taxes or extra borrowing. The cost of the plans for free secondary education up to the age of fifteen provided for in the 1944 Butler Education Act were estimated at ?58m per year, and there was also another extra ?90m per year of spending expected on post-war water supply, temporary housing, Town and Country Planning, new roads, and extra pensions. The Chancellor noted the power of delay (by using Treasury approval powers to slow down developments) as a way of checking these costs, and there seems to have been some disagreement within the cabinet about the speed with which to press ahead with developing bureaucracies to plan the implementation of the Beveridge Plan, and thus over whether any post-war government would hit the ground running or crawling on the issue.[3]

Each of the parties in the coalition government developed its own 'spin' and image during the course of the war, with the Labour Party in particular successfully producing a 'narrative' that discredited the Conservative-led governments of the 1930s as years of policy failure and wasted opportunities. But there were no national general elections for a whole decade between 1935 and 1945 and no regular local government elections were held during the war either. Further, as in World War I, the three parties within the wartime coalition government operated a 'truce' or cartel, in the form of an agreement not to contest by-elections when vacancies arose in the seats held by other parties. So the possibilities of electoral punishment by voters for the revenue squeeze (or indeed any other aspect of policy) were greatly diminished, and many of the wartime by-elections resulted in candidates from the incumbent parties being returned unopposed with very low voting turnouts. But in a few cases radical independent or minor party candidates succeeded in defeating candidates of the coalition parties, such as the 'independent Labour' candidate Tom Driberg, who defeated the incumbent Conservatives in Maldon in 1942, and the Scottish National Party candidate Robert McIntyre, who defeated the incumbent Labour Party in Motherwell in 1945 (producing the SNP's first electoral victory, and echoing fiamon de Valera's victory for Sinn Fein in the North Clare by-election in World War I).

The post-war general election was therefore the first for ten years, and produced an unexpected landslide victory (with a 145-seat majority in Parliament) for the Labour Party under Clement Attlee, while reducing the Liberals to a fringe party. The Labour Government therefore did not depend on the support of other parties for its survival as the two pre-war Labour Governments had done. But of course it also approached that task with memories— and the mythology—of the dramatic politics of the 1931 fiscal squeeze fourteen years earlier, as described in Chapter 4.

  • [1] Letter from the Chancellor to the Prime Minister, 27 June 1944, T160/1408 (Treasury file,National Archives).
  • [2] Letter from the Chancellor to the Prime Minister, 27 June 1944, T160/1408.
  • [3] Note from the Prime Minister to the Chancellor, 25 June 1944, T160/1408.
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