The Immediate Post-War Squeeze

The Attlee Labour Government was elected in July 1945, two months after the end of the war in Europe. But the war with Japan did not end until the following month, demobilization of those who had been conscripted into the armed forces was not complete until 1947 (Allport 2009), and the UK remained on a 'war footing' as far as parliamentary control of public finance was concerned until 1946.[1] But the Treasury resumed its control of large parts of departmental spending (delegated to departments during the war) in mid- 1945, meaning it could once again challenge and delay spending plans in many policy domains.

The challenge facing the government was to deliver on promises for postwar welfare state expansion while managing a transition from a wartime command economy to a peacetime mixed economy in the face of severe financial challenges. There were serious balance of payments problems arising from the dissolution or sale of UK overseas investments during the war and consequent loss of invisible earnings. And to cover the gap left by the abrupt ending of 'Lend-Lease' in 1945, 'soft' loans had to be negotiated in 1946 with the governments of the United States (some $3.75bn over a fifty-year period, conditional on sterling being made convertible from 1947) and Canada ($1.25bn). But even these amounts were soon exhausted.

The Labour Government's first Chancellor, the economist Hugh Dalton (who had hoped to be Foreign Secretary) cheerfully set about increasing welfare state spending as military spending fell. During the first eighteen months after the Labour Government was elected, some 4.3m service personnel were demobilized, which involved extra short-term government spending on gratuity payments on discharge[2] and other benefits (considerably more generous than those issued after World War I), but meant that defence spending and staffing fell rapidly in the medium term.

Against that drop in military spending, Dalton increased spending on education and food subsidies (the latter intended to offset living costs and limit pressure for higher wages). He also brought a key (and costly) part of the Beveridge Plan into effect in mid-1946, namely universal family allowances to mothers with children. But severe physical shortages of building and other materials, partly imposed by shipping constraints, also limited the government's capacity to deliver on some kinds of expansionary policies, for example, for building houses, schools, and hospitals, for some years after the war, and those shortages helped to keep spending in check at first. Moreover, the National Health Service, the flagship and most costly part of the Beveridge Plan agreed by the wartime coalition in 1943, did not come into existence until mid-1948, such that its first full year of operation was FY 1949/50, and that also had the effect of postponing the associated spending increases.

On the tax side, wartime Treasury archives record discussions among officials (reflecting on what had happened two decades earlier after World War I) about how far it would be feasible and desirable to continue with high wartime tax levels after the war. For example, in mid-1941 Hubert Henderson (a leading academic economist working in the wartime Treasury) accurately predicted there would be inflation rather than deflation after the war, and advocated 'maintaining taxation at a high level' to restrain consumer purchasing power and pay for wartime government promises entailing expansion of the welfare state.[3] In similar vein, the Permanent Secretary of the Treasury, Sir Horace Wilson,[4] two years later argued for retaining war taxation after the war ended 'until we can see other means of keeping the situation in control' and to pay for extra social expenditure. Others were more sceptical about the political feasibility of continuing with high wartime tax rates during peacetime. For example, Sir Herbert Brittain, a career official who had been in the Treasury since 1919 and therefore lived through the post-World War I episodes described in Chapter Three (Booth 2004), wrote that 'onerous taxation readily endured in war becomes very irksome in peace. Public opinion will... expect large reductions in rates of taxation rather than the maintenance of wartime rates... of previously unexampled severity.'

Brittain's political judgement seems to have been partially correct. There was some easing of wartime taxation, and tax revenues fell relative to GDP over this period. The Excess Profits Tax was abolished in 1946, immediately after the war, in contrast to what happened after World War I, and contrary to Sir Horace Wilson's suggestions for prolonging the tax into peacetime. Chancellor Dalton also significantly narrowed the tax base by raising income tax thresholds to take some 2.5m of the 14m income taxpayers in 1945 out of the tax net. But at the same time, post-war credits (the system in which part of extra taxes were to be repaid after the war) were abolished, while high tax rates remained, particularly for higher earners, meaning that the fiscal squeeze on those taxpayers increased.

Even the lower earners taken out of income tax by higher tax thresholds in many cases faced increased compulsory National Insurance contributions (a social security tax, but administratively separate from income tax) to cover half of the cost of extra spending on the National Health Service and family allowances. Dalton also doubled tobacco duty at a stroke in the 1947 budget (coupled with a costly and elaborate scheme to limit political resistance to the tax increase by allowing old-age pensioners who declared themselves to be habitual smokers to reclaim part of the duty).

Further, many taxpayers faced a long wait for repayment of post-war credits on their wartime income and tax payments. The Treasury's strategy for repaying these credits was to redeem the business tax credits quickly (to provide firms with working capital to enable them to move to peacetime operations), while delaying repayments to individual taxpayers for as long as possible until they had been eroded by inflation. Hence those credits were not released to individuals until they reached pension age (then sixty-five for men, sixty for women), no interest was paid until 1959, no adjustment for inflation was made on delayed payments, and no repayment was made even in cases of hardship.[5] Indeed, those credits were not fully repaid until the 1970s, almost thirty years later.[6] [7]

The post-war combination of redistributive taxation and food subsidies linked to rationing seems to have hit middle-class voters harder than the lower paid or those on benefits. But at the same time, the Attlee Government followed the same course as its post-World War I predecessor in choosing not to impose a levy on wartime increases in wealth to pay down wartime debt. As was noted in Chapter Three, the left called for such a levy in World War I, arguing that if labour was conscripted for war service, the same should apply to capital. The idea re-emerged when the government that preceded the Churchill coalition introduced conscription just before the outbreak of World War II and promised that in the event of war there would be heavy taxation of the wealthy and an Excess Profits Tax. The then prime minister, Neville Chamberlain, had tentatively mooted the idea of a levy on wartime increases in wealth, and the first Chancellor of the Churchill coalition government (the Liberal Sir John Simon) even implied in his first budget that such a scheme was being prepared for possible introduction at the end of the war.

But, as in World War I, Treasury officials vigorously opposed the idea, on grounds of the cost and bureaucratic effort required to value all the country's capital assets at once, particularly during a time of unstable prices such as had occurred in the aftermath of World War I, as well as the possibly adverse effects on business confidence and entrepreneurship.11 Instead, as also happened after World War I, Dalton raised rates of inheritance tax and surtax on higher incomes, which Treasury officials had argued to be a more practical and efficient alternative to a capital levy. Indeed, Martin Daunton (2002:189) argues that high levels of income tax at that time functioned as a form of capital levy, forcing the wealthy to live on their capital assets and all but confiscating high unearned incomes.

  • [1] The 'Votes of Credit' system (the system for wartime financing through blocks of fundingallocated without estimates) was replaced at the start of FY1947/47 by the pre-war system ofestimates and appropriations, following what had been done at the end of World War I (T160/1313 (1945 estimates), file 11904, p. 45).
  • [2] The Spectator, 'War Gratuities', 9 February 1945, p. 2: Total demobilization costs were estimatedat about ?7bn at then current prices.
  • [3] Sir Hubert Henderson 'Notes on Post-War Economic Problems', June 1941 in T160/1407'Economy in Public Expenditure'.
  • [4] Undated 1943 memo to the Chancellor from Sir Horace Wilson, in T160 1407, 'Economy inPublic Expenditure'.
  • [5] HC Deb 2 November 1948, cc.676-8.
  • [6] Sir Horace Wilson's 1943 memo said, 'the desirable course would be to pay out theE.P.T. [Excess Profits Tax] money very quickly and the Income Tax credits after as long an intervalas possible' (T160/1407, 'Economy in Public Expenditure').
  • [7] Undated memo (probably 1943) by Sir Richard Hopkins on the question of a capital levy afterthe war, T160/1407 'Economy in Public Expenditure'.
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