History of Income Tax

Income tax is a vital source of funds to any government. Money raised by taxing the working population can be used to fund infrastructure development as well as improving the standard of living in the country. United Kingdom was the first the country to establish a working income tax on its civilians in 1799. Initially implemented as a temporary source of income to fund the war to beat Napoleon, income tax is now an essential source of revenue for the government all over the world.

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This report will look at the significance of income tax in the UK since the late 18th century, through World War 1 and World War 2, and how it has evolved into the tax system, currently in practice. Income tax still remains as a temporary tax, and must be renewed on 5th of April through an annual financial Act by the parliament. The Prime Minister, and the Chancellor of Exchequer William Pitt the Younger introduced income tax in 1799. The sole reason the tax was introduced was to beat the French army under Napoleon. Napoleon’s army was better prepared and Britain was in danger.

The cost of war was high which led to Britain under national debt. This led to the army being provided with less food and treated poorly, which resulted in the soldiers to go on an open rebellion against the government. Direct tax upon income was intended to be a temporary solution and it was referred to as a tax to beat Napoleon. The tax was to be paid in six equal installments at a rate of 10%, people earning above ? 60 had to pay the tax. Only about one-sixth of the money was raised from the income tax, but it had proven itself a most valuable addition to the government revenue.

Pitt’s income tax was not very successful as he estimated an unrealistic figure of ? 10 million in 1799, but the actual amount received was less than ? 6 million. In 1800 he estimated ? 7 million yet it was below ? 6 million. In the following year in 1801 he budgeted a realistic value of ? 6 million but it dropped to ? 5,300,000. In 1802 Henry Addington replaced William Pitt as the Prime Minister. A peace treaty was signed with Napoleon, this allowed Addington to repeal income tax. But the war began again in 1803, Addington had to introduce income tax again as his budget exceeded by 12,500,000.

Addington came up with the Addington Act, he introduced two important innovations. Taxation at source * The Bank of England deducting income tax when paying interest to holders of gilt The Income tax divided into five types of ‘Schedules’ * Schedule A – Income from land and buildings * Schedule B – Farming profits * Schedule C – Annuities payable out of any public revenues * Schedule D – Self-employment and other items that are not covered in schedules A, B, C, or E. * Schedule E – Income from salaries, annuities, and pensions

With Addington’s method of taxation, the number of taxpayers doubled and revenue received from income tax rose by half. Although Historians have not referred to Addington as a Chancellor of the Exchequer very often, these schedules are still in use today. As Napoleon got defeated in the year 1815, income tax was repealed because the people perceived it as only a war tax since it had been born of a war and that the tax should not continue in time of peace. During the mid 1800’s United Kingdom witnessed a significant social and economic transformation, child labour was declining and slavery was eliminated all over the empire.

Sir Robert Peel who was part of the conservatives won the general election and was elected as the Prime Minister in the year 1841. ‘When Sir Robert Peel undertook the government in 1841, it was a period of confusion and darkness…. the new minister found an empty Exchequer, a growing deficit’. Even though Sir Robert Peel was not in favour of income tax, he introduced income tax again in his Budget of 1842 that was considered to be one of the most famous in the 19th century. Peel taxed people earning above ? 150, this resulted in favour of the less wealthy people.

Also under custom duties there were 1200 articles, of which Peel reduced 750 articles on his budget. His taxation plan was on action for a period of three years. But it was extended for another two years due to an increase in the national expenditure, and also to help the national railways because the railway industry had less money. When cheaper imports were available, Corn Laws were created which is a tariff on imports. This helped the local farmers as they had a competitive advantage, but Peel repealed the Corn Laws. This made him loose support of his party.

William Galdstone and Benjamin Disraeli had complete authority during the second half of the 19th century. From the year 1853 to 1866, William Gladstone was elected as the Chancellor of the Exchequer. Gladstone did not follow Peel’s method of income tax policy; instead he wanted to terminate it. He also believed that government spending should be kept to a minimum level. Gladstone reduced the income tax exemptions from ? 150 to ? 100; he thought that if more people pay then there would be a huge pressure form the public to repeal the tax.

But in order to fund the Crimean war, Gladstone brought the income tax back. Gladstone believed that he could receive a lot of revenue in the 1st year; therefore he increased the tax rate from 7d to 101/2d. But Gladstone realized that money the government received was not enough, thus in the following year he doubled the tax rate to 1s 2d. At the turn of the century, only a small proportion of the working population paid tax on income. It was common for the wealthier people in society to pay taxes rather than the poorer. 907 saw the introduction of personal allowances to the tax system. This allowed taxpayers to a certain level of tax-free income. When the new government took over, the people perceived tax in a different way. From being used to only fund the war, they were aware of how it is been used to improve their lives. However in 1909 Chancellor of the Exchequer, Lloyd George, compiled a People’s Budget in which he wanted to implement a progressive tax system on income. This would mean a tax liability of 1s 2d in the pound to anyone earning more than ? 3000.

Lloyd George believed a tax system in which everyone contributed, regardless of how rich or poor they were. In theory this was a good idea, however many people were angered by this radical concept. During the year 1909, Lloyd George introduced non-contributory old age pensions. Also included in this People’s Budget was a tax of 6d in the pound for anyone earning ? 5000 or more, this is a super-tax for the rich people. The budget was presented to the House of Lords who rejected it resolutely. This lead to the 1911 Parliament Act, which removed the House of Lords power of veto.

The People’s Budget was implemented in 1910 with great economic success, raising a surplus of ? 5,607,000 in 1910- 1911. World War 1 had a huge impact in the United Kingdom, ten million people were dead and twenty million were injured of which one-tenth were British. Like always World War 1 resulted in an increase in government expenditures, thus tax revenue was an important source of income for Britain. During the beginning of the World War 1 the standard tax rate was 6%, which gave revenue of ? 4 million, and an additional amount of ? 3 million using super-tax. As the war progressed, there was a huge increase in the number of men fighting for the war. Therefore spending money on military weapons, ammunition, and the shipping costs rose. Hence the government had increased the tax rate as the war continued, ultimately reaching 30% in 1918. This resulted in providing an income of ? 257 million with a further ? 36 million under super-tax. Government raised the number of taxpayers by reducing the exemption limit from ? 160 to ? 30 in 1915, also a rise in wage and price inflation led more people to pay income tax, therefore people who were exempt from paying tax beforehand, were now pushed into the tax bracket due to inflation. Before the 1st World War there were 1. 1 million taxpayers, but by the end of the war the number of taxpayers rose to 3. 5 million people. Regardless of having a huge tax rate, most of the money for Britain came through borrowing and an inflationary increase in the money supply. Mallet, B. and George, C. O. (1929), British Budgets, Second Series, 1913/14 to 1920/21, London: Macmillan.

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