Ione Mako: You’re listening to the Open Financeseries on Lessons From History from the Open University Business School. My name is Ione Mako, and today we’re taking a brief look at the introduction of income tax with Jane Frecknall-Hughes, Professor of Accounting at the Open University Business School. Hello, Jane.
Jane Frecknall-Hughes: Hello.
Ione Mako: So, tell me first of all, why was income tax introduced?
Jane Frecknall-Hughes: Well, at the time it was introduced England was engaged in conflict with France under Napoleon - and had been for a while - and money was running out, and it was a way by which the Government thought it could increase revenue. They wanted, originally, ten million pounds; they got six, so in monetary terms it wasn’t a huge success. But the money was very much needed because of the problems of the time.
England was very, very short of money generally, there were problems with feeding the army, the navy had mutinied because of poor conditions, huge national debt, steep inflation and things generally not looking too good. So that was one of the basic reasons for it, and I think, in many respects as well, it was very much a feature of the times.
Although we hadn’t had an income tax, it had been around as an idea for a very long time and particularly in conjunction with the French Revolution, where tax was one of the underlying reasons for that happening. And people like the political activist of the time, Thomas Paine, had actually introduced in his book The Rights of Man the same type of tax that Pitt eventually introduced, which was a graduated income tax, starting with a certain rate levied at, say, £60 per year, going up gradually.
And it was also discussed, I think, quite openly by the leading political writers and philosophers of the time, men like Samuel Johnson, David Hume, Adam Smith and so on, all of whom were thinking about not only the best way to tax the population but also whether the Government had the right to do so in the first place.
Now, given that these were the circumstances in which it was introduced, and there was a lot of unrest that was tax driven - there was the history of the war with American colonies that was based on the famous Boston Tea Party and so on, the ideas coming from the French Revolution - it was really quite a far-sighted and courageous thing that William Pitt did to introduce it, if you look at it in those terms.
Ione Mako: So what sort of taxes came before income tax?
Jane Frecknall-Hughes: Well there were lots and lots of different taxes and, basically, the Government didn’t change these - even though they could - for a very long time. They tinkered about with them, introduced perhaps a new one of the same sort, or changed the rates. And we’re talking really about things like excise duties as indirect taxes, and also a certain amount of direct taxation on things like, for example, individuals; there was a tax on bachelors for example. But there were …
Ione Mako: I’m sorry, can I stop you - a tax on bachelors?
Jane Frecknall-Hughes: Bachelors, yes.
Ione Mako: How did that work?
Jane Frecknall-Hughes: I’m not quite sure, to be honest, but I think the idea was that it encouraged people to get married and help generate some more members of the population when the population was in decline.
We’ve not only just had that in this country, it was in other countries as well, and certainly you can find examples of that in certain of the US states. But, there were things like window tax and half tax and taxes on soap and candles and beer and so on.
Ione Mako: So, VAT?
Jane Frecknall-Hughes: No, not exactly. It worked in a slightly different way, but the idea was, it was generated at a point during the production of these things, not always when somebody bought it, though it could apply in that way as well I think.
If you look at things like the window tax, that started in the late 1600s and gradually with that and the changing ideas the government was moving towards trying to tax people who were more able to afford it. So, if you had a big house with lots of windows you typically paid more tax because you had more windows (which was the basis on which you were assessed) than people who had smaller houses with fewer windows. And the same was true of an earlier tax that worked along similar lines (called the hearth or chimney tax), really.
But we do have different ideas, really, when we look back at those taxes as to what they were all about. Sometimes it was a tax on an article that people used widely because they couldn’t do without it, like candles or windows; sometimes it was a tax on a luxury item that was expensive and therefore the rate of tax was relatively higher.
But soap, for example, was considered in those days a luxury because people didn’t wash or bathe very often. And whereas today, for example, beer is a drink of choice, in those days it was almost a necessity, the reason being that the process of manufacturing beer involved boiling the product which made it safer to drink; whereas you would think that drinking water, if you couldn’t afford beer, would perhaps be better - not so, because it was contaminated by everything from raw sewage to waste from manufacturing.
So, those are the general sorts of taxes, and there were all sorts of different ones. There were also taxes on gloves and playing cards. I think on some packs of cards, even today, the Ace of Spades bears the mark or indication that it had been taxed as a pack of cards, because the designs just continued with the original notation that it had been taxed.
And things like hair powder, there was a fashion in the 1700s for wearing either your own hair powdered or powdered wigs, so the Government put a tax on the powder, and that eventually changed fashions because people didn’t like paying the tax so they stopped powdering their hair and wearing the powdered wigs and the wigs only remained as a feature of people in the legal profession. So, it’s had all sorts of different impacts really.
Ione Mako: Well, I’m going to go home and have a look at my playing cards now. So, William Pitt introduced income tax, and how did it then develop and why do we still have it?
Jane Frecknall-Hughes: Well, the reason it continued, really, was to fight the war against Napoleon, but there was an intermittent period of peace when it was repealed. The Prime Minister changed to somebody called Henry Addington; he brought it back and introduced certain reforms which actually extended the tax base, really, in effect, and raised more money. So that was quite a significant thing. And he introduced things that have remained with us to this day, like deduction of income tax at source - like, if you receive interest on your bank account you’ll receive it usually with the tax deducted so you don’t have to worry about it.
And he also classified taxes according to the source of income - or rather classified the sources of the income, I think it would be fairer to say - so that, if you had income from land it was called "Schedule A", the schedule just being the notification, the label if you like, and it would be taxed in a certain way. And those labels and classifications remain with us to this day, certainly for corporation tax for companies, though they have gradually disappeared from the personal tax legislation, we just refer to it as income from property these days.
You also asked why we still have it. Well, I think, basically, it’s a victim of its own success. It was never terribly popular but it did the job, and it did it, people eventually perceived, in quite a fair way and it raised a lot of money.
But it does linger as a temporary sort of measure because every year it has to be legally reimposed by the Finance Act and ceases each year on 5th April, and then we have a new Finance Act coming in later with bridging legislation to make sure that the Government can still collect tax in that interim period between one Finance Act ending and another starting.
There was a great move to get rid of it completely, particularly in the Victorian period. William Gladstone in 1853 when he was Prime Minister made a budget speech which was nearly five hours long, promising to phase it out by 1860, but it got hit by the need to raise finance again for war – and this time it was the Crimean War - and you can trace its continuance, really, linked to the theme of war quite significantly through to the, you know, First World War and so on. So it’s never going to go away I don’t think.
Ione Mako: What would you say are the pros and cons of income tax then, against the other forms of taxation?
Jane Frecknall-Hughes: Well, income tax is actually quite convenient to pay. Adam Smith and his four famous “canons of taxation” said that one of the things that should characterise a good tax is its certainty and convenience of payment. And, while you might not think it’s very convenient to have a chunk of your wages deducted as tax each month, in actual fact it is, because you are then not faced with a huge tax bill at the end of the year.
Now that’s for wage earners, people who are in business can also pay it in instalments, so it’s still quite an effective means of gathering tax. And also, in stable times, reasonably predictable, you know roughly how many people are in employment, you know what the tax take is likely to be. Less so these days with people losing their jobs, so that has enormous implication for government revenue raising really. So it’s …
Ione Mako: At the very moment when the debt is highest, we also are raising less income tax.
Jane Frecknall-Hughes: Yes, and we need more money to pay people who are out of employment and on benefit as well. So that’s really one of the reasons I suppose that tax rates have gone up for the higher earners, to compensate, really.
Ione Mako: So Jane, what would you say are the overall pitfalls and advantages of income tax?
Jane Frecknall-Hughes: Well in terms of the advantages first, if I may, from the taxpayers’ point of view, it’s actually a very effective way of having tax collected from, in terms of what you might owe the government.
For the Government it’s easy to increase rates, it gives them a certain flexibility, they can predict how much more, say, a percentage increase in rate will bring in in terms of tax take. You can do that, or they can do that, without really changing the infrastructure of the tax, which is helpful. The disadvantages generally of income tax is that, if you increase it, it creates a level perhaps of complexity that wasn’t there before. If you’re talking in terms of graduated rates there will be another layer of complexity to add onto an existing calculation; it makes it more difficult, particularly as the onus falls on the tax payer to do the calculations.
And also, if rates increase, people find that a very unwelcome thing, it makes them feel as if they are paying more than perhaps they ought to be and it sort of pushes them perhaps towards means of trying to avoid it in a way that the government didn’t intend that they should. So, overall, it may be good for the Government but not so good for the taxpayer in terms of ways of increasing the tax.
Ione Mako: Lovely. Thank you very much, Jane. You’ve been listening to Open Finance on Lessons From History from the Open University’s Business School.
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