Tax during war time

Introduction

“War… What is it good for?”

In fiscal terms, one answer is raising taxes.

Throughout history, war and the preparation for war have been catalysts for expanding the tax system and the tax burden.

The UK experience, from medieval monarchs to the modern day, vividly illustrates how conflict-driven needs for revenue led to higher taxes, broader tax bases, and new taxation methods.

The King’s war chest

In medieval England, monarchs relied on a patchwork of income sources to fill their “war chests.”

It was quite literally a chest in which money was collected for…err… funding wars.

Under feudal obligations meant nobles owed military service or scutage (money in lieu of sending knights) to wherever the King could use a jolly good knight or two.

These revenues often fell short during wartime, forcing kings to seek extraordinary taxation.

For example, King John in 1205 imposed a tax on movable goods that raised a staggering £60,000 (about one year’s royal income) to finance his military campaigns.

Such broad-based levies were risky and unpopular, since they affected a wide swath of the population on top of existing feudal dues.

Indeed, the backlash against heavy war taxation helped spur the principle that taxes required consent, laying foundations for the English Parliament.

As warfare grew more expensive in the 14th century (with costs of mercenaries, armour, and early gunpowder), monarchs pushed taxation even further.

England levied several poll taxes (no, not that one) in the late 1370s to fund armies during the Hundred Years’ War.

The poll tax of 1381, broadly a flat charge on every adult, proved the breaking point and sparked the Peasants’ Revolt, a gory period in English history that I have written about before.

Despite the turmoil, the relentless costs of war actually strengthened the fiscal role of the state. By the late Middle Ages, war had become “a much more complicated and expensive business” requiring resources beyond what nobles alone could provide.

Kings who managed to fund these rising costs (through taxes, loans, or squeezing out loans from Italian bankers at high interest) gained leverage over their barons.

In other words, the expense of war contributed to the rise of a stronger central state. A pattern noted by historians and encapsulated in the saying “war made the state.”

The medieval war chest thus foreshadowed a future in which broad taxation powers would become a permanent fixture of governance, especially in times of conflict.

Pitt v Napoleon

At the dying end of the 18^th century, a little man with a big ego was throwing his weight around in Europe. His name was Napoleon. You might have heard of him.

At the same time, William Pitt the Younger, at an impossibly young age of 24, was the UK’s prime minister. He wasn’t given a particularly easy ride as, at the same time, King George III was losing his marbles.

Pitt, a devotee of Adam Smith’s ideas, had already tried to make taxation more rational and oriented toward the well-off. But war pressures in 1793–1798 forced far more radical measures.

The new income tax applied a 10% rate on annual incomes over £200 (with graduated rates for incomes between £60 and £200, and an exemption for the poorest under £60). Though highly unpopular and initially evaded as an intrusive “tax on privacy,” it soon came to be accepted as the price of national survival. Many even saw paying it as a patriotic duty to defeat Napoleon.

Crucially, Pitt’s 1799 tax introduced the “remittance basis” principle – an accommodation for Britain’s global interests. He exempted overseas income from UK tax, aiming not to alienate wealthy colonial merchants and officials.

In Pitt’s view, these early “non-doms” (non-domiciled individuals), such as planters earning fortunes in Jamaica or traders in India, might have rebelled against a full tax on their foreign profits. So only money remitted to Britain would be taxable.

This war-time compromise set a precedent and the remittance basis remained a feature of UK tax law for over two centuries until its link with UK tax was largely abolished this year.

Pitt’s income tax was intended as a temporary wartime expedient, and it was repealed after Napoleon’s defeat.

However, the genie was out of the bottle.

When Britain faced budget strains again in peacetime, income tax was revived in 1842, becoming a permanent pillar of the tax system.

The Napoleonic conflict thus gave Britain not only victory at Waterloo, but also the prototype of the modern income tax.

Don’t remember ABBA singing about that second bit.

Pre First World War

In the decades before World War I, Britain’s tax system was relatively low-pressure and narrow in reach.

The tax burden was quite uneven and even regressive in effect. Lower-income households paid a significant share of their meagre earnings via taxes on everyday goods (tea, sugar, tobacco, beer), whereas the rich paid comparatively less of their income in tax.

For example, around 1914 a worker earning £50 a year might pay 8% of his income in indirect taxes, while someone making £200 paid only ~4% in tax.

Only the very richest (incomes above £10,000) faced a similar 8% burden, through a modest income tax and “super-tax” on the highest earners.

Unfortunately, Gross Domestic Product (“GDP”) estimates for the UK did not begin until decades later, so it is not possible to provide an exact figure for tax as a percentage of GDP

However, estimates suggest that tax revenue in 1910-1911 was equivalent to around 10-15% of GDP. Tax revenue in 1910-1911 was therefore a relatively small proportion of the overall size of the UK economy.

In short, on the eve of WWI, Britain was a low-tax economy with limited direct taxation and most citizens outside the income tax net.

The Great War changed everything.

Forever.

The demands of total war forced a dramatic expansion of taxation, in scale and scope, to levels previously unthinkable.

Parliament, confident of public support to win the war, enacted steep tax hikes to fund the unprecedented military expenditure.

The standard income tax rate, just 6% in 1914, quintupled to 30% by 1918.

A special higher-rate “super tax” was imposed on top incomes, and excess profits duty targeted wartime windfalls (an 80% tax on profits above pre-war levels by 1918).

Perhaps more striking was the broadening of the tax base, where the number of Britons paying income tax tripled in a few years, from about 1.1 million in 1914 to 3 million by 1920.

By the war’s end, income and super-tax combined contributed roughly 60% of government revenue, versus a much smaller share pre-war.

This shift marked a historic transformation of the UK fiscus from a light, indirect-tax state into a modern tax state with mass participation.

Not all these wartime taxes endured at peak levels.

Some rates were trimmed and the excess profits duty was dropped in the 1920s. However, the precedent of broad, graduated taxation had been set.

WWI proved that when the stakes are national survival, the public will bear heavy taxes, and the state gains new fiscal capacities that often persist.

Economists later theorised this as the “displacement effect” and that wars create a permanent upward shift in acceptable tax levels, as citizens come to tolerate a higher post-war tax burden than before.

Indeed, many social programs of the 1920s–30s were financed by the income tax infrastructure built during WWI.

World War II

In 1936, the tax-free allowance had been reduced significantly from its initial level in 1910. Stealth tax was born!

As such, a larger proportion of the UK population was subject to income tax in 1936 (approximately 11% of the UK population).

Still, the vast majority of the UK population did not have to concern themselves with icky income tax. Taxes were still only for the big people.

Estimates suggest that it is likely that tax revenue in that year was equivalent to around 15-20% of GDP.

But,as the clouds of World War II gathered, Britain again ramped up military spending and, you guessed it, tax collection.

Even before the war began, rearmament in the late 1930s drove fiscal changes.

By 1938, the standard income tax rate had been raised to 5s 6d in the pound (about 27.5%… I think!) with an added surtax of 41% on ultra-high incomes over £50,000.

The tax base had widened enormously since WWI with roughly 10 million Britons were paying direct taxes by 1938. This being a far cry from the exclusive pre-1914 income tax.

This meant that when WWII erupted, the government could draw on a much broader populace of taxpayers.

During the war, taxation ratcheted up further to meet vast spending needs. Standard tax rates climbed (into the 40–50% range and higher for top slices), and purchase taxes (a precursor of VAT) were introduced to discourage luxury consumption.

However, a key innovation was administrative rather than a new tax. In 1944 the UK introduced PAYE (“Pay As You Earn”).

Another fiscal development of the WWII era was the expansion of National Insurance (NI). This system of compulsory contributions began before WWI but expanded after WWII as part of the welfare state.

Post-War Tax Measures: Windfalls, Wealth, and ‘Wartime’ Economics

By the time Queen Elizabeth took the throne in 1952,

According to historical records, in the tax year 1952-1953, approximately 14% of the UK population  paid income tax. This represented a slight increase from 1936.

In 1952, it is likely that tax revenue was the equivalent of around 20-25% of GDP.

However, slap bang in the middle of Elizabeth II’s reign, it the OBR states that the all-time high (44.2%) for tax revenues was in 1981/2 and the beginning of Margaret Thatcher’s first stint as PM.

By the time Charles III was coronated, the Office for Budget Responsibility (OBR) forecast (published in March 2021), it was estimated that around 55% of UK adults paid income tax in the tax year 2020-21.

Figures from the Office for National Statistics (ONS), the UK tax revenue as a percentage of GDP was 34.3% in the financial year 2020-21. This is slightly higher than the 33.7% recorded in the previous year, primarily due to increased government spending in response to the COVID-19 pandemic. It is noted that other research has a much higher figure.

Perhaps of greater concern is that the UK’s tax burden is set to rise to a post-war high of 37.7 per cent of GDP in 2027-28.

In the post-war era, governments also often resorted to windfall taxes or special levies in the aftermath of crises, following precedents set by the world wars.

For instance, during both WWI and WWII the UK (and many other countries) had excess profits taxes to capture extraordinary war-time profits.

Britain’s Excess Profits Duty (1915–1921, later extended) taxed up to 80% of profits above pre-war normal levels, and a similar Excess Profits Tax was re-introduced in the late 1930s before WWII.

These were essentially windfall taxes on companies benefiting from war contracts or scarcity to curb “war profiteering”.

Such taxes were typically temporary, ending a few years after hostilities, but they set a template for future policymakers facing windfalls from exogenous shocks.

In recent times, the concept has re-emerged in peacetime crises.

The COVID-19 pandemic (2020–21) was often likened to a “wartime economy”. A similar shock to those generally brought about by war and one which required a huge fiscal response.

The UK government’s deficit in 2020/21 ballooned to £315 billion, nearly 15% of GDP, the highest borrowing since WWII (and a peacetime record).

To save the economy, the Treasury underwrote furlough schemes, business loans, and health spending on a scale reminiscent of war mobilization.

With public debt surging, economists and commentators drew parallels to wartime finance. Some advocated reviving wartime-style excess profits taxes to ensure those who prospered unusually during the pandemic paid their share.

Indeed, even as many industries suffered losses, certain companies (in e-commerce, technology, PPE supply, etc.) saw windfall gains thanks to pandemic-driven demand.

Proposals were floated for a “pandemic excess profits tax” modelled on World War II-era taxes. In other words, a special levy on profits that were “over and above” normal levels, arising solely due to the crisis.

Though the UK did not ultimately implement a broad COVID windfall tax on all sectors, it did introduce a related measure in 2022: a one-off Energy Profits Levy on oil and gas companies, following a post-pandemic surge in energy prices exacerbated by war in Ukraine.

Another post-war parallel was discussion of a one-time wealth tax or “capital levy” after WWII. This was an idea considered (though not enacted) in Britain to claw back some wartime wealth accumulation and help reduce debt.

Similarly during COVID, there were calls (from groups like Oxfam and some economists) for one-off wealth taxes on billionaires who saw massive gains while the broader economy suffered.

Indeed, calls for a wealth tax are never far from the surface when tax policy is being debated!

The current geo-political context

Today, real wars and rising geopolitical tensions are again testing the limits of the UK’s public finances.

The war in Ukraine since 2022 has not only created economic spillovers (energy shocks prompting the UK’s 2022 windfall tax), but also spurred a fundamental rethinking of defence spending.

British leaders across the spectrum agree that a more dangerous world may require significantly higher defense outlays… and that brings the debate back to taxes!

In April 2024, John Healey (Defence Secretary) unveiled a major Strategic Defence Review amidst cross-party acknowledgement that “the world is more dangerous” and the UK must be ready for possible great-power conflict.

The review set an ambition to raise UK defence spending from the NATO minimum of 2% of GDP toward 3% of GDP by the 2030s.

Such an increase would amount to tens of billions of extra pounds annually for the military and what has been described as a “war readiness” budget.

When pressed on how Britain would afford this, Healey pointedly did not rule out tax rises to fund the defence uplift.

He stated that the government would outline the funding plan in due course, noting they had already made “tough decisions” like shifting money from foreign aid to defence for an interim boost to 2.5% of GDP.

But economists quickly warned that “significant tax rises would be needed” to reach 3% GDP on defence, unless deep cuts were made elsewhere.

The Institute for Fiscal Studies weighed in with a clear analysis: beyond a certain point, reallocating from other budgets (like aid) is insufficient and getting to 3% GDP on defence will require either higher taxes or painful spending cuts in other areas.

In the IFS’s words:

“if defence spending needs to go higher than 2.5% of GDP, cuts to aid won’t be enough… 3% of GDP will eventually mean more tough choices and sacrifices elsewhere – whether higher taxes, or cuts to other bits of government. The world has changed… pre-existing promises on tax and spend might need to change as well.”.

This view highlights a historical pattern repeating itself: rising military threats = rising fiscal burden.

It therefore appears that the UK is on the cusp of another “war and taxes” inflection point.

The Government has already announced an ambition to hit 2.5% of GDP for defense by 2027, with further increases towards 3% later.

Achieving this in a sustainable way likely means confronting politically difficult choices, possibly reminiscent of past war budgets.

Conclusion

To wrap this up, the historical record suggests that when security threats loom, the taxman’s call to arms is not far behind. From medieval kings emptying their coffers and stoking revolt with poll taxes, to Pitt’s invention of income tax for the Napoleonic wars, to the mass taxation of the world wars (with PAYE as a lasting legacy), war has been a powerful driver of tax increases.

History suggests that preparing for war, or confronting other grave crises, tends to lead to higher taxes and broader burden-sharing.

As the saying (with a twist) goes, nothing is certain except death and taxes… and war has a way of hastening both.

The fiscal hawks may argue, as always, whether to borrow or tax in the immediate term. But the lesson from “tax during wartime” is that sooner or later, the bills come due, and society is changed by how they are paid.

So, tax and war. It ain’t no party. It ain’t no disco.