The Modern Era of Taxation - UK

Income tax was first introduced in 1799 as a temporary measure by William Pitt (The Younger), the UK Prime Minister at the time, as a temporary measure in order to help finance the Napoleonic wars.

Pitt borrowed money against future excise revenue in order to finance the war. However, it became apparent that the war was going to last too long to enable this method of financing to be sustained. Pitt introduced a new way to raise taxes based on an income tax at a rate of 10% which was targeted on the rich middle and upper classes. Unfortunately, this meant that it became necessary for an individual to declare his/her income.

The law bringing this new tax into force did not allow for any control over enforcing the correctness of the return. In an attempt to reduce the widespread evasion that this brought about, withholding taxes were introduced by the Bank of England, by paying its dividends net of tax.

Pitt resigned in 1801 and his Income Tax was repealed in 1802 by Henry Addington (UK Prime Minister after Pitt)?

In 1803 Addington reintroduced Income Tax and chose a method of classifying income by its source and charged each source of income separately under a Schedule, which was based on five schedules named using the letters of the alphabet, A to E. Income Tax was repealed once again in 1816.

In 1842 Sir Robert Peel (Prime Minister from 1841 – 1846) reintroduced Income Tax as a three-year temporary measure. Peel drew on Addington’s Act of 1803 for his legislation, making only minor amendments.

Under Peel’s rules, income was not all taxed in full, for example, farmers were taxed on the rental value of their land rather than their farming profits. Farmers were not taxed on their income until 1941.

Peel created a system of Special Commissioners (who were experts in taxation), with whom businessmen could deal rather than the General Commissioners (who were local businessmen). In addition, if the taxpayer disputed the amount of tax which was deemed to be payable, he could choose to appeal to either the Special Commissioners or the General Commissioners.

Peel also introduced penalties into his Income Tax system.

William Gladstone, UK Chancellor who then became Prime Minister from 1868-74, 1880-5, 1886 and 1892-4, introduced 13 budgets during the last half of the 19th century. He was aware of the limitations of the system of income tax, especially self-assessment, which led to widespread fraud. To start to redress the balance, Gladstone extended the Legacy Duty so that land and also businesses were subject to tax on the death of their owner. He also reduced the rates of indirect taxation.

Harcourt, as UK Chancellor of the Exchequer at the time, introduced Estate Duty, referred to as Death Duties, in 1894. This new Estate Duty fell most heavily on the landowners.

The new tax was highly unpopular with the families who were affected by it. They argued that an individual who chose to spend his money during his life could avoid paying the tax that would be levied on the estate of the careful person who accumulated assets to pass on to the next generation. The question of tax avoidance was also raised by commentators at the time who argued that by simply giving the estate away during the lifetime of the testator, the tax could be completely avoided.

In 1907, Asquith, the UK Chancellor at the time, introduced a system of personal allowances, which exempted a proportion of earned income from Income Tax. In 1908 old-age pensions were introduced.

In 1909 Lloyd George introduced the first progressive tax on income in the so-called ‘People’s Budget’. The budget was not generally accepted and was rejected by the House of Lords in November 1909, but it eventually became law in 1910. As a result, the power of the House of Lords to veto budgets was removed in 1911.

During the First Word War a new top rate of Income Tax called “Supertax” was introduced which doubled the rate of tax on incomes. In 1928 Supertax was renamed Surtax. In addition, motor car licences were introduced and a new tax on petrol was imposed.

In 1944 a new income tax payment system called pay-as-you-earn (PAYE) was introduced. That system deducted tax from individual’s wages and salaries before they received it. Until the introduction of PAYE, only individuals paid by central or local governments had tax deducted at source from their salaries.

After the Second World War, the National Health Service was formed and National Insurance Contributions were introduced to provide for health care, retirement pensions and sickness benefit.

Purchase Tax was used to tax spending for a large part of the 20th century. It was replaced in 1973 by VAT, which is now the primary tax on expenditure in the UK.

In 1965, two new taxes were introduced, Corporation Tax and Capital Gains Tax. Until 1965, companies were subject to income tax as if they were individuals. Capital Gains Tax was intended to reduce tax avoidance and increase the equity of the tax system rather than to raise significant revenue. This tax helps reduce the opportunities for people to earn capital growth untaxed instead of receiving income which is taxed.

In 1975 Capital Transfer Tax was introduced as a new taxation on estates but was itself replaced by Inheritance Tax in 1984.? Pre 1975, estate duty only taxed the value of the taxpayer’s estate at death. Lifetime gifts were completely exempt. Capital Transfer Tax introduced tax on lifetime transfers of wealth for the first time.