A return to the gold standard became a key objective of government policy as during the First World War the British national debt increased from £754 million in 1913 to an unprecedented £6142 million in 1919. Debt reduction and avoidance of a deficit were necessary for a return to gold. Faced with mass unemployment in the 1920s, the need to avoid a deficit was a key determinant of fiscal policy.
Mainly borrowing had funded the war finances, but there had also been important changes in the structure of the tax system. The source of government revenue shifted away from indirect taxation on expenditure towards direct taxation on income and capital. David Lloyd George's budget in 1915 lowered the tax exemption limit on earnings from £160 to £130, increased the standard rate from 5.8 to 30 per cent and reduced the super-tax threshold from £5000 to £2000. He also introduced Excess Profits Duty (EPD).
Given the inflation of the war years, the greatly increased scope of income tax meant that many working and lower-middle class incomes became subject to taxation. The proportion of revenue derived from income tax and super-tax rose from 29 per cent in 1913 to 36 per cent in 1919. EPD made up close to 35 per cent of government revenue. The experience of a more socially active state during the war, and the popularity of Lloyd George's reforms, increased public expectations of the state, legitimising the necessary level of taxation.
A Royal Commission was appointed in 1919 to consider problems of income tax. In 1920, the Commission recommended an exemption limit of £135. In real terms, the pre-war exemption limit would have been around £250, so the wartime expansion of the tax base was far from entirely rolled back. Because so many had been killed during the war, the Commission wished to encourage an increase in the birth rate. It therefore recommended more generous allowances for married men with children, while heavier demands were made on single men. The differentiation between earned and 'unearned', or investment income, first established by the Liberal government in 1907, was maintained, with a higher rate of taxation on the latter. These measures were incorporated in the Finance Act 1920.
After the war, reduction of the national debt and the restructuring away from short-term 'floating' debt was a priority for government. It could only be achieved by continuing with a relatively high level of taxation and cuts in public expenditure. Labour favoured a capital levy, a one-off graduated tax on personal property, including land. This move was not so much about raising revenue, as about social justice.
Austen Chamberlain, Chancellor in the post-war Coalition Government, was initially in favour of a plan drawn up by Inland Revenue for a graduated levy on war wealth to replace EPD. The 1920 Select Committee on War Wealth recommended a levy that would produce 500 million pounds for the Exchequer. Winston Churchill was the only other member of the Cabinet to support the levy, which foundered on city opposition and the onset of depression.
The government turned to other methods of raising revenue instead. Officials regarded 'sales' taxes on consumption as impractical because of the administrative difficulties in collection, but Chamberlain retained the Excess Profits Duty (EPD), reducing it to 40 per cent. The budget of June 1920, however, saw Austen Chamberlain inaugurate a corporation tax of five per cent on limited liability companies. EPD was again raised to 60 per cent. These were regarded as short-term measures to deal with the post-war economic crisis.
In the context of the recession of 1920-1922, the Cabinet believed that a relatively high rate of taxation was harming industry and preventing recovery. The adopted approach was the widespread cutting of government and social expenditure to effect a saving of £75 million per annum. This programme was enforced by the Geddes Committee on National Expenditure, and became known as the 'Geddes axe'. It resulted in budget surpluses during the early 1920s.
Labour's Chancellor of the Exchequer, Philip Snowden, reconsidered taxation in 1924. In order to alleviate poverty and achieve a measure of social justice, the Party wished to use fiscal reform as a means of redistributing wealth. In practice, the difficult economic circumstances militated against reform The party had previously favoured a capital levy, a one-off tax on personal capital and property above a certain level, probably between £1000 and £5000. In his 1924 budget, however, Snowden introduced no new taxes or additions, and abolished Chamberlain's corporation tax. The Labour Government was formed on condition that it set a Committee on National Debt and Taxation, which reported in 1927.