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The government needed to achieve economic recovery in order to recapture export markets and restore the balance of payments. This required an increase of production (to meet export demands) and the minimisation of home consumption, wages and prices. The Labour government elected in July 1945 was committed to the establishment of the Welfare State, a project to be funded largely from general taxation. Manipulation of taxation was an important means of achieving Labour's aim of social equality through the redistribution of wealth.
As the government's requirements expanded, industry was subjected to heavy taxation during the Second World War. At the start of war, Sir John Simon, introduced an Excess Profits Tax (EPT) at rate of 60 per cent above pre-war levels. This was soon increased to 100 per cent, of which 20 per cent was to be repaid as deferred credit after the war. For the first time, fiscal policy was deployed along Keynesian lines to regulate demand. In particular, the new Pay As You Earn (PAYE) system, introduced in 1942, was used as a means of demand management.
Reduction of various tax allowances greatly increased the number of workers liable to income tax, and raised problems of collection. From 1942 the PAYE system enabled the weekly deduction of a tax on earnings at the point of payment. This greatly increased the government's reach in raising tax at the lower end of the earnings scale. At the same time, the reduction of married men and children's allowances for middle-class incomes removed the 'middle-income dip', which had characterised interwar taxation. This also contributed to a greater 'take-off' of taxation during the war years.
The government introduced a purchase tax in 1942 to help fund the war effort. Luxury goods were subject to heavy taxes, while low rates were applied to necessities, and 'utility goods' were exempted. This differential taxation served the strategic purpose of shifting resources to the production of necessities, but was also broadly popular. Introduced as an emergency measure, the purchase tax nevertheless lasted until 1973, when VAT replaced it.
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