The taxing task of tinkering

John Rawls' Theory of Social Justice (1972) features prominently in this book. Both books are concerned with what Arthur Okun called the great trade-off - the extent to which society's desire to reduce inequality might impair economic efficiency. In Rawls' world - that of the moral philosopher concerned with the ideal social constitution - equality of basic liberties should never be compromised by inequality in other assets.

In Martin Daunton's history, practical politics predominate. He comes to the conclusion that by 1979 Britain's taxation system was so fatally flawed that serious injury was being done, not simply to incentives and thus economic efficiency but also to the British state, via the erosion of consent for how it attained and spent money.

This is, of course, a mainstay of the Thatcherite critique, but while Daunton is broadly supportive of such pro-market interpretations of Britain's postwar economic difficulties, there is much more to this work, the second volume of his history of British taxation.

The first, Trusting Leviathan (2001), skilfully reinstated fiscal history centre stage in an understanding of the evolution of the British state from 1799 to 1914. The institutional comparative advantage of this fiscal military state has long been acknowledged. Daunton provides a novel slant on how organic growth, punctuated by Gladstonian design (to legitimise Leviathan through social trust) and innovation (notably, income tax), gave Britain a fiscal constitution and capacity for extracting money that enabled it to raise the vast sums needed to extend and defend the empire.

Eventually, they also allowed the country to provide minimum standards of social welfare without incurring the political tensions generated by distributive injustice evident in other great powers.

Those tensions would, of course, soon generate explosive forces under the twin fiscal and military challenges of the first world war. But, as Trusting Leviathan shows, Britain was better equipped to contain them than its military and economic competitors.

Just Taxes takes up the story of how the fiscal constitution was put under pressure by that war but survived and, notwithstanding mass unemployment, was strengthened between the wars, only to be confronted with a ruinously expensive world war again. Daunton's account is broadly commensurate with the more revisionist stories told about interwar Britain - of how comparative political stability was engineered through incorporation of the Labour Party and the broader labour movement into politics, and of Keynesianism rejected to preclude politicians from manipulating the economy for short-term electoral advantage. To this, Daunton adds new material on taxation and national identity to explain how there was a renewal of the sense of balance and fairness that had underpinned the 19th-century fiscal constitution, although a deeply regressive fiscal system remained. He concludes that by the eve of the second world war, the big trade-off was still being comfortably managed politically and without too much injury to economic efficiency.

The transformative power of war was demonstrated as the fiscal constitution was challenged as never before by a combination of high personal taxation and stringent rationing of basic commodities. Because of the balance chosen between government and market by the first postwar Labour government and the subsequent inability of the Conservatives to reduce the tax take to any degree, there was by the late 1950s widespread concern that efficiency was being sacrificed unduly in pursuit of a vision of equity. And as personal taxation remained very high - with the highest marginal rates averaging 93 per cent between the fiscal years 1938-39 and 1978-79 - consent for Leviathan was being undermined. The political and fiscal challenge of austerity in the 1940s quickly gave way to affluence by the mid-1950s, but with it came deepening anxieties about relative economic decline and how to secure consensus for modernisation.

Tax reform was identified as central to such modernisation, yet politicians perceived the policy space to be very limited before 1979. Admittedly, it was difficult for chancellors to pursue structural reform against the weight of official Inland Revenue and Treasury safety-first advice, but even those who did found sustainable reform difficult.

Instead, most chancellors fiddled with the tax system in an endless stop-go routine and the quest for the marginal voter. The result was that by 1979 the tax system was incoherent, inefficient and inequitable.

Daunton cites the conclusion to John Kay and Mervyn King's contemporaneous study: "No one would design such a system on purpose and nobody did. Only a historical explanation of how it came about can be offered as a justification. That is not a justification, but a demonstration of how individually rational decisions can have absurd effects in aggregate."

Daunton's fine study provides that historical explanation and makes an important contribution to understanding the background to the political economy of Thatcherism. However, what we have here is history through very high politics. Public policy specialists may find it curious how little the Institute of Economic Affairs and the Institute for Fiscal Studies feature.

Economists may not be as convinced about the unambiguous evidence for adverse labour-market effects of Britain's income tax by the late 1970s.

That the publisher's puff for Just Taxes refers to taxes being almost half the national income by 1979, when they were actually 35 per cent (even the wider accounting concept of public-sector receipts - not here distinguished - was only some 42 per cent), suggests that an opportunity was missed to discuss more fully contemporary misunderstandings of Britain's fiscal system.

Daunton is right to state: "The task of creating a just system of taxation continues to be at the heart of politics." But just to whom? Back to Rawls.

Roger Middleton is reader in the history of political economy, University of Bristol.