War, Taxes and Gold: The Inheritance of the Real

The inheritance of the real (the current y of the Kingdom of Portugal. from 1415 to 1910) on national fiscal and monetary institutions is presented as a response to the challenge of foreign invasions and of their aftermath. The Portuguese crown had to preserve national sovereignty over borders defined in the XIII century in the face of external military threats from neighboring states. The social contract enforced by the crown until the early XX century relied on the ability to obtain increasingly expensive warfare. The pressure to raise revenue became a motive for fiscal change since medieval times, as war provided social legitimacy for tax reform or currency depreciation. Tax reform involved the creation of new taxes (the sisa and the deeima) with a comprehensive base, well before they were acknowledged to be part of a modem fiscal system. New methods of taxation, including the incidence of the decima on interest income, profits and even wages in order to improve the efficiency of the fiscal system were also introduced and the immunities enjoyed by the nobility and by the church were reduced. In spite of those modem features, for most of the period state finance was primarily based on domain revenues, coming from monopolies established on trade and other colonial resources. One of them, gold, was also used as money and powerfully affected the link between war and taxes. In particular, the amount and continuity of gold inflows allowed taxation to fall and remain low throughout the 1700s. The high share of customs in tax revenues and the concentration of other taxes (like the excise) in Lisbon were other peculiar attributes of the system. The fiscal collapse of the early 1800s shows how sensitive to fluctuations in foreign trade both domainial revenues and customs duties were. The importance of domainial revenues may also explain why institutional reforms did not develop in XVIII century Portugal as early as might be expected. The crown was unable to extend the modern features of its financial system and to resort to higher levels of consolidated public debt, the only way to deal with extraordinary expenditures. Wealth-holders did not support the modernization of state finance through the creation of a bank responsible for managing public debt and issuing convertible paper money. Perhaps the government's commitment to upholding property rights was not credible enough. The increase in military expenditures was followed by the fall in colonial commerce due to the loss of Brazil. Either one of the shocks would have been sufficient to bring about a large budget deficit. The resort to inconvertible monetary creation in 1797 was responsible for a period of raging inflation lasting until the 1820s. Moreover, it engendered problems in monetary circulation up to the 1850s. Money creation was only disciplined with the reform of the monetary system and the adhesion to the gold standard in 1854. Compared with the previous period of monetary and financial instability, the almost forty years that elapsed until the declaration of inconvertibility in 1891 allowed living standards to catch up with the European average. The resort to foreign public debt as a way to finance short-term public deficit was based on the assamption that in the long term the increase in tax revenues would balance the deficit. The constitutional agreement that pacified the country in 1852 and the globalisation in the capital markets associated with the heyday of the classical gold standard also enabled this experience of convergence. Outside the gold standard, Portugal endured renewed financial and political difficulties. In 1910, a revolution created a republic and a new inconvertible currency. If, for the monarchy, convertibility had been the rule rather than the exception, the pressure of war remained and so did the difficulties in tax administration. Indeed the resilience of the latter may be the only acknowledged inheritance of the real.N/