Revised, March 8, 1998

Faculty of Economics, Nova University at Lisbon; NBER and CEPR

The inheritance of the real (the currency of the Kingdom of Portugal, from 1435 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 décima) with a comprehensive base, well before they were acknowledged to be part of a modern fiscal system. New methods of taxation, including the incidence of the décima 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 modern 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 assumption 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.

When the Portuguese currency experience is imbedded in the overall evolution of its fiscal and monetary systems, a link emerges between war - on the expenditure side of the government budget - and taxes or other means of finance, especially domain revenues, coming from monopolies established on domestic and international trade. One of these revenues, gold, was also used as money, along with silver and copper. Increasingly expensive warfare became a pressure for change and times of war were also an auspicious context for the social legitimization of direct and indirect taxation capable of supplementing or replacing domain revenues. Throughout taxation and monetary creation under diverse international currency standards were part of a social contract which preserved national sovereignty in the face of external military challenges.

The contractual nature of taxation and its link to private property rights changed over time, and with it the nature of civil rights and financial freedom. The latter is an inheritance of the real (plural réis) which has not been appreciated, perhaps because the real became inconvertible during the heyday of the gold standard. Inconvertibility followed a British ultimatum - enforced by the presence of two warships in the bay of Lisbon - and the first republican uprising in Porto. Instead the inheritance of the real degenerated into a myth, that democracy brings budget deficits and an inconvertible currency. Its twin - that only a conservative dictatorship allied with the catholic church could produce financial stability emerged after the turmoil of the early 1900s.

Portuguese currency experience features stability of the price of the real in terms of gold and silver with roots far more remote than usually assumed by economists and policymakers. With that horizon the alleged incompatibility between democracy and financial discipline disappears and the uneasy relationship between civil rights and financial freedom ceases to be grounded on the monetary history of Portugal. Rather it becomes a topic in monetary mythology.

The debates about the political and social legitimacy of taxes under changing military circumstances at home, in the overseas possessions and in the European balance of powers are also part of the inheritance of the real. While the "war, taxes and gold" interaction allows an interpretation which remains relevant today, the empirical evidence that we have been able to assemble to back it up remains scanty, especially before the end of the civil war in 1834.

The relevance of war appears in the rising share of military expenditure, while the ratio of taxes to debt rises from the late 1500s to the mid 1700s. Gold coinage also captures a rising share of inflows, but it then falls - precipitating the financial and military crises of the early 1800s. The monetary regime, the organisation of expenditures and revenues, the technology of taxation and treasury operations and the patterns of deficit financing were all influenced by the political legitimacy of the monarchy. Similarly, different military challenges and responses to national legitimacy influenced the state institution-building strategies and the protection of property rights.

This is the background to the 300 year period between the Spanish and French invasions presented in Table 1 and in Appendix Tables 1 through 3. Appendix Table 4 provides data on prices in réis of gold, silver and goods for the full sample period 1435-1910 and Chart 2 illustrates the pattern from 1500 until the real was pegged to gold (at 4500 réis to sterling) in 1854. Appendix Table 5 reports European convergence and fiscal indicators from 1834 to 1910.

Table 1 and Chart 1 about here

A brief overview of the origins and scope of Portuguese financial development may help. A national currency, the libra, was created in 1253. After several debasements, in order to finance the wars against Castille, the libra was replaced by the real in 1435. One gram of gold was then worth 35 réis but successive devaluations brought the price to 107 réis in the early 1500s. On the side of taxation, the crucial date is 1387, when, for the same reason, the excise (sisa), previously a municipal tax, was transformed into a universal tax with a comprehensive base. The creation of the sisa had a «contractual» origin insofar as it was approved by the Cortes, a traditional form of estates representation. Moreover, its general character, its incidence and collection methods, were extensively discussed in the Cortes of the 1400s and beyond.

In spite of the remarkable innovation in tax design represented by the sisa, tax administration has proven difficult. To make the collection of the excise on movable goods easier, the crown and each municipal corporation agreed in 1525 by contract that a fixed sum (encabeçamento) would be due. Municipal councils would be free to set tax parameters so as to raise the pre-defined amount (cabeção). The only exception was the city of Lisbon, whose excise and real d’água were collected directly by the crown or farmed. The local self-taxation did provide a resolution to conflicts between taxpayers and crown, but at the cost of a high degree of regional inequality in the distribution of the tax. In real estate transactions, municipalities requested a rate from non-residents higher than from residents. The tax began to be applied as a sort of toll on goods carried by outsiders into the towns, with negative effects upon internal trade and economic specialisation between different regions.

As a result of these attempts to primarily tax outsiders, inhabitants of a given municipality could be exempted from the payment of the excise on movable goods, since the cabeção was raised from the tolls or from the excise. This change in the method of taxation led to the stagnation of this source of revenue. Furthermore, this transfer of tax responsibilities to municipalities reveals the incapacity of the crown to build up an infrastructure for tax administration across the territory. Giving up tax collection across mainland Portugal went along with concentrating it in the city of Lisbon, where it was easier to administer.

Portugal was involved in international credit markets although with a smaller presence than Spain. Seeking better access to northern European financial markets, where Genovese and German bankers were most active, the crown established the Feitoria da Flandres in 1508 and issued loans in Flanders through bills of exchange, payable in three months. Until the 1550s the increase in these credits implied the renewal of the bills and accumulated interest. The bills of exchange were instruments of transfer and credit, where the cargo of the spice fleets, namely pepper, served as collateral. In the Law of February 2, 1560 the crown consolidated and transformed the total amount of credits in padrões de juro, with an interest of 5%, payable in the kingdom. This measure harmed above all the foreign creditors and the interest rates charged on external debt rose to 12-16%, much higher than on domestic instruments. Since the early 1500s, creditors were accepting a kind of registered bond paying a fixed rate of interest and carrying a variable price. A public deed was necessary to sell the instrument, called padrão (or carta de padrão) de juro real. In that sense it was similar to real estate.

With this domestic and international background in mind, we present the analysis in three chronological sections, roughly corresponding to the XVII, XVIII and XIX centuries. Guiding the selection of the periods is the view that the structural attributes and weaknesses of the Portuguese financial system are better understood during changes in regime, due to wars or revolutions. Section 2 stresses the build up towards the restoration of independence in 1640 and its fiscal and monetary effects, respectively the early introduction of an income tax and successive currency debasements.

Monetary and fiscal developments following the discoveries of gold in Brazil until the late 1700s are presented in Section 3 together with the implications of currency stability. Section 4 focuses on the first experience with inconvertibility in 1797 going on to the run-up towards the Brazilian declaration of independence in 1823. It also evaluates constitutional rule, stressing the difficult coexistence of civil rights and financial freedom, describes the virtuous cycle from the early 1850s to the early 1890’s and how leaving the gold standard was followed by the demise of the monarchy. Section 5 concludes.

In the changes that took place from the end of union with Spain in 1640 to the creation of the united kingdom with Brazil in 1810, three moments of decisive mutation in the tax system are closely examined. First is the period 1640-1660, when the war for the restoration of independence urged intense tax changes - and notably the introduction of an income tax (section 2.2). Second is the drop in tax revenues from foreign and colonial trade and the risks of further involvement in the Seven-Year war, which led to a profound reform of fiscal institutions in 1761 (section 3.2). Third is the impact of the Napoleonic wars (1796-1808) on the tax system. It is apparent in the efforts to overcome the tax immunities enjoyed by the nobility and by the church. However, the most relevant aspect of this adjustment was the propensity to issue public internal debt in order to finance budget deficits over any lasting effort to reform the tax system in the direction of efficiency, equality and simplicity. Even if the tax debate in Portugal did not achieve the same salience as in pre-revolutionary France, the political crisis leading to constitutional rule was equally exacerbated by financial instability (section 4.1).

In all three instances, military pressure was decisive on fiscal adjustments and on tax reform. The transformation of state finances was largely due to the impact of increasingly expensive warfare. Financial reform, the redefinition of property rights and state functions are at the core of the political debates and actions attempting to found and build up a liberal state, as stressed in Section 4. Nevertheless, the effects of the Napoleonic wars and the subsequent transfer of the crown to Brazil (1808), the 1820 liberal revolution and the periods of civil wars and political and social unrest that followed this event undermined a smooth establishment of representative institutions as the basis of a new legitimacy for taxation. Up to the 1850s, all financial schemes designed to raise government revenue were tried, including debt issue, tax reform, forced debt, forced donations from the mercantile community, property confiscation and privatisation of state property. The result was the loss of social confidence and financial reputation.

In contrast, the fourth change in economic regime was peaceful. It started in 1851 and involved compromises that softened political conflicts and initiated a long period of stability, lasting for forty years. Yet systematic resort to deferred taxation via external borrowing narrowed the domestic tax base and made the financing of public infrastructures more fragile. When domestic political instability returned in the late 1880’s, the combination of the British ultimatum and of the Baring crisis of 1891 were sufficient to get off the gold standard (section 4.4) .

Seigneurial duties and other domain revenues are remnants of a time when it was thought that the sovereign was entitled to have enough land so as to be able to "live from his own means". Data on state revenues for selected years when available information included all sources of state revenues, summarized in Table 2, shows the balance between revenues coming from domainial sources and other revenues having their origin in taxes, the relative weight of indirect versus direct taxes and the share of Lisbon.

Table 2 about here

Any items which are part of the patrimony of the crown and can be directly exploited, rented or donated should be classified as domain revenues. This includes rents from land and houses, seigneurial duties over farmers and some other personal rights, which, in the taxonomy of state revenues proposed by Manuel Severim de Faria in the early 1600s were labelled as proprios. They were mostly received in kind and in 1588 accounted for 6% of total revenue (colonies excluded) . The biscuit manufacture of Vale do Zebro and other state manufactures were also insignificant sources of revenue.

The revenues from trade in pepper, pau brasil and gold from Mina, in Eastern Africa, are recorded in the 1588 budget, but the income from the slave trade or from Madeira’s sugar are lumped together in the revenues coming from the Atlantic trade. The figure reported in Table 2 falls from one third to one fourth of the total between 1588 and 1619.

Indirect taxes were the other main source of state revenues. There were taxes on internal circulation, transactions and consumption, and also custom taxes, which were responsible for over two thirds of revenue in 1588 and three quarters in 1619. In Lisbon, the sales tax real d’agua was collected in addition to the excise. Revenues increased to the point that, in 1588, Lisbon accounted for over half of the revenues coming from the excise and other indirect taxes. Most of the duties on foreign trade were also collected at the Lisbon’s Customs so that the importance of the rest of the country to the royal treasury kept decreasing .

During the union with Spain, the municipality of Lisbon served as guarantor of the consolidated debt emissions, through the local taxes over transactions (real d’água and realete). In 1630, 120 contos were raised through this system, proving the apparent good credit of the municipal finances. After the restoration of 1640 and until 1679, the Portuguese kings kept on this method of raising money to finance public expenditures, exacerbated by the state of war against Spain.

The tax burden rose during the last decades of the union with Spain. The end of truce with the Netherlands in 1621 and the Spanish struggle in the international arena influenced Portuguese tax revenues in two ways: first, the Atlantic trade declined and with it revenues coming from customs and monopolies; second, the Spanish treasury needed a more substantial contribution from Portuguese taxpayers.

From 1621 to 1640, there was a sequence of administrative decisions aimed at raising taxes in the Portuguese territory: the grant of extraordinary levies (serviços) asked to the mercantile community of Lisbon or the municipalities of the kingdom; the introduction of a new duty on salt (1631); the increase in the encabeçamentos of the excise (1635); the extension of the real d’agua to all the regions of the kingdom (1635); the introduction of an income tax on officers and privileged people (meias-anatas, 1631); the effort to introduce a new tax on the appeals presented to the administration (papel selado, stamped paper).

These attempts to increase taxes were responsible for the only tax revolts occurring before the constitutional regime. They eventually led to the overthrow of the Spanish rule and the foundation of a new dynasty on December 1, 1640 (known as restoration). One of the first measures taken by the new government was to repeal any tax increase decided during the union with Spain. Nevertheless, new taxes were needed to pay for the war against Spain and for the claims on overseas possessions brought out by the Dutch and the English. Selling padrões de juro or converting debts into these registered securities was another means to finance the independence effort.

Holland mobilised an army with around 60,000 men. With a larger population, Portugal only prepared an army with 20,000 men in infantry and 4,000 in cavalry at a cost of 1200 contos (Decree of 5 September 1641). This is 20% higher than total revenue in 1619, when the financial situation was more favourable. Panel B of Appendix table 1 shows military and total expenditure in selected years.

The creation of the first direct tax: the décima (tithe) in 1641 should be seen in the same light. As with the 1387 excise, a deliberation taken in Cortes gave it a legitimacy that might be important to a new sovereign. Compared with direct taxes collected in other European countries, the comprehensiveness of the base is impressive: it includes not only rents from real estate, the outstanding source of wealth in this society, but also labour income, earnings from professional activities, profits from commercial or industrial activities, and even interest income.

The second statute of the décima (1654) introduced, for the first time, the procedures for a land and house survey, in order to assess its taxable value, as well as the registry of the occupational status for all the people living in each parish. The only exception to the incidence of this tax was the real estate held by the Church or welfare institutions. Nevertheless, land and houses belonging to the members of the clergy as personal property were taxable.

The revenue of 200 contos recorded for 1660 and 1681 suggests that the décima accounted for 20% of revenues received, about the same as the excise collected out of Lisbon. The décima then overtook the excise as a source of revenue to the crown and ranked right next to customs (366 contos). In addition, the excise and similar taxes collected in the city of Lisbon amounted to 144 contos in 1660, almost 75% of the revenue came from the excise across mainland Portugal. Revenue from the excise collected through the encabeçamentos paid by the municipalities stagnated through the 1600s.

After the end of the restoration war in 1668, the Cortes of 1697 asked for the withdrawal or at least the reduction of the tax. Through a decree of 28 March, 1698 the crown chose the second alternative. The participation of Portugal in the war of Spanish succession resulted in a decree of 26 May, 1704 raising the décima from 4.5% to 10%, this time without any consent of the Cortes. Conversely, the end of the war and the period of prosperity opened up by gold mining and commercial dynamism brought the tax rate to its earlier level.

As was evident from Chart 1 above, the monetary unit was fairly stable in the 1500s even though prices were rising. Until 1640, the real depreciated from 11 to 13 reis per gram (about 20%) in terms of silver and from 107 to 142 reis per gram (about 25%) in terms of gold. The absence of war threats and the discovery of precious metal in Africa and in America helped maintain stability. But there were several devaluations, two of which in double digits against gold in 1555 and against silver in 1573.

Records of the inflows of precious metal by the Lisbon mint suggest that on the eve of the restoration, silver was the predominant specie in domestic circulation. Foreign money was used and accepted in domestic circulation, particularly Castilian dobrões (from 1643 to 1646), and patacas and meias patacas coined in Seville, Segovia, Mexico and Peru.

The increase in expenditure financed by the treasury, mainly for the restoration war, was the justification for successive currency debasements. From 1641 to 1688, the price of gold rose from 142 to 487 reis per gram (a price which was not going to be changed until 1822) and the price of silver from 16 to 31 reis per gram. This was discussed at the time by the Conselho da Fazenda (Council of Finance, created in 1591 to rationalise and centralise a more archaic system, following the experience of Spain), which became responsible for monetary affairs with the decree of February 13, 1642.

These successive devaluations had two explicit objectives: increasing revenue through seigniorage and stemming the outflow of domestic coins. It is not known how devaluation affected seigniorage revenues relative to expenditures since, aside from retrieving the details of minting operations, the precise timing of devaluation and price rises must be known. As for the second objective, we find frequent references to the shortage of coins, especially silver, explicitly acknowledging the outflow of precious metals, both in coins, or as worked metal, to northern European countries.

Portuguese coins, especially silver coins, had the best alloy and the changed balance of trade favoured the northern countries which led to the policy of debasing the currency, to prevent gold and silver from flowing out of Portugal. The different valuation of precious metals among the countries with which Portugal traded was considered to be the primary cause of the outflows of coin. The trade balance deficit only began to be mentioned as a factor in the drainage of precious metals to other countries in the 1680s and 1690s.

In 1693, gold was discovered in the Caité area of Minas Gerais, Brazil. Part of the gold mined there was due to the crown, through the so-called quinto tax, which from 1735 to 1750 was replaced by the capitação. Taxes, revenues and services were also paid in bullion, coin and even gold dust, in spite of legislative prohibitions registered in some periods to the treasury of the Conselho Ultramarino (Overseas Council, created in 1642 to deal with Empire questions, except those connected with Africa). The transportation of gold was not under the royal monopoly. Rather it was the responsibility of the Conselho da Fazenda, which organised the convoys across the Atlantic.

António Luiz Gonçalves da Câmara Coutinho, at the time Governor in Baía, in a representation to the crown dated July 1692, pointed to the lack of specie in Brazil, and indicated as one of its causes the situation traders' preference for taking money instead of sugar . The law of 8 March 1694 answered this request, by determining that gold and silver in Brazil would devalue by 10% over and above the 20% devaluation decided in 1688 by Portugal. It also states that a mint should be opened in the city of Baía so that the provincial currency could be coined there and would only circulate Brazil. After the currency system became autonomous, attempts were made to harmonise monetary circulation.

The Rio mint where gold would be coined to circulate in Portugal reopened by virtue of Decree of 31 January 1702. It was a way for the state to controlling precious metal at source, thus reducing the fraud on the journey to Portugal. Only provincial currency was coined up to then, but legislation attempted to establish tighter control over the resulting increase in gold bullion production.

During the period 1699-1788, gold coined in the Lisbon mint is less than one third of the arrivals of Brazilian gold and the correlation coefficient between the annual gold inflows recorded in Appendix Table 2 and the amounts coined are quite low. The coinage ratio rises before 1720 and in the 1740s and 1750s, while arrivals peak in the 1730s and the 1740s.

Gold arrived not only in bullion or dust, but also in coins minted in Brazil. These coins entered immediately in circulation and it was not necessary to wait for its coinage in the Lisbon mint. Throughout the 1700s, Brazil coined gold for Portugal and Portugal coined gold for Brazil. Trade also explains the disparity between the inflow and the coinage of gold in the Lisbon mint. England was the first commercial partner of Portugal and an important financial market from where several payments spread to others countries, like Netherlands and Germany. Finally, gold has uses other than coinage. Private parties tended to hoard gold in the form of jewellery, without paying seigniorage to the crown, and only went to the mint when they needed coins for their business.

The activity of the Rio mint and for a certain time that of Baía and Vila Rica was not exclusively directed to Portugal but also towards the internal circulation of the colony. However, money was not evenly distributed across regions. Like any economy with strong export-oriented production, Brazil had more coin in circulation in the coastal regions that were directly dependent on international trade. In the mining region the circulation was in gold dust, the only local production, while in agricultural regions cattle was an important means for transactions.

The existence of a mint in Brazil had two main consequences. The first was the possibility that coins and not only bullion arrived in Portugal, as Brazil was running a trade deficit with the mainland. In fact, gold imports could not be minted fast enough in the Lisbon mint: even during the 1720s its treasurer asked the church permission to work on Sundays. The beginning of Rio mint activity explains why individuals were responsible for most of the gold coined coming into Portugal after the 1720s: they resorted less and less to Lisbon mint to have their gold coined, which in turn implied a rising share of coinage for the crown. Secondly, the creation of the Brazilian mint provided trade in the colony with monetary circulation which was not dependent on the Lisbon mint. There was accordingly less of a tendency to issue paper-money to carry out commercial operations in and with the colony than in other new territories.

From the 1688 devaluation to the introduction of fiat money in 1797, gold accounted for most of the coinage, despite the increase in the silver (in absolute and relative terms), registered since the 1770s. While from coinage fluctuations alone one might conclude that a gold monometallism prevailed in Portugal, it should be noted that during the 1700s Castilian currency circulated in Portugal ,and that it was not recoined until 1785.

The change in the legal value of silver in 1688 resulted in a significant coining of this metal in the 1688-1690 triennium, of about 1200 contos, mainly through reminting. This coinage, whilst continuing into the 1690s, dropped to about 240 contos (1691-99). From 1700 on, the shortage of silver for daily exchange in Portugal made itself felt again. This is shown both, by the acceptance of patacas in circulation in 1702.

This shortage changed the market value of silver, which resulted in the alteration of its legal value in 1734 (from 31 to 33 reis per gram) and in 1747 (to 36 reis per gram) setting then a ratio between these two precious metals which remained unchanged until 1822. The revaluation of silver against gold increased silver coinage on impact but there was no lasting effect since economic agents expected a higher revaluation of the metal which continued to be in short supply.

In the meantime patacas dominated circulation in the coastal zones, especially the Algarve. However, the fact that in the 1780s the external value of the Castilian coins was higher than its internal value, led to the prohibition of Spanish currency as legal tender in 1785. The refusal of transactions in Castilian specie explains the increase of remintage of Castilian coinage into national currency but it still did not reach areas near the border.

The state also controlled the destination of silver, namely during wars, because it was the species used to pay soldiers' wages. At the time of the war of Spanish succession, the purchase of silver is required in a decree of the Casa de Bragança to be delivered to the treasury of the Junta dos Três Estados (created in 1640 to supervise war taxes). In the same period several other warnings, citing the daily increase of war expenditures, state that the coinage of silver is to be provided to the Junta dos Três Estados. Once again, during the Seven Years war, the Provedor of the mint was ordered to buy all the silver reaching domestic residents, so that it should be sent immediately to the treasury.

Current and extraordinary expenditures of the state explain the relative importance of the crown in the quantity of gold coined. In periods of greater difficulties the state gave orders to the mint for the treasurer to make payments directly or to coin immediately and to send it to the royal treasury. The Lisbon mint was the property of the crown, which was also an important customer of it. The abundance of gold replaced the resort to currency debasement by the use of Lisbon mint as a state reserve fund.

Portuguese gold coins were not only coined at the Lisbon mint. After 1702 Brazil coined gold for Portugal, in order to control gold production and collect royal rights over it. The Lisbon mint coined provincial coins, namely for Brazil, providing a monetary connection between Portugal and the colonies – aside from the tax revenues including not only seigniorage's revenue, but also an additional due equal to 10% when the coinage was provincial.

Population growth from 1720 (just after the war of Spanish succession) to 1781 (before the substantial price increase at the end of the century) does not completely account for the increase in the price index shown in Chart 1 above (the average annual rates are 0.26% and 0.39% respectively). In any event, from 1680 to 1714 prices increased, due to the war of Spanish succession, then dropped until 1719 and a relative stability obtained between the 1720s and the 1780s. Accordingly, three major gold minting periods suggest themselves: the first from 1703 to 1714, the second from the early 1720s until 1736 and the third from 1738 to 1763.

Until the extent to which gold coins circulated domestically is well understood, the domestic money stock cannot be precisely estimated, and its changes are limited to the recorded gold outflows to England. The analysis of mintage composition suggests that until the 1720s, coins of 4800 réis prevailed. On the contrary, between the 1720s and 1740s, small value coins (480 and 800 réis) dominated. While this dominance of small coins declined when the legal value of silver was raised after 1747, the mintage of small value coins lasted throughout the century. This fact can explain why some payments, such as agricultural payments, were made less frequently than even on a monthly basis and certainly not daily. With higher amounts to settle, coins of higher quality can be used. The analysis of the copper coinage may also support this conclusion on the quality of Portuguese monetary circulation allowed by small value gold coins, as global and annual amounts of this metal coined were small when compared with the coinage of silver and gold.

A substitution in domestic monetary circulation took place by mid-1700s. After the 1740s coins of 6400 réis, the coins with the highest face value were the most important in minted composition of gold, precisely in the period when the state dominated gold mintage. The spreads pictured in Chart 2 reflect both price and composition effects, while the bands are based on the two extreme cases of currency denominations, the largest and the smallest. With the exception of three years, 1719, 1737 and 1778, the gold spread is within the legal values.

Chart 2 here

In short, both metallic currencies were present in domestic circulation. The Castilian currency allowed the scarcity of silver to be overcome, explaining why only patacas were only reminted after 1785. Lisbon mint activity was dominated by gold coinage, because silver did not generate enough profits and the productive capacity of the Lisbon mint was limited. This may be why the crown did not require Spanish monies to be recoined, as did other European countries, like England and France.

Individuals could go directly to the Lisbon mint to coin the precious metal they received. From 1703 to 1714, coinage to private entities dominated. Conversely, at the beginning of 1720s, the state became the dominant recipient, except for some years in the 1740s and the 1790s. A partial conversion of the debt was carried out in the 1740s with the redemption of the capital in debt and the decrease of interest charges.

Until the arrival of the 1725 fleet, gold was directed to individuals rather than to the state, and the converse happened thereafter. Therefore, revenues that arrived in bullion or gold dust from Brazil became revenues available to the crown and were transformed into currency, that was used to finance current and extraordinary state expenditures. War was one of the most crucial extraordinary state expenditures. In these circumstances, the Lisbon mint could be used as the state reserve fund.

During the seven years war, without any silver being coined and with problems caused by the war and the cancellation of the Rio de Janeiro fleet’s sailing, the state gave orders to the Lisbon mint to estimate the amount of gold in reserve and to coin all of it at once. In the 1730s, during a period of conflict in Colónia do Sacramento, several requests were made to the treasurer of the Lisbon mint to transfer currency to the Conselho Ultramarino to pay for uniforms, ammunition, powder and various other war materials, with destinations Rio de Janeiro, Nova Colónia, Pernambuco and Paraíba.

While this policy of currency debasement was a response to increased expenditures, typical of times when bullion was scarce, it does not imply that wars alone were responsible for debasement and for tax increases. On the contrary, at a time when there was no shortage of gold, fiscal measures might be postponed or substituted by the increase in monetary issue. This is the main reason why after several decades enjoying an abundance of gold, the fall in gold inflows after the 1760s severely threatened state finances.

State revenue more than doubled over a century characterised by stable prices. Two types of revenues supported this rise in the financial capacity of the crown. Firstly, the revenues associated with the king’s monopolies, based mostly in two new sources of earnings for the treasury: the monopoly over the extraction of gold and diamonds, and the monopoly over the sale of tobacco. Finally, the excise and other consumption taxes paid in Lisbon more than doubled their previous value, following the general increase in state revenues and overtaking the revenues coming from the excise paid elsewhere in the mainland.

In the beginning of the 1760s the Portuguese crown was challenged on several fronts. In 1755 a dramatic earthquake destroyed most of the capital city, being responsible not only for serious losses in private properties and wealth, but also demolishing the royal palace and public buildings, such as the customs and royal warehouses. In addition, the Atlantic traffic was confronted with a sharp drop in some staples (sugar, tobacco), which were sources of state revenues through monopoly or custom taxes. Moreover, gold mining was already in its descending trend, lowering the revenues associated with the monopoly enjoyed by the crown. Finally, the participation of Portugal in the Seven Years war became imminent, with the inevitable rise in state expenditures.

The first measures were aimed to revise the regulations over the monopoly of gold mining and the payment of duties associated with it (Decree of 5 December 1750), custom taxation (especially for sugar and tobacco, decrees of 10 April and 20 May 1756) and the prevention of smuggling (Decree of 14 November 1757). The law became particularly severe against smuggling, since tax revenues were seen as crucial in a time of financial stringency. Secondly, the fiscal institution was changed, with the creation of the Erário Régio (Royal Treasury, created by Decree 22 December 1761) when the collection of all taxes and state revenues was centralised in one single department. Until then different revenues were directed to distinct offices subjected to a loose and distant control by the Conselho da Fazenda.

Another major initiative dealt with the regulation of the décima. All its tax administration was centralised away from local officials; the methods to assess wealth, survey and evaluate real property, and tax profits from loans were improved; the universal character of the tax was reaffirmed. Its rate also returned to 10%, but this was a less important change. Its modernity in the Portuguese fiscal system is evident and understood even by contemporary reformers, like José Abreu Bacellar Chichorro, who, writing in 1793, characterised the décima as a modern and equitable tax in its principles, but with deficient application in recent years. Forty years later, Mouzinho da Silveira, still considered the décima a crucial ingredient of the liberal tax system.

The importance of the revenues coming from the décima is well expressed in table 2 above. On average it amounted to 11% of all the revenues for the period 1762-1776, almost the double of the excise collected, except for the city of Lisbon. Even including Lisbon the revenues from the décima are not very distant (11% against 14%), and if only the period after 1765 was taken into account, the receipts are equivalent (an annual average of 663 contos for the décima, against 700 contos for the excise).

However, the structure of tax revenues did not change with this reform. On the contrary, the importance of customs remained and that of crown monopolies was reinforced in the 1700s. Even when 1716 revenues of the monopolies over the tobacco and the Brazilian gold and diamonds are compared with the period 1762-1776, an increase of 100% in this type of revenues is apparent.

In order to increase the share of the income tax in the state revenues, a country-wide tax administration was necessary. After the difficulties of the 1760s, renewed commercial affluence was reflected in increasing custom revenues and stable revenues from royal monopolies, in which tobacco started to become more and more relevant.

War gave legitimacy to new taxes and to system reform. In the 1640s (as in the 1380s when the excise was created as a general tax) the creation of a new tax was sanctioned by the Cortes, transforming the decision into that of a national response to the threats to the autonomy. In the 1760s, in spite of the absence of the Cortes, the long preambles to the decrees gave an ideological and even historical justification for the reforms.

War was an exceptional situation that required extraordinary expenditures and exceptional means to finance it. Holland and England seemed to deal better with these challenges – and thus were able to assume a great power status in early modern Europe – because they combined civil rights and financial freedom. On the contrary, the Portuguese treasury obtained higher and higher sources of revenues distinct from taxation, making it more independent from increased contractual relations with other political or social entities. An enquiry on comparative state revenues in Europe, ordered by the French controller-general of finance Bertin, summarised in Table 3, shows Portugal with the higher state revenues per capita than France or Spain, but a distant third relative to Netherlands and England.

Table 3 about here.

Aside from gold, another reason why the pressures for change did not seem to be particularly strong during this period was that Portugal did not play a major role in the European power struggle, and indeed severed its union with Spain, which under the Habsburgs did have such ambition.

The relevance of domain revenues was not a reminiscence of earlier times. Rather, the ones that mattered in financial terms started with overseas expansion and were based on an entrepreneurial attitude towards business opportunities and wealth accumulation. It was the monopoly assumed by the crown over some trades and goods rather than the importance of taxes on overseas trade, which set the Portuguese fiscal system aside from other European cases.

This patrimonial relationship had evident advantages. Revenues that were easier to collect and based on the monopoly of a few goods allowed the crown to lower the tax burden on mainland Portugal. As a result, peasant uprisings, as well as remonstrance by local élites, were avoided.

Moreover, royal control over gold production through the collection of the quinto and capitação, established a close relationship not only between state revenues and monetary emission, but mainly between state expenditures and gold coinage. The mint became a last resort when extraordinary expenditures found the Royal Treasury short of means.

Indirect taxes on commercial transactions appealed to governments because the tax was hidden in the price of the product. Therefore, they were most widespread across Europe. In Portugal, the excise had been the first general tax and founded in 1387 the proto-history of the modern fiscal system. It represented the social acceptance that the king could not live from his estate revenues alone, but had a public role and should be supported by the nation.

This "contractual" basis for taxation regressed in the mid-1600s, with the definition of a fixed amount for the excise to be paid by each municipality. The self-taxation by each community transformed the nature of the excise and represented a retreat in state formation, because tax administration failed to cover all the country. The fiscal system became more concentrated in Lisbon, where the excise on movable goods maintained the nature of a transactions tax. As a result, the excise shaped power relationships between centre and periphery and indeed developed into a pathology of Portuguese tax system which lasted well beyond the period.

This concentration in Lisbon of the tax system is also evident in the case of customs. As the capital city was the major port of the country, the national gate to the Atlantic commercial network, it concentrated most of the foreign trade. Controlling this commercial gateway minimised transaction costs to collect taxes, explaining the importance of customs revenues.

Lower tax collection costs also explain efforts to collect the excise in Lisbon and to claim a proprietary relationship towards some trades and goods which were highly valued in European markets. Tax collections in Lisbon in 1766 accounted for 59% of the total.

Portugal´s participation in European wars was a bad omen. French invasions followed and then the opening of Brazilian ports to foreign trade in 1808. A brief respite in the 1820s led to constitutional rule, but the country experienced civil war from 1828 to 1834. The old financial system faced successive crises together with increased war expenditure. The impact of the war in state finance and monetary circulation might not be very different from other European experiences. However, the combination of the war and the loss of Brazil is uniquely serious.

In spite of new taxation and legislative efforts to overrule the tax immunities enjoyed by the nobility and by the church, the results were insufficient to overcome the financial problems of the state. In 1796 church and nobility were required to pay the excise duties. The church was also taxed in 1800 by ecclesiastic décima and in 1809 was included in the exceptional defence contribution, by an increase of the décima. In 1800 décima was extended to the comendas. These measures widened the tax base and lessened existing tax inequities, but the results were very modest.

State revenues that increased in 1804 almost 37%, when compared with the average of the previous period, dropped again from 1804 to 1810 (see Appendix Table 1). Explaining this decrease was paramount the behaviour of the two structural state revenues: the customs taxes and the monopolies. In spite of the décima almost trebled from 1797 to 1810 and raised 44% from 1804 to 1810, it did not counterbalance the collapse of other state revenues. The behaviour of custom taxes shows a decline of almost 50% from 1804 to 1810, explained by the French invasions and by the drop of colonial revenues as consequence of the opening of the Brazilian ports to foreign trade in 1808. Looking to the revenues from monopolies, they became much more dependent on tobacco. The rise in the excise and other indirect taxes from the end of the eighteenth century to 1804, as its reduction from 1804 to 1810, is due to the collections in Lisbon. Economic difficulties, as a consequence of French invasions, explain the drop of 36% in indirect taxes at the end of the 1810s. The weight of a financial structure centralised in Lisbon and fiscally concentrated in custom taxes and monopolies, made solutions designed to extend the geographical domain of tax or the tax base insufficient.

Therefore, the state needed to adopt others means to overcome the financial deficit, by innovations in monetary and debt policy. In 1796, the bonds started to be transmitted by endorsement. The loan dated October 29, 1796, raised 4000 contos, issued in bonds with the minimum value of 100,000 réis and 5% of interest, opening a new period in the history of Portuguese public internal debt. The March 13 1797 loan increased to 4800 contos, the interest was 6% and bonds had a lower minimum value of 50000 réis. It was also stated that these bonds could be used for some state payments.

A new law of July 13, 1797, stated that 1200 contos should be issued in small bonds and circulate as money at their nominal value. These smaller bonds created a new means of payment, paper-money, an inconvertible fiduciary one that after 1797 was in circulation with gold and silver coins. The relation between the debt and the paper-money was confirmed in the new period of Portuguese monetary history.

Other proposals to solve the financial problems through public debt were presented in the last decade of eighteenth century. Authors linked to Lisbon Academy of Science, created in 1779, presented some important reformist projects. Rodrigo de Sousa Coutinho, who was president of the Erário Régio(1801-1803), besides holding other public offices proposed the issue of internal public debt, with tax revenues serving as colateral along the lines of what was happening in England. He suggested the creation of a bank, whose objectives were the management of the public debt and the issue of convertible bank notes. This would have required an efficient tax administration, together with the creation of new tax revenues.

Coutinho’s proposed bank was not created and paper-money was an inconvertible fiduciary means of payment. The different solution adopted was justified by the preference of capitalists to fiduciary circulation that, despite the problems for the population and the state, gave profits to those who could hoard gold and silver coins. Further issues of paper-money were made in 1805 and 1807, in spite of the fact that in the first year of the century a law tried to forbid it. The preamble to the law of May 31, 1800 gave the reasons for this measure, as the loss to the royal treasury created by the interest costs, the inconvenience to trade and circulation because of the discount, and the price rises it induced.

The mistrust of wealth holders on the ability of the crown to honour the loan agreements are consistent with the lack of support for Coutinho's reform proposals. In 1796 the first public loan was a failure, bringing about the issue of paper money in 1797 as the next logical step to solve financial problems. The lack of credibility of the crown as debtor as well as the absence of an institutional control over financial matters were certainly responsible for that mistrust .

Price fluctuations were already seen by contemporaries as a consequence of the discount of paper money. The price index in chart 1 above shows that after a period of moderate inflation during the second half of the eighteenth century, prices increased after the 1790s. From 1797 to 1813 prices more than tripled, dropping in the following two years. If this inflation can be explained by the devaluation of paper money, this fiduciary means of payment was certainly not the only source. Napoleonic wars had disrupted production and distribution channels, namely of grain. The consequence was scarcity in supply and higher prices across Europe.

The circulation of paper money was also considered a loss to the state, because it made expenditure in metal coins, namely with army and navy, higher than it would otherwise have been. Devaluation reached 60% in the period of French invasions. Paper-money circulation was also limited to the cities of Oporto and Lisbon cities, as we learn from a representation of the Mercantil Lisbonense association dated September 1837.

The amount of paper-money in the three issues was about 17177 contos, the first issue being 97% of the total. Thus, the first issue in 1797 was much higher than the law allowed, which exhibit the dimension of the financial problems faced at the end of the eighteenth century. To have an idea of what this figure represents, if we compare it with total gold and silver coinage in the same period, 1797-1807, we notice that the total coinage was 25% of paper-money issues. Paper-money was certainly important in monetary circulation at this period, even if restricted to Oporto and Lisbon. We can also understand that this means of payment was responsible for the hoarding of coins. After the Liberal Revolution various attempts to extinguish paper-money were made. It was in this context that the Bank of Lisbon, the first issuing bank, was created in Portugal in 1821. Only half of the intended capital was raised, thus preventing the redemption of paper-money. Hence, in 1834 a decree tried to extinguish paper-money, but two years later its amount still attained about 3000 contos.

During the 1810s internal public debt increased and in 1817 reached 16795 contos, from which only 36% was consolidated debt (see Panel C of Appendix Table 1). This difficult financial situation explains why in 1809 the crown had decided to sell its properties (próprios). Between 1810 and 1820 the crown sold essentially lands, but the result was only 439 contos, a very low amount when we compare with public debt, that continued to be more than 17,000 contos in 1819.

The crown also resorted to external borrowing, but external debts did not weight in the financial difficulties of this period, as they were not paid with internal resources. Foreign loans due to French wars were paid by the indemnities of the Treaty of Vienna and the foreign loans between 1815 and 1828 became Brazilian debt.

Some legal measures were taken to increase the circulation of coins in the early to mid 1800s. The law of March 6, 1822, tried to bring back gold coins into circulation, by increasing its legal mint price. While from 1798 to 1821 the total gold coined was only 2880 contos, in the 1822-1823 biennium it increased to 4362 contos. Another aspect of the monetary currency of this period was the circulation of several foreign coins - with increased transaction costs for economic agents.

The financial crisis of the 1790s had important consequences for public debt and the monetary regime. But, even though criticism of tax discrimination were made and reforms were presented, the actual solutions did not address the major weaknesses of the tax system remained. Between 1810 and 1820, the attempt to obtain greater revenue through the sale of crown properties also failed - as the amount was small in proportion of the public debt.

The liberal revolution of 1820 was clearly influenced by the difficulties suffered by the Portuguese state after the 1790s. The French invasions, the subsequent war and abandonment of mainland Portugal by the Court had disruptive effects on a very fragile tax administration concentrated in Lisbon. Following upon the opening to foreign trade of the Brazilian ports, Lisbon became less important as a gateway to the Atlantic commercial network. Colonial trade also dropped and revenues collapsed.

The monopolies of the crown, which accounted for most of the state’s income throughout the 1700s, had been closely related with the colonial trade. They were influenced by decreasing revenues from gold, which moreover were spent in Brazil after 1808. Losses on the tobacco contract were also felt due to commercial and political events, even though it maintained its position as a major source of revenue to the crown. Finally, from 1811 to 1820, the Portuguese government on the mainland territory incurred in substantial debts, in order to finance public administration and the army at a time when ordinary revenues were very low (Panels B and C of Appendix Table 1).

This period of difficulties made the peculiarities of the state’s income more apparent. Just like the attempts to change the tax system and the resort to public credit from 1790 to 1808 were linked to reformist thought on these topics, the liberal revolution of 1820 was another moment when reformist proposals resumed. However, the liberal experience had lasted too little time to bring about important changes.

The most relevant decisions concerned public debt and monetary circulation. While projects to create a bank in Lisbon in order to rule monetary circulation and to act as a privileged creditor of the state had been conceived in the late 1700s, the first bank with these characteristics emerged in Rio de Janeiro, just after the arrival of the Court in 1808 and the transfer to this city of the kingdom’s capital. Then the Bank of Lisbon was created in 1821, in order to redeem the paper money that had been issued since 1797.A related measure was the effort to estimate the amount of the public debt, either consolidated or floating. Plans were made to privatise properties of the crown in order to pay the debt.

The creation of the Bank of Lisbon in 1821 to restore monetary stability after a time of inflation and distress in state finance during the Napoleonic wars, brought a major change to the financial system. The first Portuguese bank provided two main functions. One was related with its contract with the state to redeem the paper-money, receiving the monopoly of note issuing. Due to this «public» function, the Bank of Lisbon started a long period of financial assistance to the state. The second purpose of the bank was the practice of the commercial operations of discounting and issuing foreign bills of exchange, discounting government debt titles, keeping interest-paying deposits or providing loans.

Banking operations were not absent before the creation of the Bank of Lisbon. The privileges granted to the first bank and the instability following the first liberal revolution certainly prevented the emergence of other banks before 1835, when the Banco Comercial do Porto was granted the note issuing privilege in the northern part of the country and broke the monopoly enjoyed by the Bank of Lisbon. This rewarded the assistance given to the liberal party by the commercial interests associated in the Associação Comercial do Porto.

Tax administration was disrupted in the 1820s, customs’ revenues diminished and the tobacco contract (accounting almost 20% of state revenues) did not find contractors for the period 1824-1826. At last, the contract was awarded, but with a drop of 28% when compared with the revenue for the period 1821-1823. The 1822 budget presented a deficit of 1,607 contos (22% of the revenues), much more important than the 246 contos deficit (only 3% of the revenues) in the 1821 budget.

Furthermore, state revenues for the two years 1821 and 1822 displayed a substantial reduction when compared with budgets for previous years. The difficulties in state finance and the political instability that followed on the end of the first constitutional experience were not the most favourable context for any reform or any improvement in the financial situation.

The excise law of 19 April 1832, decreed by the new Treasury minister, Mouzinho da Silveira, reflects a new tax design. All the tax duties paid on transactions of movable goods were abolished, as well as toll taxes paid in some municipalities. The excise was maintained but only on real property transactions. Therefore, the old tax on consumption was completely transformed into a tax on property sales. The preamble of the decree constitutes a programme of radical changes to the tax system. The enormous variety of taxes surviving from the accumulation of duties over centuries of fiscal history was to be rationalised and the fiscal system reduced to only two taxes: the custom tax on imports and the direct tax based on the old décima.

The abolition of the taxes on transactions was not complete. The excise and similar taxes paid in Lisbon were maintained in Silveira’s decree. It was the most complete acknowledgement of the importance played by this tax as a source of state revenue. It was also an acknowledgement of the difficulties faced in tax collection across the country. In the mid 1850s, taxes on consumption were reintroduced as local taxes and became important sources of revenues for municipal councils. Municipalities retained the collection of local taxes on consumption, which had been abandoned by the central administration, because they were difficult to impose and unpopular. Lisbon was the only place where the consumption taxes were maintained as central administration tax until 1922. Therefore, the biases displayed by the structure of the revenues since the 1600s were perpetuated throughout the 1800s: firstly, the concentration of the state revenues in Lisbon (largely based on customs and consumption duties); secondly, the importance of the revenues resulting from the tobacco contract.

The rationalisation project proposed by Mouzinho da Silveira was not implemented. The importance that the revenue tax should have in the fiscal reform was condemned by the situation of the public administration and the state of civil war existing in Portugal until 1834.

With the end of the civil war more urgent matters required the attention of the liberal governments. In fact, the financial situation of the kingdom had not improved when compared with the 1820s. The public debt almost doubled since the beginning of the civil war in 1832. All this new debt was foreign and rose from a proportion of almost 30% of national income in 1832 to more than 55% in 1834.

Together with the necessity to control the chaotic monetary circulation (heterogeneous composition of paper money issued from 1797 to 1799, convertible notes from the Bank of Lisbon which later became inconvertible and a large variety of coins from different countries), the public debt was the primary policy challenge from 1834 on. All financial measures taken by successive governments, in this period of intense political instability which lasted until 1851, must be viewed with this in mind.

Capital markets helped finance the public deficit throughout the period. As the deficit remained particularly high in the 1830s, increased by the pressure attributed to the debt service. Alleged solutions to the budget deficit contributed to exacerbate the situation. Civil servants had their salaries reduced or were paid by debt titles. State suppliers had their payments postponed and eventually converted in debt titles. The violence and the illegitimacy of these means exacerbated the disbelief in the capacity of the state to defend the property rights. Suppliers and potential creditors run away from contracts with the state or attributed them a risk premium. The support of civil servants was given up too.

In order to cope with debt obligations, Church property was first nationalised and then sold to private bidders together with crown estates. The sales were devised as a way to bring extraordinary revenues into the treasury. The results were insignificant, either as a source of revenue to redeem consolidated debt (either foreign or domestic), or as a way to accept state annuities as payment. However, the sale of crown and Church estates helped retire public floating debt and paper money.

There were no other sources of extraordinary revenues comparable to the nationalised estates. Incompressible budget deficits were financed through a variety of short term debt instruments – bills, contracts or promissory notes - which created a market for public debt titles. Like the paper money issued from 1797 to 1799, the nominal value of these titles were traded at a discount, representing the perceived sovereign default risk.

In 1842 a new government was formed, supported by a larger parliamentary majority. Financial stabilization coupled with infrastructural modernisation (roads, railroads, ports) formed the program of the new administration led by the Duke of Terceira, but whose main personage was Costa Cabral, labelling the period from 1842 to 1846 as the cabralismo.

The first task of the new government was to restore the financial credibility of the state. It tried to reduce expenditures, to increase revenue through land tax reform and new taxes and to compress the debt service, through the conversion of the foreign debt to a fixed rate of interest of 4%. Furthermore, it tried to consolidate the floating debt through a long term loan associated with the renewal of the tobacco monopoly in 1844. The winner of the public auction would pay an annual rent to the government and lend 4000 contos in order to redeem the floating debt.

The second package of the program dealt with the modernisation of the infrastructures. In order to give stronger incentives to private investment the state backed the projects, either by granting exclusives that would secure amortisation, or by subsidising those investments. Then better transports would increase wealth and expand the tax base. Financial stabilization, inturn, might avoid crowding out effects of the public debt on private capital formation.

New banks were created, as the Companhia União Comercial, coming out from the alliances between Lisbon’s capitalists in order to bid at the auction of the tobacco monopoly. It participated not only in state finance, but also developed new activities in commercial banking and was a direct competitor to the Bank of Lisbon in the note-issuing business. The Companhia Confiança Nacional was another financial institution, born in 1844 to raise the 4000 contos associated with the tobacco contract, and to finance the business company created to carry out the modernisation of the infrastructures.

The revolt in Northwestern Portugal (Maria da Fonte) led to another civil war in 1846 showing the incapacity to build up an agreement on the constitutional regime. The programs of financial stabilization and infrastructural modernisation promoted by Costa Cabral resulted in the bankruptcy of the financial and public works enterprises used as vehicles for the projects.

During the 1850s paper money was totally redeemed, the circulation of the inconvertible notes of the Bank of Lisbon was reduced (they were eventually withdrawn in 1856, together with a multitude of foreign coins). This paved the way for monetary reform, which occurred in 1854, when Portugal joined the gold standard. The decision marks the beginning of a virtuous cycle during which the real achieved again convertibility and stability. Between the 1850s and the early 1890s nominal and real convergence to the European average was recorded, the longest to date under a democratic regime .

Monetary stability followed the new political period opened up in 1851 with the Regeneration movement: «a revolution to end all the revolutions», as it was then defined. The different liberal factions settled an agreement about the political regime, which was sanctioned in 1852 by constitutional changes. The political scene was pacified as the two major parties agreed to alternate in power. There was a broad consensus about economic modernisation and institutional reform. The introduction of the metric system, new economic legislation and a vast plan of public works were based on a general awareness of the need to remedy the backwardness of the country.

Another important feature of the monetary system established in 1854 was the competitive nature of note issuing for most of the country, with eight joint stock banks issuing convertible paper money, including the Bank of Portugal. It succeeded the Bank of Lisbon in 1846 but was granted the monopoly in the Lisbon district, which included the largest financial market . The north-western part of Portugal, where note issuing banks were concentrated was also the place of departure for most of the emigrants going to Brazil and other New World destinations. Banks provided remittance facilities to these emigrants, discounted and issued bills of exchange, or foreign currency exchange even when they did issue notes. As a result the concentration in banking decreased at this time..

Chart 3 shows that full convertibility of the real into gold allowed higher debt financing of the government deficit. The credibility of government policy was a crucial element to support the program of public works outlined by the new Regeneration governments - whatever the motives invoked for joining the gold standard . Indeed, the credibility effect was even stronger than the international crisis of the early 1850s. The stability of the gold standard brought about the external reputation which was essential to make Portuguese state securities attractive to foreign investors. The debt would then function as an anticipation of future state revenues, maximised by the positive effects coming from the public investment on social overhead capital formation.

Chart 3 about here

For long-term stability, however, it was also essential that tax efficiency would cope with the substantial increase in the service of the public debt. The partial nature of the tax reforms of the mid 1800s, the inability of tax collection to span the territory turned debt service into a threat to the country's solvency. Customs revenues and the tobacco contract (this latter surviving from the old monopolies) accounted for almost 50% of the state income in 1890. In contrast, the direct taxes diminished their weight in the fiscal revenue throughout the period: in per capita terms they only increased 14% between 1864 and 1890, against 95% in customs taxes. In territorial terms most of the state revenues continued to originate in Lisbon. Adding the consumption taxes of Lisbon to the part of custom taxes paid over the imports through the port of the capital city, we obtain almost 40% of all state revenues. With the inclusion of direct taxes and other duties paid by the inhabitants of Lisbon the proportion would certainly be greater than 50%.

These characteristics of the fiscal system constitute its structural insufficiency, threatening the stability of the period. The last years of the 1880s saw the return to higher deficits in the public accounts. Moreover, the domestic political situation deteriorated, with republican agitation and frustrated revolution in 1891 suggesting a decline in the legitimacy of the monarchy itself. Three other major events were responsible for putting an end to this period: the British ultimatum in connection with Portugal’s claim of the territories between Angola and Mozambique, the bankruptcy of Baring, the London banker of the Portuguese crown, the difficulties in Brazil, affecting the prospects about emigrant remittances.

The suspension of the gold standard in 1891 occurred well before the general movement away from the international monetary system at the beginning of the First World war. The first motive to the suspension of the gold standard must be attributed to the high trade deficit. Emigrants’ remittances constituted the variable that allowed the equilibrium in external payments. The Brazilian difficulties in the late 1880s and early 1890s affected the flow of migrant remittances, shocked the external equilibrium and disturbed the expectation of long term exchange rate stability. The second motive came from the structural insufficiency of state finance, exacerbated from 1888 to 1891 by exceptionally higher public deficits and the unavailability of external financing.

The monetary consequences of the suspension of the gold standard were twofold. First, due to the difficulties of other issuing banks and their bankruptcy in 1891, the Bank of Portugal gained the monopoly of bank notes issue in 1891. Second, the real started a continuous movement of depreciation against the sterling until 1898. This movement was reversed with the increase in the remittances from Brazil and increased demand for the Portuguese currency. In 1905 the level of the exchange rate prior to the suspension of the gold standard was attained, but there was no attempt to come back into convertibility.

The financial and monetary crisis at the beginning of the 1890s had strong incidence in financial policy. The incentives towards public investments in the country’s infrastructures ended in the 1890s, opening up a more restrictive policy. In addition, the response to financial difficulties followed the very same paths than before the adhesion to the gold standard. In order to reduce expenditures the payment of the foreign public debt amortisation was suspended. The increase in state revenues came from rises in existing taxes, some of them with a temporary character, but which turned into permanent. Domestic and foreign creditors were taxed too. The interests received by the internal creditors were subjected to a new tax of 30% after January 1892. Six months later the external creditors endured the budgetary difficulties of the Portuguese state. From June 1892 the Portuguese government suspended the payment of two thirds of the interests based on the foreign debt. Being paid in foreign currency this second type of interests became much more onerous, in a time when the real was falling against the pound.

As a result of these measures the reputation of the state fell even further and the recourse to foreign loan became impossible - until the Portuguese involvement in the First World war. The unilateral character of hidden or overt taxes over the interests on public debt exacerbated the disbelief in the capacity of the state to support the property rights.

Finally, there was an increase in the revenues coming from patrimonial sources, even if their weight was much lower than in earlier times.

On 5 October 1910 a republican revolution ended the constitutional monarchy. Symbols of the old rule, the flag, the national anthem and the currency were changed with the new regime. On 28 March 1911 the real was replaced by the escudo, which however remained inconvertible.

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.

In 1387, when the main source of revenue was still land properties and seigniorial rights, municipal excises (sisas) were transformed into an universal tax with a comprehensive base. The new tax was supposed to pay for the war with Spain. It had a contractual origin insofar as it was approved by the Cortes, a traditional form of estates representation which acted as garantor of private property rights. In the early 1500s, creditors began accepting registered bonds from the crown and internal public debt emerged. There were also short-term loans issued in Flanders which were consolidated in 1560. Yet revenues came primarily from monopolies established on trade and other colonial resources, such as gold, and from custom duties collected in Lisbon.

The fiscal and monetary institutions of the XVII century reflect Spanish rule in the 1580s and the restoration of independence after 1640. Until 1688, successive debasements of gold and silver coins were required to pay for the war. The tenth (décima), created in 1641, was a direct tax levied on income coming not only from real estate, as it was the case in the rest of Europe, but also from labor, commercial and industrial activities and interest on loans and accounting for 8-10% of total revenues.

The contrast with England, a country presented as paradigm of the evolution from the domain state to the tax state, is the continued dependence on revenues that were not primarily based on taxes to secure financial stability. In fact, taxes on domestic residents and especially on those living outside Lisbon were lower and more poorly collected because of the importance of domainial revenues. The tax revenues of what was essentially a city-based system were as sensitive to fluctuations in foreign trade as they were to foreign invasions.

The XVIII century began with the discovery of gold mines in Brazil, allowing a period of monetary stability, which was not disturbed by the increase in the legal price of silver in 1734 and 1747. The crown received royal duties over gold production (quinto or capitação). Consequently gold arrivals generated a tax revenue and contributed to maintain a financial structure based on monopolies and custom taxes. The crown ordered the coinage of the gold received in bullion or dust and was the major customer of the Lisbon mint. When extraordinary public expenditures found the treasury short of means gold coinage was the last resort. Moreover, after 1725, most of the gold coming from Brazil to private individuals was coined at the Rio de Janeiro mint.

Gold financed the payments deficit with England and Europe at large, was used for debt redemption and privately hoarded. The rest circulated. Silver was used in the trade with Asia. While Portugal did not have different monetary systems for internal and external trade, domestic circulation and credit were concentrated in the coastal areas.

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.

Pombal’s fiscal reforms of 1760 followed the decline in Atlantic trade and the increase of expenditures due to the European wars. They include regulations on production and the gold trade, on custom duties and the repression of smuggling. With the creation of a central treasury (Erário Régio), the collection of the tenth was placed under the control of the central government.

At the turn of the century, revenues coming from foreign trade and from the monopolies of colonial goods represented more than 50% of the total. The dramatic coincidence of the increase in military expenditures as a result of the French invasions and the end of the trade monopoly with Brazil brought about a very large deficit.

The only solution to these financial difficulties was the resort in 1797 to inconvertible paper money - which was responsible for a period of raging inflation which lasted until the 1820s and a revolution characterized by anti-seigneurial demands. The revolution did not lead to tax revolts. Revenues coming from domainial sources had a higher share in Portugal than elsewhere in Europe and the pressure to increase expenditures was lower. This may explain why institutional and fiscal reforms allowing a greater resort to public debt develop later than in major European countries.

Following the French invasions, government revenues fell and expenditures increased leading to attempts to reform the tax system and to resort to borrowing which proved unsuccessful. The tradition of currency convertibility and stability with a low public debt, which had been established during the XVIII century, was broken by monetary disorder.

The constitutional government tried to simplify the tax system, keeping custom duties and the tenth, and making the sisa a tax on real estate transactions. The first banks were created. Church properties were nationalized and later sold to private entrepreneurs. The proceeds were used to redeem the floating debt but- in spite of reforms - tax revenues were not sufficient to support the attempts to consolidate public debt. Overall, deeper institutional reforms were needed to provide political and financial stability and warrant the support of commercial interests.

The political and constitutional framework needed to sustain financial stability and to reform the tax system was lacking and problems in monetary circulation lasted until the early 1850s, when the currency became convertible and money creation was subject to well defined rules. 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 helped sustain this experience of real and nominal convergence under democratic rule. Monetary stability based on currency convertibility supported more extensive resort to debt, and it was coupled with rates of GDP growth higher than in the rest of Europe.

Foreign held public debt as a way to finance short-term deficits was a development strategy which assumed that in the long term the increase in tax revenues would take care of the debt service. This required an efficient public administration, capable of collecting taxes. But attempts at increasing tax revenues originated strong social opposition, as it was the case of the revolt against the introduction of a consumption tax in 1867-1868 (known as Janeirinha). Earlier attempts at reforming property surveys, which should increase land taxes, met with the same fate. As direct tax revenues declined, custom duties and taxes on tobacco rose to 50% of the total. Low taxes, especially outside Lisbon, hindered the sustainability of government accounts and the solvency of the country. At the end of the 1880’s budget deficits increased again and the political scene began to show signs of instability which erupted in a suspension of currency convertibility in 1891. Inconvertibility was to last through most of the XX century.

If, for the monarchy, convertibility had been the rule rather than the exception, the pressure of war remained through the early XX century and so did the difficulties in tax administration. Indeed the resilience of the latter may be the lesson from Portuguese monetary and fiscal history, which retains the greatest current policy relevance.

Monetary disorder and financial crisis have been associated with Portuguese constitutional monarchy rather than with the republic. Yet the crown maintained civil rights and financial freedom during four decades whereas the republic never introduced the latter and soon lost political freedom as well. The monetary myth is ingrained in the collective memory of people. Somehow the unhappy sequence of French invasions, loss of Brazil and civil war, which preceded entry in the gold standard, and the demise of the monarchy, which followed the exit, are more salient than the virtuous cycle of four decades.

There are other examples of this selective memory in Portuguese history. Some even occurred in the recent past. Rather than favoring a particular interpretation for the resilience of monetary myths, this paper hopes to contribute to making the legacy of Portuguese fiscal and monetary institutions better understood at home and abroad. This will hopefully lead to further research on the remarkable but forgotten inheritance of the real on national fiscal and monetary institutions.