Imperial Spain's serial defaults...

WHEN the 18-year-old Isabella of Castile married the seventeen-year-old Ferdinand of Aragon in 1469, they were so poor that they had to borrow to meet the expenses of their wedding ceremony, writes Nathan Lewis at New World Economics in this section from his forthcoming book, The Magic Formula.

The ceremony was modest; both the bride and groom, centerpieces in the factional politics of the time, traveled to Valladolid in secret, and met for the first time four days before their wedding.

But things were already looking up for the pair. When she was younger, Isabella was sometimes in need even of food and clothing.

The wedding effectively united Spain into a single entity, making it a major presence in European affairs. Spain thrived under Ferdinand and Isabella's leadership. Longstanding civil wars ceased; serfdom was abolished; bandits were eradicated; roads were improved; the judicial system was reformed, along with tax administration and many other government institutions.

The year 1492 proved a double landmark, as Spain's overseas empire began its amazing expansion, and also, the last Muslim rulers were driven from Spain for the first time since 711. Soon after, Spain invaded and expanded its realm in Muslim North Africa.

Tax revenue of less than 900,000 Reals in 1474 rose to over 26,000,000 Reals in 1504, without the imposition of any new taxes. The gains came from economic expansion, and improved tax administration. Isabella died in 1504. Before his death in 1516, Ferdinand considered expanding Spain's holdings to include all of North Africa to Egypt, and eventually, Jerusalem and the Holy Lands. But, he instead contented himself with consolidating Spain with the invasion and acquisition of Navarre, on the border with France.

More inheritances formed the empire of Charles V (1516-1556), the grandson of Ferdinand and Isabella, who ruled Spain in addition to southern Italy, the Netherlands, Austria and the Holy Roman Empire – nearly all of Europe between France and Russia. Thus, the Spanish Empire in Europe was never really a matter of expansion via the typical mode of military conquest or colonization, so much as a federalization, in the person of Charles V himself, of disparate, mostly independently-governed and autonomous existing entities. However, the later contraction of this empire, under the pressure of foreign military advance and domestic secession, was real.

Already by the mid-16th Century, while Spain's overseas empire was expanding dramatically, in Spain itself and in Spain's European holdings, a process of economic decay had begun. This strange contrast, between difficulties at home and glittering advances worldwide, appears to have been related to Spain's liberal attitude toward the overseas empire, amounting to benign neglect arising from the sheer difficulty of effectively managing such a realm in that era.

Kingdoms had been small and ruled by direct personal interaction. Charles V was an example of the old type of king that personally led his armies into battle. In one anecdote from early in his reign, Charles once asked for a pen and paper, but none could be found in the castle.

Spain's government asked little of its overseas colonies except for a share of silver mining production, and even this imposition was thoroughly evaded. The Spanish eight-Real coin, later known as the silver Dollar, began to be minted in 1497. Later, the enormous flow of silver from the mines of the New World were minted into these silver Dollars, which became the premier international currency of the world, a common coinage throughout the Americas and also throughout Asia, where it became the regular silver coinage of China.

The Chinese Yuan, Japanese Yen, Korean Won, Philippine Peso, Hong Kong Dollar, and US Dollar were all eventually derived from the Spanish silver Dollar, along with various other Dollars and Pesos throughout the Americas. The value of the Spanish silver Dollar was maintained essentially unchanged until it was effectively retired in the early twentieth century. Thus, with Low Taxes and Stable Money, the Spanish Empire expanded abroad, even as Spain itself was taxed and devalued into oblivion.

At its peak around 1600, after the union with Portugal in 1580, the overseas Empire spanned the world, including virtually all of Latin America from Mexico south including California and the Caribbean; the Philippines, the Marianas, Micronesia, Guam and Palau; and a network of trading ports along the islands and coastline of West and East Africa, southeastern Arabia, India, Malaya, Macau (China), Bali, and Japan.

From the beginning of his reign, Charles was faced with constant challenges and was forever short of funds. Wars with France in the 1520s, Ottoman Turkey in the 1530s, and revolt in Germany in the 1540s and 1550s, placed a constant strain on finances. Charles borrowed enormous sums from German and Genoese bankers, and also went from realm to realm to try to extract more taxes.

At first, Italy and the Netherlands bore the brunt of this revenue-collecting, but that resource was soon exhausted. In time, Charles was refused; these countries considered themselves independently-governed states. They were willing to fight and pay for their own defense, but would not fund any foreign wars. Eventually, Charles turned primarily to Spain, and especially Castile, to raise taxes, and raise them he did.

The centerpiece of this tax system was the alcabala, a device that originated during the Muslim rule of Spain. It was a 10% tax on the transfer of all real and personal property. However, unlike a modern retail sales tax or VAT, it applied to all transactions, and could be imposed many times in the process of a product moving to market. In effect, it was a tax on the division of labor itself, and quite destructive of commerce despite its seemingly low rate.

Also, it behaved as a tax on all asset transfers. Queen Isabella, in her Last Will, called for the abolition of the tax. Cardinal Jimenez pleaded with Charles V to eliminate it. But it also produced the most revenue among the many taxes of the day, and so it was kept.

More taxes were added: The cruzada was once an emergency tax levied in times of war, but it became payable every three years by all inhabitants. This single tax brought in nearly as much revenue as all of Spain's overseas empire. The terces reales was a one-third tax on all church tithes; the subsidio a tax on all clerical rents and incomes; the excusado a further tax on church tithes. Additional customs duties (both external and internal) were imposed, along with a tax on sheep and cattle. The servicio had been a temporary tax granted during emergency, but it became permanent, and a major revenue source.

The outcome of this barrage of taxes in Castile was an explosion of tax avoidance, evasion and resistance. Peasants who would sometimes murder the tax-gatherers were not afraid of less violent means of avoiding taxes. These taxes did not produce much revenue. By the end of the Charles' reign, and after the imposition of many new taxes, the region of Aragon was paying less in revenue than it did at the beginning. Many of these taxes were administered by tax farmers – then, as ever, vicious, corrupt, and hated everywhere.

The countryside of Spain was depopulated as farmers fled the taxman, or were driven into destitution as their animals and goods were confiscated. One avenue of escape was the New World: with every shipment of silver and trade goods that came to Spain from overseas, thousands of emigrants left on the outbound ships for lands free of the hated taxes. Spain thus exported its best talent, the most ambitious, energetic and adventurous of its people.

Another escape was the civil service: government employees were tax-free. Their headcount swelled to enormous numbers. "There are a thousand employees," wrote one, "where forty could suffice if they were kept at work."

A third escape was the nobility: the nobility were free of many taxes. A fourth alternative was to join the gypsies, living in the underground economy, and possibly from outright crime.

Prince Philip told his father in 1545: "the common people, who have to pay these servicios, are reduced to such utter misery that many of them walk naked." Merchants and manufacturers closed their businesses, and purchased entry into the ranks of the hidalgos, a lower class of the tax-exempt nobility. Their assets were converted into government debt. This also gave them access to the court. Now, instead of being a productive taxpayer, they could engage in directing some of the flow of taxes paid by others out of the government and towards their own pockets.

Within the court, a continuous battle waged for the patronage and favors of the king, and with it all manner of monetary rewards. The more intensely the taxes fell upon the lower classes, the more intensely the nobles and wealthy sought ways to avoid being taxed. Attempts were made to introduce tax systems that fell upon all classes proportionally, but the terror of being subject to taxes was so great that these were all refused. After all these efforts, Charles gained about a 50% increase in nominal annual tax revenue over the 37 years of his reign; but, along with the inflow of silver from the New World, agricultural prices also increased by 100% during that time. By 1543, 65% of tax revenue was used to pay interest on the debt. An attempt was made to pay down some of the debt, but the bondholders complained that there was no other investment that would turn a profit.

During this time, the overseas empire was experiencing incredible success. The empires of the Aztecs and Incas fell with astonishing rapidity in the 1520s and 1530s. In the following decades, the Spanish adventurers consolidated their rule throughout the Americas, subduing and often enslaving millions of natives.

In 1522, Ferdinand Magellan's fleet accomplished a circumnavigation of the world. In following decades, Spanish and Portuguese traders traveled throughout Asia, transporting silver and luxury goods between Europe and India, Siam, the "spice islands" of the Moluccas, China, the Philippines and Japan.

In the 1570s, they established a trading route across the Pacific between China and Spain's colonies in Mexico and South America. Spanish galleons carried silver from mines in Bolivia and Mexico to China, and carried all manner of silks, porcelain, spices and other manufactured goods back to Europe. Before long, Chinese manufacturers were making goods according to European specifications, including clothing in the latest continental fashions. The Spanish government attempted to charge tariffs on this trade, but they were almost universally evaded.

Charles' son Philip II became king in 1556, and had the unfortunate duty of defaulting on the enormous debts his father had amassed. He defaulted in 1557, 1560, 1575 and 1596.

In 1566, a revolt broke out in the Netherlands, then under Spanish rule. Twenty thousand troops were sent under the command of the Duke of Alba to suppress the revolt. The Netherlands had been somewhat autonomous from Spain, and taxes were based on long-standing Dutch norms.

To pay for the expense of the troops, Alba imposed a variety of new taxes including the hated alcabala in the Netherlands. Whatever their previous grievances (mostly centered on the Protestantism sweeping Europe at the time), the Dutch now had a new reason to fight. The revolt turned into a disastrous civil war that lasted eighty years, with catastrophic consequences for Spanish finances.

The independent Dutch Republic was established in 1581, although battles with Spain continued until 1648. The Netherlands had always been a center for trade, but independence freed the Netherlands from Spanish taxation and created a new competitor for Spain's overseas trade empire. Many of the new Dutch traders were simply the merchants of Spain with a new flag. As the Spanish coinage was later debased, during the seventeenth century, the Netherlands maintained a scrupulous policy of monetary stability. The Netherlands became the wealthiest nation of the seventeenth century, and the finance capital of Europe, before it too succumbed to overtaxation in the eighteenth century and was eclipsed by Britain.

Philip II's empire was harried by both the Dutch and the English, who interfered with shipping especially along the North Atlantic coast. In 1588, Philip decided that he would invade England, and sent off an Armada of 130 ships to accomplish that goal. The Armada was defeated, mostly by terrible weather rather than the over-matched English navy. But, England showed that it would fight with all of its resources; and certainly one reason for this was that they would rather be ruled by Elizabeth I than fall under the oppression that Philip II imposed upon his own people.

The costs of the Armada and Philip's other imperial ambitions were enormous, and funded by more debt and more taxes. The milliones and sisas piled heavy new excise taxes upon the existing tax structure.