This derogatory term did not originally refer to Italians, which is its chief sense nowadays. Dago comes from the Spanish given name Diego, and over time has extended in meaning to include Portuguese and eventually Italians. It dates to the 1830s. From E.C. Wines’ 1833 Two Years in the Navy, referring to the natives of Minorca:
These Dagos, as they are pleasantly called by our people, were always a great pest.1
The application of the term to Italians dates to the 1870s. From Francis Henry Sheppard’s 1875 Love Afloat: A Story of the American Navy:
Our band is all broke up. Arrowson has got every Dago, and Greaser, and nigger against me.2
2Historical Dictionary of American Slang, v. 1, A-G, edited by Jonathan Lighter (New York: Random House, 1994), 553.
Copyright 1997-2014, by David Wilton