First, this is the initial story I got in the e-mail:
In George Washington's days, there were no cameras. One's image was either sculpted or painted. Some paintings of George Washington showed him standing behind a desk with one arm behind his back while others showed both legs and both arms. Prices charged by painters were not based on how many people were to be painted, but by how many limbs were to be painted. Arms and legs are 'limbs,' therefore painting them would cost the buyer more. Hence the expression, “Okay, but it'll cost you an arm and a leg.” (Artists know hands and arms are more difficult to paint)
Sounds like a believable story, right? Well, in actual fact it's a much more recent American phrase coined sometime after WWII.
Like many etymologies, the exact origin of the phrase is unknown. Though there are some guesses...
The phrase “costs an arm and leg” is used to describe anything that is considered to be extremely expensive or excessively pricey. So it may have originated during the War when many soldiers would lose limbs, in reference to the high cost paid. This is the more literal meaning.
A second guess is that it may have originated from earlier expressions like “I would give my right arm” from 1616, meaning to be willing to give something of great value for someone or something. Another is “If it takes a leg” from 1872, which expresses desperate determination.
Further research showed me that there is actual Snopes page dedicated to this specific email I received. Apparently, it's a list of false etymologies which have first appeared on the Internet as far back as 1999.
Interestingly, I also found the same etymology in the 2008 book The Biggest Joke Book Ever by Jack Jacoby.
Whatever the real origin is, the earliest citation of “It Will Cost You an Arm And a Leg” remains in The Long Beach Independent in December 1949. This is way after George Washington.
And now you know.