The Collaborative International Dictionary of English v.0.48:

Dago \Da"go\ (d[=a]"g[-o]), n.; pl. Dagos (-g[=o]z). [Cf. Sp.
   Diego, E. James.]
   A nickname given to a person of Spanish (or, by extension,
   Portuguese or Italian) descent. [U. S.]
   [1913 Webster]

WordNet (r) 3.0 (2006):

dago
    n 1: (ethnic slur) offensive term for a person of Italian
         descent [syn: wop, dago, ginzo, Guinea,
         greaseball]