Comments on the Theory of Fiscal Policy

The paper by Dr. F. R. Faridi is an excellent attempt to present the fiscal policy of an Islamic state in a scientific manner. In the very beginning the learned author summarises the basic elements of his theory, namely: (a) the three-sector economy, i.e. public sector, private sector and voluntary sector; (b) Zakah as the basis of Islamic fiscal system; and (c) the functions of Islamic economy defined in terms of allocation, distribution and stabilization. In connection with methodology he explains that the source of guidance is the experience of the early stages of the Islamic state and the writings of the jurists. Later in the paper he develops his three-sector model. While elaborating the three sectors he also mentions the motivations of the respective sectors. The motivation of the private sector is profit, while the motivation of voluntary sector is the fear of Allah Almighty (Taqwa) and reward in the life-hereinafter (Al-Akhira). However, he does not clearly specify the motivation of public sector and its implications. It would seem to include the ‘compensatory’ or ‘balancing’ role. It may be pointed out that the public sector, as it is prevalent in the modern times, would also have an angle of ‘welfare’ besides regulation as its motivation.

With regard to the fiscal functions of an Islamic economy, the learned author confines his treatment to allocation, distribution, and stabilization functions. Stabilization function has been taken to include the problem of inflation. However, sufficient justice to the problem of inflation has not been done, while the more recent phenomenon of ‘stagflation’ has not been touched. Perhaps he does not deal with inflation because the problem was not there in the early period of Islamic stage from which he derives his theory. However, the demands of the present day are such that the problem of inflation is going to be with us for quite sometime. Another important omission with regard to the functions of Islamic economy, is the problem of ‘growth’. The learned author has not given due place to the problem. It has been accepted as an important objective of fiscal policy and a function of the present day states. Moreover, unlike inflation, there does exist the importance of this objective in the Islamic literature as well as in the early days of Islamic history. In fact, the term Zakah itself includes the connotation of growth to which the author has not paid much attention. Moreover, the objective of economic growth and betterment has been recognised as a proper desire and need of indivi duals. The motivation of betterment has been mentioned in the Holy Quran in terms of endeavour to seek the bounty from the Allah Almighty (Ibtigha Min Fadlillah). This occurs in several places in the Holy Quran. Moreover, there are some Ahadith of the Holy Prophet (peace be upon him) wherein people have been advised and encouraged to use the funds and’assets for income generation so that these are not exhausted and depleted through the process of Zakah.

While enunciating the principles of fiscal policy and its tools, there is a mention of taxation. However, problems of public borrowing, programmes of public expenditure etc., have become an integral part of fiscal policy today, and connot be brushed aside. The learned author has not devoted much attention and space to these problems. The author has paid some attention to permissibility of taxation other than of Zakah. This was not really needed because there is not much dispute left now with regard to permissibility of taxation other than Zakah. Later he mentions that ad hoc levies or imposts for supplementing welfare expenditure for defence purposes are administratively difficult to operate and also uneconomic. This can be questioned. There are precedents of special donations demanded by the Prophet (peace be upon him) for the purpose of defence. However, in more recent history we have examples of special levies and imposts, by secular governments, during and immediately after war - the World War II. These were not only operationally successful in raising funds but also economically helpful in mopping out excess liquidity with the trade community because of inflation. He maintains that taxes other than Zakah would not be ‘residual’ but ‘compensatory’ in terms of Islamic economics. In this regard he indicates the resource gap as a basis for taxes other than Zakah.

Dr. Faridi has casually mentioned a possibility that Zakah levies may mean a sudden diversion of resources from saving to spending or from investment in Zakah-ab\e uses of funds to non-Zakah-Me uses of funds. However, due attention has not been paid to the problem of “capital formation” in an Islamic economy, especially as a result of imposition of Zakah, Ushr etc. It is well known that even in non-Muslim economies fiscal administration faces a paradox in terms of fiscal objectives pursued. The objective of improvement in distribution would suggest some transfer of resources from relatively higher income groups - possessing higher marginal propensity to save — to relatively lower income groups — having lower marginal propensity to save or higher marginal propensity to consume. Moreover, promotion of capital formation is an important and necessary, though not sufficient, condi tion for the process of economic growth, the importance of which can hardly be minimised in today’s world. Growth and development implies not only increase in per capita income and GNP — usually taken as a measure gf growth — but also development taken in a wider sense including growth of technology besides capital formation. Every country today aims at growth and development as an important objective. This is especially true because an overall economic growth nowadays is a symbol of ‘strength’ of Muslim countries viz-a-viz non-Muslim countries. The learned author has not tackled this problem of ‘paradox’ in the objectives of fiscal policy.

The learned author has devoted quite a bit of effort and space to develop his three-sector model. In doing so public sector and government have in some places been taken as synonymous. The two terms have been used interchangeably. In fact there is a difference between the government and public sector as we understand them today, both in respect of legal and administrative entities and in respect of functions and objectives pursued by both. The author gives an impression that ‘profit’ is the motive force for private sector alone, while the public sector has only regulatory and a balancing role to perform. In many muslim countries of today and even in some non-Muslim countries public sector is reasonably large, comprising a large number of public enterprises producing a variety of commodities and services. Being business units, these public enterprises also have a ‘profit’ motive besides other objectives and goals of public sector. In fact some Muslim countries have their entire industrial activity in the public sector, and these enterprises inevitably try to operate with a profit motive. Thus, the balancing role and profit motive are not necessarily mutually exclusive. The fact that the author has taken government and public sector as one entity is also evident from the fact that he assigns the allocative role to the public sector. In reality allocative role is a function of the government, which is performed partly through government policy measures, and partly through instrumentality of the public sector, which is legally and operationally an independent wing under the government.

The concept of voluntary sector as the third sector of his model seems to be the major element of the theory of fiscal policy as presented by the author. In this connection two points need to be mentioned. In the first place, voluntary sector is not the characteristic of an Islamic system alone. Even in capitalistic system there is a reasonably large sized voluntary sector, or subsector of the private sector. In case of U.S.A., for example, there is an institution of ‘non-profit’ corporations and organizations in different fields of life. Most of the hospitals and the universities in the United States constitute part of this voluntary subsector of private sector. This vast field is not motivated by profit but by social, moral, and spiritual considerations. Moreover, even in case of primary and secondary education, the Catholics and the Jews have their own private network of higher and primary schools because the sponsors do not like their children to go to the government-sponsored schools where ‘secular’ education is given. Similarly, there are certain small television and radio networks sponsored by religious groups and motivated by moral and spiritual considerations. Then, of course, there are huge foundations for social and welfare purposes such as Ford Foundation and Rockefeller Foundation, to name just two of them. The budgets of some of these foundations are larger than the total budgets of certain Muslim countries. Thus, voluntary sector is not a unique or distinctive feature of an Islamic economy.

The second point, in connection with voluntary sector, is that the learned author has built his framework of voluntary sector on the basis of ‘voluntary’ payment of Zakah and Sadaqat in a Muslim country. Flowever, if a Muslim country wants to enforce Zakah and Ushr etc. as part of Islamic system as a whole, collection of Zakah would have to be on a compulsory basis and at the state level. This would mean that much of what Dr. Faridi has put in voluntary sector, would in fact be a part of Baitul Mai or state treasury, and thus constitute an activity of the government or public sector as he prefers to describe it. When Islamic system is enforced the collection of Zakah would not be confined to Alamwal ul Batinah (invisible or non-apparent assets), alone, but would also include Alamwal uz Zahirah (visible or apparent assets). Collection of Zakah from Alamwal uz Zahirah would be much larger than the collection of Zakah from Alamwal ul Batinah, because we are living today in a monetised economy where financial assets, investments, bank deposits, insurance policies, provident funds, and many similar assets have become very important, and certainly larger in value on a collective basis than the Alamwal ul Batinah. Naturally, when the Islamic economic system is sought to be enforced, as a beginning has been made in Pakistan for example, the collection of Zakah can hardly be included as an exclusive part of voluntary sector. This will have to be a different subsector of public sector or an independent wing of the government machinery. Moreover, any country which decides to enforce Islamic economic system must also introduce collection of Ushr through the government. In Muslim countries with agricultural orientation, the collection of Ushr would be substantial, and in some cases may exceed the collection of Zakah from Alamwal u! Batinah. If we add up Zakah on Alamwal uz Zahirah, collection of Ushr and Khums, the sum total would be several times larger than the collection of Zakah on Alamwal ul Batinah. Thus linking Zakah and Ushr with the voluntary sector, does not hold good on either a conceptual basis or an operational level. Whether or not there is a voluntary sector in the sense and form presented by Dr. Faridi, his point that motivation for Zakah and allied activities is fear of Allah, or Taqwa and Al-Akhira is well taken. This is what distinguishes Zakah and Ushr from taxes.

Dr. Faridi has given a detailed treatment of allocation and distribution functions of fiscal policy. Although a good part of the discussion is based on the usual discussion of fiscal policy in the standard Western literature, some interesting additions have been made. Fie maintains, for example, that an optimum allocation of resources in an Islamic economy is the one that establishes an equilibrium between the moral and economic imperatives of the society given its income and the state of technology. As we have mentioned earlier we may not agree that income and technology be taken as given. In our view, growth as a symbol of strength is in itself an important objective of fiscal policy. However, the concept of equilibrium between moral and economic imperatives is a sound policy guide. We wish this were dealt with more clearly and elaborately inasmuch as this mix or blend is the characteristic of an Islamic society. The discussion on moral imperatives not nearly as adequate as one would wish it to be.

In connection with distributive function, he uses the concept of Poverty Line. However, income tax exemption is not a very valid criterion for its determination. Empirical research alone can determine a sound and acceptable Poverty Line. Income tax exemption limit varies from country to country, as the author admits later. Then, there are certain Muslim countries where income tax just does not exist. Income tax exemption limit, or existence of income tax itself, are all policy variables constituting in themselves the parts of fiscal policy mix of a particular state or government. Although the author has gone in great length to discuss allocative and distributive functions of fiscal policy, he does not discuss much about fiscal operations. In fact the two go together. Perhaps, this is why much attention has not been paid to guidelines for public expenditure programme and the question of public borrowing — as mentioned earlier - which constitute an important part of fiscal system in any type of economy. Anyhow the learned author has done some good groundwork for the theory of fiscal policy in an Islamic society. Others can later take up some of the issues which have received insufficient attention of Dr. Faridi.

Dr. Muhammad Uzair

The author maintains “that the distribution function of an Islamic economy may be discharged largely by Zakah"  I do not think that this is strictly correct to say that Zakah is the major tool of redistribution in an Islamic economy. It will be a very big omission not to point out that there are other major devices for redistribution in the Islamic economic system. They may not have as large an influence as Zakah, but they are very significant and they should be pointed out. One of them is Nafaqat-ul-Wajiba which is an obligatory family support, not only for one’s own immediate family members but also for relatives. In Maliki Fiqh, a support for poor relatives can be imposed by state. Another is the law of inheritance, which hardly needs any elaboration. Then comes the Islamic rules of ownership and of the use of natural resources. Islamic laws about mineral wealth on or below the ground and such other compulsory injunctions also fall into this category. It is provided in Islamic injunctions, that certain natural resources must be reserved for the whole community. Finally, there is the prohibition of interest. This also has a positive effect on income distribution. All these tools tend to make income more equally distributed. Keeping in view all these measures we can not say that the income distribution function in an Islamic economy is largely discharged by Zakah.

There is also a confusion about the intended functions of Zakah and the functions of taxes. Dr. Faridi has mentioned that in the provision of public or quasi-public goods by the state, the disbursement of Zakah can be used.f This may sound on the surface to be acceptable but, in fact, it is not. Zakah cannot be spent to produce public or quasi-public goods. There are strong indications in Quran that Zakah is essentially for the poor. Almost all sects of Muslims prohibit expenditure of Zakah on building a mosque because it is used by both rich and poor. Thus we should not say that Zakah would help produce public and quasi-public goods. No! It can be transferred to the poor only. Some may interpret the spending on welfare goods as Fi Sabil- lillah but the most authoritative interpretation would not allow this.

Dr. Faridi maintains that the tax system in Islam will serve to meet primarily the same needs for which Zakah has been levied. I do not think this is an accurate statement. The tax system in Islam, to the extent it is permissible, is to produce public and quasi-public goods and has nothing to do with what Zakah was meant to do. The idea to harmonise the tax system with Zakah, on the face of it, may seem to be very innocent but it is a complicated issue.

Three-sector model (the third sector) is very significant and deserves a separate paper.

It is good idea to use negative income tax concept to analyse the concept of Zakah. We, however, should be careful in applying the concept of negative income tax to Zakah in view of the fact that negative income tax has been found to work as a disincentive to work. This will not be so in case of Zakah because Zakah is Haram for those who can work. There is a moral stigma in case of Zakah.

Dr. Anas Zarqa

I should first congratulate Dr. Faridi in the beginning for presenting a lucid and imaginative paper. He tackles his topic with depth and clarity and without repeating earlier rudementary approaches to fiscal policy in Islam.

However, paper can be improved in style if it can get rid of some repetitions while dealing with such problems, as allocation, distribution, stabilization and more precisely when dealing with what be calls the third (voluntary) sector.

I fully agree with Dr. Zarqa that there are devices other than Zakah in the Islamic system which will improve income distribution. It is well known that Zakah is primarily meant for meeting the economic needs of needy persons. Eliminating poverty is its prime objective. It is true that Zakah will transfer income or wealth from those who have to those who have not. But it was never designed to achieve full equitable distribution of income in the Islamic society.

Dr. Faridi is of the opinion that other taxes and fiscal measures are needed to attain the socio-economic goals of society. I agree with him. But he fails to show his preference whether he is largely for direct or indirect taxes. Perhaps direct taxes (on income and wealth) are more equitable and more in conformity with Islamic norms. It is true that Muslim countries of today are developing and the general practice is to depend heavily on indirect taxes. There is a difficulty in the assessment of income and wealth and in the prevalence of tax evasion. But we expect that the introduction of Zakah coupled with the introduction of fully integrated Islamic policy in all spheres of social life, will improve greatly the fiscal apparatus. Income and wealth can be assessed more correctly. Zakah-’pzyers will feel when they are assessing their Zakah that they are discharging a religious duty. Hence more use can be made of direct taxes, which is almost impossible in the present secular state of mind and policy. Direct taxes can hit the right source and thus decrease the sufferings of low income groups or rather increase the net gains from new taxes.

There is a discussion about Nisab where it seems that there exists some misunderstanding about it, when Dr. Faridi makes the point that Zakah should be paid only to those who fall below Nisab and those who have the requisite Nisab but still fall below poverty line may receive non-Zakah transfer payment.

Here we have to be clear about the real meaning of Nisab. Nisab means that minimum level of income (or savings) which is left over after meeting all necessary living costs of the Muslim. Some jurists made long list of these costs to include such things as expenditure on food, rents, working tools, house furniture, servant salary, means of transportations, debts and expenditure on education and buying books of knowledge (See Qardhawi, vol 1, pp. 151 —153).

This list has been derived from the saying of the Prophet (peace be upon him) (No Zakah or Sadaqah is due except out of abundance).

The relevant point in this regard is that those who possess the Nisab are not poor and definitely they are above the poverty line.

Dr. Faridi rightly points out that the government should formulate an expenditure programme in the field of education and health to help the poor. He seems reluctant to advise that government can indulge in long-term projects from Zakah. Islamic government can embark on a range of productive projects in industry and agriculture which will provide permanent employment for the poor and as such will create continuous flow of income. Such projects will be financed out of Zakah proceeds. Supplying the poor with food, clothing and the like is just one form but it is not the only permissible and accurate form. (See Qardhawi, Islamic Economics, p. 247).

We come now to the role of the voluntary sector. Although we are all in agreement about its importance, yet it seems that this role is highly exaggerated, to the extent that the government role is left completely outside its social responsibility. The role of the public sector in developing economy is vital in the allocation of resources to the infra-structure facilities, to the heavy industry to revolutionize agricultural methods and to train the workers and the like. His contention that public expenditure in an Islamic society will necessarily tend to decline and Islamic administration will be less-expensive seems strange. On the contrary the economic and social responsibility of the government will increase in the Muslim society and in regard to the outside world.

Dr. Faridi does not mention any fiscal tool other than taxation to cope with public expenditure. There is a limit for taxation. Why not suggest public borrowing? That raises many questions. Should the borrowing voluntary or compulsory? How such sources can be tapped in an economy with no interest rate? The paper should have taken up such important issues.

Fiscal policy cannot be drawn in a vacuum. Dr. Faridi could have served the purpose better if he had given us the overall policies of an Islamic government with specific concentration on Islamic economic policy as a whole. Integration of economic policies is very crucial for the success of fiscal policy or any other policy. Monetary policy and fiscal policy are perhaps more related, the paper deprived us from seeing how this link can be worked out.

Mohammad Ahmed Sakr

Source: Fiscal Policy and Resource Allocation in Islam, Ziauddin Ahmed, Munawar Iqbal and M. Fahim Khan. Republished with permission.