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Fiscal Policy, Economic Growth & Development

Fiscal policy nowadays, is entrusted with promoting'economic growth through mobilizing resources from non-essential consumption and channelizing those resources to investment through improving productivity and by providing incentives to save and invest. Fiscal policy should also create conditions that are conducive to economic growth by designing tax and expenditure policies that have least disincentive for the desire to save and invest and for work effort. Fiscal policy in an Islamic state should not be a retarding factor. Tax and expenditure policies should be geared to serve this purpose and any conflicts that may arise should be resolved. More emphasis should be given to growth as with economic growth revenue base will also increase. Ibn Khaldun warned against possible adverse effects of excessive taxes on desires to invest to work hard and subsequently on economic growth.

Most Muslim countries of today may be considered as economically developing countries. (Emphasis here is on the world “economically”, as the world developing alone is often used to mean developing in all aspects of life vis-a-vis developed countries. This may not always be true.) Fiscal policy in case of countries which are still developing will have a primary role to play in raising capital formation. Capital formation encompasses all expenditure that increases productivity and includes investment of the private sector as well as of the public sector. Capital formation in a Muslim state will include investments on development of human and material resources as well as investment on development of spiritual and moral values of the people. Material development should be a means to achieve the goal of creation of man in this world which is to worship Allah and as such economic development should operate within the constraints of Islamic Shari'ah.

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Fiscal policy in a Muslim state should aim at achieving full employment of all its resources. All persons who can work should be provided jobs that suit their abilities and in line with Islamic Shari'ah. Floarding of financial resources is not allowed in a Muslim state and is penalized via Zakah. Land taxes such as Kheraj that are based on fertility and site rather than on productivity and improvement will deter under utilization of land. To achieve the goal of full employment of resources the state has to take fiscal and non-fiscal measures that penalize those who keep resources unutilized. In the past a Muslim state could impose Zakah and Kheraj or land tax. Non-fiscal measures could also be taken in addition to moral instructions of Islam which urge able Muslims to work. Fiscal tools available to Muslim states today are many and may be used to achieve increased productivity. Some of the measures that may achieve this goal are:

  1. Shifting resources from non-essential consumption to capital formation. Fiscal policy may achieve this via taxes on lavish consumption or progressive income taxes designed in such a way that they do not have a disincentive effect and do not lead to any distortions in the market system. Government expenditure should be rationalized and restricted to outlays that achieve the objectives of a Muslim state.
  2. A Muslim state has to increase investment and ensure that it is directed to high priority areas. Public investment in parti cular has to be carefully evaluated and properly managed. Private investment has to be encouraged. This may be achieved through lower taxes on corporations investing in high priority areas. Funds reinvested by the corporations may be favourably treated and dividends may be taxed lightly. Resources may be generated for investment through favourable tax treatment to savings.
  3. Natural resources are finite. Their depletion deprives future generations from making use of those resources. They should be, therefore, utilized efficiently. When the state is using such resources as a source of revenue, it has to rationalize government expenditure and make sure that equity between different generations is achieved. User charges and taxes on potential yield are also important.
  4. Given the state of technology in the Muslim World, investments from outside Muslim states may be essential if improvement and expansion of productive capacity are to be achieved. In this area tax concessions may be given such as loss-carry-forward scheme. Accelerated depreciation allowances allowing for a shorter write-off of the capital expenditure and tax holidays. Beside these tax concessions, other fiscal concessions such as government subsidies grants, easy loans and improved communication facilities may also be provided. Other non-fiscal facilities include free land lower transport and electricity charges and guaranteed purchase of a percentage of the production by the government. However, the efficiency of such concessions is still unsettled. It is, therefore, important to rigorously evaluate the utility of introducing such a scheme before a Muslim state embarks on it.


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