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Role of Fiscal Policy

There was a wide-ranging discussion on the role of fiscal policy in an Islamic economy which touched on almost all aspects of public finance. The starting point of the discussion was whether the objectives of fiscal policy in an Islamic economy were in any way different from those in other countries. The papers presented by Faridi, Salama, Kahf and Metwally strongly emphasise that fiscal policy in an Islamic state should have an ideological orientation. Specifically this means that fiscal policy in an Islamic economy has to be evolved in the ideological framework of Islam and cannot be value-neutral. It is the responsibility of an Islamic state to promote Islamic values and, since Islam gives equal attention to both material and spiritual welfare, the state policies including fiscal policy have to reflect this basic philosophy. This then is the distinguishing feature of fiscal policy in an Islamic economy.

An Islamic state has to defend both its geographical and ideological frontiers. It should have enough resources to maintain a strong defence capability. It has also to guard the faith of the people and to keep them Islamically motivated. Further, it has to ensure that basic economic needs of the entire population are adequately met. Like other states, an Islamic state has also the responsibility for maintaining law and order and for providing the necessary infrastructure to promote economic growth. There was no difference of opinion among the participants in the Seminar in regard to these basic functions of an Islamic state. There was a shade of difference, however, in regard to the responsibility of an Islamic state to raise the living standards of the poor beyond subsistence level by direct state action. Kahf is of the view that the responsibility of the state ends after ensuring the fulfilment of a “socially determined subsistence standard of living” for the poor which includes indispensable food, clothing and shelter. Most others feel that the Islamic state should also be active in reducing inequalities of income and wealth and in promoting an egalitarian economic and social order.

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The view one holds about the responsibilities of an Islamic state has an important bearing on his views about the taxation policies that should be followed. Thus Kahf stands for a low level of taxation and quotes the views of early Islamic thinkers like Imam Malik, Ibn Hazm and Kattani that imposition of taxes over and above Zakah is justified only to meet defence needs, assurance of a subsistence living for the poor and the indispensable expenses that safeguard the collective interests of Muslims. Kahf is also against the use of taxation for purposes of income redistribution. He is in favour of giving maximum scope to private effort and enterprise so that economic activity proceeds without being inhibited by high levels of taxation. Other participants took a more pragmatic view about the scope and justification for additional taxation in an Islamic economy. They felt that the state has a wide discretion in determining the limits of taxation. They favoured active use of tax policy for achieving the goals of an Islamic society which, they believed, include promotion of an egalitarian socio-economic order, acceleration of economic growth and maintenance of monetary stability. However, all were agreed that to keep taxation within reasonable limits, all wasteful expenditure should be avoided and administrative expenditures should be kept to the minimum.

A good deal of attention was focussed in the Seminar on the potentialities of Zakah as an instrument for eradicating poverty, as an income redistributive measure and as a stabilisation device. Zakah, it was recognised, was the most important component of the social security system of Islam. However, ability of Zakah alone to eradicate poverty depended on the number of people who needed Zakah assistance in a particular country. If the teachings of Islam are faithfully followed in a society, glaring income inequalities would not exist nor would there be many people subject to abject poverty. In such a situation proceeds from Zakah should suffice to eradicate poverty. However, if for historical reasons and neglect of Islamic teachings, the number of poor people in a country is very large, it is the duty of an Islamic state to supplement the resources obtained through Zakah by other means to meet the minimum basic needs of the poor.

The importance of Zakah as an essential income redistributive mechanism in an Islamic economy was emphasised by several participants. The payment of Zakah is obligatory on Muslims possessing nisab while those who do not possess nisab are eligible to receive assistance from Zakah funds. Faridi is of the view that nisab allows for a dynamic interpretation in terms of cost of living index and reasonably defined current standards of living. He brings in the concept of the “poverty line” in this context and suggests that government may designate a poverty line based on current living standards. Persons having income above the poverty line would be required to pay Zakah and those having income below the poverty line would be eligible to receive the transfer payment. This view of nisab differs from the traditional view according to which nisab is fixed not in terms of income but in terms of possession of a certain quantity of gold or silver or assets equivalent in value to that quantity of gold or silver. There was not enough discussion on this point in the Seminar and it would perhaps be useful to take it up again on some other occasion. Another point made in connection with the redistributive aspects of Zakah was that if glaring inequalities of income and wealth exist in a society, Zakah alone may not suffice to achieve the desired reduction in such inequalities, especially because the Zakah rates are fixed and cannot be changed. It follows from this that an Islamic state would have to use other fiscal policy instruments, including progressive taxation, for redistributive purposes.

The use of Zakah as a stabilisation device also figured in the discussions. Some participants pointed out that Zakah could be used as a counter-cyclical device as it is not obligatory on the state to disburse all the Zakah proceeds within a particular time period. Thus, some part of Zakah proceeds could be withheld in an inflationary situation and these funds could be released to increase purchasing power in a period of depressed economic activity. However the general feeling was that as Zakah rates are fixed and the purposes for which Zakah proceeds can be used are also prescribed in Shari'ah, there is not much scope for using Zakah as a stabilisation device. Moreover, the primary aim of the Zakah system is to help the poor and it would not be appropriate to withhold disbursements from the Zakah collections to serve as an anti-inflationary purpose in the face of persistence of poverty.

The theme recurred again and again in the Seminar that though Zakah is a basic pillar of Islam and serves a highly important purpose, it should not be expected to achieve all the objectives of an Islamic state. Faridi puts it explicitly when he says that “Islamic tax system should be so structured as to fill the ‘objectives gap’ indicated by or incidental to Zakah ”. He goes further and states that there is nothing wrong in using other instruments of fiscal policy even to modify the economic effects of Zakah if this is considered necessary from the viewpoint of the general welfare of the Ummah. On the other hand, if certain developments in the economy tend to frustrate the objectives of Zakah, other fiscal policy instruments should be used to arrest or control them.

Metwally assigns highest importance to fiscal policy in an Islamic economy to achieve the economic objectives of an Islamic state. He is of the view that major reliance will have to be placed on fiscal policy to achieve stabilisation and equilibrium in the money market in an Islamic economy because monetary policy without the availability of the interest rate weapon will not be able to achieve this objective. In this connection he puts forward the idea of “economic dues” on “both incomes and idle assets” whose rates may be varied from time to time for stabilisation purposes. An increase in the rate of dues on idle cash, he claims, can be used to bring about a reduction in the quantity of money demanded at a given level of income. By making the alternative to investment more costly, the enhancement of economic dues can stimulate private investment. Metwally’s proposal is theoretically attractive but its practical implementation will not be easy. Moreover, the main problem with his idea of variable economic dues on idle cash is that it may in effect amount to varying the rate of Zakah which is not permissible in Shari'ah. His fear about the inability of monetary policy to achieve an equilibrium in the money market in the absence of interest rate weapon also appears to be unfounded as models have been developed by Muslim economists which show that alternative mechanisms are available in an Islamic economy to bring about the necessary equilibrium in the money market.

Attention was also given in the Seminar to ways and means of meeting the budgetary deficits of the governments in Islamic countries.

It was recognised that taxation has its own limitations as a means of raising resources, and government may need to borrow to meet inescapable needs. One way of meeting the situation is suggested by Chapra in his paper. This consists of making a provision for interest- free borrowing by the government from the commercial banks in some proportion to the interest-free demand deposits held by them. The other option consists of central bank making the needed resources available to the government on interest-free basis. Borrowing from the central bank has of course to be kept within reasonable limits to t safeguard monetary stability but there appears to be nothing wrong in government borrowing from the central bank from the viewpoint of Shari'ah.


Source: Money and Banking in Islam, Ziauddin Ahmed; Munawar Iqabal; M. Fahim Khan.