Sources of Finance for Present Muslim States
In this part application of various taxes in present Muslim countries is suggested. Sources available to Muslim states of today are numerous ranging from land taxes, income taxes properly designed, indirect taxes, public enterprises, user charges, and fees. Where these sources are not adequate or may not be feasible, debt policy may be used. A problem that would have to be resolved concerning debt policy is what instruments could the government use to issue public debt. Should it be the shares of public enterprises or inflation-proof bonds or bonds linked to security scheme or mudarabah bonds. This has to be settled before any debt policy is adopted.
Taxation on the other hand does not pose much difficulties. Modern taxes applied on income, wealth and domestic transactions properly designed may not be inconsistent with Islamic Shari'ah. Jurists’ views in this regard have been presented in another paper.
The Role of Taxation in Muslim Countries
- Taxation could play an important role in Muslim countries of today whether rich or poor. It is agreed that taxation may achieve the following goals:
- Curtailing unnecessary consumption for poor countries this enhances resources available for capital formation. In oil-rich countries it is necessary to reduce lavish consumption prevailing in those societies and reduce consumption of some goods which are harmful to health, or domestic industries or the habits and way of life in those societies.
- Taxation may serve as a means to reallocate resources from investments that have little beneficial effect upon development to those having greater benefit for growth. Corporation taxes could play such a role. Those investing in sectors needed by the nation could be subject to lower taxes. Also resources may be directed to poor regions by tax incentives. In general corporations should be subject to taxes as they make use of government expenditure, they cause spillover effects, and they can grow into monopolies.
- Taxation could be used as a tool to alter economic behaviour in creating incentives to save, to enter the market sector, to utilize resources and to encourage private capital formation.
- Taxation provides sources of finance for a modern Muslim state to execute government programmes.
- Taxation could be utilized as a means for stabilizing the economy and reducing aggregate demand. Where taxes are elastic functions of incomes, especially in countries which rely on few exports, it may serve as a tool for stabilization of incomes.
- A progressive tax system may help in reducing income inequalities and hence achieve social harmony in Muslim states.
Designing an Optimal Tax Structure in a Muslim State
Taxation is not always without some adverse effects. If taxes go beyond a certain limit, they become a factor for economic retardation rather than growth. Tax structure in case of any country must meet equity, economic efficiency, revenue and administrative criteria. Those criteria are, in my view, broadly consistent with what Muslim jurists in the past have laid down for Kheraj. Certain fundamental requirements that should be satisfied by the tax structure include:
- Taxation should reduce unnecessary consumption without imparing output and should help accelerate capital formation.
- Where foreign exchange gap is wide, luxury imports should not be encouraged and should be subject to higher taxes. Where foreign exchange gap does not exist, it is consistent with Islamic teachings that luxury imports should not be expanded and import duties may help in reducing consumption of those goods where they are price elastic.
- Burden of taxation on profits of firms contributing most to economic growth must be minimal.
- In order to encourage economic activity excessively high marginal rates on incomes must be avoided.
- To avoid continuous revision of tax rates, the built-in flexibility of the tax structure is significant if the tax is to provide maximum revenue productivity. A very elastic tax is also effective in reaching additional incomes generated by the growth process, thus providing a fiscal stabilizer as well as adequate financial resources at the hand of the government. In this respect fiscal experts sometimes caution against a fiscal drag that may occur due to increased progressivity.
- The tax structure must conform to accepted standards of equity and ability to pay. However satisfying vertical equity is not easy to achieve but a goal Muslim states must work to achieve while designing tax structures.
The economic structure in many of our countries poses some problems for the tax structures; such as the predominance of agriculture which may necessitate land taxes. The yield of land taxes applied in some countries like Ethiopia and Bolivia in 1973 was substantial. It is well known that Japan relied on land tax for its development in 1870. Designing a broad-based tax on the line of Kheraj may be a break-through for countries endowed with fertile land resources. Land taxes imposed on acreage basis may produce sizable revenues to a country like Sudan as found by the writer.
Other problems are related to methods of assessment where presumptive methods are used when income taxes are applied in the absence of proper accounts. Such methods in many cases contradict the equity criterion, and in many cases, the economic criterion as well. Such methods encourage corruption and also discourage wider adoption of book-keeping especially where corruption prevails. Also departures from equity arise when personal income taxes effectively reach wage- income receivers compared to its inefficiency to reach business income and incomes generated from capital sources. Evasion rate is found to be very high in many developing countries. It was found that one-third of the population of Western Nigeria evades taxes. This may be reduced in an Islamic state by emphasising holiness of the levies, rationalizing expenditure programmes, proper design of levies imposed on the criteria spelled out in this paper and efficient administration of the imposed levies.
Source: Fiscal Policy and Resource Allocation in Islam, Ziauddin Ahmed, Munawar Iqbal and M. Fahim Khan. Republished with permission.