System Constraints on Taxation

The above analysis highlights the usefulness and necessity of a tax system to serve the socio-economic, objectives of an Islamic state. An attempt has also been made to prove that it is permissible for the Islamic state to conscript resources to meet its ordinary and welfare expenditure. It will be argued, however, in the succeeding paragraphs that there are certain inbuilt constraints in the Islamic socio-political organization that prescribe the permissibility frontiers of taxation by the Islamic state. The limitation lies in the ideological-cum-moral parameters of an Islamic society and applicable to normal conditions only. It is these which point to an optimum level of taxation which, if exceeded, results in the diminution of aggregate socio-economic welfare of an Islamic society.

The permissibility frontiers of taxation, envisaged here are not quantifiable. Nor the optimum level translatable in terms of certain universally valid magnitudes. Abstracted from its quantitative implications the optimum level may be derived from two characteristically unique inbuilt system constraints of the Islamic economy. In the first place, the Islamic taxation policy will be so designed as to compensate or supplement the “resources gap” arising out of or incidental to Zakah and Sadaqat. It will not be an independent variable but a derived one.

Its dynamics will operate within the outer limits set by Zakah and voluntary contributions'.to the aggregate socio-economic welfare of the community. The Islamic taxation system will be an adjustment to the resource flow originating in these sources. An assessment of the “resource gap" thus left uncovered compared to the overall fiscal needs of the public authorities, given the socio-economic goals of the community and its stage of economic development will determine the quantitative aspect of the tax effort, and as a corollary thereof, its structure and rates It will define the assessment base of direct taxation in so far as the equity and ability to pay considerations intrinsic to Zakah levies are not negated through a thoughtlessly conceived system of secular levies.

In the second place, Islamic tax system will be so structured as to fill in the ‘objectives gaps’ indicated by, or incidental to Zakah. It will serve to promote primarily the same ends for which Zakah has been levied. If certain aspects of the economic impact of Zakah tend to frustrate the general design of the Shari'ah and act to the detriment of economic growth, Islamic tax policy will be accordingly adjusted. For instance, if in full employment, or in comparatively rigid supply conditions, the transfer of resources exerts an upward pressure on the price level, taxation policy will be suitably adjusted to arrest the price spiral. Or if Zakah levies cause a sudden diversion of resources from savings to overspending, or from investment in Zakah-Me to Zakah-free economic activities whose overall impact on the economy is likely to be detrimental to general welfare of the Islamic community, tax policy will have to be readjusted. Similarly, any difference in the burden of Zakah incidental to the rates applicable on varying forms of wealthsaving may result in an unbalanced intersectoral allocation of community’s resources, say, between agriculture and manufacturing, the tax policy will have to take due account of it in so far as this unbalancing effect runs counter to the overall objectives of an Islamic society. On the other hand, if certain developments in the economy tend to frustrate the ultimate objectives of Zakah, taxes will be used to arrest or control them. A general inflationary rise in prices may be the case in point, as it releases forces that tend to increase the income disparities and distort the flow of resources.

This analysis, however, does not make the assertion that Islamic taxation policy will be a ‘residual’ exercise only. It does maintain, however, that it will be primarily a ‘compensatory’ policy or one that is complementary to Zakah. It will be clear as we proceed through this analysis that the Islamic taxation policy will nevertheless be an effective allocative and distributive device pivoted to the central Islamic levy — Zakah. Somewhere it will appear to enjoy a comparatively freer hand. Even so, the general system constraint can never be lost sight of.

It may be argued, however, that ‘resource gap’ concept is inadequate for the dynamics of modern economy that involves a much wider scale of governmental economic activities which need financing on such a large-scale that render the ‘resource gap’ formula derived from Zakah impracticable. But this objection is not so formidable as it appears to be. In the first place, development finance depends only partly on taxation. Bulk of finance for public investment has traditionally come from non-fiscal sources of budgetary receipts, such as public borrowing, both internal and external, money creation, and income from economic activities of the state. In the second place, aggregate public expenditure in an Islamic society will necessarily tend to decline for many reasons. For one thing, an Islamic administration will be a less-expensive one in view of its distinctive cultural milieu. Secondly, it will depend, to a large extent, on private initiative for development. Thirdly, a sizable part of its welfare expenditure, will be met out of Zakah. Thus taxation will surely decline in importance, as a means of public budgeting.

Another significant system constraint taxation policy derives from the distinctive nature of the Islamic economy. Islamic fiscal policy conceived in the terminology currently in vogue, and with reference to modern fiscal theory, will be a fruitless and self-defeating exercise. It is imperative to have a clear vision of not only the value base of an Islamic economy but also to spell out its modus operandi. Without such an effort, we are likely to fall in line with other economists and paint the economic landscape of an Islamic society largely similar to that of a value-less and profit-based society.

Elements of an Islamic Fiscal Theory

An economy has to deal with four basic problems. The limited supply of productive resources leads to the problem of scarcity which involves a specific decision as regards the allocation of the available productive resources and the institutional means through which the desired allocation is to take effect. Closely linked to it is the problem of distribution which relates to the manner in which the ‘real output’ is divided among the various individuals and family spending units of a society. The attempt to increase the productive base of the society to bring about an improvement in the societal welfare over time, creates the problem of economic growth and the institutional means through which it has to be vigorously pursued.

Contingent upon the devices chosen to tackle all these problems, economic disturbances of varying intensities occur, which require a set of measures, conveniently summed up as stabilization policies.

The nature of decisions taken by a particular society to effectively tackle one or all of these problems, and the institutional means already in existence or freshly designed for that purpose do not depend on only economic considerations of cost and benefit. Nor is there any degree of specificity associated with the economic targets or institutional means such that defy their total or partial substitution. A particular decision as regards the allocation of productive resources which determines both the volume and composition of real output to be produced and its division between the market or government sectors arises out of the preferences, values, and the political influence of various sections of a society. Similarly the distribution of effective demand between the various spending units of a society is vitally linked with a given state of income and wealth distribution and desire of the society to alter it.

It will be wrong to assume, therefore, that the superficial similarity of tools of economic policy used in different societies prove the “means specificity” of the economic issues stated above.

In a different context Ibne Hazam has also recognized the compulsive economic power of the Islamic state in extraordinary situations.

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