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Theory of Fiscal Policy

The present study attempts a theoretical exposition of the fiscal dynamics of an Islamic economy. In view of the absence of any empirical base in the modern world, the exposition relies heavily on the following techniques of analysis:

  1. The norms and values that are relevant to and direct the economic aspect of individual and collective behaviour in an Islamic society have been spelt out in terms of their likely impact on the allocation, distribution and stabilization branches of public economics.
  2. The behaviour of an Islamic economic system in the past has been taken as the datum for theoretical projection in future. In other words, the total absence of any empirical base in the modern Muslim societies has been partly compensated for by a selective adoption of the past Islamic societies, as the sample.

The use of latter technique could render the whole analysis anachronistic. But this has been avoided through the complex device of introducing the significant elements of current economic systems and integrating them, as far as possible, with an Islamic economy. This has helped us to visualise the future working of an Islamic economic system.

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The main elements of this theory may be summarised as follows:

  1. Islamic economy has been characterised as a three-sector economy, namely, the private sector, the voluntary sector, and the public sector. The three sectors working in conjunction, furnish the institutional framework of an Islamic economy.
  2. Zakah provides the base of the fiscal system and defines its scope of operation within the general institutional framework of the Islamic economy.
  3. The allocation, distribution and stabilization functions of an Islamic economy are processed and implemented through all these sectors jointly.
  4. Public sector’s role is minimal but crucial in so far as it operates continuously to ensure an optimal allocation of community’s resources, rectifies sub-optimal distribution of income, and introduces an element of stability.

Is a Fiscal Policy Possible in an Islamic State?

It has been argued in certain knowledgeable quarters of Islamic theorists that a fiscal system beyond what is defined by Zakah is un- Islamic. The argument relies on the sanctity of private property recognized by Islamic Shari'ah and contends that any compulsory government charge on it is patently unjust. Since taxes constitute the core of modern fiscal policies, an Islamic fiscal policy is contradiction in terms. A refutation of this assertion may be briefly stated in few paragraphs.

The socio-economic policy goals of an Islamic state are as follows:

  1. Justice and equity.
  2. Provision of the socio-economic needs of the community or socio-economic welfare.
  3. Enhancement of the community’s economic resources or economic growth.
  4. Improvement in the cultural milieu of the community.

These policy goals have been derived from the Quran and Sunnah and implemented in the simple socio-economic system prevalent during the Prophet’s (peace be upon him) lifetime and the Caliphate. Later, as the Islamic society became more complex, Islamic thinkers such as Al-Ghazzali, Abu Ubaid, Imam Yusuf, Ibne Taymiah, Al-Shaatbe, and others dealt with these policy goals and their implications and also suggested appropriate devices for their attainment. Recent additions to this literature are extremely valuable in view of their contemporary relevance and modern exposition. We can take them as given and envisage the path along which the fiscal mechanism in an Islamic state is likely to operate.

It may be correctly argued that Zakah is the most important fiscal and distributive mechanism of an Islamic economy. But as pointed out subsequently, Zakah may generate certain incidental effects on the economy, which can be redressed only by an appropriate mechanism of secular levies. For instance, a situation may arise where Zakah levies may lead to such a diversion of resources that is not desirable from the point of view of general socio-economic goals of the society. To prevent this, an appropriate fiscal device may be required. Moreover, the policy goal of an Islamic society to alleviate poverty, may in certain situations, necessitate the imposition of subsidiary welfare levies. Later in this paper we have specified such situations.

The argument that Zakah receipt may sometimes fall short of resource requirements for welfare expenditure, has been recognized by the Quran itself inasmuch as it has exhorted the Muslims to expend voluntarily a part of their resources. Many Islamic thinkers have also taken note of it, as discussed in the following paragraphs. Although such situations may not ordinarily arise, they are nevertheless important in the context of many Islamic countries of today, where the phenomenon of mass poverty co-existing with a relatively small member of wealthy people may call for additional mobilization of resources. Moreover, equitable distribution of income in a situation where exogenous developments have led to an unprecedented rapid accumulation of personal incomes, may not be wholly attainable through Zakah levies alone. In such a situation Zakah may be interpreted as the minimum rather than the maximum effort to alter the situation. But it seems probable on the basis of evidence recorded in early Islamic literature that a compulsory additional charge on such extraordinary income is permissible under Islamic law.

The allocation function of the Islamic economy may also require an appropriately devised tax system. An optimal allocation of community’s resources between different sectors of the economy and within each sector is likely to call for a tax policy geared to this need. Similarly, the allocation of resources along the time and spatial scale requires a judicious use of tax policy together with monetary policy and other regulatory measures. Economic welfare of the Islamic community may involve a more appropriate time and spatial allocation of its resources. The intertemporal allocation of scarce resources or their conservation in the interest of the Islamic collectivity through state conscription or public management has been alluded to in the Quran itself in the Surah Yusuf.

The verses regarding Fay have specifically laid down an equitable intertemporal allocation of the Fay proceeds. Although initially all such proceeds were distributed without regard for the succeeding generations, Hazrat Umar changed this policy in respect of the distribution of the conquered lands of Iraq and Egypt. These lands were retained by the state not only to prevent concentration of wealth but also in the interest of future generations as the argument of Mawaz reveals.

An Islamic state may require additional mobilization of tax resources to: (a) regulate price movements; general concern of Shari'ah in this respect is reflected in its prohibition of speculative hoarding of essential goods, although specific instructions in regard to control of prices are absent for obvious reasons; and (b) to provide such goods as are imperative for the welfare of the society and cannot be left to the private enterprise. That the Islamic state is entitled to additional mobilization of resources, through ad hoc levies or other methods when and if the conventional resources of the state exchequers are not able to meet emergency requirements, has been ably argued by classical Islamic thinkers. During the Aam-E-AI-Rimiadah; Hazrat Umar is reported to have underlined the fiscal power of an Islamic state clearly.


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