Comparative Study on Sources Of Public
Finance in Islamic Economy and Capitalist Economy
Applicability Of Islamic Public Finance
To Preset Trend
Introduction
ž Since
interest is prohibited in Islam, the Govt in an Islamic economy cannot issue
interest based credit instruments like Trade bills/bonds or obtain interest
based sovereign debt. Where in general economics interest rate is reward for
saving, the govt issues various debt instruments to raise funds from general public, foreign nationals , banks to
fund projects and for deficit financing on the basis of interest rates. Apart
from different sources of Non-tax revenues viz fines, fees, revenue generated
from Public sector enterprises, revenue including interest or profit from the
investments, user fee etc., Based on the literature
review, of Islamic economy no taxes levied other than Zakah. Accordingly; this
study explores the sources of revenue for a government in Islamic economy. In
discussing sources of tax revenue it is maintained that zakah is the only tax
the government in an Islamic economy can levy. Where e in general economics
taxation is the central part of modern public finance, its objective is to
raise revenue necessary in a welfare state to fulfill its obligations. There
are various sources of taxes mainly personal income tax, corporate income tax,
wealth tax, Value added tax, service tax etc.,
ž One thing is found common in both the
institutes as govt can charge service/performance based fees, duties, surcharge
etc in providing public goods. Furthermore, the profitable operations of state
owned enterprises form of important part of non-tax revenues.
ž This study discuss that how the government can finance its deficit keeping in
view that low taxation and low interest
in general economics as like that of
interest rate is prohibited in islam & zakah rate are very low.
BACKGROUND OF THE
STUDY:-
ž The
role of government in a economy has always been important issue , economist and
policy makers since from the evolution of political economics by Adam
smith in wealth of nation to Keynesian
frame work has been accepted government as a not only a regulator of a economy
but also as an active economic player.
ž In the midst of great recession, the
role and importance of government has once again reappeared as an important
issue. Like bailout package of US govt to financial sector in Dec 2008,
providing huge subsidies to its agricultural sector. So one cannot ignore the
role of a state as a regulator and as a active economic player.
ž In this backdrop, this study takes an
important issue in public finance in a Islamic economy and general economics,
more specifically, it put a glance at sources of tax revenue, how it is raised
and utilized for public finance in Islamic point of view. Also to see does this
applicable to present trend.
PROBLEM OF STATEMENT:-
ž This
study analyses public finance literature in general economics and Islamic
economy on the other hand source of revenues to the governments for funding
ever increasing public expenditure , reduction in budgetary deficits and
applicability of Islamic ideology of public finance to present trends
OBJECTIVES OF THE
STUDY:-
ž The
study sets the following important objectives.
ž To
suggest the different sources of revenue
for the state in Islamic point of view
ž To
explore the ground rules for zakatable assets and zakatable income fund in the
study of Islamic faith.
To estimate the
potential of tax revenues that can be collected in zakah
IMPORTANCE OF STUDY:-
ž The
study has significance in academics as well as in public policy making in
respect to Islamic faith could be a alternative to policy making and adds to
the literature of contemporary developments in both literatures and public
finance practice of general economics. To discuss the means of revenue and
sources of public finance through and beyond zakah in an Islamic economy.
RESEARCH METHODOLOGY:-
ž This
study is conceptive and theoretic in nature. It clarifies various charges in
the institution of zakah as like taxation in general economics
SCOPE OF THE STUDY:-
ž Comparative
study of sources of revenues in Islamic economics (Zakah) and General economics
(Direct & Indirect taxation). This study sets to contribute in public
policy making as well as add to the academic literature of general economics as
a alternative system.
LIMITATIONS OF THE
STUDY:-
ž The
study is purely theoretic and comparative in analyses the sources of public
finance (taxation and zakah only)
LITERATURE REVIEW:-
ž In
conventional economics, the government has following sources of revenue:
general sales tax, excise duty, customs duty, Import& export duty, Property
tax , development surcharge, personal income tax, corporate income tax. Apart
from that non-tax revenue by way of earning through profitable operations of
state owned enterprises, fines and activity based charges & duties are also
important sources of revenue to state. In general economics, if government
needs to finance deficit it can issue treasury bills/bonds or obtain loans from
domestic as well as international sources.
ž In
islamic economy, the problem comes in the issuance of debt( due to prohibition
of interest) and imposition of taxes beyond zakah is not recommendable. Zakah
is a combination of a net worth tax and production tax.
ž In
islamic thought zakah is a religious obligation to pay a part of wealth and
production to the government. However, in most countries, zakah is not
collected by the government and is not considered a compulsory payment. Eminent
Muslim scholar Ab-ul-ala Maududi (1970) reasoned that zakah is a religious
obligation and not a substitute for tax. Taxes other than zakah can be imposed
in an Islamic economy if these taxes are levied by the legislative council and
used for public welfare. He reasoned that the taxes discouraged in a hadith are
those which were imposed by autocratic kings for their own lavish consumption
and this kind of usurpation of public property was discouraged.
ž Disucssing
the issue of distributing zakah, islahi(185) and Qardawi (2000) explained that
it is not necessary to make some living
person the owner of the zakah. Zakah can be given to any person or cause
or an organizaiton working for a cause, not necessary to make some living
person the owner of the zakah. Zakah could be distributed on the welfare of the
people as well as given to people themselves. If a policy of full employment
requires high MPC; then, a progressive taxation like zakah could help in
boosting aggregate demand and increasing employment.
ž As modern day problems in estimation
of zakah, Usmani(2003) asserted that zakah on shares would be paid on the net
liquid assets/share i.e. by excluding from the total assets, the value of
assests used as means of production. And the liabilities owed to the business
are deductable. Then, the zakah can be paid on the value of net liquid
assets/share multiplied by number of shares held by the investor.
ESTIMATION OF ZAKAH
ACCORDING TO THE EXPENDITURES:-
ž Haque
& Mirakhor (1998) classified government expenditure into i) asset creating
and ii) non-asset creating. Non asset creating activities can be financed
through tax revenues. But, in asset creating activities, equity modes of
financing can be used whereby financing would be generated by way of an
instrument. As per their recommendation, this instrument would be priced using
the formula.
ž I=w1
WI+W2PPI+W3LSI+W4 ROG
ž Where
ž WI
= worked index
ž LSI=Stock
index, a measure of market performance index based on ROE.
ž PPI=index
representing average returns on commercial participation papers
ž ROG=return
on government investments and project
W1 W2 W3 and w4 are
weights assigned to each variable.
INSTITUTION OF ZAKAH:
AN IMPORTANT SOURCE OF PUBLIC FINANCE IN ISLAMIC ECONOMY
ž Zakah
is a religious obligation to pay a part of wealth and income to the government.
ž For
calculation of zakah, people used the cross rate between gold and silver and
determined their nisaab in gold as well. This cross rate has changed
historically; that is why, we will have to resort to the original base i.e. 612
grams of silver when there is no bimetallic monetary standard in operation. One
important implication of this principle is that tax exception amount in silver
is much lower than gold using current cross rate and hence taxable assets will
increase in magnitude. Zakah would be as per the ceiling rates defined for each
category of wealth or production.
ž The
classification is as follows:
ž a)
2-½% on cash, wholesale value of held for trade inventory and capital in excess
of need payable once a year at a particular set date.
ž b)
5% on production using both labor and capital. It is charged at the completion
of the production process.
ž
ž c)
10% on production using either labor or capital. It is charged at the
completion of the production process.
ž d)
20% on production using neither labor nor capital. This is applicable on
treasure or any other natural Gift obtained without using neither labor nor
capital.
Issues in Estimation of
Zakah
ž Wealth/Assets
subject to Zakah include Cash in hand, Cash in Bank, gold and silver not in
daily usage (for women), gold and silver owned by men, held-for trade
inventory, property/plot purchased for the purpose of resale. Production is not
limited to agriculture nowadays, but the major part of it is coming from
industries as well as services sector. Therefore, industrial production could
also be taxed just like agriculture. Services income could also be taxed on the
same principle.
ž Khan
(2005) stated that investment in stocks should be interpreted as any other
investment with some means of earning income. Stock is a means of earning
dividend or capital gains. Just like means of production/income are exempt from
Zakah, investment in stocks should be exempted from Wealth Zakah as investment
in stocks means that the money is not kept idle rather it is invested and even
its value could reduce to zero or increase by a long way theoretically.
Therefore, any income arising from investment in stocks i.e. capital gains or
dividend must be subject to Income Zakah. Similarly, this argument could be
extended to introducing Income Zakah on mutual funds, investment in NSS,
debentures, bonds etc. Furthermore, if land/building/house is leased, the
land/building/house becomes the means of earning rent. Hence, income Zakah
could also be introduced on rental income on houses, assets, buildings etc.
Non-Tax Revenues
ž Non-Tax
Revenue can come from profitable operations of State Owned Enterprises (SOEs).
State Owned Enterprises (SOEs) in postal services, railways, airline industry,
steel industry, communication industry, public utilities, transportation
industry, aviation industry etc can be run effectively and generate profits as
they operate in industries which have significant potential for economies of
scale, economies of scope and face relatively inelastic demand. With deficit
financing not an option available, there will be an automatic check on
government to run these State Owned Enterprises (SOEs) effectively and
efficiently.
ž Fines
and Penalties is another source through which government will generate funds.
Ideally, this is not a source of revenue as the objective of fines and
penalties is to enforce law, improve competition and put right market
imperfections. But, this will materialize only when the good practices are
rewarded and bad practices penalized.
Funding Non-Revenue
Generating Activities
ž The
real problem arises in funding operations of non-revenue generating activities
like the operations of courts and police etc. It is to be noted here that in
Muslim societies under the rule of Caliphates, there was no concept of jail
which is a later invention. The Islamic punishments like Capital punishment on
Murder, Forced Rape etc, monetary fines and physical punishment in extreme
cases of stealing, fraud, robbery etc do not require people to be imprisoned.
As a matter of fact, these prisons become the usuries for bringing societies
even more seasoned criminals rather than a place for rehabilitation. Besides
the convicted person, the family of the convicted also gets heavily affected by
such imprisonment. Therefore, reforming the penal law based on Islamic
principles will significantly reduce expenditure on making, developing and
maintaining such prison cells. If we study the judicial system in Caliphates
time, the judicial system did not have high cost of advocacy. Infact, there was
no concept of 3rd party advocacy
ž As
the law of the land was simple and its implementation enforced strictly. The
society put huge emphasis on honest testimony. The judicial system was highly
centralized and that too in Umar (rta) and Usman (rta) period when the Islamic
state was spread all over Arabia and touching North Africa as well as Eastern
Europe.
Alternative for Public
Finance Other Than Zakah
ž Next,
we discuss how the budget deficit could be financed in an Islamic economy.
First of all, it is to be noted that sources of revenue (tax and no-tax) will
be substantial enough to meet necessary development and non-development
expenditure. Furthermore, if true Islamic values are adopted, non-development
expenditure in providing perks to the government officials will also reduce.
Looking beyond imposing more taxes, Usmani (2003) proposed issuance of GDP
growth linked Instruments to finance public debt. In public finance, a Nominal
GDP linked bond could be issued. In public projects valuation, this benchmark
rate would be used to find PV of Cash Flows.
ž This
would be appropriate due to following:
ž i.
It will not lead us into falling in time value of money as we are using an
enterprise or output related
ž Benchmark
rather than interest based benchmark.
ž ii.
The Cash Flows are obtained using equity contractual modes like Mudarabah and
Musharakah.
ž iii.
In this case, we are calculating valuation models for the investor and not for
the borrower. Borrower
ž or
financee will be obliged to provide the returns based on these valuations. But,
the investor can
ž Use
this “indicative valuation” to rank investment alternatives.
Conclusion
ž This
study brings the sources of revenue for a government in an Islamic economy.
Though Zakah rates are low, but Zakah base is very broad and can include all
productive activities.
ž The
government in an Islamic economy can manage its operations without resorting to
interest based deficit financing.
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