Fiscal Policy in Islam

MANAGEMENT CENTRE INTERNATIONAL ISLAMIC UNIVERSITY

MALAYSIA

MASTER OF BUSINESS ADMINISTRATION

FISCAL POLICY AND THE ROLE OF GOVERNMENT IN ISLAMIC

ECONOMICS WITH EMPHASIS ON ZAKAT IN CONTRIBUTING TO

THE ECONOMIC WELL-BEING OF THE NATION

COURSE : AL SHARI’AH, ECONOMICS AND SOCIETY (FIN 6620) LECTURER : PROFESSOR DR ASLAM HANEEF

NAME : ARIFFHIDAYAT ALI (G0531827) DATE : xxxxx

FIN 6620 Individual Assignment -Fiscal Policy and the role of government in Islamic Economics with emphasis on Zakat in

contributing to the economic well-being of the nation

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1.0 Abstract:-

Fiscal policy relates to the level of government expenditure which impact on the

aggregate demand function within conventional economics. The key words within

the above statement are government, expenditure and consumption. These terms

are correlated to policy choices over resource allocation, socio-economic justice,

distribution etc.

The writer would like to approach the above from the perspective of Islamic

economics, its worldview and the roles and functions of government in Islam.

Some comparative study between Islamic economics and conventional economics

will be attempted to elaborate and contrast. Zakat will be cited as an instrument of

economic and social justice, as instrument of public policy and attainment of the

Islamic “din”. Since Islam is holistic, the discussion will touch on man’s relation

to God, his relation to others in the social context, and his relation to Nature

within the context of the use and application of resources and property. This

worldview will fully explain the need for government, its role in economic

activities for the betterment of its citizens.



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To discuss the above the writer has chosen the following articles:-

1. Monzer Kahf, Potential Effects of Zakat on Government Budget, IIUM Journal of

Economics & Management 5, No 1 (1997) pg. 67-85

2. Azmi, Dr. Sabahuddin, The Economic Role of The State (Chapter 3), Islamic

Economics, Public Finance in Early Islamic Thought, Goodword Book (2002)

3. Siddiqi, Dr Muhammed Nejatullah, from Public Expenditure in An Islamic State,

Finance In Islam, Mukhtar Zaman (Ed.) Banking and Finance: Islamic Concept,

1993, Karachi: International Association of Islamic Banks (Asian Region) pp.

103-127

The discussion will not restrict itself to the above articles but will include other

sources and readings. The writer will also touch upon monetary policy in Islam as

there cannot be a discussion on fiscal policy without touching on the Islamic

worldview of money. The writer hopes to reaffirm that there is value to be

obtained in Islamic economics as a credible alternative to conventional

economics. The writer own opinions will be highlighted in Italics.



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2.0 Economics policies and Islam:-

Policies are geared towards achieving goals. Fundamentally, this involves the basis of

economics, the idea of making choices. Policies are expression of the guiding worldview

be it laissez faire, Marxism and Keynesianism. All of them are devoid of religious

connotations although developed in the Judeo-Christian environment unlike Islamic

economics. This carries a very important implication to implementing policies.

Conventional policies are geared towards satisfying the secular whilst Islamic policies are

geared to satisfying the present as a precursor to the afterlife.

Definition, goals and types of fiscal policy:-

Fiscal policy is defined as the actions of a government in setting the level of public

expenditure and how that expenditure is funded1. Key terms being government, public

expenditure and funding. Pertaining to goals, Keynesian economics revolves around the

role government. This emerged as a response to the experiences of WW1 and the Great

Depression where economies stagnated thus the need for intervention. This can be

summed into terms such as government expenditure, multiplier/accelerator theory, and

deficit spending. It expressed itself in the Welfare State, infrastructure and other forms of

spending. The opposite of the expenditure coin is revenue financed via taxation, public

sector debt instruments and external borrowings.

1 http://en.wikipedia.org/wiki/Fiscal_Policy. Extracted from the Internet on 12 December 2007.



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The two types commonly cited are discretionary and non-discretionary fiscal

policy. Under discretionary fiscal policy, the government actively plays a role in

affecting the aggregate demand by utilizing either expansionary or contractionary

policies. Non-discretionary fiscal policy mostly arises out of the impact of the tax

structure on government revenue. We find this in most economics textbook with

discussion on the multiplier, aggregate demand (AD) analysis.

Definition of Islamic Economics:-

This can be defined as the basis of economics arising out of the theological basis of

Islam; i.e from the Qur’an and the Sunnah. Whilst the basis was divinely inspired over

1400 years ago, the current understanding and applications must be linked to them

without exception. It is both a science and an art, which deals with the routine of the

Muslim’s economic life i.e. how he earns his income and how he spends it. It is a science

in the sense that it involves many scientific methods in the production of the material

goods, their distribution and consumption.2 It is a product of the Islamic worldview based

on the holistic relationship between Allah, man, nature and Islam as a religion or “din”.

2 AbulKalam S.M. The Basic Principles of Islamic Economics, Finance In Islam, http; // www.financeinislam.com. Internet article retrieved on 24 December 2007.



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Article Review

First we review Dr Sabahuddin Azmi, Chapter III, The Economic Role of the State in his

book Islamic Economics, Public Finance in Early Islamic Thought. He discussed public

finance based on practices of the early Islamic state under the Prophet (p.b.u.h) and the

caliphate. He states that the theory of public finance is closely related to the role of the

state. The state is regarded as an agent of the wants of the citizens, it performs role to

tackle market imperfections and policies are required as corrective measures. Dr. Azmi

first discusses the nature of the state. Nature is defined as the basic qualities of a thing.3

This definition means the Islamic state has qualities determined by the Quran and the

Sunnah. Verses of the Quran are littered with references to the role of rulers and the state

in Islam namely “provision of ease and alleviation of hardship, to generate prosperity,

nurturing a climate of love and affection and ensuring freedom from moral corruption,

hunger and mental tension.4 In line with “din” and the role of man as both khilafah and

abd’ owing existence to Allah, the rulers in Islamic state carries position of trust and they

are responsible to utilize the resources of the state for the welfare of the people. First and

foremost, the writer identified the basic needs of the people as being the most important

to be provided by the state. These needs include food, clothing and shelter. Other needs

were also mentioned depending on the availability of funds in the Treasury. This is an

approach that recognizes that Treasury expenditure within the state may go beyond

3 Hornby A S, Oxford Advanced Learner’s Dictionary of Current English, International Student’s Edition, Seventh Edition, Pg 976, Oxford University Press 4 Azmi, Sabahuddin, Islamic Economics, Public Finance in Early Islamic Thought (2002), Goodword Books, New Delhi



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provision of basic amenities and should be rigorous enough for other expenditure. This

then becomes a policy issue in terms of how much to spent, is deficit spending permissible

so on and so forth.

Dr. Azmi moves on to discuss the provision of social goods through the state. Provision

of social goods or merit goods goes beyond providing basic needs and includes the

provision of infrastructure and other services that encourage economic activities. Dr.

Azmi states that these goods should be provided free of charge if the benefits are

generalized but chargeable if it serve only a particular group of people. This again point

to a policy issue as it is extremely difficult to separate public and private benefits to be

charged and we are confronted with such economic jargons such as the “free rider

problem” and measuring externalities.

Dr. Azmi then moves to discuss the supply of social goods via the voluntary sector. In the

early Islamic state, the organization was relatively limited and thus the role of voluntary

sector was extensive in terms of financing the building of mosques and paying for war.

One instrument he cited was the used of “waqf” properties, endowments to supplement

the state’s obligation in providing public goods. The writer opines that “waqf” continues

to be an important institution in modern Islam although its role requires a re-definition



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since the role of the state in providing public goods, providing social welfare etc has

grown tremendously. Any revitalization of waqf under private initiative requires will on

the part of both the public and private sector to overcome administration and

implementation issues.

Dr. Azmi then moves on to discuss the functions of the state. Early Islamic literature did

not categorize the functions and writings on this was scattered. He points to al-Ghazali

who stated that the objectives of the Shariah relating to persons are to protect the religion,

life, reason, progeny and prosperity and the state must protect these five necessities.5 Al-

Mawardi extended the list namely protection of religion, maintenance of law and order,

protection of the Islamic state by defending it against enemies of Islam, provision of

conducive environment for economic activities, provision of public administration,

collection of revenue from available sources and also to raise revenue by imposing new

taxes if the situation requires and disbursement of funds on those heads that are

obligations on the treasury.6 Dr. Azmi goes on to cite Ibn Khaldun and the roles of the

state. One function that deserves mentioned from the list is to oversee the mint to prevent

fraud in currency.

5 Azmi, Sabahuddin, Islamic Economics, Public Finance in Early Islamic Thought (2002), Goodword Books, New Delhi 6 Azmi, Sabahuddin, Islamic Economics, Public Finance in Early Islamic Thought (2002), Goodword Books, New Delhi



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The writer opines that the above lists of functions are generally found in both Islamic and

conventional economics. However in the Islamic state, revelation and ijtihad are the key

drivers for the state to fulfill its roles. In conventional economics, the “ism” of ideology,

the role of “ballot” boxes guides the fulfillment of these functions. On preventing fraud

in currency, the writer opines that early Islam already recognizes the impact money,

inflation and the possible roles of monetary policy in ensuring the Makasid al Shariah in

economic life besides the predominantly fiscal function of the state.

The above discussed the role and functions of the state, Dr Azmi moves on to the pre-

requisites of the state namely the character of the state itself, its institutions and its

practitioners. He states that the state requires an efficient, honest administration. Officials

are to be honest and trustworthy in implementing their roles. Injustices, tyranny are not

acceptable traits and where this exists it breeds corruption and disenfranchises people in

the community and lead to economic stagnation. Another point being put forth is the need

to check unhealthy market practices via the institution of al-hisbah.

The writer opine that the above is synonymous with role and functions of man within the

Islamic worldview since the state is just a political and social institution established by

man to administer his affairs on Allah’s earth.



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The rest of the chapter discusses the following:-

- The need of the state to maintain enough coercive power and maintain a strong and

ready military which include a voluntary and regular paid militia.

- The provision of social security via grants and pension. This should be targeted to

those who have fought in the cause of Islam i.e. “jihad”. Beyond this, social “welfare

nets” are also required for old persons and inhabitants who needed financial

assistance due to famine and natural disasters.

- Notwithstanding the provision of social security, the virtue of hard work and looking

at economic activities as an obligation were stressed upon. Al-Ghazali considered

productive work as part of worship.

- Major emphasis on economic development was also placed in early Islam. Being

agricultural based, most policies were geared at improving the productivity of the

land. In the event that private enterprise did not cultivate such lands, government

intervention namely direct cultivation remains an option. The revival of

dead/unclaimed land is stressed upon to the extent that the state can grant ownership

to parties willing to cultivate these lands.

- Another emphasis is on the distribution function. Dr. Azmi identified income

distribution was the main objective of early Islamic fiscal policy. The rules of

taxation were established to ensure proper collection from the wealthy to be



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distributed in a just way among the needy. Whilst taxation serves as a source of revenue,

zakat brings the wealth of the rich and the prosperous to benefit society as a whole.

As conclusion to the chapter, Dr. Azmi stresses on the positive and balance view of

Islamic fiscal policy practiced by the state and he has sort to contrast this against

capitalism, socialism and Keynesianism. He also concludes that the role of the Islamic

state are guided and constrained by Islam’s own ethical philosophy.7This includes the

economic functions to be played by the state to be based on the dictates of the Shariah.

The writer opines that Dr. Azmi tries to address the complexities of running a state

guided by the dictates of the Shariah. An area that was discussed in the above was the

traditional instruments to fund the government budget to provide for all the above

amenities. Another important point raised was the fact that early Islamic finances were

predominantly driven by the voluntary sector. The roles of zakat, taxation and waqf were

touched upon nevertheless a fundamental question remains in the event that the revenue

collected are inadequate to support expenditure was not discussed. Since zakat is seen to

be restrictive in terms of its quantum and its recipients are deemed fixed whilst waqf is

seen voluntary in nature, the role of various types taxation is seen as the only instruments

of fiscal policy that is amenable to change and will serve as the major source of

7 Azmi, Sabahuddin, Islamic Economics, Public Finance in Early Islamic Thought (2002), Goodword Books, New Delhi



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government revenue. It should be noted that Dr. Azmi did not mention that the Islamic

state during the times having the capacity to borrow funds. This he discussed later and

stated that there were initial debates on the permissibility of the state to borrow funds

nevertheless borrowing was nevertheless permitted as a last resort. Modern Islamic

states have embraced this and examples of the borrowing instruments are leasing

instruments, partnership and limited partnership instruments, output sharing instruments,

public debt mode and certificates, voluntary public debts, sale-based public debt, loan-

based financing and involuntary public borrowing.8

In discussing fiscal policy, we should not avoid discussing monetary policy. In the above,

the role of money was not discuss nevertheless this is understandable as the author is

seeking to explain the role of government in an Islamic state. It seems that there is a

substantial role for the government to play and we can pose the following questions:-

- Is there a tendency for a “big” government and a bureaucracy to manage all of the

above?

- Will government borrowing “crowd out” private investment, a charge that is often

leveled at “big” government by monetarists?

- Will the over reliant on taxation be a disincentive to work among both Muslims and

Non-Muslims citizens?

8 Kahf Monzer, Budget Deficits and Public Borrowing Instruments in an Islamic Economic System, Finance In Islam, http; // www.financeinislam.com. Internet article retrieved on 01Jan2008.



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Some writers have defended the above by stating since all loans in Islam have to be

interest-free, much government spending would be financed either from the proceeds of

taxes or on a profit-sharing basis. Hence, the scope of public debt would be much

smaller.9 Another way to defend against the charges of “big” government is the Islamic

worldview of property and nature as being owned by Allah and Islam abhorrence of

wastage and extravagant expenditures.

With regards to the disincentive to work as an impact of taxation, we would have to

assess the tax structure being applied whether proportional, progressive or regressive.

Keynes favored progressive taxation to combat unemployment however taxing income

alone cannot spur overall economic activity.10 Zakat has been cited as more progressive

as the contribution is not derived only from income but also from idle assets i.e.

accumulated wealth or idle assets. Furthermore, for Muslims they are urged to be useful

member of society, so much so that hard work and lawful earning, supporting one’s

family, and even the pursuit and dissemination of knowledge are all equated with acts of

ibadah.11

9Munawar Iqbal and M.Fahim Khan, A Survey Of Issues and a Programme for Research in Monetary and Fiscal Economics of Islam P83-85 10 M.M. Metwally, "Fiscal Policy in an Islamic Economy" in Ziauddin et. al. Fiscal Policy and Resource Allocation in Islam, Islamabad, The Institute of Policy Studies and Jeddah, International Centre for Islamic Economics, 1983, p. 61, pp. 72-73. 11 Kamali, Muhammad Hashim, Source, Nature and Objectives of Shari’ah, Paper presented at Shari’ah Symposium in Malaysia, September 1989.



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The overall assessment of Dr. Azmi’s work is that it provides us with an important

historical analysis of the governments’ role in the economy, the major drivers for the

state, the use of fiscal policy and the role of the voluntary sector in the economy.

Moving on, we discussed the article by Dr Muhammed Nejatullah Siddiqi, Public

Expenditure in an Islamic State in Mukhtar Zaman (Ed.) Banking and Finance: Islamic

Concept, 1993, Karachi: International Association of Islamic Banks (Asian Region), pp.

103-127.

Dr. Siddiqi article reaffirms what has been discussed by Dr. Azmi however there are

several interesting approaches that he has taken. He concedes that the state has an

economic purpose of need fulfillment, reduction of inequalities and development. He

stated that the power of the state is to be exercised in a democratic manner i.e. matters are

to be decided in consultation with the people and secondly the people have the

responsibility to the state. He then goes on to discuss the role of the state in modern terms

namely the goals of employment, stability and progress in science and technology. He

stipulates that without achieving these goals, the basic economic purposes to be achieved

can be affected. He further discussed the role of stabilization policies. Since his article

touches on Islam within the context of present conditions, he divided the functions of the

state into three categories namely, functions assigned by Shariah on a permanent basis,

functions derived from Shariah via Ijtihad and functions assigned to the



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state by the people via syura or consultation. Since Dr. Azmi has discussed early Islamic

thought, we have decided to focus on the second and third functions namely the modern

application of the secondary sources. Dr. Siddiqi cited environmental protection as a

problem and policy making based on the demands and needs of the people. Dr. Siddiqi

acknowledges historical, geographical and other variables that may impact the state.

He also brings in the discussion over public interest and personal freedom. He then lists

down the expenditure elements prescribed by the Shariah. He discusses Fard Kifayah

which is defined as duty not addressed to the individual but to the community as a whole.

He argues that these social obligatory duties should be carried out via individual

initiative, voluntary community action and in the event that both of them are deemed

insufficient, the state should provide via public expenditure. Whilst admitting that certain

functions of the Islamic state does not differ from conventional state, he cited the role of

Da’wah or communicating the message of Islam as being unique. With reference to the

present situation, Dr. Siddiqi lists the following as functions of the state namely

protection of the environment, supply of necessary public goods, scientific research,

capital formation and public development, subsidies for priority private activities and

expenditure necessitated by stabilization policies.12In coming to this, Dr. Siddiqi comes

12 Siddiqi, Muhammed Nejatullah, Public Expenditure In An Islamic State (In Mukhtar Zaman (Ed.) Banking and Finance: Islamic Concept, 1993, Karachi: International Association of Islamic Banks (Asian Region), pp. 103-127



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from the point of view that Islamic states are currently in the state of decline and

impoverishment. He sees government expenditure as a way to move forward. He sees

deflationary and inflationary fiscal policy as valid policy instruments to be pursued. On

the environment, he sees this as an extension of protecting the individual and the public

interest in line with the dictates of the Shariah.

Moving to a controversial area in the article is the expenditure on activities assigned by

the people. He sees this as something natural based on the early Islamic practices. He

further cites that public money is a trust and must be spent for public interest. Whole

sections are devoted to this discussion in terms of equity/fairness being paramount. This

includes the used of Zakat proceeds and should be fully disbursed within the same

locality till the needs are met and the state should exercise efficiency in its distribution.

This also applies to other forms of public revenue namely taxes, fay, and kharaj etc. This

distribution again requires concurrence of the people affected by these taxes.

He moves on to try and develop a theory of public expenditure in Islam which he

summarized as follows namely expenditures mandated by Shariah, expenditures

necessitated by Fard Kifayah, expenditures to reduce market failures, expenditures

assigned to the state by the people and expenditure in the wake of stabilization policy. He

further claimed that any public expenditure unrelated to the above is not legitimate

expenditure and has no basis in Islam.



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Dr. Siddiqi continued his discussion on Fard Kifayah by asking the question: What makes

the individual fail to do the needful? Several reasons were put forward namely lack of

information, moral failures, lack of resources and technical difficulties. This discussion

reaffirms the role of the state in ensuring that the duty of Fard Kifayah is observed.

Similar to Dr. Azmi, Dr. Siddiqi reaffirms the incentive to work from the Islamic point of

view. He touches upon disincentive to work with reference to the Western “welfare”

state, the tax system and the laissez faire solutions to these problems. To him, the solution

stems from the Islamic worldview with regards to both Fard ‘Ain and Fard Kifayah.

There exist religious motivations not to be over reliant on charity and the desire for social

uplift from a lowly (poor) position. He stresses further on the responsibilities of the

individual as well as of the state to ensure that there exist a suitable environment for

seeking employment.

Dr. Siddiqi analyzes the incentive to save and stated that public expenditure should not

reduce savings in society. Here he relates savings to the investment function and cited

history on investment in productive activities leading to economic growth and

development. This we opine reaffirms both the “multiplier” and “accelerator” concept

within conventional economics.



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Dr. Siddiqi discussed the limits of public expenditure and individual freedom in making

economic decisions so long as this does not impinge on the well being of the community.

In doing this he put forward the example of “big” government and the prospect of higher

taxation to finance expenditures. He appeals to the political process between the ruler and

the people as well as established Islamic injunctions against excessive and wasteful

expenditure.

In the final part of the article, Dr. Siddiqi reaffirms the priorities of public expenditure

based on Al Ghazali and also cited Shatibi namely that expenditure depends on

availability of resources. He states that it is imperative to adhere to the consultative and

democratic decision making especially with regards to additional taxation.

The writer opines that Dr. Siddiqi article is controversial as he stresses on the

democratic and consultative environment of the Islamic state. Western liberal democracy

has often attacked Islam whereby human rights, freedom and democracy are not

respected and Islam is viewed as theocratic and totalitarianism in outlook. These

indictments have been levied on the likes of Iran and Saudi Arabia on both political and

economic levels. The experience of these states themselves is difficult to reconcile with

the consultative state. From the Western outlook this is a failure of dominant worldview.



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Freedom from the Western point of view is individualistic and laissez faire centered

whilst Islamic concept of freedom takes into account the maslahah of the society and the

role of the state as the guardian of individual and social welfare and freedom. The more

important debate that stems from the above is to explain the dichotomy between Dr.

Siddiqi Islamic state and the present realities. These realities stems from interpretation of

Islam as well as the societal context in which these states exists. Some of the

understanding pre-dates Islam e.g. the treatment of women and Islam has played a

liberating role in these societies rather than creating the present bondage.

Dr. Siddiqi discusses democracy within an Islamic state by not mentioning the role of

non-Muslims. This is applicable also to Dr. Azmi’s discussion. What then are the roles of

non Muslims in an Islamic state? Are they just subjects to be taxed to generate adequate

revenue for public expenditure? Similarly will they have rights to be consulted by the

government and the people? In so far these questions are important for a multi-religions

nation such as Malaysia in so far that these have economic ramifications. If the desires

of Dr Siddiqi are only applicable to states where Muslims are the majority, neither is his

vision applicable to states where Muslims are in the minority. How then will these

Muslim safeguard their economic sovereignty? Therefore we opine that the voluntary

sector remains important in ensuring the economic well-being of Muslims in the absence



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of state provision. Following from this, the roles of zakat, waqf, sadaqah and other forms

of voluntary acts might be more important in countries where Muslims are in the

minority. This is clearly exemplified with the role played by “waqf” and other charitable

organizations such as North American Islamic Trust in the United States.

In the beginning of his article Dr. Siddiqi identified employment, stability and progress in

science and technology as objectives that must be pursued to reach other economic goals.

The writer would like to relate this to supply side economics. Islam places emphasis on

production ensuring adequate supply of goods and services. This controls the potential of

demand push inflation. Inflation impacts the poor and on the capacity to engage in

profitable economic activities by producers. Supply side can also assist in bringing out to

individuals out of “subsistence economic” level into the productive sector. Zakat plays a

major role here and so does the institution of waqf.

Finally we discussed Dr Monzer Kahf, Potential Effects of Zakat on Government Budget,

IIUM Journal of Economics & Management 5, no.1 (1997) pp 67-© International Islamic

University Malaysia Press.



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The study is on the potential direct and indirect effect effects of zakat implementation on

the Government’s budget within the context to contemporary society.13The author made

several assumptions, and then discusses the potential direct substitution effect of zakat

reducing the needs for government expenditure. He goes on to argue the potential indirect

effects of zakat implementation on productivity, on tax, on consumption and investment,

on employment and the use of zakat as a government economic policy.

Dr. Kahf started by pointing out that poverty relief as an economic concern as a later day

phenomenon with the advent of socialism and the welfare state. This he contrasted to

Zakat that has been legislated since the advent of Islam more than 1400 years ago with

individual, social and international dimension and remains one of the cornerstones of

Islam.

The paper is divided into 3 sections plus a conclusion. The first being the assumptions of

the study. The basic assumption is the implementation of Zakat in an Islamic society.

Other factors must also be in evident about Zakat to study its potential effects on

government budget. The first assumption assumes that Zakat proceeds are sufficient to

cover needs. Zakat proceeds should be high enough to achieve the target of poverty

13 Dr Monzer Kahf, Potential Effects of Zakat on Government Budget, IIUM Journal of Economics &

Management 5, no.1 (1997) pp 67-© International Islamic University Malaysia Press.



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eradication. He began by stating that there a differing opinions in the Shariah in terms of

the wealth and income subjected to Zakat. Traditional opinion pronounced that Zakat

covers only four items of agricultural products thus in modern society the proceeds of

Zakat will be small. Liberal opinion states that Zakat must be imposed on the wealth and

income of the rich and covers all forms of excess wealth, income in our modern

understanding of terms. To Dr. Kahf, if this definition is accepted, Zakat proceeds may

reach as high as 8.6% of the GDP. Without assuming this, the proceeds from Zakat will

be too small thus its effect of its collection and distribution in terms of poverty

eradication is limited as government themselves has other revenue sources for poverty

relief.

The second assumption is that Zakat is collected and distributed by the government.

Zakat is a religious obligation and the Quran addresses the responsibility of collection to

the head of the Islamic state. The paper assumes that Zakat must be collected and

distributed by a government body autonomous from the Government budget. This body

will collect the Zakat supported by the authority of law, on all items of wealth and

income of the rich as determined by law. The assumption carries two benefits, namely the

reliance on law besides state supervision thus fulfilling the desired objective of poverty

eradication. The third assumption is that the government regulates the methods and

approaches of Zakat disbursement. The government is to collect zakat in cash or in kind,



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determines the dates of collections and the government will distribute the proceeds in

cash or in kind. The fourth assumption is that the costs of collection and disbursement are

minimized namely the creation of an efficient way to administer zakat. The fifth

assumption is that Zakat does not create economic distortions from the perspective of

equity and justice. The sixth assumption is that Zakat collection does not reduce other

government revenue. Zakat is not seen as an alternative to taxes already collected in

society and zakat collection does not reduce other revenues paid to the government. The

final assumption being made is that all Zakat proceeds are disbursed within the year of

collection. This eliminates the time lag between collection and disbursements, avoiding

accumulation of the proceeds in the government coffers. This assumes that the body can

collect but also to disburse the proceeds without unwanted delays.

Dr. Kahf then examines the substitution effect of Zakat whereby zakat replaces certain

expenditure within the government budget, citing Pakistan as example. He notes that the

substitution effect arises are those items saved from the current government budget which

corresponds to the seven categories of zakat recipients as stated in the Quran. In his study

he cited that the government budget for subsidies and calamities relief benefit both the

rich and the poor. The same goes for education, health and other public expenditure

which to a large extent still excludes the rural poor in Pakistan. He concedes that due to

this, it is difficult to estimate the amount of budgetary savings that can be affected by



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implementing zakat. Dr. Kahf than discusses the indirect effects of zakat on the

government budget. He contrasted zakat from other forms of social security or social

insurance. Zakat according to him is based on the principle of solidarity among members

of society and the rich have a moral and legal obligation to support the poor. To analyze

the potential indirect effects of zakat, he explores the following four areas namely the

effect of zakat on productivity and the ability to be taxed, the effect of zakat on aggregate

consumption and aggregate investment, the effect of zakat on employment and the

amenability of zakat to be used as a tool in the implementation of Government economic

policy.

Effect of Zakat on Productivity

Dr. Kahf states that the ultimate objective of zakat is the enrichment of the poor and

transforming them from recipient to payers. This means that zakat must be in a form of

direct payments ensuring that the poor have an income to cover their basic needs as well

as providing means for them to reestablish their economic potential. Dr. Kahf opines that

improvements in the income of the poor increases consumption, improves health,

education and overall welfare. These improvements will lead to improve productivity.

With improve productivity, output and income will increase. More tax revenues results

out of economic growth. In essence, the writer concludes that zakat expenditure lead to

economic growth and development in the nation.



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Effect on Consumption and Investment

The initial position begins with the proposition that the marginal propensity to consume

(MPC) is higher among the poor. As a result, with income redistribution via zakat will

lead to higher aggregate consumption in society. Increase in consumption is satisfied via

production, which entails increased investment and output via the multiplier effect. This

will result in higher employment and government revenues from taxes. In terms of

aggregate consumption the writer states the goods consumed will be commodities

fulfilling the basic needs of the poor thus production will be centered towards fulfilling

these needs.

Effect on Employment

Dr. Kahf states that zakat transfer of incomes creates both direct and indirect effect of

raising employment. The direct increase in employment comes from the employees

needed to run the zakat organization itself whilst the indirect effect stems from the

supporting and producing industries that will spring up due to the needs of producing the

goods and services to satisfy the increasing demand of society. The writer however

admits that the increase in employment depends on several factors e.g. availability of

spare capacity, availability of resources and the current state of technology.



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Zakat as a Tool of Economic Policy

In discussing the above, Dr. Kahf cites restrictions to the use of zakat as a tool of

economic policy due to the Shariah. He however identified a few factors within

government controlled. The first being on how much zakat is collected in cash or in kind.

By influencing the collection type, the government may influence the level of economic

activity in society. The same applies for zakat distribution. The government may decide

on the ways on how the zakat proceeds is to be distributed namely in the most efficient

and convenient manner for the poor. Dr. Kahf also states that the government may decide

on the timing of the collection and distribution of zakat, the government may collect and

distribute in advance and also delay the collect of zakat from one year to another.

In conclusion, Dr. Kahf summarizes his position on the potential effects of Zakat on the

government budget, namely it frees up existing revenues, and it promotes employment,

productivity, taxation and output. Zakat is also seen as a policy tool to influence

economic activity. To him by approaching zakat in this matter, the Maqasid al Shariah

can be achieved. He is also of the opinion that via zakat, there will be more commitment

from Muslims being Shariah driven and the collection and disbursement of Zakat will not

be influenced by political maneuverings.



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The writer opines that Dr. Kahf is a very useful reminder to all of us on the important of

zakat in serving economic and social goals. He places a lot of responsibilities on the

shoulder of the government. One of the issues that need to be raised is the requirement

that the government should also pursue zakat evaders. Zakat is a duty towards Allah

rather than towards the government. This goes back to the fundamental existence of man,

if man is a creature subservient to Allah, there will not be a need for government to

employs laws and penalty against evaders. Here is the realization of Dr. Kahf part that

man is fallible and may forget. Scholars have concluded that the government needs to put

in laws to deter zakat evasion which is detrimental to the well-being of the nation and

individuals.14Moving on, the writer would like to discuss the 8 categories of recipients

which implies that application of zakat funds can be limited as a tool of discretionary

fiscal policy as categories like amil, new converts to Islam, riqab, ibnus sabil are no

longer pronounced in modern society.

In his discussion on the impact of zakat on productivity, Dr. Kahf assumptions are

simplistic and he does not provide evidence. However, there are defenders such as M.A.

Mannan and Ziauddin Ahmad of this point of view namely that zakat funds can be used to

fund various development projects in education, health care and other social activities.15

14 Diabi, Ali, The Concept of Zakat Evasion – An Economic Interpretation, Review of Islamic Economics, Vol 2, Issue 2, 1993, pages 17-27. 15 Mannan M.A., Effects of Zakat Assessment and Collection on the Distribution of Income in Contemporary Muslim Countries, Management of Zakat in Modern Muslim Society, Paper Presented in Seminar on Management of Zakat in Modern Muslim Society held in Karachi, Pakistan (1985).



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In discussion on the impact of zakat on consumption and investment, Dr. Kahf has many

supporters in the opinion that consumption increases leading to an increase in aggregate

demand in society. This inadvertently leads to economic growth and development. The

same can be said for investment since zakat promotes further investment in productive

capacity. This will add to the nation’s capital stock and thus may lead to the shift of the

Production Possibility Frontier (PPF) outward to the right leading to the nation’s

growth.

In discussion the impact of zakat on employment, there is a fundamental belief that zakat

increases employment opportunities. Since Islam discourages hoarding of wealth, zakat

indirectly imposes a tax on the rich in society. Since this is an accepted phenomenon, it is

likely that the wealth being distributed will add to the productive capacity within the

nation and increases employment.16

16 Sadeq, Abu Al-Hasan, A Survey of the Institution of Zakah: Issues, Theories and Administration, Discussion Paper No. 11, Islamic Research and Training Institute, Islamic Development Bank, Jeddah (1994)



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Conclusion

As concluding remarks, we can sum up that all three authors’ stresses on the importance

the state plays in guiding the economy as a whole. The economic role of the government

stems from the responsibilities the government has towards Allah and the Muslim

ummah. It is not a responsibility to be taken lightly. Therefore, managing the fiscal policy

becomes a religious imperative in an Islamic state.

Zakat meanwhile can be seen as an instrument of fiscal policy to be used in a prudent

manner by the state. Important lessons pertaining Zakat is that it plays a very significant

role in Islamic Economics namely it promotes economic growth, stimulates consumption,

savings, investment, production. All this is part of the standard conventional aggregate

demand function namely:

GDP = Consumption (C) + Investment (I) + Government (G) + Net Exports (X)

It does not end here as at the same time Zakat promotes social justice, distribution and

welfare for the citizens. In essence, Zakat answers the title of this paper as it contributes

to the economic well-being of the nation. To put it more simplistically Zakat explains the

fundamental economic questions of what to produce, how much and for whom albeit

being guided the Islamic worldview.



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Additional References:-

1. Wiki Encyclopedia at http://en.wikipedia.org/wiki on Keynesian economics

2. Finance in Islam, Learning Islamic Finance at http://www.financeinislam.com

3. McConnell Campbell R. and Brue Stanley L., Economics, Principles, Problems and Policies,

International Edition 2005 (16th Edition), McGraw-Hill/Irwin , New York

4. Abul Khair Mohd Jalaluddin, The Role of Of Government in an Islamic Economy (1991),

Publisher A.S. Noordeen, Kuala Lumpur

5. Lipsey Richard G. & Chrystal K. Alec, Economics for Business and Management (1997),

Oxford University Press Inc., New York

Fiscal Policy in Islam

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