Comparative
Study on Sources Of Public Finance
In
Islamic Economy And Capitalist Economy: Applicability Of Islamic Public Finance
To Preset Trend
INTRODUCTION:-
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.,
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.
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:-
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.
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.
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:-
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:-
The study sets the following important objectives.
·
To suggest the different sources of revenue for the state in Islamic point of
view
·
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:-
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:-
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:-
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:-
The
study is purely theoretic and comparative in analyses the sources of public
finance (taxation and zakah only)
LITERATURE
REVIEW:-
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.
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.
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.
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.
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:-
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.
I=w1 WI+W2PPI+W3LSI+W4 ROG
Where
WI = worked index
LSI=Stock index, a measure of market performance
index based on ROE.
PPI=index representing average returns on commercial
participation papers
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
Zakah
is a religious obligation to pay a part of wealth and income to the government.
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.
The classification is as follows:
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.
b) 5% on production using both
labor and capital. It is charged at the completion of the production process.
c) 10% on production using either
labor or capital. It is charged at the completion of the production process.
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.
To estimate Zakah on wealth, the
following model is established:
ZR = 0.025 [ZA -
(MNA x PMNA]
Where
ZR = Potential Aggregate Zakah
Revenue
ZA = Potential Aggregate
Zakatable Assets
MNA = Minimum Nisab Amount i.e.
market value of 612 grams of silver
PMNA = People with Minimum Nisab
Amount
Zakatable assets include all
assets above the value of nisab except the assets in personal use and
means of production. Minimum
Nisab Amount is the market value of 612 grams of silver. Population with minimum
nisab amount is to be estimated looking at wealth distribution of population.On
the surface, it can be seen that as Zakatable assets increase, Zakah revenue
increases. Minimum nisab amount in silver terms would remain constant, but its
value in currency would change. But, the effect of inflation would impact
almost all endowments of an individual overtime.
Issues in
Estimation of Zakah
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.
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
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.
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
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
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
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.
This would be appropriate due to following:
i. It will not lead us into
falling in time value of money as we are using an enterprise or output related
Benchmark rather than interest
based benchmark.
ii. The Cash Flows are obtained
using equity contractual modes like Mudarabah and Musharakah.
iii. In this case, we are
calculating valuation models for the investor and not for the borrower.
Borrower
or financee will be obliged to
provide the returns based on these valuations. But, the investor can
Use this “indicative valuation”
to rank investment alternatives.
Conclusion
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.
The government in an Islamic
economy can manage its operations without resorting to interest based deficit
financing.
great
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