MBF707: Monetary and Fiscal Framework in Islamic Finance COMSATS Institute of Information Technology (Virtual Campus)

Lecture 21 FISCAL POLICY IN AN ISLAMIC ECONOMYAND THE ROLE OF ZAKAT: Empirical Approach (Source: IIUM) 2

Review of the Last Lecture 3

Findings from the last Lecture  Macroeconomic policies in Islam can indeed cover a wide array of topics, this lecture addresses a few.  The Islamic economic system must in the first place ensure economic justice in economic transactions.  This will make macroeconomic management to be pursued to the minimum while the state will always be in constant surveillance to see that economic growth and stability is guarantees and secured.  If governments failed to exercise restraint on excessive expenditures during good times, they will have no choice but to intensify fiscal policy to stimulate spending when recession hits the country. 4

Findings from the last Lecture  Conventional theories are emphasize much more on analyzing the consumer behavior to protect economy from economic problems creating inflation, deflation and stagflation (more materialistic). Their focus is to maximize profit and minimize losses.  However in Islam, it not only stresses on material growth and well-being but also spiritual growth. The system is based on justice; it stimulates zakat and waqf to improve the economic society.  Saving and investment are really important during economic boom in the light of Quranic education narrated in surah Yusuff.  The benefits of savings in good times turn into investment and accrue benefits during economic recession. 5

Topics to Cover  Introduction  Goals of Distributive Justice  Distribution of Zakat  Government Spending, Taxes and Zakat  Conclusion 6

Introduction  Islamic economic system is based on the Al-Qur’an and Sunnah.  The economic system recognizes the importance of ownership of resources, motivation, and decision making process.  Islam allows private ownership and public ownership but everything belongs to Allah.  The wealth must be halal, devoid of riba, and must pay Zakat.  The basic motivation of an individual Muslim is to be successful in this world and hereafter.  A Muslim producer faces a constrained profit maximization not only by the resource constraints but also by the Islamic laws and the Islamic ethical values.. 7

Introduction  Resources belong to Allah and the wealth is held by human beings only in trust.  The third pillar of Islam is Zakat, which is an obligatory on various assets.  Financial assets include savings and financial investments, produce, inventory of goods, salable crops and cattle, and precious metals.  Zakat transfers some of the income and wealth from the haves to the have-nots  The word Zakat is mentioned more than thirty times in the Al- Qur'an, usually along with Salah.  A generous person can pay voluntary charity, Sadaqah, which can be used for financing useful projects for the betterment of the community. 8

Introduction  Zakat shares wealth between the contributors with less fortunate.  Zakat means purification and growth- Zakat purifies the assets of the contributor and his heart from selfishness and greed. At the same time, it also purifies the heart of the recipient from envy and jealousy, hatred and uneasiness.  Muslim takes it as an investment to get rewards in hereafter  Reduces economic imbalanced and social injustice in the society.  The trust is discharged, because a portion of our wealth legally belongs to other people and this portion must rightly be given out to them. 9

GOALS OF THE DISTRIBUTIVE JUSTICE 1.Guarantee of fulfillment of basic needs for all, 2.Reduction of inequalities in income and wealth, 3.Purification of the donors inner self and their wealth.  Distributive justice of income and wealth in the economy can be achieved through the Zakat system.  The more unequal the distribution of income the greater the demand for luxury goods and the producers allocate more resources toward the production of more of luxury goods in response to the market forces. 10

GOALS OF THE DISTRIBUTIVE JUSTICE  The distribution of income divides output into consumption goods and investment goods.  An economy which has relatively larger size of investment goods in relation to consumption goods will attain higher economic growth over time.  Thus, higher saving rates will promote higher investment and economic growth which in turn increase the Zakat collection and also reduces the number of eligible Zakat recipients. 11

Distribution of Zakat “Alms are for the poor and the needy, and those employed to administer the funds; for those whose hearts have been (recently) reconciled (to the truth); for those whose in the bondage and in debt; in the cause of Allah; and for the wayfarer; (thus it is) ordained by Allah, and Allah is full of knowledge and wisdom.” 12

Distribution of Zakat The 8 categories of people, 1.The poor, One who has neither material assets nor means of livelihood; 2.the needy, one with insufficient means of livelihood to meet basic needs; 3.Zakat administrator, one who is appointed to collect and administer Zakat-efficiency. 4.New convert, one who has converted to Islam; 13

Distribution of Zakat The 8 categories of people, 4.New convert, one who has converted to Islam; 5.slave, one person who wants to free himself from bondage or the shackles of slavery; 6.debtor, individual who is in debt when he/she borrows money to buy basic needs consisting of halal expenditure; 7.path of Allah, one who fights for the cause of Allah; 8.finally, a wayfarer, one who is stranded in a journey. 14

Government Spending, Taxes and Zakat An economy can be classified into three major sectors: 1.the household, 2.businesses, and 3.the government sectors.  The households sector receives income in return and spend on goods and services.  Business firms employ labor and other factors of production to produce goods and services  Government collects Zakat and taxes from the household and business sectors and also allocates the budget for the various government expenditures. 15

Government Spending, Taxes and Zakat  Direct taxation is preferred to indirect taxation,  Tax exemption should always be provided.  Although the Zakat payment is a religious obligation, practically the payment of Zakat by individuals, in some Muslim countries, are individual choices.  There is not well-organized system of zakat collection in the Islamic countries. 16

Government Spending, Taxes and Zakat  The tax collection is for military equipment; builds highways, schools, universities, hospitals, pay salaries to the government servants, welfare payments to the less fortunate.  Transfer payments are, non-exhaustive as they do not employ resources and therefore do not directly contribute to the production of current output.  Government purchases and transfer payments have different impacts on the allocation of resources. Government spending results in reallocation of resources for the production of more public goods, while the government transfers will change the composition of private goods and services. 17

Government Spending, Taxes and Zakat  Transfer payments are quite different in the sense that they rearrange private consumption (basic necessities).  The transfer payments could promote the growth of small and medium scale industries and generate more employment opportunities for the poorer groups. 18

Conclusions  Summary and the Way Forward. 19

Thank You 20