Fiscal policy in an

Islamic state and

Zakat as a
instrument of fiscal
policy.
 What is Fiscal policy?
• Fiscal policy is the policy of government concerned
with government revenue, government expenditure,
government borrowing and government debt. More
specifically, fiscal policy is the action by the
government to spend money, or to collect money in
taxes ,with the purpose of influencing the condition
of national economy. Government spending is an
injection into the economy, adding to aggregate
demand =expenditure=national income ,whereas
taxes are withdrawal.
 Objectives of the Islamic state.
• An Islamic economy is one that has established an
Islamic economic system based on the Quran and
Sunnah. The Islamic economic system recognizes the
importance of ownership of resources, motivation, and
the decision making process. Islam allows private and
public ownership, but in the final analysis everything
belongs to Allah. The wealth must be halal, devoid of
Hiram’, and when the wealth is above the nisab, the
owners must pay zakat. The basic motivation of an
individual Muslim is to be successful in this world and
hereafter. Islam recognizes the importance of profits
as an objective of a Muslim entrepreneur to give him
an incentive to work hard and be successful. Thus, a
Muslim producer faces a constrained profit
maximization not only by the resource constraints but
also by Islamic laws and Islamic ethical values.
Objectives of the fiscal policy of the
Islamic state
• The fiscal policy of the Islamic state basically has the same
objectives as that of the secular state. They are as fellows:
• 1. Eradication of unemployment.
• 2. equitable distribution of wealth.
• 3. Economic stability.
• 4. Faster economic progress.
• In an Islamic state , fiscal policy holds greater importance because
owing to the illegality of interest , prohibition of accumulation of
property and wealth and the ban of speculative motive for demand
of money , the monetary policy would not be very effective. In the
Islamic economy the chief instrument of Fiscal policy is Zakat.
 Zakat as an instrument of Fiscal
policy.
Elimination of interest is the corner stone of the monetary policy of
Islam. the most important element of Islamic fiscal policy is Zakat
(and Ushr) which as a form of worship is one of the basic articles of
faith in Islam. In this perspective Zakat cannot be regarded as a tax,
for its economic effects are from those of the taxes.Zakat has been
made obligatory by Allah Almighty. The Holy Quran contains several
verses , which declare zakat obligatory on Muslims. Zakat on
agricultural product is technically called Ushr. The rate of Ushr has
been fixed in the Shariat, which is 10 percent on barani (rain
-irrigated) land and five percent on land irrigated by artificial
means.zakat must be expanded in the same area from where it is
collected. If, however surplus remains after supply the wants of the
deserving people of the area ,it can be transferred for expenditure in
other areas.
 Equitable distribution of wealth
• In Zakat, Islam has a built in redistributive mechanism.
Islam disapproves of concentration of wealth. It
prescribes several measures for the promotion of
circulation of wealth and elimination of concentration of
wealth so that wealth and income may be equally
distributed among the members of the society.
 Achieving full employment without
inflation.
• Stability in the value of money is essential for the
success of the economic system of Islam. In order to
stabilize the value of money, the current capitalist
system uses such instruments as changing the interest
rate and open market operation., the monetary policy
would not be conductive to the achievement of the goal
of full employment without inflation. As a result of the
enforcement of of the zakat system not only will the MPC
and APC increase , but the investment gap at every
income level also decrease. In consequence of the two
facts stated above, the aggregate demand in Islamic
economy will increase which will open up greater
employment opportunities.
 Impact of Zakat on Consumption.
• In Keynesian theory consumption is the real income.
This may be shown in he form of equation as C=f (y).
Among other factors the distribution of wealth in the
societyu also effects consumpton.the more skewed the
distribution of wealth the lesser the MPC>the more just
the distribution of wealth the grater the MPC.The rate of
consumption will rise as a just distribution of wealth , and
just wages and incomes.
Y

C+Z

C
B
A
X

Effect of Zakat on consumption

In this diagram , the line AC indicates rate of Consumption without zakat., while the line
B(C+Z) shows rate of consumption with Zakat. This line is higher than the line of
consumption rate without zakat. Hence zakat will flow from the rich with low MPC to the
poor with high MPC. As a result the aggregate demand in economy will rise and
employment opportunities will also grow. The incomes of the poor people will increase.
The distribution of wealth will become equitable. Economic development will accelerate
and economy will move towards stability.
 Impact of zakat on Investment.
• Scarcity of capital is the main impediment in the advancement of the
developing countries. Since the capital formation in these countries
is very low, to make of this deficiency they need huge investment of
material and human resources to set up a social and economic
infrastructure for economic development. To construct railways
,power and irrigation systems ,educational facilities and hospitals to
provide health facilities. Islam enjoins upon its followers to give
away their their surplus money to the maximum. Islam severely
condemn hoarding of wealth. At the same time it levies zakat on
hoarded wealth at the rate of 2.5%.One result of keeping wealth idle
is the yearly reduction of amount due to the payment of Zakat. On
the other hand the owner deprives himself of the profit which he
could have earned if he had invested it in business. The owner, by
investing his money in business can save himself from the sin of
hoarding and at the same time can earn profit from it. Hence as a
result of zero interest rate and prohibition of accumulation of wealth,
the level of investment in Islamic economy will be much higher than
in an interest based economy.
 Demand of new Investment in Islamic economy.

Expected rate of profit

YYI

R2

R1

0
X
B I1 I2

Volume of Investinvestment

E/(E-1)

The relation between Zakat and demand for new investment is shown in the following Diagram.
The diagram indicates that despite an expected zero rate of profit, the investment in Islamic Economy
would be positive. However when the expected rate of profit is negative at following rates, the investment
would be zero. That is:
R = E1/(E-1)
Is the rate of Zakat on idle assets, while E is the rate of Zakat on the profit earned from investment.
 Impact of Zakat on Economic
development.
• Human development through economic and social
progress is the duty of an Islamic state.It is the main
responsibility of the state to ensure the provision of basic
necessities and facilities of life to all the citizens.For this
purpose to achieve:
• 1. human and material resources should be utilised to
the full,
• 2. production and rate of employment should grow,
• 3.the fruits of economic development should reach every
member of the society in a just and equitable manner.
 Zakat and Economic development

Y0
Y=C+S(I)+Z
C’ + (s) + (G)
C.I.Z C’ +1

C’

0 Z
Y0 X B Y1

Real NNP

In this Diagram

C = Consumption.
C’ = Rise in Consumption due to Zakat.
G = Government expenditure.
Z = Zakat,Ushr,Sadakat.
Y0 = National income before the collection of zakat.
X = National income with Zakat collection..
B = National income with Zakat collection.
Y1 = Public sector expenditure and national income after the effects of Zakat.
The diagram makes it clear that zakat will raise national income and the level of
employment and there will be a steady growth in the overall economic progress.
Thank You