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The Role of Taxation - Expenditure and Debt
The Role of Taxation - Expenditure and Debt
Abdel-Rahman Yousri Ahmad Egyptian, Borne 1940 B.A Economics, Cairo University, Egypt, 1960 PhD Economics, St. Andrews University, U.K,1968 Professor of Economics and Islamic Economics, Alexandria University, Egypt (1968- now) Author of three books and many articles in Islamic Economics. Winner of the Islamic Development Bank Prize in Islamic Economics (1997) Formerly: Head of the Economics Department, University of Alexandria, Egypt. Director General of the International Institute of Islamic Economics, International Islamic University, Islamabad, Pakistan
Lecturer
Introduction
It is quite essential to recognize major Characteristics of the Islamic Fiscal System before dealing with Taxation , Expenditure and Public Debt in an Islamic Economy
1.Collection and distribution of the Islamic fiscal Duty: Zakat 2.Collection and employment of Non-Zakat revenues: Taxes and other State revenues. 3.Control and Management of Public Property and Resources.
FUNCTIONS
Public Expenditure
Budget
Public Revenues
Non-Zakat Revenues (Taxes and other) Collection according to Shariah and Ijtehad
Historical View
Only Zakat (the Islamic Fiscal Duty ) was collected from Muslims and no Taxes were imposed on them in the early centuries of the Islamic State. Taxes were only imposed on non-Muslims because they were not committed to Zakat. Historical experience reveals that Zakat revenue was in some periods more than sufficient in covering public expenditure, and in other periods insufficient.
Caliph Umar s view was that distributing conquered arable land among Muslims who achieved the conquest was bound to concentrate wealth in their hands, whereas Kharaj revenues paid by the indigenous owners of the conquered land, would in the long run be much beneficial to ordinary citizens living in the Islamic State . It should be noticed that Muslims landowners, who lived in countries, that by virtue of their conquest joined the Islamic State, paid only Zakat (5%-10% in case of Agricultural products) which carried a much lower rate of taxation than Kharaj.
During the Umayyad period, a question was raised with respect to treatment of Kharaj land when leased to Muslims? Should it pay Kharaj or Zakat? Umar II (Umar ibn abdel-Aziz) ruled out that land from which kharaj was paid could not be transferred to Muslims, who could lease such land, but in that case, they would be required to pay kharaj. Under the Abbasids and thereafter the mass conversion of Christians and other nonMuslims to Islam eroded the Kharaj (tax) base of the Islamic State.
A Tax initiated by Caliph Umar ibn al Khatab and was, levied on merchandise brought from outside, once its value reaches Nisab. To Muslims, rate of this Tax was equal to Zakat on trade, i.e. 2.5% on value. Ushr (Zakat) had to be paid to the Asher (Collector of Ushr) on the instant of coming with merchandize from outside. To Christians and the Jews (People of the Holy Book) Ushr was 5% (i.e. double that of Zakat) To Other Merchants coming from countries that were hostile to the Islamic State , Ushr was 10% or equal to rate (s) imposed by these countries on Muslims entering their land with merchandise.
History: Ushr
Principle of Taxation
Taxation is accepted in all civilized (or democratic) societies as a fundamental element in the social contract between Ruler and citizens. The Quran reports a version of a social contract in Sura 18:94 : People living under the continuous threat of some foreign invaders (Yajuj and Majuj), expressed to the new ruler (Dhul Qarnain) their readiness to pay for him Kharaj (tax) if he erects a barrier (Wall) which would protect them against those enemies. The ruler (Dhul Qarnain) concluded this social contract with people on condition that they would help him in all efforts needed for building the barrier.
Zakat is the Heart of the Islamic Tax System Nothing can be said about Taxation in an Islamic system without firstly knowing the nature and role of the Zakat system. We have to recognize similarities and differences between Taxes and Zakat. This is important particularly to those who have objections at calling Zakat an Islamic Tax It is also important because any tax that may be imposed besides Zakat should be guided by the basic principles of the Zakat System and should not contradict or duplicate Zakat.
i.
Just like taxes, Zakat strictly speaking is neither voluntary payment nor a donation and should be collected and distributed by the State (though it could be given directly to its recipients without government intermediation). In Shariah a central treasury ( Beitu-almal) is trusted to collect it annually. In recent times, Pakistan, Sudan, and Saudi Arabia have enacted legislation to enforce the Zakat. ii. Zakat unlike taxes which are imposed and enforced through man-made legislations. Zakat is a duty commanded by Allah as part and parcel of religion and, in principle, is a personal exercise intended to purify human soul. iii. The religious aspect of Zakat establishes differences with Secular Taxes in three major areas, namely Tax burden, Tax avoidance and Tax evasion: >>
(a) Tax burden; Tax imposed on producers and sellers is considered part of their costs and a burden which could possibly be transferred to consumers through market mechanism ( depending on elasticity of demand and supply). This is quite different from Zakat, whose payer consider it a religious duty and never a burden and therefore should not be transferred on other people. (b) Tax avoidance; which is utilization of the tax regime by means that are still within the law (or by exploitation of lope holes in the law,) to one's own advantage in order to minimize the amount of payable tax. A Muslim who knows that he is paying Zakat by order of Allah SW will never do this. On the contrary A believer is normally pleased when his income and wealth are increasing and hence would be paying more Zakat. (c) Tax evasion; is the general term for efforts by individuals and other entities to evade taxes by illegal means, and this can never be done by any believer.
iv. Based on the Islamic conception of justice Only Muslims having Nisab (a set level of income or wealth; money and real assets) are obliged to pay Zakat. On the other hand Zakat revenues are distributed among several categories, with special preference or priority given to the societys poor and the needy groups. v. In most contemporary democratic and developed societies Taxation would, to one degree or another, have socio-economic justice amongst its targets. Yet, no special right or priority in Tax revenues is necessarily given to low income groups as in Zakat. vi. On the other hand, historically as well as in nondemocratic and developing societies socioeconomic justice is often missing.
a. Historically in non-Islamic societies, e.g. in medieval feudal Europe taxes were collected from ordinary folks in favour of the Nobility and rich landlords. b. In non-democratic and developing societies taxation is a source of injustice. Taxation imposes more burden on low and middle income groups , e.g. through taxes of regressive rates and through ability of the politicians and rich people to evade taxes by means of corruption.
vii. The Islamic system of Zakat enjoys a permanent and stable character. This is unlike secular Taxation where a Tax may be removed or added and its rate is subject to adjustment by Legislators . viii.Whereas Tax rates may be excessively progressive to the extent that they discourage individuals or firms to produce more and earn more income, or may be regressive to the disadvantages of low income groups, Zakat rates are proportional and can be generally described as low or relatively quite moderate when compared with tax rates.
The need for imposing Taxes besides Zakat could arise for several reasons. Public Interest within boundaries of Shariah and its intents may render Taxation necessary for fiscal, economic or non- economic purposes. Laying Rules for Islamic Taxation is therefore an essential and important task. The Role of Taxes in an Islamic Economy would naturally be linked and influenced by ethical and Shariah constraints imposed on taxation.
Islamic Taxation
Zakat should specifically fulfil this target. In Hadith; Allah SW has imposed on rich people a duty (Zakat) to be paid from their amwal (i.e. wealth and income), and this would suffice poor people. If the poor in society should ever face hunger or clothing insufficiency, it would only be due to rich people not fulfilling their duties.
3. Any proposed Taxation should not contradict the basic principles of the Zakat System. For example no tax should be imposed on low income people or on orphans wealth, or levied at a rate that involves injustice because of its regressive or progressive nature. Taxes should therefore complement and not contradict the Zakat System.
4. A Tax, should never carry or assume the same obligatory and permanent nature of Zakat. A Tax which would be originated for purpose of achieving a given fiscal or economic target (that could not be done by Zakat) has to be removed once this target is done. Otherwise taxation would entail a sinful bedaa ( origination of idea or action that changes religion) and injustice..
Taxes can be levied to discourage any kind of consumption or activity that may be potentially harmful to human health or to Islamic ethical values.)( Consensus of Muslim Fuqaha is always needed before issuing fatwa (Shariah pronouncement) that a new kind of consumption X or Z is definitely harmful and therefore should be prohibited (i.e. Haram). Whereas Consensus is often difficult to reach and Fatwa is delayed, harm of X or Z has manifested practically in some cases, and potentially is expected to spread and becomes serious. Examples: heavy taxes that can be imposed on tobacco smoking, or on some types of undesirable entertainment.
First: The Government within Philosophy, Values, and Institutions of an Islamic system and upon its responsibility of Disbursement and Employment of Zakat resources would always be responsible to assign Public Expenditure for: (a) Covering needs of all Zakat recipients in the household sector, and in particular sustaining Low-income categories (the Poor and Needy) with necessities, and nourishment. (b) Investment that would directly or indirectly benefit the poor, needy, wayfarers, and (c) Subsidies to help micro or small enterprises facing particular financial difficulties or heavy indebtedness.
(d) National Defence, to protect the Muslim Nation from actual or existing enemies or from expected or potential ones (e) Provision and maintenance of Domestic Security and the Judicial System, (f ) Maintenance and running of the Hesba System . This system ensures that markets are not involved in activities or transactions that are prohibited by Shariah, but by no means intervenes in the private economic activities or in market mechanism.
All previous items of Public Expenditure would be financed from Zakat revenues. yet in case of insufficiency of Zakat revenues Public Expenditure will depend on non-Zakat resources (taxes and/or loans).
Second: Public Expenditure based on Targets behind additional Taxes. Within the spirit of the Islamic Taxation System, Government is responsible of Employment of Tax revenues in accordance to purposes for which a tax was imposed. Examples: Government would be responsible to assign Public Expenditure for: (a) Medical treatment of people who suffer illness because of tobacco smoking, when a Tax is imposed to for this purpose. (b) Educational Programs designed to make people aware of the harmful effect of types of entertainments that implicitly carries non-ethical values, when a Tax is imposed to for this purpose. Or alternatively for the same purpose providing or subsidizing types of entertainments that are Shariah permissible.
(c) Financing Medical Centers that offer free treatment to people suffering from pollution as well as Research Centers which target the development of cleaner and environmental friendly methods of production. This when Taxes are imposed for purposes of fighting Pollution and improving the environment. (d) Financing Research Centers for purposes of modernizing and improving the defence system when a Tax is imposed for such target.
How Far Public Expenditure At Present Can Be Extended For Public Utilities?
Within an Islamic System Three Main Factors determine the answer of this question: (1) The Islamic conception of social and economic welfare, which is never in opposition with betterment of human, social life as long as this is does not mean targeting excessive Affluence or Extravagance. (2) The Nature of Public Utilities, For example Public Necessities that cannot be provided by individual or private efforts or through Market would be the responsibility of the Government. (3) Fiscal Policy and availability of Public Revenues that can be assigned for extra Public Expenditure.
The criterion of Dharorat alKhums ( the Five Necessities) of Imams Ghazali and Chatbi, when considered at the macro level can be very useful in high lightening some of the Necessary Public Utilities that the Government within an Islamic economy would be responsible for.
For example Basic Education is related to Necessity of teaching Religion and Intellect Maintenance. Provision of Sanitations, and Medical Care are related to Necessity of Maintenance of Human Life, Family and Progeny. Argument asserting that the Government within an Islamic System is responsible for provision of Utilities such as Basic Education and Public Health, Sanitations and Medical Care , means that Public Expenditure has to be expanded continuously with growth of population.
We have to know:
Where from financial resources would be obtained to cover Public Expenditure? Or How far income and wealth conditions would allow the Government to provide necessary resources for an expanding Public Expenditure?
A Revival of the Waqf System at Present would reduce the need to extend Public Expenditure in the area of Public Utilities.
AT PRESENT:
With majority of Muslims in the Islamic World are living in poverty: What is the Role of Public expenditure in providing Public Utilities, other than those provided through Zakat Expenditure? Within the Islamic Conception of Human, Social and Economic Welfare, Public Expenditure should at least cover Sufficiency Level of Public Health and Education for low income groups (the poor and needy). Therefore Public Expenditure would at least cover provision of clean water for households, sanitations, and health care for common diseases as well as Primary or Basic Education for children of poor families. The government, most likely would have to rely on taxation for meeting such Public Expenditure. Yet other alternatives to Taxation have to be explored
In the short-run
Public Expenditure in the Short-Run is dependent on; 1. The Scope and Nature of the Role which an Islamic Government is permitted to play in the economy for solving Macro-economic Problems. 2. Available Public Revenues, and ability as well as flexibility to change the size of these revenues or to re-allocate them according to targets and policies.
PUBLIC DEBT
Framework
History. WHY Public Debt?
The Prophet Pbuh encouraged Good Loans, in money or in kind, to finance the Muslims army or to provide Muslim households with clean Water. Companions of the Prophet Pbuh who granted Good Loans waived voluntarily their rights in these loans. Thus Loans had no burden at all on Beit-ul-Mal ( Treasury). During the late Abbasside period many Rulers resorted to taxation ( frequently on unfair basis) and increasing the supply of Fulus (Cheap Metal Money) rather than Public Borrowing, in order to cover deficit which resulted from a greater volume of Public Expenditure above Public Revenues.. The economy of the Islamic State increasingly suffered from unfair taxation and greater cheap money supply. (Ibn-Khaldun and al-Maqrizi).
History
In the Late period of Ottoman State, Sultan AbdelHamid, and other Muslim Rulers, borrowed on interest-bases from European Money Lenders. In our time the majority of Muslim States have accumulated high Public debt from Domestic as well as foreign sources on interest-bases which is entirely against Shariah. While Public Debt is continuously growing in the Muslim World, Majority of Muslim States are not collecting Zakat, and are imposing direct and indirect taxes on Muslim citizens. All this is absolutely against Islamic Sharia and its intents.
WHY Public
Debt ?
In a situation where Actual or Planned Public Expenditure exceeds available Public Revenues. First : Should we think that such situation is not coercive or binding, we have to find out ways to reduce Public Expenditure in a manner that does not affect public interest . Second: Should we accept such situation as inescapable or undisputable , we have to find out means to cover the resultant or expected Budget Deficit: (a) The government resorts to Borrowing from individuals, corporations, financial institutions in or outside the country, and from other governments. Accordingly Public Debt results from Borrowing. (b) The government resorts to Taxation. ( Another option but unfamiliar one is selling some real Public Assets owned by the State to finance Deficit).
As a Rule Borrowing should be regarded as a last resort, because Indebtedness in itself is undesirable.
Islamic Ethics and Rules concerning Public Debt can be reached by drawing an analogy between Private and Public Debt. Two Main Factors are bound to affect such an analogy and reflect differences: (a) Differences between Micro and Macro considerations. (b) Nature of Government responsibilities which are different from that of individual or private responsibility.
1. On Shariah grounds, the Government would be obliged to repayment of Public Debt. It can not for any reason or under any circumstances waive the rights of the Creditors whether these were individuals, banks, foreign governments, or else. 2. Repayment of Public Debt should be executed promptly in due time according to conditions that have been declared by the government when the Debt was made. 3. Since interest (usury) is prohibited, an Islamic government is not allowed under any conditions to obtain interest-based loans from banks, institutions or foreign governments, or to borrow from the public by issuing treasury bills, bonds or any interest-bearing securities.
4. Public Borrowing from non-Islamic banking, financial institutions or governments, even if interest- free and within Shariah boundary should be minimized. Foreign Investment is a better substitute. Experience in the Islamic World showed that the political consequences and influence of foreign indebtedness is quite undesirable, particularly under conditions of growing Poverty Gap and continuously Increasing Debt.
We have to Know how a Good Loan System can be revived in our time.
(a) Good Loans may be arranged through issues of Sukuk or any interest-free securities. (b) It would be quite important to avoid any serious depreciation in the real value of a Good Loan interest free securities over years. The nominal value of such securities may be fixed in terms of Gold or in terms of a weighed average of some selected transferable currencies. (c) Good Loans securities should be redeemable according to a given time schedule. Furthermore we have to know how Good Loans played very serious role in providing Public Utilities in the Past through non-governmental entities. (System of Waqf)
6. If the government resorted to Taxation as a means to repay Public Debt, it should strictly maintain Islamic Rules Concerning Taxation (as previously exposed). 7. A Public Debt should not be employed for financing luxurious or semi-luxurious Public goods or Utilities. This Rule is established by drawing an analogy between Public and Private Debt. The Rule should be confirmed by the government fundamental responsibility in observing and promoting Islamic rational patterns of consumption and investment at the macro level.
Contemporary Experience shows that while Public Expenditure and Public Debt increased together in an alarming manner in many Muslim Developing countries, the pattern of government spending has been far from being restricted to Public Necessities. In an Islamic economy this situation should be subject to correction.
First of all because borrowing, whether on private level between individuals or on Public level, is not a normal mode of Islamic Finance. Second, because government within an Islamic Frame should not be involved in business and ,hence, enter into competition with the Private sector. For centuries eminent Muslim scholars were against government involvement in trade or business as this thought would inevitably be leading to State Monopoly and contradict its basic responsibility in fairly monitoring markets. Government should, within the Islamic conception of Public interest, do its best to provide most favourable investment climate to private activities.
8. A Public Debt in an Islamic system should never be initiated or used for businesses or economic activities in expectation of Profit.
In secular economic systems Public Debt is employed in financing public projects which are expected to realize profits or at least whose future returns would pay off their Debt . This policy has been familiar in many developing countries, among them Muslim countries, particularly during the 1960s, and 1970s .
The policy proved to be mostly unsuccessful as Public Projects financed in such way could not only pay their Debt off ,but also faced losses. Governments, in consequence, had to borrow again and again or had to issue new money, not only to repay Public Debt used in financing such Projects but also to subsidize them.
Examples of emergencies:
(a) War and the need to expand public spending for defence. (b) Serious economic depression ( lower level of real GNP accompanied by higher level of unemployment) that would necessarily require greater public expenditure in order to raise the level of Aggregate Demand. (c) Acute shortage of necessities, e.g. basic food stuffs, in domestic markets and inability of the private sector to solve or eliminate the problem. Under which conditions government intervention is required and Public Borrowing would be needed to cover exceptional public spending on imports of the required necessities.
(d) The private sector in all Muslim Developing countries would never be attracted to Investment in industries that need heavy finance, advanced technology, and skilled labour while not giving quick or attractive returns before a long period of time. In case if these industries are quite strategic to economic development the government would have to intervene in accordance to the conception of Rational Public Interests .Careful feasibility studies should be done before such intervention. Public borrowing would be necessary to establish such industries and repayment of such Debt can be arranged in the long run by selling successful projects to the private sector and/or by taxation.
* Thanks to all who Listened and Carefully Followed the Presentation. * Thanks to Allah SW ***
Abdel Rahman Yousri Ahmad