Public Finance in Islam

OBJECTIVE

The objective of the study is to explain the Islamic economic in general and public finance in particular which is aligned with the development of Islamic economy in today’s world. The literature in Islamic public finance is rich both in terms of coverage as well as scope of analytical content. Islamic public finance has been discussed and being practiced by the Muslim scholars ages ago. The elements in Islamic public finance can be gauged by numerous instructions in the Quran. It is heartening to note that this study is to give a clear understanding about contemporary economic works in accordance with the teaching of Islam. A clearer comprehension on Islamic public finance definitely helps having a better view of the whole. Besides, shariah is relevant to economic policies where the economic theory can be affected by the implications of these policies. When it comes to economic policy recommended by the modern economics, we must take into account the Islamic goals. It should not conflict with the rules and objectives of shariah. Therefore, we can analyze economic problems with a fresh insight and explore solutions which are distinctively Islamic.

INTRODUCTION

Public finance comprises a range of policies whose goal is to assemble resources for the public sector and to allocate them according to precedence of the state in the distribution of public sector. A course on public finance is a mixture of positive and normative. The positive analysis is directly related to the conventional approach. The normative elements are arised from the Islamic goals and objectives, responsibility of Islamic state and the Islamic behavioral norms in general.

From the conventional view, public finance is about the role of the government in economic life on the basis of market failures and the necessity to modify the distribution of income resulting from the market process. In other words, public finance also can be described as maximizing the social welfare function by the public authority.

Back to the objective of the study which is focusing on public finance from the Islamic perspective. Islamic system relates to all aspects of life. In economic life, Islam seeks to organize society in such a manner that every individual is enabled to live as Allah wills to man. There are three aims in Islamic economy which are fulfillment of the basic needs of all human beings, economic development and equalities in distribution of income and wealth. Islam does so by orienting behavior through faith and moral values as well as by providing codes of conduct, rules of transaction and institutions securing social cohesion such as the family and the state. Those objectives are directly related to the discussion of Islamic public finance.

Public finance describes the budgetary sector of public policy, dealing with taxes, public expenditure and borrowing. In the Islamic point of view, those factors cannot be avoided from being discussed at it is a possible source of revenue but the way it generates revenue must based on Quran and Sunnah. The state in Islam is not born of the necessity to safeguard individual interests because Islam promotes the concept of equality among the humankinds. Islam resorts profit sharing as the sharing instrument of mobilizing private savings for investment in the public sector. The profit is a significance source of capital formation. Thus, it is relevant to the capital budget which will benefit all parties.

In order to implement Islamic aspects in public finance, all parties have to play their roles for example the state. Muslim community needs a ruler which is set up through mutual consultation. Quran and Sunnah state that the government has some functions that it need to carry out in order to serve all the people. Those functions are derived from Quran and sunnah by ijtihad which covers analogical reasoning as well as reasoning based on public interest.

GOVERNMENT INCOME

Any attempt to formulate the theory of Islamic public revenue or to know the structure on this revenue depends on understanding of public revenue model that were applied on the early period Islamic civilization. During early Islamic state the major portion of state expenditure were financed meanly from tax base sources. These sources of taxes income were mostly generated from Ghanima and Jazia. Latter on during Abu bakr and Umre the imposition of kharaj and Ushr were implemented. it was because the Islamic state widen from Iraq to demashq and from khurasan to African content. The Islamic state needed revenue for its military, and social expansion in non Arab countries so during caliph Umer the institution of Bait Al-mal were established only to save the government earrings and manage government expeditions. Ghanima, Jazia, Kharaj, Ushr and Zakat were among major source of revenue on that time.. In order to clarify the issue we need to evaluate the terms one by one:

First of all, kharaj or land tax is a major source of revenue for an Islamic state. During chelahpat of Umar Ibn khatab,,the kharaj or land taxation is levied which was a good source of state revenue during Islamic chelaphat. Umar leased conquered lands to people in return for fixed levy and it was called kharaj. And Arabs used to call land or house rent as kharaj. It was a revenue used for payment of salaries of army, children allowance for the whole Muslim nation(IRTI 1995, page 44).

In order to collect kharaj revenue efficiently and equally, scholars divided kharaj base fiscal instrument into two parts which are kharaj wazifa and kharaj muqasima. kharaj wazifa was the rent imposed on lands based on the size of land and type of cultivation of farmers on the land. The amount of kharaj wazifa is flexible and the state also take into account the potential earning of land with and its fertility, and the exact amount of tax is decide by ijtihad. However, kharaj muqasima is the poll tax based on crop sharing between tenant and stat; its rate is depend on the amount of harvest and the state take kharaj based on percentage of harvest. Reason behind flexible rate of kharaj is the contentious downward trend of prices of crops which prevailed during that time (IRTI 1995 page 44). When difficulties exist in the market (the decrease and increase of price), burden of kheraj were reduced by state in order to bring equilibrium between supply and demand.

Justice is one the priniclpe of Shariah and the collection of kharaj taxes fulfills all condition of Shariah principle. A major Muslim scholar Abu Yusuf emphasized on the imposition of kharaj based on capacity of tenants, if the rate of kharaj is beyond the capacity of tenants, that’s inequitable and injustice which contradict the shariah principles.Abu Yusuf point out that justice in kharaj will lead to increased kharaj revenue and economic growth and the kharaj collected with injustice will lead to recession in the economy. More interestingly, the amount of revenue from kharaj before Harun El-Rashid period was about to 200million derham. With the advice of Abu Yusuf it increased during Abasiat chelaphat to 4,257,000 derham.the poverty level in most of Muslim state were at minimum level and the state had enough resource to finance the public expenditure. On that time the rate of kharaj was determined by imam in the best interest of the Muslim nation and its flexibility in determining the rate could achieve the economic goals of nation was one the best fiscal policy tool of Islamic state.

Moreover, agriculture taxation was in the form of Ushr which is a great tool for governments to raise fund. During Islamic period Ushr was one of the major source of government revenue, it was collected form farmer in order to utilize for the social welfare of society. The state uses the Ushr revenue for provision of health facilities and distribution of education to the poor.

More importantly, the role of Ushr is very limited in agriculture taxation which fixed to 5% of total production of land but the potential of agricultural income might be large and the state can levy extra agriculture taxes to meet its policy requirement. Most of developing countries have majority Muslim population and their economies are based of agriculture and the states development effort is about to fail and they are more dependent on advance countries in terms of capital, technology and food. If the government takes into account levying ushr on agriculture to finance its development projects of rural areas, certainly it helps to raise agriculture output, employment and health facilities. One of the countries that ushr was levied on farmers is Pakistan, Let’s take as example the case of Pakistan, its estimated that on the basis of 1976-77 crop production the total yield from Ushr was Rs.1617 million which is almost twelve times larger than land revenue in four provinces of Pakistan. Therefore, levying ushr as agricultural tax is a good tool to raise fund for the state and utilized for development of agriculture sector and eradication of poverty.

Finally, another major source of government revenue is collecting Zakat and the payment of Zakat is compolsary for those who have to ability. To be said that Zakat is a religious obligation and it’s paid to purify ones income and wealth. Actually the object of zakat payment is to distribute the wealth between poor and rich and alleviation of poverty in the society and zakat has its own difference and characteristics from the tax.

Primarily, Zakat is an Ibadah (act of worship) which Allah has made compulsory on human being, to express gratitude to Him and to obtain His nearness (Taqwa). Tax is not the same thing as Zakat. Tax is a social obligation without having special sense of gratitude to Allah or to obtain nearness to Allah while Zakat is essentially a matter between Allah and His servants, but tax has been primarily a matter between citizens and the state authorities.. Furthermore, Zakat is based on Nisab, any wealth below a limit is exempted from Zakat. This is not true in case of many taxes in modern times. Concept of exemption is there in case of tax but it is applicable only when and where the Government or Tax authorities specifically prescribe. also Zakat is a permanent and regular system. None can change it in any way. On the contrary, most of the taxes undergo change from time to time.
There is also difference in the objective and aim between Zakat and Tax. As Allah has said, "Take from their wealth Charity (Zakat) so that thereby you make them clean and pure and pray for them. Your Prayer (for them) is a source of comfort for them. Allah is All hearing, All-knowing" ... (Tauba : 103)
The intent of Zakat is to make wealth pure (in moral sense) and cleanse the heart of human beings from greed and hoarding. The object of Zakat is spiritual as well as economic. But the object of tax is much more mundane and worldly. Tax could never achieve the moral and spiritual objectives of Zakat in any time of history.
Zakat is a compulsory payment by individual and the state is entrusted to collect it and zakat revenue is earmarked to be spent on certain ways detailed in the Quran: for the poor, the deprived, and for those who are unable to pay their debts and for destitute travelers in the path of Allah. Also, zakat should be collected from the following items: animal wealth, commercial assets, gold and silver, agricultural products, honey and animal products, mineral wealth and treasure extracted from the earth or sea, estate, factories and all other earning assets and from income of employees. However, some assets are not subject to zakat, according to Muslim scholars they are the items which individual uses for transport, housing, instrument necessary for carry work and furniture’s. For assets to be subject to zakat certain conditions must be satisfied, only those assets which are growing or which have growth potential are subject to zakat, also those assets which exceed a certain minimum can be taxed as zakat (IRTI 1995 page 390 ).
More importantly, in contemporary era there is no Islamic state to apply the Islamic taxation system but Muslim states finance their revenue through conventional taxes, beside that some muslim states like Malaysia, Pakistan, and Bangaladish levy Zakat taxation only and as we mentioned about the aim of zakat is different from taxaes.

In case of Malaysia, there is authority of Islamic Council for each state and in total there are 14 Islamic Councils and under supervision of Islamic council, Zakat is collected by Center of Zakat Collection called PPZ. The objectives of PPZ are To increase the collection of Zakat, To increase the amount of Zakat payers in years by years To increase the ability of professional management aligns with the current technology. To maximize the customer satisfaction through services offered and to inculcate the Islamic work environment. Types of Zakat they raise from Malayisa muslims are Zakat on Income,Zakat on Business ,Zakat on Savings, Zakat on Shares, Zakat Employees Provident Fund, Zakat on Gold, Zakat on Wealth and Property, Zakat on Agricultural,Zakat on Cattle,Zakat on Buried Treasure.

The fund raised from Zakat from 1994 to 2001 are as fallowing,

STATISTIC OF PAYMENT FOLLOWING THE TYPE OF ZAKAT FROM

1994 – 2001

|2001 |2000 |1999 |1998 |1997 |1996 |1995 |1994 | |Zakat on Income |RM 33.2 |RM18.5 |RM7.4 |RM10.7 |RM12.2 |RM11.8 |RM8.9 |RM9.4 | |Zakat on Business |RM13.6 |RM12.6 |RM9.6 |RM10.0 |RM13.2 |RM4.3 |RM3.3 |RM4.3 | |Zakat on Saving |RM7.9 |RM7.7 |RM6.3 |RM6.2 |RM7.9 |RM7.8 |RM6.9 |RM7.4 | |Zakat on Wealth |RM14.9 |RM16.6 |RM9.2 |RM15.9 |RM16.2 |RM16.0 |RM12.1 |RM10.9 | |Qada' on Zakat |RM0.4 |RM0.4 |RM0.6 |RM0.5 |RM0.8 |RM1.1 |RM0.8 |RM0.8 | |Total Zakat |RM70.0 |RM55.8 |RM33.1 |RM43.3 |RM50.3 |RM41.0 |RM32.0 |RM32.8 | |Others |RM0.3 |RM0.2 |RM0.2 |RM0.3 |RM0.3 |RM0.3 |RM0.3 |RM0.3 | |Total |RM70.3 |RM56.0 |RM33.3 |RM43.6 |RM50.6 |RM41.3 |RM32.3 |RM33.1 | |

Islamic Budgeting system

Definition of Budget: The definition and implementation of Islamic budget is differ from the conventional budgeting system. Based on the Shariah and from Islamic perspective, a well planned budgeting system that ensure and give gurrante to all individuals to access national resources and optimal allocation, supervise markets and facilitate the fulfillment of individuals obligations toward each other.

Three main criteria that we should focus when we make a budget from Islamic perspective:

1. Public interest( mashlahah)

2. Productive efficiency

3. Allocative efficiency

Mashlahah: Mashlahah means seeking something useful or removing something that is harmful for individual and for society as well. This criterion is rooted in the Maqasid Al shariah. The Maqasid Al shariah aim at preserving and protecting five things.

a. Religion

b. Life

c. Reason

d. Descendants

e. Property

We should concentrate on above matters to make budget that don’t harm or go against Islamic objectives.

Productive efficiency: It means producing a product or service at least cost. Islamic state should intervene to the firms to achieve these criteria. To continuing production that needed by the society, may be the government can give subsidy that reflects on budget.

Allocative efficiency: This means producing goods and services that the society wants most. Islamic state should not allocate the resources that will use to produce haram or prohibited things even if wanted by society.

Budgeting in early Islam. During the prophet era, there was no formal budget for the state. Whereas revenue sources were identified by the Shariah, expenditures were open ended because they were geared to facilitate the realization of the objectives of defense, protection of religion and social justice. However large deficit were encountered and were financed through voluntary contributions, non interest borrowing and collecting zakat ahead of time.

During the period of four Caliphs, many major innovations were introduced on both the revenue and expenditure sides. The rapid expansion of the Islamic state led to significantly higher expenditure requirements. In addition, during the time of Umar’s internal economic stability considerations become important and were achieved through allowing the importance of necessary goods shortages and in turn price increase. Moreover trade taxes were reduced or waived. With the expansion in the size of the state, employment objective became important. To tackle the situation, Umar introduced new revenue and modified expenditure system by prohibiting interest rate.

What modern budget means:

A government budget is a legal document that is often passed by the legislator, and approved by the chief executive-or president. For example, only certain types of revenue may be imposed and collected. Property tax is frequently the basis for municipal and county revenues, while sale tax and/or income tax are the basis for state revenues, and income tax and corporate tax are the basis for national revenues.
The two basic elements of any budget are the revenues and expenses. In the case of the government, revenues are derived primarily from taxes. Government expenses include spending on current goods and services, which economists call government consumption; government investment expenditures such as infrastructure investment or research expenditure; and transfer payments like unemployment or retirement benefits.
Budgets have an economic, political and technical basis. Unlike a pure economic budget, they are not entirely designed to allocate scarce resources for the best economic use. They also have a political basis wherein different interests push and pull in an attempt to obtain benefits and avoid burdens. The technical element is the forecast of the likely levels of revenues and expenses.
National Budget - this is when a country finds out what the government's expected income and expenditure will be for that year.
Deficit Budget: The Islamic teachings allow a great deal of flexibility to the government in shapping its budgetary policy. There is nothing mansus(prescribed specifically by the Quran and Sunnah) about the budget of state being balanced or unbalanced or the quantum of budgetary deficit. The only constraint is it cannot borrow from the interest based sources to cover its budget deficit. It can borrow only from the institutional and non institutional sources on interest free basis.

In modern times, when the state has to incur sizable capital expenditure for undertaking infrastructure and other highly capital intensive projects, it would be inconsistent to rely only on taxation to finance such expenditures. Modern juristic opinion there for to borrow from the banking system to meet a part of its budgetary deficit. Borrowing from the central bank of the country is also not ruled out. However the state should be aware of borrowing from the commercial bank and the central bank at same time because of the inflationary implications of such financing. As a last resort, government can borrow from abroad after a good deal of deliberation. Borrowing from abroad, whose servicing entails payment of interest could only be justified on account of dire necessity. During the time of Umar, he did not experience any budget deficit. But nowadays, most of the countries come out yearly budget with huge amount of budget deficit.

Budget surplus: In the time of the first caliph, Abu Bakr, any funds remaining in the treasury after meeting all required expenditures were returned to all Muslims in equal shares on the grounds that revenues in the Treasury belonged to the community as a whole and the state was just a trustee designated by the Shariah. But it’s not necessarily needed to return all the surpluses. It could be accumulated for future inconvenience. In general, the budgetary system in early period did not encourage surplus in the Treasury but favored expenditure expansion with balance budgets. But nowadays, it is very rare to find a country that is operating budget surplus for a few years continuously.

Some other criteria’s need to follow under Islamic budgetary system:
Moderation: One of the characteristics of the favored servants of Allah is that they are those who, when they spend, are neither extravagant nor miserly. (Quraan 25:67)
And let not your hand be tied (like a miser) to your neck, nor stretch it forth to its utmost reach (like a spendthrift) so that you become blameworthy and in severe poverty. (Quraan 17:29) Extravagance: Any spending on anything sinful or overspending on allowed things which are wasteful is extravagance. (Ma’ariful Quraan 6:512) Those who waste are termed the brothers of the Devil (Qur’aan 17:27) When you eat, drink, give charity and wear clothes, let no extravagance or pride be mixed up with what you do. (Ibn Maja, Nasai) Miserliness: Miserliness means not to spend in avenues where one is directed to spend. The hadith states: It is the sagacity of man to adopt the middle path in spending. Another Hadith states: The person who sticks to the middle path and moderation in spending will never become a destitute and poor. (Imam Ahmed, Ibn Kathir) The Prophet sallallahu alaihi wa sallam said: Every day two angels come down from Heaven ... (and one of them) says, 'O Allah! Destroy every miser'. (Bukhari) There are two habits which are never present together in a believer: miserliness and bad manners. (Tirmidhi)

Financial Institution of Islamic Public Finance

Islamic banking

Banking is the most developed part of the Islamic financial system. Islamic banking in Malaysia operates alongside conventional banking. This is done either through the opening of Islamic “windows” in conventional institutions or the establishment of separate banks, or branches and subsidiaries, which specialize in Islamic financial products.

Some of the more popular instruments in Islamic financial markets are trade with markup or cost-plus sale (murabaha). Leasing (Ijarah) is designed for financing vehicles, machinery and equipment. Profit-sharing agreement (mudaraba) and Equity participation (musharaka) are common instrument that bank use to financing business.

Islamic banking is the most important financial institution in Islamic public finance as the bank is the financier for the public in a long run and short run.

Bait-ul-mal

Baitulmal is the institution that acts as a trustee for the Muslims. Baitulmal also acts as the organisation that responsible for the management and dispersion of zakat collected for the poor and deserving.

In Malaysia, Baitulmal administered by Majlis Agama Islam Negeri (MAIN) line with the Federal Constitution which placed religion under the jurisdiction of the state, including financial management and Baitulmal assets. Baitulmal funds are used wisely to improve the living standard of the poor to become self-reliant and contribute as well.

For instance, JAKIM has launched Department of Waqf, Zakat and Haj to pave the way for recipients to start a business and engage in agriculture to allow them out of poverty. The department also promotes a program that aims to raise awareness and financial literacy in the Muslim community through instruments such as waqf, zakat, sadaqah, hibah, wasiah, and nazr as financial management and investment for the future.

Economic Implications of the Islamic fiscal policy

Distributive effects

In a fully functioning Islamic public finance, poverty should not increase as zakat fund will raise the standard of living to the poorest. Since zakat raise an income to the poor, it will shift the purchasing power from rich to the poor and producer will likely to change its production to essential goods. In a short run, income differential between zakat payer and zakat recipients also will reduce.

Resources Allocation

Zakat as an obligatory payment for muslim will bring redistribution of purchasing power from the more wealthy peoples to poorer peoples. The transference of purchasing power also will encourage the public expenditure on the poorest such as health, education, and housing facilities.

Monetary stability and economic stabilization

Zakat funds can be used as a counter-cyclical device, because the state is not obligated to disperse all zakat funds within a specific time. These funds can be used when the economy faces a recession which is the poorest will heavily affected by higher inflation.