Articles on Islamic Economics

A Brief Note on Automatic Stabilizers in Islamic Economic Framework

Salman Ahmed Shaikh

Non-discretionary fiscal policy with automatic stabilizers can help in stabilizing the business cycles. Below, we discuss how the institution of Zakat can act as automatic stabilizer in an Islamic economic framework.

Institution of Zakat as Automatic Stabilizer

Zakat is a compulsory payment to the government on one’s income and wealth in an Islamic economy. Zakat is levied both on one’s wealth and income. Zakat is a source of purification of one’s wealth and earnings. Through consistent application of this principle, Zakat must be levied on all forms of wealth and income.

Verse 60 of Chapter Al-Tauba lists the heads of Zakat and directs the government in an Islamic economic framework as to who should be the beneficiaries 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 truth); for those in bondage and in debt; in the cause of Allah; and for wayfarer; (thus it is) ordained by Allah, and Allah is full of knowledge and wisdom (Al-Tauba: 60)”.

The institution of Zakat prescribes wealth Zakat of 2.5% and income Zakat of 5% (when productive enterprise uses both labor and capital as major inputs) and 10% (when productive enterprise uses labor or capital as major inputs).

In its economic character, the proportional Zakat linked with income can act as an automatic stabilizer. When aggregate personal disposable income increases, more Zakat can be collected and the government would receive higher Zakat proceeds to allocate them as transfer payments to Fuqura (poor and needy), Masakeen (extremely poor and needy) and Gharimeen (borrowers in trouble), for instance.

When personal disposable income decreases, obligatory Zakat would also decrease and thereby provides an automatic relief to the income earner who is going through a lean patch. Besides, the proportional income levy, Zakat on wealth redistributes wealth too. So, if an economy is in disequilibrium and policies fail to immediately recover and boost incomes, wealth Zakat enables the distributive allocation that works independently of business cycles and help stabilize the extremes of business cycles. In this way, wealth Zakat acts as a permanent stabilizer.

Transfer Payments as Automatic Stabilizer

When the personal disposable incomes decline in recessions, more people will become eligible for Zakat. Since Zakat is levied on both income and wealth, the redistribution of wealth will always be functional and operative in Islamic economic framework due to wealth Zakat irrespective of the phase of the business cycle. Transfer payments to unemployed, poor, needy and debtors will continue even when the economy faces a recession.

Besides this, a consistent and credible low tax rate policy with broader Zakat base will ensure in minimizing distortions, boost aggregate demand, encourage investment by decreasing costs of doing business and this could also simultaneously solve microeconomic problems of imperfection in markets by increasing competition and helping to reduce market power.

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