Salman Ahmed Shaikh
In Islam, Zakat is a religious obligation to pay a part of wealth and production to the government who has to subsequently distribute the Zakat proceeds for the socio-economic development in the heads of Zakat identified in Quran (ChapterTauba: 60). In its economic character, the institution of Zakat is an effective fiscal distribution mechanism. It will help to reduce the gap between the rich and the poor.
Zakat is a progressive system of taxation. Zakat on wealth redistributes wealth and resource endowments. Zakat on production with intensive mix and use of factors of production (labor and capital) is levied at 5%. Zakat on production with less intensive mix and use of factors of production (labor or capital) is levied at 10%. Finally, the windfall gain is taxed at 20% if it arises from neither the use of labor nor capital.
Zakat covers all heads of income including income from service industries, manufacturing industries and agriculture. It covers rental income, personal income, corporate and business profits of proprietors and firms. Furthermore, it also covers income on financial instruments like stocks and all types of mutual funds.
The institution of Zakat levies a special tax on cash, cash equivalents and capital in excess of need that makes sure that the money circulates and is used in the productive activities. Tax on cash and capital will force the people to invest their money in productive uses. With prohibition of interest, this money will only go in business, either with the start of one’s own business or equity participation through Mudarabah, Musharakah and joint stock companies.
In an Islmic framework, the institution of Zakat also results in an increase in tax base because it covers all heads of income. It will also benefit the taxpayers as the rates in the range of 2.5% to 10% are very lenient as compared to the current rates in conventional taxation system.
Since it is not only a state obligation but more importantly a religious obligation, it is expected that it will not result in significant tax evasion and even tax avoidance. More importantly, it will reduce confinement of wealth in few hands. The flow (income) and the stock (wealth) both are taxed and hence it ensures appropriate transfer of wealth and transfer of asset ownership to the needy.