Non-discretionary fiscal policy with automatic stabilizers can help in stabilizing the business cycles. In this article, we discuss how institution of Zakat acts as automatic stabilizer in an Islamic economy.
Institution of Zakat as Automatic Stabilizer
Zakat is the 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, by its nature of being a source of purification of one’s wealth and earnings and through consistent application of this principle, 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 economy 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)”.
Beyond Nisab, 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 both labor and capital as major inputs) is prescribed.
Proportional Zakat linked with income acts as an automatic stabilizer. When aggregate personal disposable income increases, more Zakat is collected and more amount remains at the disposal of government to allocate as transfer payments to Fuqura (poor and needy),Masakeen (extremely poor and needy) and Gharimeen (borrowers in trouble).
When personal disposable income decreases, obligatory Zakat also decreases and thereby providing 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.
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 an Islamic economy due to wealth Zakat irrespective of the phase of business cycle. Transfer payments to unemployed, poor, needy, debtors etc will continue 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.