FISCAL POLICY: ISLAMIC VERSUS CONVENTIONAL

PREPARED BY:

ROSWAHIDA BINTI AHMAD SHUBELI 07BB03001

PREPARED FOR:

MISS HAFIZAH BINTI ABDUL RAHIM

BMES 7003

COMPARATIVE STUDY OF ISLAMIC ECONOMICS

13th August 2010

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CONTENT

1. ACKNOWLEDGEMENT 1

2. INTRODUCTION 2

2.1 HOW FISCAL POLICY BEGAN. 3

2.2 THE ROLE OF THE GOVERNMENT 4

IN ISLAM

3. FISCAL POLICY

3.1 IN CONVENTIONAL PERSPECTIVE 5

3.1.1 TYPE OF FISCAL POLICY 5

3.1.2 EFFECT OF FISCAL POLICY 7

WITH KEYNESIAN TEORY

3.1.3 EFFECT OF FISCAL POLICY WITH AD-AS 8

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3.2 IN ISLAM PERSPECTIVE 9

3.2.1 PROPHET YUSUF FISCAL PLANNING 9

3.2.2 SOURCES OF REVENUES IN 11

EARLY ISLAMIC PERIOD

3.2.3 ZAKAT EXPENDITURE 12

3.2.4 MOBILIZING BAITULMAL’S ASSETS 12

FOR ECONOMY RECOVERY

4. CONCLUSION 15

5. BIBLIOGRAFY 16

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1. ACKNOWLEDGEMENTS

All praise to Allah (swt) the most Gracious and most Merciful, by whose grace and blessing to

Miss Hafizah binti Abdul Rahim, our lecture of subject Comparative Study of Islamic Economic,

due to the opportunities to us in discussing about fiscal policy in Islamic and conventional.

I also thankfully to our college (Selangor International Islamic University College) for allowed

us to learn and have the knowledge in this subject matter. And to all the Librarians of our

university college in their co-operations helping us regarding some journal and books about

fiscal policy.

I also take this opportunity, while relying on the instruction of the Prophet to the effect that:

“whoever does not thank people does not thank Allah”

I indebted to this discussion from online journal, articles and books as supporting to the idea and

get all the information from it while writing the assignment.

I have given all our effort to this paper work and we hope that this paper work will provide

lessons and information which will complete the need of this assignment and also answering all

the question of fiscal policy between Islamic and conventional.

May Allah (Almighty) reward them all for their contribution and consider our efforts for his sake

only.

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2. Introduction

Fiscal policy is a policy to change tax and government spending to protect economy

stabilization.

Main purpose of fiscal policy are to:

a) To achieve economic growth continuously without inflation and unemployment.

b) To achieve equality in income distribution with to draw nearer the gap between rich

and poor people.

Type of fiscal policy are:

a) Automatic stabilizers

b) Discretionary fiscal policy

There are two approaches to analyze fiscal policy.

First, about the economics law governing the economy in which these macroeconomics policies

are pursued were made. It can be in two way:

a) An economy governed by Syariah principles

b) An economy governed by civil or western law while some aspects of Shariah principles

are observed in selected economic activities.

The first approaches has been a natural choice.

Second, much more on research and investigation as it means extracting information and

knowledge from real economic life . In Malaysia for example, government have power to control

zakat collection and disbursement, which also control waqaf and faraid management.

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2.1 HOW FISCAL POLICY BEGAN.

Classical economy

Classical economic theory has always claimed that the economy is always at full-employment.

Guarantee that, all output produced by firms will be taken up by consumers. So, supply creates

its own demand. In the short-run these will be temporary disequilibrium the capital, labor and

product market, but in long run the economy is always in equilibrium or full employment. The

market is therefore perfect and there isn’t need for government to interference in the economy.

However classical economy was proven wrong as the US economy got into the Great Depression

in the 1930’s. Which is huge amount of unemployment due to business shut downs and bank

failures took place. It is clearly shows that is something wrong with the market.

Keynesian economics

In criticizing the classical economist, John Maynard Keynes says that there is not enough

demand in the market. In his explanation, in short run, it is the demand for goods and services

that will determined the level of GDP, rather than the supply of factor inputs. The Great

Depression was a result of low spending. Consumer and business spending not strong enough to

bring back the economy to full employment. The only way to rose up demand and GDP is by

increasing government spending.

Supply-side economics

In 1980’s American economy was hit by stagflation. Most blame on over-regulation, lowering

productivity and motivation to increase output among producers. Neoclassical economic thinking

surfaced in the disguised of supply-side economics calling for changes in taxes to produce more

output then increasing economic activity.

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2.2 THE ROLE OF THE GOVERNMENT IN ISLAM

In the traditional economic, government is only a tool. Only when market is found inefficient or

fails to generate efficiency, only then, government will intervene to set things straight again.

However government in Islam is divinely inspired and thus, inherent in nature. This is because,

man as economic agents, consumers and supplier alike, are by nature weak and unstable. This

has been mentioned in al-Quran(70: 19-21). Another verse is (4:128) man is greedy and

selfishness.

Therefore, unlike conventional. Islamic economic not just calculate material in fiscal policy but

also spiritual to increase the country performance.

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3. FISCAL POLICY

3.1 IN CONVENTIONAL PERSPECTIVE

In conventional, they only focus on how to increase and protect they material from goes down.

3.1.1 TYPE OF FISCAL POLICY

the way are by automatic stabilizers and discretionary fiscal policy.

a) Automatic stabilizers

This is one of government tool to reduce the situation of economic if it in boom or recession by

automatically. When economy in boom, automatic stabilizers will make it reduce the boom. And

opposite, when economic in recession, automatic stabilizers will reduce the recession.

Type of automatic stabilizers:

i) Progressive Tax And Proportional Tax

This will help government in changes in society income and aggregate demand(AD).

When economic in boom, society income would increase and aggregate demand also increase

and price also increase. When government put progressive tax and proportional tax this will

reduce society income, AD and price.

When economic in recession, society income are become smaller then AD also decrease. In this

case, firms will reduce supply of the product and employment. This will lead to rose in

unemployment. When government put progressive tax and proportional tax, these tax will reduce

due to decrease of society income. This mean decrease in income would not so massive. Then,

AD will reduce and this will help to reduce unemployment.

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ii) Maximum Price And Minimum Price

This method would guarantee of price stabilization in economy.

During economic boom, maximum price policy will prevent price increase above maximum

price or ceiling price.

During economic recession, minimum price policy will prevent price to goes down below floor

price.

b) Discretionary Fiscal Policy

This method are action by government to changes government spending and tax to overcome

problem of inflation or unemployment and encourage economic development.

Type of discretionary fiscal policy:

i) Contractionary fiscal policy

This is use to prevent inflation. During economy are facing inflation, government may reduce

government spending and increase tax to make AD goes down. When AD goes down, price

would decrease and this will control inflation.

ii) Expansionary fiscal policy

This method are for prevent deflation and encourage for economic growth. During economy in

deflation with unemployment rate become increasingly, government may increase government

spending and reduce tax for rise up AD. This will rise up job opportunity. Lastly, deflation can

be control and economic will growth.

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iii) Stable fiscal policy

This method are same with expansionary fiscal policy. To prevent deflation and encourage

economic growth. During deflation, increase government spending and tax. As a result AD will

increase, this will reduce unemployment and will increase income of the country. This lead to

economic growth.

3.1.2 EFFECT OF FISCAL POLICY WITH KEYNESIAN TEORY

i) Decrease Government Spending

When government decrease government spending, this will also decrease AE and country

income. This lead to no more inflation.

ii) Increase tax

When tax be increase →society consumption decrease →AE decrease → income country

decrease → no inflation

iii)Increase government spending

AE increase → income country increase → no more deflation

iv) Decrease tax

society income increase → society consumption increase → AE increase → country

income increase → no more deflation.

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v) increase government spending and tax in same time.

Two possibility may happen:-

a) changes in government > changes in tax or changes in government equal to changes in tax

AE will increase → income country increase. Income country in massive if changes in

government more than changes in tax.

b) changes in government < changes in tax

This will lead to decrease in AE → income country will decrease.

3.1.3 EFFECT OF FISCAL POLICY WITH AD-AS

a) Contractionary fiscal policy

Price increase → real country output increase → increase in both are depend to economy

capacity and slope of AS.

b) Expansionary fiscal policy

This lead to price and real country output decrease. The decrease of both also depends on

capacity of economy and slope of AS.

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3.2 IN ISLAM PERSPECTIVE

3.2.1 Prophet Yusuf Fiscal planning

In Quran has provide a best basic what a goos fiscal policy should be like. In surah Yusuf

(12:43-49) tell the story of a Pharaoh in Egypt who had a strange dream.

The king (of Egypt) said: "I do see (in a vision) seven fat kine whom seven lean ones devour and

seven green ears of corn, and seven (others) withered. O ye chiefs! Expound to me my vision if it

be that ye can interpret visions." (43) They said: "A confused medley of dreams: and we are not

skilled in the interpretation of dreams." (44) But the man who had been released, one of the two

(who had been in prison) and who now bethought him after (so long) a space of time, said: "I

will tell you the truth of its interpretation: send ye me (therefor)." (45) "O Joseph!" (he said) "O

man of truth! Expound to us (the dream) of seven fat kine whom seven lean ones devour, and of

seven green ears of corn and (seven) others withered: that I may return to the people, and that

they may understand." (46) (Joseph) said: "For seven years shall ye diligently sow as is your

wont: and the harvests that ye reap ye shall leave them in the ear― except a little, of which ye

shall eat. (47) "Then will come after that (period) seven dreadful (years), which will devour what

ye shall have laid by in advance for them, (all) except a little which ye shall have (specially)

guarded. (48) "Then will come after that (period) a year in which the people will have abundant

water, and in which they will press (wine and oil)." (49)

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In the dream, the King saw seven green ears of wheat and seven withered or dying ears of wheat.

Then prophet Yusuf interpret the dreams. Prophet Yusuf said that Egypt would enjoy seven years

of prosperity with abundant harvests. In modern times, this mean high economic growth. He

advised the people of Egypt to hardworking in plant their crop, use a little for food and

sustenance and store the rest. This is because after the period of prosperity, Egypt would suffer

from drought for seven years when no crops would grow. In modern term this mean a bad long

recession. But with the reserve in store, the people of Egypt could survive the seven bad years.

Prophet Yusuf add more advice to the King, have to lease the best portions for seeds to plant

later when rains filled the Nile. In other words, people must set aside money for savings and

investment. To postpone current consumption to make way for production of future goods was

one of the main messages that Prophet Yusuf wanted the Pharaoh to think about.

What was tell in Quran was a simple budget policy. During economic booms, when earning is

high and business secured more profit, the budget should call for higher savings rather than

higher spending. For example, during good years, government normally earns higher tax

revenues. According to Prophet Yusuf’s fiscal planning, the government should not forget that

the economy might eventually slow down one day. So it is good policy not to overspend such

that more revenues can be set aside as reserve.

During a recession however, Keynesian theory suggests higher government spending to help

stimulate aggregate demand. But how can we increase public spending if fewer reserves are

available for government spending. Bad fiscal policy allows government to overspend during

economic booms, leaving them with lower reserves to work with when the country recedes into a

major slow down.

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Fiscal policy in terms by the government to manipulate taxes and spending such that

consumption and investment behavior this would help to achieve full-employment level of

output and price stability. For example, if the economy hit by a recession with declining sales,

output and employment, economic theory suggest more spending. More spending will increase

production, employment and income. One way to increase spending is to reduce taxes. Lower

personal income tax will increase disposable income and therefore raising consumption. Lower

corporate tax will increase net profit, which can increase more business spending. But does Islam

allow manipulating taxes and zakat? Taxes can be manipulate but zakat will fixed every year

2.5%.

3.2.2 SOURCES OF REVENUES IN EARLY ISLAMIC PERIOD

Zakat Special levy or tax on wealth and agriculture

products.

Kharaj Land tax

Jizya Poll tax on non-Muslims

Ghanimah Spoils of war

Fay’ Properties received from enemies without

actual fighting

‘Ushur Custom duties

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3.2.3 ZAKAT EXPENDITURE

Recipients (asnaf) Objective

Fuqara (very poor) Elimination of poverty and provisions of basic

needs

Masakin (poor) Elimination of poverty and provisions of basic

needs

Amilun (tax collector) Ministry of finance

Muallaf (newly converts and those near to

Islam

Welfare and diplomatic expenditure

Al-Riqab (slaves) Welfare

Al-Gharimin Welfare

Ibnu Sabil Highways and roads, motels diplomatic

expenditure

Fisabilillah Military expenditure, education,

communication

3.2.4 MOBILIZING BAITULMAL’S ASSETS FOR ECONOMY RECOVERY

According to Keynes, the level of output of GDP is determined by demand. More demand for

goods and services by consumers, business and government means higher spending, which will

stimulate production, thus increasing output and employment.

To increase aggregate demand, based on monetary policy BNM intervention in the money

market in lowering the Kuala Lumpur Inter-bank Offer Rate (KLIBOR). At lower base lending

rate, banks are expected to make more loans as the demand for financing is also expected to

increase. Lower interest rate, investment and the GDP are expected to go up. But what if the

contrary is true, that is investment is interest inelastic or not sensitive to interest rate.

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Likewise, even at lower interest rates it does not mean that banks are willing to make more loans.

The supply of loans too may be insensitive to interest rates due to fear of more bad debts if new

loans are made.

How Islamic economic institutions in this country could do their part, especially those who are

currently holding abundant supply of assets and cash. Here the BaituMal (Islamic treasury) can

do its noble part, especially in providing capital and land resources.

Islamic public assets such as zakat funds and waqf properties on a large scale. If this public asset

difficult to mobilize on a grand scale, which finally all Muslims will stand to lose. If those

assets are properly utilized so that more benefits can be generated from them, or else, like in a

hadith its effect on donors when the charity or waqf properties were not properly mobilized by its

trustees to benefit society.

In Malaysia, there are a lot of waqf land that have been misused. Misused is including leaving

them idle, failing to collect rent from tenants and even gazetting these lands for non-religious

purpose. Education and learning is a scarce commodity today, so those waqf properties may help

to solve the problem.

However, without capital, waqaf properties would not can mobilized. Here now are the use of

zakat. Zakat means “growth”. It is actually a tax on assets that are growing or increasing in size.

Zakat is obligation not a personal thing. The state has a legal claim on this tax, which include

zakat tax on wealth, income and agriculture produce.

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Among the eight asnafs, zakat spending for fisabilillah purpose is so wide that itihad can be

made on how zakat funds can put on full force to improve the live of Muslims and mankind.

Spending for the way of Allah can be mean many things such as education, national defense,

communication and infrastructure development.

Surplus of zakat and idle of waqf lands are revived to the maximum advantage of Muslims.

Doing so will stimulate the demand for raw material and labor, which brings more jobs and

value-added activities to the local economy and thus help economics recovery. And there will be

sufficient projects for contractors as well as other interested parties.

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4. CONCLUSION

Macroeconomic policies in Islam can indeed cover a wide array of topics, which this paper has

only address a few. The Islamic economic system must in the first place ensure economic justice

in economic transactions. This will make macroeconomic management to be pursued to the

minimum while the state will always be in constant surveillance to see that economic growth and

stability is guarantees and secured. For example, if governments failed to exercise restraint on

excessive expenditures during good times, they will have no choice but to intensify fiscal policy

to stimulate spending when recession hits the country.

So now we can see that the different fiscal policy from Islamic and conventional. The theory

from conventional are much more on analyze the consumer behavior to protect economy from

having economic problem which is inflation, deflation and stagflation. They more to material. As

their focusing to maximize profit and minimize losses. However in Islam, it not just stress on

material but also spiritual. Here we can see the justice in Islam. Stimulate of zakat and waqf to

improve the economic society.

Saving and investment are really importance during economic boom as been told in Quran in

surah Yusuff. The return from the saving and investment will be use full during economic

recession. This mean that, during in stable position we have to remember the economy is not

always in booms. When the period for economic goes down we must be prepared for what aver

are up coming.

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5. Bibliography

BOOK

FOONG, L. M. (2005). DASAR FISCAL. In TEKS PRA-U MAKROEKONOMI (pp. 202-212).

SELANGOR : PEARSON MALAYSIA SDN BHD.

(1999). In A. M. IBRAHIM, ISLAMIC FINANCIAL SERVICES AND PRODUCTS (pp. 43-80).

KUALA LUMPUR: IKIM PUBLISHING UNIT.

ONLINE JOURNAL

1.

http://islamiccenter.kau.edu.sa/english/Publications/Ziauddin%20Ahmed/Fiscal%20Policy/FIS

CAL%20POLICY%20-%20ZIAUDDIN%20-%20%5BCOMPLETE%20BOOK%5D.pdf

2. http://islamiccenter.kau.edu.sa/arabic/Magallah/Pdf/Old-1-1/Faridi_09.pdf

3. http://iei.uv.es/~rdomenec/EUbudget/EUbudget.pdf

4. http://courses.cit.cornell.edu/tp253/docs/malaysia_pbcs.pdf

5. http://www.ief.es/Publicaciones/PapelesDeTrabajo/pt2003_11.pdf

6.

http://www.emeraldinsight.com/journals.htm?issn=03068293&volume=33&issue=2&articleid

=1537573&show=pdf

7. http://www.princeton.edu/~erp/ERParchives/archivepdfs/M144.pdf

8. http://kisi.deu.edu.tr//yesim.kustepeli/w4499.pdf

9. http://abacus.bates.edu/~daschaue/aschauer85.pdf

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