An In-Kind Tax On Agricultural Products, Agricultural Land,

and Livestock: A Preliminary Study in the Comparative

Economics of Taxation

 

 

 

 

 

 

 

 

 

By:

 

 

USAMAH A. UTHMAN

 

 

 

 

 

 

The Author is an Assistant Professor of Economics

The Finance and Economics Department

King Fahd University of Petroleum and Minerals (KFUPM)

DHAHRAN 31261, Saudi Arabia

 

Final Version: May 5, 1996

Review of Islamic Economics,Vol.4, No.2,1997/ 1418

 

 

 

 

I am thankful to KFUPM for a research grant to fulfill this project.  I am also thankful to two anonymous referees for their comments.  Any mistakes are mine.

 

 

 

 

          An In-Kind Tax On Agricultural Products,

Agricultural Land, and Livestock:  A Preliminary Study

in the Comparative Economics of Taxation

 

Introduction

 

            This paper may sound very peculiar to many readers, especially those who are not familiar with the economic teachings of Islam.  Yet, it is no less important for three reasons.  First, it introduces the reader to the taxation system of a different economic system.  Second, and more important, it shows some of the economic implications of that system, especially when contrasted with some of those existing in Western countries. “Zakat” is a major form of Islamic taxation, a form of worship, and one of the pillars of the Islamic faith. This paper is only a prelude to agricultural and livestock taxation under the Islamic economic system.  Third, the literature on public finance is replet with papers that discuss in-kind transfers and subsidies1, yet papers on in-kind taxation are quite rare.

            In order to discuss the economics of  “Zakat” it is necessary to give the reader some idea about the Islamic jurisprudence on that matter.  This is part I.  Since I am not a specialist in Islamic Jurisprudence, I had to rely on the work of someone else for that purpose.  Unless otherwise indicated, part I represents a very condensed summary of what Yosuf AlGaradawi, a great contemporary Muslim scholar, has concluded as the accepted rules on Zakat, in his monumental study, “Fiqh Alzakat  (The Jurisprudence of Zakat), Vol. 1, 1969.”  For the sake of brevity and manageability, I have avoided many details and controversies that were discussed in that book.  Part II of the paper discusses some of the economic efficiency implications of the revenue side of  Zakat.  No attempt is made to discuss the expenditure side.

I.  The Jurisprudence of Zakat

I. 1       General Requisite Conditions for Zakatable Wealth2

            There are six general requisite conditions for Zakat to be collected.  These are:

1.         Absolute Ownership:  which implies acquirement, disposition, and the exclusion of others.  This condition implies also the exclusion of any form of wealth that cannot be attributed to a private entity, trusts, any form of wealth that is illegally3 acquired and, debt.4

2.         Accretion:  The accretion of wealth has to be either of its own kind, such as livestock, the result of growth, such as agricultural products, or growable  in  value  via  exchange,  such  as  money,  gold,   silver, and  other tradables.  Consequently, things that are intended for personal use such as one’s own house, car, books, and professional equipments, such as those of a physician or an engineer, are all examples of Zakat-exempted forms of assets.

3.         “Nisab” or the minimum level of wealth below which no Zakat is collected.  There is a “nisab” for each kind of Zakatable asset (to be discussed later in the paper).

4.         Excess over basic needs (subsistence):  The basic needs of a household must be met first before any Zakat is collected.  The definition of basic needs changes according to the change in time, place and, economic and social conditions.

5.         Absolvency from debt:  Which implies that if the individual’s debts are such that they reduce the value of his actual wealth below “nisab”, then he is exempted from Zakat.

6.         The elapsing of twelve lunar months on the ownership of the particular form of wealth.  This condition is applicable, however, only on livestock, money, gold, silver, durable agricultural products and commodities intended for trade, but it is not applicable to perishable agricultural products, honey and, minerals.  Garadawi (p. 162) reasoned that the first group of wealth needs time to grow, while the other group is the result of growth and cannot be grown further.  The discussion in this paper will be limited to Zakat on livestock, agricultural products and agricultural land.

I.2        Zakat on Livestocks

            Livestock includes camels, cattle, sheep and goats; all are taxed in-kind.  The requisite conditions for Zakat on livestock in addition to the general ones mentioned above are the following.  First, the ownership of “nisab” or above.  “Nisab” of camels is five, for sheep and goats is forty, and for cattle is thirty.  Second, the elapsing of one year of ownership.  Third, it has to be “saemah” (grazing in an open range) for most of the year, and has to be intended for breeding and milking.  Implicitly, those livestocks that are intended for personal use are Zakat-exempted.  Fourth, a livestock should not be laborious, such as those used for transportation and  irrigation.  There  is an important  difference  of opinion among Muslim scholars about Zakat on livestock that are fed by the owner (i.e. that is not “saemah”).  Garadawi and the majority of scholars seem to be the opinion that it is Zakat-exempted5. But if a (non-saemah) livestock is intended for trade, then it has to be treated like commercial goods and to be taxed at 2.5 percent of its pecuniary value.  This point is discussed in I.3 below. The breakdown of Zakat brackets and the discussion of the economics of Zakat shall be elaborated upon in Part II of this paper.

I.3        Zakat on Commercialized “Saemah”:

            Another important difference of opinion among Muslim scholars is on Zakat on commercialized “Saemah”, should it be treated as a commercial item and hence taxed at 2.5 percent of its pecuniary value, or should it be treated as a “saemah” and taxed in the usual manner of an in-kind Zakat?  Garadawi (pp. 530-3) does not seem to favor one over the other but it is clear that there should not be double taxation.  In other words, a livestock in this case is either treated as a livestock and taxed in-kind, or treated as a commercial item and taxed at 2.5 percent of its monetary value, but not both.  I am more inclined to prefer that whenever possible and practicable, an in-kind tax should be enforced because the original treatment is so, and because of the efficiency implications (to be explained later) that go with an in-kind tax.

 

I.4        Zakat on Agricultural Produce

      Garadawi contends that all kinds of agricultural products are ZakatableZakat is collected in-kind in case of durable and, storable products such as wheat, rice, corn, dates, barely and raisin.  Perishable products, such as fruits and vegetables are zakatable in their

pecuniary values.  The tax rate in both cases is a flat proportional 10 percent if land is irri-

 

gated by rain, springs or if the plant is self-seeking of water by its roots.  Products that are irrigated at some cost by digging wells for example, are taxed at 5 percent.  A weighted average of the two rates is applied if both methods of irrigation are used.

      The stock of durable agricultural products is measured in terms of volume, not weight.  Such measurement is the standard for evaluating all kinds of agricultural products.  “Nisab” for these products is five “wesgs” and each “wesg” is three hundred sa’a.  It is not clear what are the volume-equivalents of these measures in today’s terminology, but Garadawi estimates that a sa’a of wheat weighs 2.176 kilograms and that is equivalent to 2.75 liters of water.  “Nisab”, then,  is  equivalent  to  652.8 kilograms of wheat (p. 372).  The same volume of other products shall have, of course, different weights.  “Nisab” for perisable products that are measured by weight is the pecuniary value of five “wesgs” of some medium-valued durable product such as wheat or rice.

            It is important to note that the estimation of “nisab” and Zakat is to be done only after durable products have actually been refined and dried, debts are deducted, and one fourth to one third of the produce is left for the household’s consumption (depending on the family size).  Perishable products are taxed right after their sale and the monetary equivalent is to be paid.  The tax rates for both perishables and durables are the same (Garadawi, p. 359).

I.5        Zakat on Products from Animals

            Products from animals such as dairy products (of non-saemah livestock), honey, milk, eggs are zakatable at 10 percent of its net pecuniary revenue (i.e. after deducting costs).  The general rule, as Garadawi explains (p. 431), is that items that are not zakatable in-kind, such as bees, silk worm, and “non-saemah”, are taxed in their products.  “Nisab” and the tax base in general  are  estimated  at  the pecuniary  equivalent of  medium-valued durable agricultural product.6 (Garadawi, p. 428). If these animals were commercialized, however, (i.e. became objects of trade themselves), they shall be taxed in the same way as commercial items are - at 2.5 percent of their pecuniary value.  (Garadawi, p. 431).

I.6        Kharaj

            Kharaj is an in-kind tax levied on land that was captured by force or settlement and was not distributed  among the individuals of the capturing army.7    Such a land becomes a national property, but its inhabitants may still cultivate it as long as they pay the tax (Kharaj) levied by the state (Garadawi, pp. 405-410).  If the  occupant is a non-muslim he pays only Kharaj but no  Zakat; if he is a muslim, however, he pays both.  The reason for such a distinction is that Zakat is a form of  an Islamic worship in addition to its being a fiscal duty; Kharaj is a tax on (rent from) land.  Zakat is estimated, however, after   estimating   Kharaj   (Garadwi, pp. 415-9). Economically speaking, Kharaj is treated like a debt or an expense that reduces  the  Zakat   base.  Kharaj  is  Zakat  (tax)  deductible.   There  is an important difference as to how to dispose of government revenues from each type of taxes.  The expenditure of Zakat is earmarked, by Qur’an, for eight categories of people.  As stated in Qur’an: “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 God; and for the wayfarer: (thus is it) ordained by God, and God is full of Knowledge and Wisdom.”  (S. IX, section 8, verse 60).  Kharaj, on the other hand, can be spent on any government programs.  The economics of Zakat and Kharaj are discussed in Part II.

II.        Some Economic Efficiency Implications of Zakat on Livestock and Agricultural Products

 

II.1      Zakat  on Livestock

            It was indicated earlier that Zakat is levied in kind on cows, buffaloes, sheep, goats, and camels.  The structure of this tax is more complicated than taxes on all other forms of wealth.  The source of complexity is not only that the tax has to be paid in kind, but also that the animals to be paid are a combination of different ages and thus different relative values.  Each age is given a different name.

            The tax on livestock has the features of both progressive and proportional taxes.  It is progressive in the sense that the average tax rate increases at some brackets with the tax base.  However, under progressive tax, a person’s income is divided into several brackets, and a different tax rate is applied to each income bracket.  Under Zakat system,  the realized stock is not divided into brackets, but treated as one bracket.  The rate changes as the volume of realized stock changes.  In other words, a new, single tax rate is applied on the whole tax base at different sizes of the tax base.

            Marginal and average tax rates change together, but they are equal to each other at each level of taxable stock.  To illustrate, assume one’s livestock is the worth of 200 “Derhams” (an old Islamic currency) of camels, the tax rate on which is 2.5 percent.  Should his stock rise to the worth of 1,000 Derhams, the rate will be 4 percent.  The 4 percent rate is applied to the entire stock and not only the increase in stock.  The fact that the marginal tax rate is always equal to the average tax rate, implies that this tax has a feature of a proportional tax.  The average tax rate, however, is not the same at all levels of the tax base.  We can thus call it progressive-proportional, or for simplicity quasi-progressive or quasi-proportional tax.

II.1.1   Zakat on Camels

            This is the most complicated of all.  If the stock is less than five camels, it is tax-exempted.  At five camels and up to nine, the tax in kind is one sheep or goat, not a camel.  At 10 camels and up to fourteen, the tax is two sheep or goats; at 15 camels and up to nineteen, three sheep or goats; and at 20 camels and up to twenty four, four sheep or goats.  The tax in-kind does not increase between 5 to 10, 10 to 15, 15 to 20, 20 to 24.  It is only when the stock reaches 25 camels, the in-kind tax has to be paid in terms of camels, and here we need to give the following glossary in Table 1 to help us read Table 2, since each age has a different name [Shehata, p. 167].

Table 1 Description of Payable Zakat on Camels

Name of the Animal (camel)

Value in terms goats or sheep

Value in Currency terms in the early days of Islam

        Age

Bint-Maghad (She)

       8

          40 (Derhams)

1 yr. old and entered the second.

Ibn Laboon (male)

     10

          50 (    “       )

2 yr. old and entered the third.

Hukkaa (she)

     12

          60 (    “       )

3 years old.

Jatha’a (she)

     14

          70 (    “       )

4 years old.

            However, to avoid using these complicated names, I have referred to each age by a Roman numeral in Table 2, and used the Arabic numerals to refer to the number of camels to be paid of each age.  In the first column of Table 2 the number of camels, or the size of the stock, is given where the asterisk refers to the beginning of a new “bracket”, and where the in-kind tax changes.  Column 2 indicates the tax in kind to be paid.  For example, at 25 camels, 1 I or II (a male) has to be paid, which means that one camel-she of one year old or one male camel of two years old has to be paid.  At 130 camels, for example, it says 2 II and 1 III.  This means two camels of two-year old and one camel-she of three-year old has to be paid as a tax.  In order to be able to compare these taxes, we have to convert them into their money equivalents.  These are columns 3 and 4.  The tax rate (column 5) is obtained by dividing the entries of column 4 by those of column 3.  Column 6 indicates the value of tax had camels been money.  The tax on money holdings is a flat proportional tax of 2.5 percent.  The purpose of doing this is to compare the tax on money holdings with the money value of the in-kind tax on camels8.

Table 2: Zakat on Camels

     1

         2

      3

        4

      5

      6

No. of Camels

Tax in Kind

Value of the stock of  Camels

Value of Zakat mea-sured in cur-rency units

Tax Rate

Value of Tax had camels been money (taxed at 2.5%)

     1

0

     40

     0

      0

     0

     2

0

     80

     0

      0

     0

     3

0

   120

     0

      0

     0

     4

0

   160

     0

      0

     0

     5*

1 sheep/goat

   200

     5

    2.5*

     5

     6

1 sheep/goat

   240

     5

2.0658

     6

     7

1 sheep/goat

   280

     5

   1.79

     7

     8

1 sheep/goat

   320

     5

   1.56

     8

     9

1 sheep/goat

   360

     5

   1.39

     9

   10*

2 sheep/goats

   400

   10

    2.5*

   10

   11

2 sheep/goats

   440

   10

    2.27

   11

   12

2 sheep/goats

   480

   10

    2.065

   12

   13

2 sheep/goats

   520

   10

    1.92

   13

   14

2 sheep/goats

   560

   10

    1.79

   14

   15*

3 sheep/goats

   600

   15

    2.5*

   15

   16

3 sheep/goats

   640

   15

    2.34

   16

   17

3 sheep/goats

   680

   15

    2.21

   17

   18

3 sheep/goats

   720

   15

    2.065

   18

Table 2. Cont’d.

No. of Camels

Tax in Kind

Value of  the stock of Camels

Value of Zakat mea-sured in cur-rency units

Tax Rate

Value of Tax had camels been money (taxed at 2.5%)

   19

3 sheep/goats

   760

   15

    1.97

   19

   20*

4 sheep/goats

   800

   20

    2.5*

   20

   21

4 sheep/goats

   840

   20

    2.38

   21

   22

4 sheep/goats

   880

   20

    2.37

   22

   23

4 sheep/goats

   920

   20

    2.17

   23

   24

4 sheep/goats

   980

   20

    2.065

   24

   25*

1 I or II (a  male) 

 1000

   40

    4.00*

   25

   35

1 I or II (a male)

 1400

   40

    2.86

   35

   36*

1 II (a female)

 1440

   50

    3.47*

   36

   45

1 II (a female)

  1800

    50

    2.78

   45

   46*

1 III (a female)

  1840   

    60    

    3.26*     

   46    

   60

1 III (a female)

  2400

    60

    2.5

   60

   61*

1 IV (a female)

  2440

    70    

    2.87*    

   61    

   75

1 IV (a female)

  3000

    70    

    2.33   

   75

   76*

2 II (a female)

  3040 

  100    

    3.29*

   76

   90

2 II (a female)

  3600

  100

    2.78  

   90    

   91*

2 III (a female)

  3640

  120

    3.29*

   91

 129

2 III (a female)

  5160

  120

    2.33

 129

 130*

2 II & 1 III

  5200

  160

  *3.065

 130

 139

2 II & 1 III

  5560

  160

    2.87

 139

 140*

1 II & 2 III

  5600

  170

  *3.04

 140

 149

1 II & 2 III

  5960

  170

    2.85

 149

 150*

3 III

  6000

  180

  *3.00

 150

 159

3 III

  6360

  180

    2.82

 160

 160*

4 II

  6400

  200

  *3.13

 169

 169

4 II

  6760

  200

    2.95

 169

 170*

3 II & 1 III

  6800

  210

  *3.09

 170

 180*

1 II & 3 III

  7200

  220

  *3.06

 180

 190*

1 II & 3 III

  7600

  230

  *3.03

 190

 200*

5 II or 4 III

  8000

  240

  *3.00

 200

 300*

6 III or 5 II & 2 III

 

 

 

Then in each additional 40 camels, an additional 2-year old, and in each additional 50 camels, an additional 3-year old.

 

            In figure 1, I have plotted the tax rate on the money value of Zakat on camels (column 5) against the money value of the tax base stock (column 3).  figure 2 compares the pecuniary value of the tax on camels (column 4) to the value of tax had camels been substituted for by money holdings (column 6).  The peaks in figure 1 refer to the turning points where the physical amount of the in-kind tax changes.  The amount of the tax between any two peaks remains constant.  Garadawi (p. 209) explains that the reason for such relief is the existence of many small (baby) animals between these numbers of livestocks.  Consequently, the effective tax rate decreases between any two peaks as the tax base increases.  It is also noted that the tax rate alternates below and above 2.5 percent (the tax rate on money holdings).  Beyond 130 camels the tax rate is always above 2.5 percent, but almost steady.  Had camels been taxed at 2.5 percent flat rate, the tax would have been one Derham per camel (column 6).  The alternation in effective tax rates has a carrot-and-a-stick impact on investment.  The decrease in the effective tax rate between every two peaks encourages investment.  When the stock is large enough, the effective tax rate increases suddenly, reducing the stock by a larger amount and providing an incentive for further breeding and investment.

II.1.2   Zakat on Goats and Sheep

 A similar analysis for sheep and goats is done in Table 3 and Figure 3.  Figure 3 relates the effective tax rate on sheep and goats against the value of the in-kind tax base of those animals.  The tax rate alternates until the number of sheep is 400.  Afterwards, it is steady at one percent at each peak.  the tax rate is always (except at 40 sheep) below 2.5 percent.  Compare this graph with figure 1 on camles.  Since each unit of camels is usually more expensive, and each camel-she is not as physically productive (in terms of the number of animals she can breed every year), there is less need in the case of sheep and goats for a carrot-and-stick treatment.  No such analysis was conducted for cows as I have been unable to get their money or sheep equivalent.  The breakdown of Zakat on cows, however is given in Table 4.

 

 

Table 3:  Zakat on Sheep and Goats

 

        1

        2

           3

       4

      5

        6

No. of Sheep and Goats

Tax in Kind

Value of Sheep & Goats (Derhams)

Value of Zakat (Derhams)

Tax Rate

Value of Tax had sheep been money

   40*

1 sheep/goat

      200

     5

  *2.50

    5.00

 120

1 sheep/goat

      600

     5

    0.83

  15.00

 121*

2 sheep/goats

      605

   10

  *1.65

  15.125

 200

2 sheep/goats

    1000

   10

    1.00

  25.00

 201*

3 sheep/goats

    1005

   15

  *1.49

  25.125

 300

3 sheep/goats

    1500

   15

    1.00

  37.500

 399

3 sheep/goats

    1995

   20

    0.75

  49.875

 400*

4 sheep/goats

    2000

   20

  *1.00

  50.00

 500*

5 sheep/goats

    2500

   25

  *1.00

  62.50

 600*

6 sheep/goats

    3000

   30

  *1.00

  75.00

 700*

7 sheep/goats

    3500

   35

  *1.00

  87.50

 

Table 4:  Zakat on Cattle

 

    No. of Animals                     In-Kind Tax

 

    0 -   29                                                         0

  30 -   39                     Jatha’a (a one-year old cow)

  40 -   59                     Musinnah ( a two- and an almost three-year old cow)

  60 -   69                     Tabi’a (a one-and almost two-years old)

  70 -   79                     Musinnah and Tabi’a

  80 -   89                     Two Musinnah

  90 -   99                     Three Tabi’a

100 - 109                     Musinnah and two Tabi’a

110 - 119                     Two Musinnah and Tabi’a

110 - 119                     Two Musinnah and Tabi’a

120 - 129                     Three Musinnah or four Tabi’a

 

and so on, where the addition of a Musinnah or a Tabi’a alternates every additional ten cows. If the value of a cow goes proportionally with age, then we may note from table 4 that the tax rate on cattle follows the same carrot-and-stick fashion noticed about Zakat on camels and sheep.

 

            A change in the monetary value of a livestock will change the position of the curve along the abscissa.  However, the amplitude of the curve will not change, which means that the tax rate on the value of the livestock (in Figures 1 and 3) will not be changing.  This implies that a change in the own price and/or a change in the general price level will not push the owners of the livestocks into higher tax brackets.  Consequently,  an in-kind tax is inflation-neutral.  This should be expected as both the tax base and the tax payment are measured in real (physical) terms.  This is one of the important features of an in-kind tax.





II.2 Tax Incidence and Welfare Cost

            An important issue that is quite often discussed when it comes to the economics of taxation is the issue of incidence and welfare cost.  This section discusses how some of the requisite conditions of Zakat affect incidence and welfare.  But before we tackle that issue, a long digression may be needed.  Most taxes are thought to disturb the optimality conditions in terms of prices and output, and generate at the same time a deadweight loss in social welfare.  A specific (per unit) tax, for example, shifts the marginal cost of output upward, while an ad valorem tax shifts the marginal revenue (or price) downward.  This is the source of the distortionary effects of these taxes.  There are some taxes, however, that are known to have no deadweight loss and hence are not distortionary.  Among those are the lump-sum  tax,  the  profit  tax   and,   the property tax.    This is true of course under certain assumptions.  A change of assumptions and extentions of models may yield different results.  Musgrave and Musgrave (1989) (hereafter referred to as M&M) explain that a deadweight loss can be avoided if  the surplus can be isolated out as a base of taxation without imposing a tax at the margin, but unfortunately it is difficult in practice to determine the amount of surplus involved (pp. 282-3).  In other words, although the above-mentioned taxes are theoretically plausible and desirable, yet they are practically not very optimal.

            An IKT tax yields at least the same desirable qualitative results as those of a profit tax in the sense of preserving the pre-tax optimum conditions.  Why?  Before we answer that question, we may have to answer the following question:  what makes a profit tax different from other taxes such as a sales tax and a severance tax, for example?  The reason lies in the point of inflecting the tax.  A severance tax, and a sales tax, have a direct, preemptive impact, as they are inflicted on (and during the time of) the economic activity, be it production itself or buying and selling.  Both are in rem taxes and thus, both are distortionary.  A profit tax, however, is only indirect on the input-output mix and is inflicted only after the point in time when the economic activity has actually been completed.  This is why a profit tax does not disturb marginal conditions.  M & M (1989, p. 265) explain that “the monopolist (or any other producer) must absorb the tax (on profit).  The reason is that the monopolist will have maximized profits prior to tax and hence can do no better after the tax is imposed.  Since the tax imposed so as to equal x percent of profits, the firm will remain best off  by having the largest possible gross profits.  With a tax rate of 34 percent, 66 percent of $100 million is better than 66% of  below $100 million.”

            To explain the neutrality of a profit tax further, we may compare it to two other taxes.  Schiller (1991, pp. 546-7), illustrates that a property tax if paid regardless of output or services is in the nature of a fixed cost.  Thus, it shifts the average total cost upward (as in figure 4, a), but leaving the MC curve unchanged.  Consequently, the optimal output at q1 is unaffected by the tax.  A payroll tax, however, adds to the cost of employing labor and thus increases marginal cost.  Both the MC and ATC curves shift upward, reducing output and employment (as in figure 4, b).  A profit tax, however, is paid only after profits are made, and this is neither a fixed nor a variable cost.  Consequently, neither MC nor ATC is affected and the pre-tax output is unhindered (as in figure 4, c).

Text Box:   (a) Property Tax		  (b) Payroll Tax	      (c) Profit TaxFigure 4:  Impact of Property Tax, Payroll Tax and Profit Tax

           

 

 

 

 

Text Box: Source: Schiller (1991)

 


            Now I come to answer the first question of why an IKT should yield at least the same qualitative results as those of a profit tax.  It may be argued that an IKT is a tax on both the input and the output of the firm, hence should raise the cost curves and disturb the optimum conditions.  But the fact the ITK tax is, like a profit tax, imposed only at the end of the production period (the sixth requisit condition for the payment of Zakat), implies that inputs are neither taxed at the input stage nor during the production period.  Inputs have done their job in the production process, and thus an IKT is not actually taxing them.  An IKT is not a profit tax, however, since its tax base is not profits.  But, what kind of a tax is it then?  Collection of Zakat requires the allowance of a one-year period of  accretion (requisite condition No. 2) while personal consumption is not taxable (requisite condition No. 4).   Since we count and tax the number of heads or volume of crop at the end of the year, regardless of profit, an in-Kind Tax  is an inventory tax9.  Like a profit tax, it is inflicted only at the point in time after the economic activity has been completed.  Both are not  in rem taxes.  Since the IKT is imposed so as to equal x percent of inventory, the firm will remain best off by having the largest possible gross inventory stock (that maximizes profit).  With a tax rate of 10 percent, say, 90 percent of 10 million heads of livestock is better than 90 percent of  below 10 million.  The IKT will not be distortionary because the firm will have maximized its stock prior to the tax and hence can do no better after the tax is imposed.  Like a profit tax, since Zakat is estimated and paid only after production has actually taken place, it is neither a fixed cost nor a variable cost.  Consequently, neither MC nor ATC is affected by Zakat and the pre-Zakat stock is unaffected.

            We may argue, then, that under both taxes, the producer cannot shift the tax burden to the consumer and the full incidence of tax falls on the producer.  The only difference between the two taxes, as far as incidence is concerned, is that under a profit tax, profits are taxed directly and shall have to be estimated beforehand, of course, while under an in-kind tax, profits are taxed indirectly and need not be estimated for tax purposes.  Whilst the measurement of profits from an economist point of view is difficult, it should not be difficult to measure the size of a crop or a livestock produced.

            Mathematically, a profit tax can be represented by the following porfit equation:

                        p = R (q) - C (q) - t [R(q)-C(q)] = (1 - t)[R(q) - C(q)]10         (1)

where 0 < t < 1. Setting the derivative of (1) equal to zero,

                                    dp

                                    ---        = (1 - t) [R/ (q) - C/(q)]    =   0

                                    dq

 

since 1 - t ¹  0, R/(q) - C/(q) = 0.  Hence, R/(q) = C/(q).  In other words, the producer  sets marginal revenue equal to marginal cost, as if no taxes were imposed11 (Henderson and Quandt, 1980, pp. 186-188).

            I should emphasize once again that an IKT is not another form of a profit tax.  The comparison to profit tax is offered only as an auxiliary device.  As a matter of fact, since Zakat is an inventory tax, it is not inflected on the flow of profits.  There is in Zakat less weaking of the profit motive.  A profit tax is an income-statement tax, while Zakat (in general) is a balance-sheet tax.  The former is inflicted on the flow of income, while the latter is inflected on the stock of assets.  This is a major difference between Western and Islamic taxes in general.  A tax on a flow may retard it, while a tax on a stock may mobilize it.  More differences shall be explored in the next pages.  Since the IKT has at least the same optimality resuslts of a profit tax, if not better, it can be reasonably compared to it in terms of its impact on government revenues.

II.3      Impact on Geovernment Revenues: Because a profit tax and an in-kind tax are imposed on two different tax bases, we should expect the tax revenues from each to be different.  Under a profit tax, the government parts with a revenue equal to the slice of profit forgone by the producer.  The value of the government revenue under an in-kind tax, however, is equal to the quantity of output collected times the market price.  Applying the same tax rate in each case, revenue from an in-kind tax (IKT) is, of course, larger than that from a profit tax.  In terms of Figure 5, a profit tax may generate revenue to the government equal to abcd, while an IKT (at the same rate) yields a value equal to (Q1 - Q2). P1.

            Figure 5:  Tax Revenue Under Profit and IKT Taxes

 

 

 

 

 

 

            Mathematically, the government tax revenue from a profit tax is

                                                            GTRp = tpp                                          (2)

and the government tax revenue from an IkT is

                                     C                    C

            GTRi   = ti p   +  q  tiq  where    q  is average cost                                  (3)

 

                        = ti (p + C)                                                                             (4)

 

Conclusion: for an tp = ti           ,           GTRi > GTRp.

 

Question:  Find the tax rate tp  that will equate GTRi and GTRp.

 

                                                                        ti (p + C)

                                                            tp =   --------------

                                                                           p

                                                                                      C

                                                            tp =        ti + ti   p

 

If  p is called the gross profit rate, g, then

     c

                                                                                    1                                   

                                                            tp = ti ( 1 +   -----  )                             (5)

                                                                                 g

                                   

It is obvious that tp needs to be (much) greater than ti for the tax revenues to be the same under both schemes.  Differentiating tp with respect to g in (5), we get

                                                            tp              ti

                                                         -----  =   -  ---    <   0    

                                                            g              g2 

 

 

Obviously, the higher the profit rate, g, the lower the tp value required to generate an equal tax revenu generated under an IKT. Or, stated differently, a higher profit rate, g, is required to lower the tp value necessary to generate an equal tax revenue.  Taking the second derivative,

                                    2tp           2ti

                                  -----    =   ------    >   0

                                   g           g3

 

                                   

 

which implies that g has to increase at an increasing rate to lower the tp value, or that tp can be reduced at an increasing rate as g rises.  Alternatively, (5) can be re-written as

                                                              tpg

                                                ti   =  --------                                                    (6)

                                                         1 + g

 

                                    ti             tp(1 + g) - tpg             tp

                                   ----      =   -----------------     =  ------    > 0                    (7)

                                    g                (1 + g)2               (1+g)2

                                   

                                    2ti          -2tp(1+g)                -2tp

                                ------   =    ------------         =   --------   <  0                     (8)

                                 g2           (1+g)4                  (1+g)3

 

From (7) we conclude that as g rise, ti needs to rise too.  The reason for this is that an increase in g also implies an increase in GTRp.   Since tp > ti (for a  revenue-neutral change of the tax scheme), ti needs to rise as GTRp rises.  But equation (8) indicates that ti has to rise at a decreasing rate. The important point here is that an IKT imposes a lower tax rate on a larger tax base than many other taxes.  The incentive for tax evasion under an IKT is expectedly lower.  Some of the other good elements of Zakat as a tax shall be elaborated upon  in the following section.

II.4  Some Elements of a Good Tax

            The goodness of a tax may be discussed from several points such as efficiency, equity, compliance, easiness of administration and evaluation, investment incentives, the impact on taxpayers and tax recipients.....etc.

II.4.1  Efficiency:

            We have already explained that an IKT is inflation-neutral and that a change in the general price level does not push the taxpayers into higher tax brakets (II.1.2).  Also, we have already shown that an IKT does not disturb the optimality conditions in terms of output and prices.  The full incidence of the tax falls upon producers with no welfare loss due to Zakat (II.2)

II. 4.2  Tax Administration, Evaluation and, Compliance

            The estimation of profit may be quite difficult from an economic point of view.  Profit estimation in day-to-day business is the result of business practice and accounting conventions, and a profit tax may become thus too subjective.  Consequently, physical output which can be measured more objectively makes an in-kind tax practically superior.

            The measurement of the tax base in Islam is not affected (at least not directly) by the methods of depreciating assets.  This should provide for taxation neutrality as to the method of depreciation followed.  Such neutrality makes investment less prone to government rules and regulations and more in line with market conditions.  Since Zakat is inflicted on a balance sheet stock, as we indicated earlier, we may argue that neither profits reported will be affected by taxation, nor taxation is affected by reported profits.  The implications (some were already discussed) may go much beyond the weakening of tendencies to underreport economic activities.  In a Western tax system, profits are affected by taxes, and taxes are affected by (reported) profits.

            A profit tax may not be equitable.  A large company reporting a relatively modest rate of profit may pay relatively much less taxes than a smaller company making a larger rate of profits.  It would be inadmissable to argue that the smaller company’s ability to pay is larger just because it is making a larger rate of profit.  In a way, this may be regressive in relation to the size of networth.  McLure (1992) suggests expensing (the deduction of all expenditures in the first year) as an alternative to subjective depreciation methods.  Taxes will be inflicted, according to McLure’s proposal, on cash flow.  But expensing is actually a special case (a form) of depreciation.  Cash flow taxation, though may be superior to profit flow taxation in some respects, yet they share the same problems mentioned above.  Tait (1992) observes that McLure’s Simplified Alternative Tax (SAT) avoids inflation accounting in principle.  But in case “Inflation is high, the SAT still does not cure the problem, because within the annual accounts, asset valuations (for balance sheet purposes I guess) will not be comparable and some inflation adjustment will be needed.”  An in-kind tax, though a balance sheet tax, avoids stock valuation and inflation accounting problems, simply because both the tax base and tax payments are evaluated in physical (real) terms.  Also, and as a I have indicated in II.1.2, a change in the price level will not push asset holders into a different tax bracket and hence an in-kind tax is inflation-neutral.

            It was explained earlier (II.3) that the lower tax rate and the larger tax base under IKT relative to other taxes weakens the incentive for tax evasion.

 

 

II.4.3 The relative impact on Households, Taxpayers and, Tax Recipients

            Since the tax burden under an IKT is fully absorbed by the producers (and not passed on to the consumers), it follows that an IKT has no impact on the expenditure, or the uses side of a household account.  To see this, assume that disposable real income (DRY) of a household is (M&M, p. 240).

 

                                                                            E - Ty               DY

                                                            DRY =   ---------    =       -----

                                                                            P + Ts              GP

 

 

where

 

            E   =  earnings                          Ts  =  sales tax addition to price

                       

            Ty =  income tax                       GP =  is gross (or market) price after tax

 

            P   =  price (at factor cost)        DY =  is disposable money income

                     of products bought

 

Since Ts = 0 under an IKT, it follows that

 

                                                       E - Ty               DY

                                    DRY/   =  ---------    =      -------

                                                          P                     P

 

 

            One has to remember that an IKT is not an income tax.  The point shown here is that, an in-kind tax leaves the household  with a higher level of real disposable income.     An in-kind tax gives a relief to the needy on the downside of output due to a supply shock or when inflationary pressures ensue.  Taxpayers are relieved by an in-kind tax in recessionary periods or shortage of liquidity. Producers will be paying their “debts” to the government in kind at whatever market price it could command.  As far as the needy people are concerned, since these taxes are out of goods that are necessities for the average household in society, the payment of the monetary equivalent will probably not do them much more service12. For if more stock will have to be sold in order to generate money for tax payment, the extra amount will have to be picked up by those who are well-off, but at a lower price.  The expected reduction in revenue from products, the demand of which is usually inelastic, may make it somewhat difficult for producers to pay their dues.

II.4.4 Tax Avoidance and Incentive to Investment

            Zakat is recurrent every year on the same stock of output (in kind in the case of livestock or in market value of commercialized crops13 and other commercialized goods) as long as the stock is not sold or consumed and if the remaining stock is above some minimum exempted level (Nisab).  As a result, hoarding or speculative tendencies are discouraged since the size of the stock shall be decreasing every year14. Speculative storage, however, can take place only to the extent that capital gains, thorugh price appreciation, are expected to exceed the value of the tax payments.  To illustrate, assume for simplicity that the producer’s cost is zero.  Also, assume that the price of the product grows in real terms (i.e., relative to the general price level) at a rate of r percent in any year n.  The revenue function in any year n is Rn = P0 (1 + r)n Q0.  Also assume his stock decreases at a rate of 2.5 percent a year, i.e., at the tax rate.  His revenue function then becomes

                                                                                             Q0

                                                            Rn = P0 (1 + r)n    ------------

                                                                                      (1 + .025)n

 

The equation tells us that although a larger output, Q, may lead to larger revenue, but it also means a larger tax base and payment.  The tax rate acts as a discount rate of the physical stock and total revenue.  Also, since price appreciation is not always the norm, the deterrence of  Zakat against hoarding and speculation becomes  more  powerful over the years, inducing sales and may be lowering prices in the course of time.  Such pressure is more obvious in the case of non-self-reproducing stocks (such as grain), and non-earning-income assets such as non-cultivated, commercialized land.           

            If it is accepted that investment is the process of delayed future consumption, then it does not make sense to tax the means of growth that themselves are not capable of growing, such as land and buildings15. Taxing growables or realized incomes from non-growables may be called the principle of specificity.  Zakat and Kharaj preserve that economic principle.

            Unlike the Western property tax, the fact that Zakat is imposed not only on current output but also on previously accumulated stock of wealth that are directly taxable, such as livestock, commercialized goods16, and money, implies, that the more early in the past an income is earned, the more often it will be subject to tax (Zakat), year after year.  This motivates wealth owners to consume more and/or invest more.  But since consumption is not taxable in an Islamic economic system, at least not by obligatory religious legislation, wealth owners have the incentive to redistribute the-further-in-the-past income towards present consumption, and the-closer-to-the-present  income  towards future consumption i.e., investment.  It is often the case that not all of past accumulated output can be consumed at the present, which implies that some of that output will be redistributed towards the future too, i.e., invested.

II.4.5 A Disgression: Comparisions and Contrasts with a Western Experience

            For the sake of contrast and comparison, it may be useful to discuss briefly an experience from a Western country.  Lindert (1986) reports that in 1982-83 the United States had great difficulty exporting more grain and cotton due to tough competition from highly subsidized products from Britain and France.

            “[G]overment bins were nearly filled to capacity with crops purchased from farmers in earlier years.  The Reagan administration devised the “payment in kind” (PIK) program as a temporary solution.  Farmers were told that for each acre they switched away from growing grain or cotton they would be given, roughly, the estimated grain or cotton crop free from government storage.  This allowed them to slash farming costs, of course, and they were to sell the surplus crops on the market instead of selling freshly grown crops.  The farmers’ response was enormous.

            ......  That is, the government needed more wheat so that it could get farmers to produce less wheat (emphasis added)....  So a new arrangement was quickly devised whereby the farmers took less grain and cotton from the government and more cash payments from the taxpayers instead.

            ......   The United States reversed gears as quickly as possible, scrapping PIK within a year and resuming aggresive subsidized exporting.”  (pp. 244-45).

 

            Direct in-kind subsidies that are used to stabilize the incomes of producers (and sometimes consumers) are not new.  But what could be new is an insight that an in-kind tax may subsidize producers’ incomes!  For if we assume farmers have produced far beyond the competitive equilibrium, an in-kind tax at the rate of 10 percent, say, lifts some of the excess supply and is expected to boost prices (and incomes) by more than 10 percent for products of an inelastic demand.  An in-kind tax, here, acts like an indirect subsidy!  Since farmers, under the Islamic tax law, are not being paid cash in return for their in-kind payments to the government, overproduction is not being encouraged by the government - an opposite arrangement to the American one.  To put it differently, and in-kind tax sounds as if the government is “buying” from the farmers a specific percentage of their output by forgoing the cash equivalent of their tax dues.  The government’s “liability” of purchase is limited, however, to what could have been the pecuniary tax liability of farmers.  By contrast, implicit in the American PIK program is an infinitely elastic demand curve on the part of the Government for farmers’ grain.  There is an important lesson here for us to learn; a very old taxing scheme may provide a very viable solution for some contemporary policy problems.

            In pecuniary taxes, such as a sales tax, the government will have to wait until sales receipts are realized.  Not only this, but waiting for sales will generate a greater uncertainty as to the time and value of the tax to be collected.  The in-kind tax does just the opposite as no waiting of sales17 is allowed and the tax is collected and disposed of in kind.

            Should the need arises, the understanding of the economics of Zakat should help us on the best way to go about designing new taxes.  This is a fourth reason, in addition to the three mentioned in the introduction of the paper, why the study of the economics of Zakat is important.

II.5      A More Appropriate Property Tax?  Another point of comparison between the Islamic system of taxation and the Western one has to do with the taxation on agricultural land.  Ciriarcy-Wantrup (1952) writes:

            “Recurrent (annual) taxes on the present value (emphasis added) of resources may be regarded as a special type of taxes on net revenues.  If present value is the sum of discounted future net revenues, then in each interval (year) in which the tax is paid, net revenues of all future intervals are taxed.  The further, therefore, net revenues are distant from the present, the more often they are subject to the tax.  This  provides  an  incentive  to  redistribute  net  revenues  in  the  direction of the present in order to reduce the number of times they are taxed.  This process continues as long as discounted savings in tax payments are larger than the decrease in present net revenues that would have occurred with such redistribution under pre-tax conditions.  Redistribution of net revenues in the direction of the present can be accomplished only through redistribution of use rates in the same direction.  This means depletion ..... Property taxes, threfore, affect the utilization plan in much the same way as the interest rate” (Wantrup, pp. 178-9).

 

            Under the Islamic economic system, property tax is not levied on the present value of the land but rather on its actual output.  The Islamic tax on agricultural land (Kharaj) has two schemes.  One scheme is called an Area Kharaj, under which the tax is levied according to the area and type of crop.  This is fixed in amount and could be paid in cash, in kind, or a combination of both. (This is in the nature of a lump-sum tax and tend to be regressive).  However, the tax can be amended if it can be proven that farmers cannot afford it.  The other scheme is called a Partnership (Sharing) Kharaj, where some percentage  (a proportional  tax)  of the crop   is to  be paid18. The  authorities can switch back and forth between the two schemes depending on equity and efficiency consideration [Al-Nu’aim, p. 422-7].  Obviously the partnership scheme is a more flexible one.  However, both schemes would alleviate the distortionary effects of a property tax levied on the present value of the land. The Kharaj tax (and Zakat) are not levied on the present value of land, which can hardly be objectively  measured, but on whatever services the land actually renders in the year the tax is collected.  Implicitly, future income streams are taxed only once and only when they actually materialize  and  thus discouraging depleting practices.  This preserves the principle of timeliness.

            Aaron (1974) argues that “the property tax cannot reasonably be regarded as an excise on housing services and other commodities produced with taxed capital.”  He decomposes the incidence of the property tax into three effects: (a) a cpaital tax effect, which is related to the proportion of capital ownership; (b) an excise effect, which may lead to capital movements among regions and industries and may affect the labor share of income; (c) an immobility effect which may influence the prices of local goods and services which may not be subject to competition  from  other  localities,  such  as housing and some labor services.  If we apply Aaron’s analysis to Kharaj, we find that an area Kharaj will produce both of the capital tax effect and the excise tax effect.  A partnership Kharaj would produce only the excise tax effect.  None of the two Kharaj schemes would produce the immobility effect as long as the Kharaj base and rate are the same everywhere.  This is especially true since Kharaj is subjected on the actual output from land  not on land per se.  Of course, the capital tax effect can be eliminated by applying a partnership Kharaj everywhere, and the excise tax effect can be reduced by varying the tax rate.  Mieszkowski (1980 ) explains that “The decline in the proportion of the population engaged in agriculture and in the importance of inhereted farmland (in the United States) have worked to make wage income, or the return to human capital, increasingly important.”  By contrast, an in-kind tax (and payment) helps to maintain the importance of the agricultural sector, not only because of its efficiency and equity to the taxpayers, but also because an in-kind payment, especially of livestock, represents not only an income-consumption subsidy but also a means of investment.  This kind of arrangement coupelled with a legislation that Zakat cannot be transferred anywhere before the needs of the poor in the localities where Zakat is collected are met, helps to prevent the immigration of the poor people from rural to urban areas.  Incidents of farmers in the Western countries killing large numbers of their living stocks, either because of excess supply or drought, are quite known.  If in-kind taxation, along with other measures, were allowed, the direction of immigration in many countries would have been reversed.

II.6:  Equity in Zakat and the Theory of Taxation: Some Concluding Remarks

            The benefit theory of taxation has little place to consider when it comes to Zakat for two reasons.  First, there is the well-known criticism regarding the difficulty of measuring the benefits received by individuals and their unwillingness to reveal their true preferences especially when it comes to public goods (Aronson, 1985, pp. 306-7).  Second, and more important, Zakat revenues are earmarked for categories of people who, for various reasons, may be called “needy.”  There is no occasion here to talk about the measurement of benefits to people who cannot pay taxes.  As Browning and Browning (p. 299) put it, “if some people are taxed to provide funds to redistribute to other people, we cannot tax the recipients according to the benefits they receive, for that would completely negate the effects of the redistribution.”  The benefit theory of taxation may have some relevance when it comes to the discussion of Kharaj for which there is no jurisprudence earmarking.  But since we are not analyzing the expenditure side of Islamic taxation, we are not going that far.

            There are three different concepts of equal sacrifice in the ability-to-pay theory.  These are equal absolute sacrifice, equal proportional sacrifice, and equal marginal sacrifice.  It is important to note here that the word “sacrifice” does not refer to income, but to utility from income.  The subjective, utility-based, analysis of these equity concepts is not operational simply because the whole discussion rests on the necessary assumption that “interpersonal utility comparions are admissable.”  “Yet it is an assumption generally rejected by the ‘new’ welfare economics.” (Musgrave, 1959). But let’s suppose, for the sake of the argument, that personal utility curves can be assigned and compared.  Since utility is a function of comprehension, it follows that an infant, who is somehow wealthy, should be taxed more than an equally-wealthy, grown-up person.  Also, an insane person should be taxed more than an equally-wealthy, sane person.  Thus the view of equal marginal sacrifice implies that taxes should be regressive with age and sanity too!!  The idea of minimum aggregate sacrifice may endanger economic incentives by taxing some people at much higher progressive rates than others, and thus may create a compliance problem, especially as the tax rate reaches confiscatory levels (Aronson, p. 310).

            The Islamic system of taxation avoids in rem taxes, since taxes are imposed on asset-holders (persons), not on the activities or objects as such.  M&M (p.215) explain that such aviodance relates the payments of taxes to the taxpayers’ ability to pay and provides for more equity in the tax system.   It may be reasonable to conclude, then, that the Islamic taxation system is more in line with the ability to pay theory of taxation.  Since each type of wealth has its own treatment in terms of Zakat in Islam, it can be said that  people who hold the same type of wealth shall receive the same tax treatment.  This provides for horizontal equity which “requires that people who are deemed to be in an equal economic position should pay the same amount in taxes” (Aronson, 1985, p. 305).  Also those who have more shall pay more. This provides for vertical equity. It may be more appropriate to look at taxation in Islam (that is proportional) as more in line with the idea of equal proportional vertical sacrifice.  Under normal circumstances, individuals are treated individually. The index of the ability to pay is neither income nor consumption.  Instead, it is the inventory stock of what can be consumed (but is not) or what is intended to be traded (but is not), or what can be spent (but is not.)

            The reader may have noticed that there is some uniformity in the tax (Zakat) rates in Islam, where all agricultural products are taxed at the same rate (5 to 10 percent) and all commercialized goods are taxed at 2.5 percent.  Atkinson and Stiglitz (1980,p.366) explain that:

            [A]ccording to convetional wisdom, there is a definite preference for a uniform rate structure, and this view appears to influence government policy-making.  The British Government, when announcing the introduction of a value added tax claimed that:

                       

                     “a more broadly-based structure... by discriminating less between different types of goods and services, would reduce the distortion of consumer choice... Selective taxation gives           rise  to  distortion  of  trade  and of personal consumption Patterns, and  can  lead  to  the  inefficient  allocation  of  resources.”  (HMSO, 1971, p]”

 

 

            The standard textbook analysis however is in contrast with the view of the British Government.  When the excess burden is to be minimized subject to a government revenue constraint, it is argued that the optimal tax rate on any good is inversely related to its price elasticity of demand (p. 369).  Atkinson and Stiglitz note that this finding “is often regarded with considerable skepticism.”  When the problem is posited in an indirect utility-function (of prices and wage) subject to a production constraint, we are warned to be careful not to conclude the optimality of uniform taxes from the first order conditions of the model.  Two reasons are given to us.  “First, the specification of the tax rates may not uniquely determine the behavior of the system.  Second, there may be more than one solution to the first order conditions.” (p. 374).

            The conclusions of the papers discussed in Atkinson and Stiglitz (1980) are based on the assumption that proportional taxes cause market prices to rise.  However, if our demonstration in this paper that an in-kind tax does not affect market prices is taken as valid, then the Atkinson-Stiglitz conclusions do not follow.

            If the problem of taxation is looked at from the view that each producer is also a consumer, then the uniformity in taxing all goods should intuitively make sense from an equity perspective.  It could very well happen that a person’s production and consumption bundles are taxed differently from those of another person’s if uniformity in taxation is not maintained.  The case should be more apparent if we remember that it is much easier to think of a “representative” consumer than a “representative” producer.  There is usually much more heterogenity in production than there is in consumption.  This is especially true the more advanced the economy is.

Summary

            Zakat is a major form of Islamic taxation,  a form of worship, and one of the pillars of Islam.  There are six general requisite conditions for Zakat to be collected.  These are: Absolute ownership, accretion, Nisab (or some minimum level of a wealth stock) that differes from one type of wealth to another, the excess over one’s basic needs, absolvency from debt, and the elapsing of one lunar year of the stock to be taxed.  Livestocks of camels, cattle, sheep and goats are all taxed in kind.

            Agricultural products that are durable and storable, such as wheat and rice are taxed in-kind, while perishables are taxed in their value.  The treatment for both, however, is the same in terms of “Nisab” and tax rates.  The tax rate is 10 percent if land is irrigated by rain, springs, or if the plant is self-seeking of water by its roots.  Products that are irrigated at some cost, by digging wells for example, are taxed at a rate of 5 percent.

            Kharaj is another form of an in-kind tax levied on land that was captured by force or settlement but was not distributed among the individuals of the capturing army, and thus becomes a national property.  Its inhabitants may still cultivate it as long as they pay tax (Kharaj) to the state.  There are two schemes of Kharaj, one is a fixed lump sum that varies with the area of land, and another that is proportional to the produce of land.

            The effective tax rate on livestocks is quasi-progessive (-proportional) in the sense that different amounts are collected at different intervals of the stock, the amount being charged is on the whole stock and not on the increment of  the stock.  In other words, a new single tax amount is applied on the whole tax base at different levels of the base.  Marginal and average tax rates change together, but they are equal to each other at each level of wealth.  The tax rates on livestock are inflation-neutral since both the tax base and payment are measured in real (physical) terms.

            It has been shown that an in-kind tax is an inventory tax and is just like a profit tax, a lump-sum tax and tax on rent in the sense that it has no distoritonary effects on output and prices and hence there is no deadweight loss associated with it.  An in-kind tax, however, is practically superior since it is much easier to measure the size of crop or livestock than to measure the actual surplus under the other taxes.  The incidence of taxation falls entirely on the producers.

            A profit tax and an in-kind tax have different impacts on the government’s revenue since they are imposed on two different tax bases.  for the same tax rate the latter is larger than the former.  for a revenue-neutral change of tax schemes and rates, a profit tax rate must be larger than that of an in-kind tax.  Higher profit rates reduce the required profit tax rate.  Convrsely, it was shown that at higher profit rates, an in-kind tax need to rise (for a neutral revenue), but at a decreasing rate.

            Some elements of good tax are discussed.  The Islamic system of taxation avoids in rem taxes, since taxes in Islam are imposed on asset-holders (persons), not on activities or objects as such.  As a result the payment of taxes is related to the taxpayer’s ability to pay and provides for more equity in the tax system.  Since the tax burden is fully absorbed by producers, an in-kind tax has no impact on the expenditure, or uses, side of a houdehold account.  A household is left with higher real disposable income when compared to his income under a sales tax, for example.  Speculative tendencies are discouraged by the fact that Zakat is recurrent every year on the same stock of livestock, and commercialized crops and goods, as long as the stock is not sold or consumed.  The tax pressure is felt more and more over the years; inducing sales and maybe lowering  prices in the course of time.  Such pressure is stronger in the case of non-self-reproducing and non-earning-income assets such as grain and non-cultivated, commercialized land.  An in-kind tax gives a relief to the needy on the downside of output due to a supply shock, or when inflationary pressures ensue.   Taxpayers are relieved by an in-kind tax in recessionary periods or shortage of liquidity.

            An in-kind tax may be compared and contrasted to a Western experiment.  If farmers produced far beyond the competitive equilibrium, an in-kind tax lifts some of the excess supply and thus is expected to boost prices (and incomes for farmers) for products of an inelastic demand.  An in-kind payment to the government does not encourage overproduction.  This is an opposite arrangement to the American PIK program during the Reagan administration.  The government’s “liability” is limited to “buying” a specific percentage of the farmers’ output by foregoing the cash equivalent of their tax dues to her.  Implicit in the American PIK program is an infinitely elastic demand curve on the part of the government for farmers’ grain.

            Unlike the Western System of taxation, under the Islamic taxation, property tax is not levied on the present value of the expected benefits of land, but on its actual output when the tax is collected.  This provides for two principles of good taxation - specify and timeliness.  While the Western property tax may call for a redistribution of future benefits to the present (causing depletion of resources), the Islamic taxation system does just the opposite.  Wealth owners are motivated to redistribute the further-in-the-past income towards present consumption and the-closer-to-the-present income towards future consumption (i.e., investment).

            Zakat is more in line with the ability-to-pay theory of taxation, than it is to the benefit theory since the recipients are generally needy and cannot pay taxes.  Horizontal equity is provided for by the fact that the people who hold the same type of wealth shall receive the same tax treatment.  Vertical equity is provided for by the fact that those who have more pay more.

            The Atkinson-Stiglitz caution about inference on the optimality of uniform taxes may not be applicable in the case of  Zakat (and Kharaj) since their analysis assumes that proportional taxes raise prices.  If our analysis that Zakat does not influence prices is valid, then the Atkinson-Stiglitz skepticism may not be applicable in the case of Zakat and Kharaj.

References

Aaron, Henry, “The Property Tax: Progessive or Regressive?  A New View of Property Tax Incidence”.  American Economic Review, May, 1974.

 

AlGardawi, Yousuf, “Fiqh AlZakat”, Arresalah, Beirut, Lebanon, 1969/1991, 25th Ed., Vol. 1 (in Arabic).

 

Annu’aim, Abdulaziz, “Taxation System in Islam”, Dar Alittihad, Cairo, Egyp, 2nd Ed., 1975 (in Arabic).

 

Aronson, J. Richard, “Public Finance”, McGraw-Hill Book Company, 1985.

 

Arryyes, Mohammad Diya’Uddeen, “Al Kharaj and The Fiscal System of the Islamic State,” Dar Atturath, Cairo, Egypt, Fifth Ed., 1985 (in Arabic).

 

Atkinson, Anthony and Joseph Stiglitz, “Lectures on Public Economics,”
 McGraw-Hill Book Company, New York, N.Y., 1980.

 

Browning, Edgar and Jacquelene Browning, “Public Finance and The Price System,” MacMillan Publishing Co., Inc., New York, 2nd Ed., 1983.

 

Ciriacy-Wantrup, S.V. “Resource Conservation Economics and Policies,” University of California Press, Berkeley & Los Angeles, 1952.

 

Eichner, Alfred A., “The Macrodynamics of Advanced Market Economies.” Armonk, N.Y.: ME. Sharp, 1991.  But the quote was taken from Rima, Ingrid H.  “The Megacorp and Macrodynamics: Essays in Memory of Alfred Eichmer: A Review”, Journal of Post Keynesian Economics, Vol. 16, No. 2, Winter 1993-94, pp.. 189-95.

 

Ghavari, Firouz, “In-Kind Versus Cash Transfers in The Presence of Distortionary Taxes”, Economic Inquiry, Vol. XXXIII, January 1995, 45-53.

 

Henderson, James and Richard Quandt, Microeconomic Theory: A Mathematical Approach,” McGraw-Hill International Book Company, 3rd Ed., 1980.

 

Lindert, Peter H., “International Economics,” Irwin, Homewood, Illinois, 8th Ed., 1986.

 

McLure, Charles E., “A Simple Consumption-Based Alternative to the Income Tax for Socialist Economics in Transition,”  The World Bank Research Observer, Vol. 7, No. 2, July, 1992, pp. 231-37.

 

Mieszkowski, Peter, “The Advisability and Feasibility of an Expenditure Tax System” in Aaron, Henry and Michael Boskin, eds.  The Economics of Taxation, Washington, D.C.:Brookings Institution, 1980.

 

Musgrave, Richard and Peggy Musgrave, “Public Finance in Theory and Practice,” McGraw-Hill Book Company, 5th Ed., 1989.

 

Musgrave, Richard, “The Theory of Public Finance”, New York: McGraw Hill, 1959, Chap. 5, pp. 90-115.

 

Phelps, Edmund S., “Profits Theory and Profits Taxation,”.  IMF Staff Papers, Vol. 33, No. 4, December, 1986, pp. 674-96.

 

Qur’an (S. IX, Section 8, verse 60), Translation and Commentary by Abdallah Yousuf Ali, Dar Alfiqer, Beirut.

 

Schiller, Bradley R., “The Economy Today,” McGraw-Hill, Inc., 5th Ed., 1991.

 

Shehata, Shawgi, “The Contemporary Application of Zakat.” Dar Al Shroog, 1977 (in Arabic).

 

Tait, Alan A., “A Not So-Simple Alternative to the Income Tax for Socialist Economics in Transition: A Comment on McLure.”  The World Bank Research Observer, Vol. 7, No. 2, July, 1992, pp. 239-48.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

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