1. 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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2. 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. 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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4. 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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5. 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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6. 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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7. 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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8. 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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9. 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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10. 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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11. 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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12. 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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13. 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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14. 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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15. 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 Welfare and diplomatic expenditure
Islam
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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16. 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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17. 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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18. 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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19. 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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