FISCAL POLICY IN AN ISLAMIC ECONOMY AND THE ROLE OF ZAKAT

Abstract

This study incorporates zakat into a simple macroeconomic model of an Islamic economy and analyzes the role of zakat in the national income determination. The reduced form aggregate consumption function suggests that the determinants of consumption are: Zakat expenditure, taxes, income and asset holdings of individuals. Zakat could be used as a counter-cyclical policy through discretionary and non-discretionary fiscal policy. Discretionary fiscal policy is carried out by varying the disbursement of zakat to the recipients. During the expansion phase of the business cycle, the government reduces zakat expenditure to close the inflationary gap. This action helps increase the zakat surplus, in the Baitul-Mal. Likewise zakat expenditure could be increased by using the zakat surplus accumulated during the boom periods, when the economy is in the down-swing to spur aggregate spending and economic activities. Therefore, zakat could complement taxation and government spending as tools of stablization policy.

JEL classification: E20, E62, H30

Key words: Fiscal policy, Islamic economy, Zakat.