That Ramadan is in full fledge makes this a good time to discuss the principle of zakat. I should emphasize that I am not Muslim, and so, am observing this from the outside as an economic phenomenon and idea. The Word of God part is quite beyond me.
As we all know the essential idea is that an observant Muslim should distribute 2.5% of their surplus wealth each year to the needy. This zakat is a duty, an obligation, not a target that only those so disposed should just try to meet.
The aim is, formally at least, that those needy are enabled to rise above their poverty through access to economic resources. In the background, we can see some sensible economic planning, in that wealth should indeed be circulated.
The idea, the aim, to an economist seems to be entirely sensible. There are a couple of little cavils, quibbles perhaps, which come to mind though. Note again, this is as an observer who is not Muslim -- that this is a religious obligation is not my department at all.
The first is the definition of what is that surplus. By the gold standard the Nisab -- the amount which is not surplus wealth -- is some 85 grams of gold. Some $3,600 in today’s money that is. This is not, by today’s standards, a considerable sum of money.
In a rich country that’s about one month’s wages -- not right but of about the right sort of order of size. Or the price of a reasonable second hand car perhaps (actually, at that price, third or fourth hand car).
Back when the standard was set, it was more like five years’ average income. For up until about 1750 and the start of the Industrial Revolution, incomes in general never did rise much above $600 a year in modern money. I know that’s difficult to believe, but that is so -- all of history really was variations around that $1.50 to $2.00 a day, what we now call absolute poverty.
Note that this is after inflation has been taken account of. What has changed is that for much of the world, incomes have risen considerably -- but our Nisab, the measure of what is the minimal level of wealth one may keep for oneself, has not.
We can quibble all we like about the details but it has gone from something like many years’ average income to more like a month’s average income in one of today’s rich countries. That’s something of a change.
The second observation is that the rate at which zakat is levied -- 2.5% -- is quite high for the modern world. Economists have always been wary of wealth taxes. If it’s a decently high rate then everyone wealthy has to sell some portion of their holdings to pay a 10% or 20% tax.
If every wealthy person must sell at the same time, then the value of those holdings fall as the market is flooded -- who but the wealthy, all of whom are selling, can afford to buy them after all? Thus, the argument is that if we are to have a wealth tax then it should be linked to the amount that you can earn from that wealth each year. To the income it generates, not the stock of wealth itself.
Back when the zakat rate was set, that 2.5% rate was well within such a limit. We know that the rate of return to capital -- similar to, but not exactly the same as, the interest rate -- has fallen substantially over the centuries. Medieval Europe had annual interest rates of 10% and 20%, records from the Levant (our name for the trading nations of the Middle East) show similar sorts of numbers.
If you can make 20% on your capital and you must give 2.5% of the capital to the poor, then that’s, roughly and without a calculator, 10% or a little more of your income from your capital.
This avoids that problem that all must liquidate some part of their capital holdings in order to pay the tax or levy. There’s also the point that we’re rather happy with capital continuing to accumulate over time, as more capital to do things with is one part of what makes society generally richer over time. Capital accumulation at a societal level at least, is a good thing.
But high rates of return to capital in the past have been replaced by much lower rates these days. If you are invested in, say, the London Stock Market, you are making 4% return on your capital.
After a 2.5% wealth levy and inflation you’re making nothing. And if you’re in bonds then this past decade has meant you losing money in nominal terms, let alone after we take inflation into account.
This is not just something special to these past few years after the financial crisis. The rate of return to capital has been falling for centuries. As we’d expect, each generation is saving and adding to the stock of capital available to society. When there’s more of something, the price declines. A decreasing return to capital is an expected result of there being more capital.
An economist, when given a blank sheet of paper, might well come up with something like the zakat. A societal duty from the fortunate to those less so, why not?
A modern economist would also rather insist upon the Nisab being set at a substantially higher number and the zakat at a lower rate. Or, perhaps, one or the other should change, the rate kept but the number raised, or the number kept static and the rate lowered.
The economist is also aware that what he says has absolutely no influence upon the Word of God -- nor should it. All of the above is therefore only an observation or two.
Tim Worstall is a Senior Fellow at the Adam Smith Institute in London.