Sunday, June 23, 2013

Gaming Islamic Tax

My previous post mentioned zakat, the Islamic religious tax. An earlier post discussed the question of how strongly religious believers actually believe, where religion lies on the range between a pretty story and a real fact, between belief in Santa Claus and belief that the sun will rise tomorrow.

It occurs to me that the behavior of Muslims with regard to zakat provides one possible way of investigating the question. With zakat, as with most tax systems, a clever taxpayer can adjust his behavior to minimize the amount he owes. Someone paying because the state forces him to or because his neighbors will see him as a bad Muslim if he doesn't would presumably try to arrange his affairs to minimize taxes. Someone who is paying because God will reward or punish on the basis of perfect information about what he does and why or someone paying because he believes that he ought to do what God wants should be less willing to try to game the system.

How could one do so? Zakat consists of two categories. One is a fixed percentage of output for certain agricultural crops—ten percent for crops that are not irrigated, five percent for crops that are. The other is a capital levy of 2.5% on certain forms of wealth—gold and silver (except for jewelry) and a merchant's trade goods. For both, there is a minimal level below which no tax is owed. For agricultural crops it is something on the order of half a ton a year of dry produce, low enough so that a small farmer might choose to try to hold his output just below the cutoff so as not to have to pay any tax on it. If one had good data on agricultural output by individual Muslim farmers in a place where zakat was paid, it would be interesting to see whether farms producing crops that zakat was due on tended to produce quantities just below the cutoff.

The other category provides at least two different and more effective tactics for minimizing taxes. To begin with, gold and silver are taxable if held as wealth but not if used as jewelry.  Convert your working cash into jewelry, convert it back when needed for your business, and you avoid most of the tax. It would be interesting to see whether Muslim populations are more inclined to hold wealth as gold and silver jewelry than other populations that are in other ways similar.

The second tactic is based on the fact that the tax on a merchant's trade goods is based on the weight of the gold or silver for which they were purchased. Here again, there is a minimum value below which no tax is due. The weight of silver below which no tax is due is about eight times the weight of gold below which no tax is due. If the price ratio between gold and silver was eight to one, which isn't too far off what it was in the Middle Ages, the quantity of trade goods on which tax was owed would be the same whether they had been bought for gold or silver. 

Currently, an ounce of gold is worth about sixty-five times as much as an ounce of silver. That means that the minimum value of trade goods on which tax is due is about eight times as high if the goods were bought for gold than for silver. It would be interesting to see whether, in countries where zakat is collected according to the traditional rules, merchants, especially small merchants, deliberately arrange to do business in gold instead of silver in order to stay below the level at which it would be due.

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At 1:29 PM, June 23, 2013, Anonymous Nathan said...

I'm afraid I don't have a source for this at the moment, but I remember reading that in Pakistan, the zakat is enforced by the government on a particular day once a year. In the days leading up to that date, lines at banks are out the door as customers withdraw every penny from their accounts, only to redeposit after the day of reckoning.

Another point I would like to make is that efforts to avoid the tax don't necessarily show insincerity of belief. Muslims may believe, as do Orthodox Jews, that God set up both the rules and the loopholes, and that taking full advantage is not forbidden, as long as one follows the letter of the law.

However, the example from Pakistan does seem to be genuine evidence of non-belief, as the fixed collection date which applies only to money in bank accounts, not to cash, is a rule that has no basis in Islamic law, but is rather a government policy instituted solely for convenience. Any Muslim who avoids paying the tax by conveniently withdrawing and redepositing two days later may be fooling the government, but he knows he's not fooling God, which means he probably doesn't actually believe or care all that much.

In fact, since Islam promises an eternal paradise or an eternal Hell, it seems that someone who takes any action which could reduce his chances of paradise, even to the slightest degree, must either:

1) Assess the likelihood of such a system to be 0% or
2) Have an infinite temporal discount rate.

At 2:30 PM, June 23, 2013, Blogger David Friedman said...

Islam doesn't, as far as I can tell, promise an eternal hell to Muslims who have violated legal rules. As long as their violation doesn't go far enough to classify them as non-muslims, the penalty is, I think, a finite period of torment before they are admitted to heaven.

At 5:11 PM, June 25, 2013, Anonymous Ricardus said...

Here's another interesting way to test the question. I'd love to hear your thoughts on it.

At 5:31 PM, June 27, 2013, Anonymous Rick said...

Mr Friedman, did you know that your father was Keynesian?
Who would have thought it!

At 9:58 PM, July 17, 2013, Anonymous Anonymous said...

I think the premise that assessing zakat dilligence reflects on faith is bit thin, because faith itself is irrational. To have faith in most cases, that of anyone who reads the koran with a certain level of education, requires some form of cognitive disjunction. Not paying zakat properly is just another example of this cognitive disjunction.


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