Ibn Khaldun’s Theory of Taxation and its Relevance Today (Cont'd)
Previous | 1 | 211. Tax rate vs. tax revenue
It seems that Ibn Khaldun has fully perceived that tax rates and tax revenues are two distinct things. A high tax rate is no guarantee that it will maximize tax revenues. Rather, it will be showing a diminishing revenue after a certain stage. Because higher tax rates discourage work effort and encourage tax avoidance and even tax evasion, the tax base will shrink as the rates increase. Therefore, an increase in a tax rate causes a less than proportional increase in tax revenue. It is very obvious that at a tax rate of zero percent, the government would collect no tax revenues, no matter how large the tax base. Likewise, at a tax rate of hundred percent, the government would also collect no tax revenues because no one would willingly work for an after-tax gain of zero (i.e., there would be no tax base).
Figure 8: Front cover of Ibn Khaldoun: Un génie maghrébin (1332-1406) by Smaïl Goumeziane (Paris: Editions Non Lieu, 2006).
Between these two extremes there would be a tax rate that would collect the maximum amount of revenue. But a government in its initial stage does not require to opt for maximum-income rate because the life is simple and a lower than maximum income level is sufficient to meet the needs. Only at its full grown socio-economic and political structure the state would resort to higher rate for higher revenue. Ibn Khaldun himself states that expenditure was higher when the kingdoms were in their heyday than when they were in decline. Expenditure could then be covered without the state having to oppress and ransom the population: "The ruler and his entourage are wealthy only in the middle period of the dynasty" (II:97). As soon as it crosses that maximum income level, a kind of vicious circle starts. A still higher rate results a decline in revenue and a declining revenue induces to further increase the tax rate (cf. II: 91-92).
More revenue at moderate rate and less revenue at an excessive rate may also be explained in term of two different effects - the arithmetic effect and the economic effect – which the tax rates have on revenues. The two effects have opposite results on revenue in case the tax rates are increased or decreased. According to the arithmetic effect if tax rates are lowered, tax revenues will be lowered by the amount of the decrease in the rate. The reverse is true for an increase in tax rates. The economic effect, however, recognizes the positive impact that lower tax rates have on work, output, and employment - and thereby the tax base - by providing incentives to increase these activities whereas raising tax rates has the opposite economic effect by penalizing participation in the taxed activities. At very high tax rate negative economic effect dominates positive arithmetic effect, therefore, the tax revenue declines.
12. Principles of taxation
While presenting his ideas on taxation Ibn Khaldun emphasized various principles that must be observed to have a sound taxation policy, such as equity and efficiency, justice and neutrality, ability to pay, economy, benefit and convenience principles. In imposition of taxes justice and ability to pay must be observed. "Do not ask for more than is tolerable. Do not charge anyone too much. Treat all the people justly. This makes it easier to gain their friendship and it is more certain to achieve general satisfaction" (II:150).
He warns of the bad consequences of violation of equity, efficiency and benefit principles when he says: "The assessments increase beyond the limits of equity. The result is that the interest of the subjects in cultural enterprises disappears, since when they compare expenditures and taxes with their income and gain and see the little profit they make, they lose all hope. Therefore, many of them refrain from all cultural activity. The result is that total tax revenue goes down, as (the number of) the individual assessments goes down" (II: 90-91). The characteristics universally associated with a good tax system are fairness, simplicity, least interference with economic decisions as also certainty, stability and acceptability by the taxpayers. All these elements of a good tax system are implied in Ibn Khaldun's statement. He also reminds of the bad consequences of injustice and discrimination in matter of taxation, discussed in the following section.
13. Consequences of injustice and discrimination in tax imposition
In addition to excessive and oppressive rate of taxation, injustice and discrimination results in decline in tax revenue. Ibn Khaldun makes a detailed analysis of the extortion that characterised the north African states during the period of their decadence:
Figure 9: A page from an Arabic Ottoman manuscript from the Secretum Secretorum attributed to Aristotle (MS Reis el-Kuttap, Asir I, 1002.) The Secretum Secretorum (The Secret of Secrets) otherwise known as The Education of Princes was a popular medieval book. It first came to Latin from Arabic from Syriac translations of a supposed Greek original attributed to Aristotle. The Arabic text is attributed to Ikhwan al-Safa of Basra (10th Century) who report to have taken the bulk of it from the translation of Yahia ibn al-Batriq, a Christian from Syria. This book captured the attention of Ibn Khaldun who quotes and analyses it at length in his Muqaddimah. (Source).
"Injustice brings about the ruin of civilization… Attacks on people's property remove the incentive to acquire and gain property. People, then, become of the opinion that the purpose and ultimate destiny of acquiring property is to have it taken away from them. When the incentive to acquire and gain property is gone, people no longer make any efforts to acquire any. The extent and degree to which property rights are infringed upon determines the extent and degree to which the effort of the subjects to acquire property slackens" (II:103).
"The proven fact is that civilization inevitably suffers losses through injustice and hostile acts… and it is the dynasty that suffers there from. Injustice should not be understood to imply only the confiscation of money or other property from the owners without compensation and without cause… it is something more general than that. Whoever takes someone's property, or uses him for forced labour, or presses an unjustified claim against him, or imposes upon him a duty not required by the religious law, does an injustice to that particular person. People who collect unjustified taxes commit an injustice. Those who infringe upon property rights commit an injustice. Those who, in general, take property by force by force commit an injustice. It is the dynasty that suffers from all these acts, in as much as civilization, which is the substance of the dynasty, is ruined when people have lost all incentive" (II:106-07).
"One of the greatest injustices and one which contributes most to the destruction of civilization is the unjustified imposition of tasks and the use of subjects for the forced labour" (II:108-109). In fact, justice is inevitable not only in tax policy. It is the basis of an entire system. "The religious law persists only through royal authority. Mighty royal authority is achieved only through men. Men persist only with the help of property. The only way to property is through cultivation. The only way to cultivation is through justice. Justice is a balance set up among mankind" (II:105).
From the preceding quotes, it is clear that Ibn Khaldun considers injustice as the most injurious and deleterious to the health of the government. It may be noted that the decline in the volume of trade forced the North African states, which required a relatively high budget if they were to function, to tax the population increasingly heavily. This proves that, prior to the period of ‘decadence', a major proportion of the state budget must have derived from taxes on trading profits. The taxes permitted by Islamic Shari'ah were not enough to supply the states with the huge resources they needed if they were to last and if their apparatus were to function properly. These states never established a regular, efficient fiscal system. So they had to resort to illegal methods and to what Ibn Khaldun called ‘injustice'.
A very close form of injustice is discrimination. Ibn Khaldun is especially against any discrimination in imposition of taxes. "Do not make a noble man (sharif) pay less because of his nobility, or a rich man because of his wealth, or one of your secretaries, or one of your intimates and entourage" (II:150). The reason is clear: people may tolerate an unjust tax if levied justly on all tax payers. But they express resentment if some of them are exempted or lightly taxed.
14. Ibn Khaldun - a forerunner of supply-side economics
Ibn Khaldun's ideas on tax cuts are "comparable with those of supply-side economics" (Baeck, 1994, p. 117) . He has rightly been considered as the forerunner of Laffer's curve , 600 years before Laffer (Lipsey and Steiner 1981, p. 449). Arthur Laffer himself, who popularized during the 1980s the notion that higher tax rates may actually cause the tax base to shrink so much that tax revenues will decline, gave the credit for invention of Laffer's curve to Ibn Khaldun (Laffer, 2004) .
Laffer has honestly and earnestly admitted: "The Laffer Curve, by the way, was not invented by me. For example, Ibn Khaldun, a 14th century Muslim philosopher, wrote in his work The Muqaddimah: 'It should be known that at the beginning of the dynasty, taxation yields a large revenue from small assessments. At the end of the dynasty, taxation yields a small revenue from large assessments'" (Laffer 2004).
14.1. Empirical evidences from the United States' economy
Empirical studies of tax cuts that took place in USA during the twenties, sixties and eighties support Ibn Khaldun's theory of taxation and show that it is still vital and well-suited if similar conditions are found. "Prodded by Secretary of the Treasury Andrew Mellon, three major tax cuts reduced the top marginal tax rate from 73 percent in 1921 to 25 percent in 1926. In addition, the tax cuts eliminated or virtually eliminated the personal income tax liability of low-income recipients. The results were quite impressive. The economy grew rapidly from 1921 through 1926. After the rates were lowered, the real tax revenue (in 1929 dollars) collected from taxpayers with incomes above $50,000 rose from $305.1 million in 1921 to $498.1 million in 1926, an increase of 63 percent" (Gwartney 2006).
The results of the Kennedy-Johnson tax cuts of the mid-sixties were similar. "Between 1963 and 1965, tax rates were reduced by approximately 25 percent. The top marginal tax rate was cut from 91 percent to 70 percent. Simultaneously, the bottom rate was reduced from 20 percent to 14 percent. For most taxpayers the lower rates reduced tax revenues. In real 1963 dollars the tax revenues collected from the bottom 95 percent of taxpayers fell from $31.0 billion in 1963 to $29.6 billion in 1965, a 4.5 percent reduction. In contrast, the real tax revenues collected from the top 5 percent of taxpayers rose from $17.2 billion in 1963 to $18.5 billion in 1965, a 7.6 percent increase. As in the case of the tax cuts of the twenties, the rate reductions of the sixties reduced the tax revenue collected from low-income taxpayers while increasing the revenues collected from high-income taxpayers" (ibid).
During the 1980s, the policy of tax cuts used by president Reagan is generally referred to Reagonomics. "Major tax legislation passed in 1981 and 1986 reduced the top U.S. federal income tax rate from 70 percent to approximately 33 percent. The performance of the U.S. economy during the eighties was impressive. The growth rate of real GNP accelerated from the sluggish rates of the seventies. U.S. economic growth exceeded that of all other major industrial nations except Japan" (Gwartney 2006).
In an article, Laffer (2004) has shown through data of "Before and After: Total Income Tax Revenue" during the years from 1978 to 1986 that in USA during the 1980s ‘across-the-board marginal tax-rate cuts resulted in higher incentives to work, produce, and invest, and the economy responded. Between 1978 and 1982, the economy grew at a 0.9 percent annual rate in real terms, but from 1983 to 1986 this annual growth rate increased to 4.8 percent. Prior to the tax cut, the economy was choking on high inflation, high interest rates, and high unemployment. All three of these economic bellwethers dropped sharply after the tax cuts'. Another proof comes from Gwartney in his article on "Supply-Side Economics". He says: "Probably the most detailed study of the tax changes in the eighties was conducted by Lawrence Lindsey of Harvard University. Lindsey used a computer simulation model to estimate the impact of the eighties' tax-rate changes on the various components of income. He found that after the tax rates were lowered, the wages and salaries of high-income taxpayers were approximately 30 percent larger than projected. Similarly, after the rate cuts capital gains were approximately 100 percent higher than projected, and high-income taxpayers' business income was a whopping 200 percent higher than expected."
It may be noted that the policy of tax cuts provided the political and theoretical foundation for a remarkable number of tax cuts in the United States and other countries during the eighties. "Of eighty-six countries with a personal income tax, fifty-five reduced their top marginal tax rate during the 1985-90 period, while only two (Luxembourg and Lebanon) increased their top rate. Countries that substantially reduced their top marginal tax rates include Australia, Brazil, France, Italy, Japan, New Zealand, Sweden, and the United Kingdom" (Gwartney, 2006).
Ibn Khaldun's view of taxation offers a useful example of how an economic concept can be reapplied in an entirely different setting. As insightful as this view undoubtedly was for the times he lived in, one would think that it might not seem to be applicable to the modern age of democratic governments, because no elected government would ever raise tax rates beyond the point where tax revenues would fall. But the experiences of United States and many other countries show that it is viable even in a changing situation if the tax rates cross the optimum taxation limit. According to Laffer (2004), "the higher tax rates are, the greater will be the economic (supply-side) impact of a given percentage reduction in tax rates. Likewise, under a progressive tax structure, an equal across-the-board percentage reduction in tax rates should have its greatest impact in the highest tax bracket and its least impact in the lowest tax bracket."
14.2. The Indian experience
The last two decades of the Indian experience also supports the soundness of Ibn Khaldun's theory of taxation based on tax rates cut. Influenced by the propounders of the supply-side economists, the Indian authorities also brought a tax reform applying the tax rates cut policy and experienced good effects on tax revenue collection. That policy still continues in spite of political changes. Recently, Jude Wanniski authored an article entitled "India swings on the Laffer curve" in which he wrote: "One clear reason can be found in a headline in Bloomberg's financial network on 11 January 2005, over a story by Andy Mukherjee writing from Singapore: "India's Tax Plan May Again Bet on Laffer Curve." I was most pleased to read that Finance Minister P Chidambaram is hinting at a "massive" change in the country's tax system, slashing tax rates on personal and corporate incomes in a second gamble on "the Laffer Curve", which Chidambaram mentions by name as an idea he has embraced with enthusiasm" (Wanniski 2006).
Wanniski further writes: "The concept became the foundation for president Reagan's supply-side tax cuts in 1981 and 1985 that brought top rates on personal income to 28% from 70% in 1980, and slowly but surely countries around the world are experimenting with it - the former communist countries of Russia and Eastern Europe, the People's Republic of China, and most notably India and the other countries of the Asian subcontinent" (ibid).
In addition to the United States and India, tax reduction policy has been adopted throughout the world in the late eighties. ‘Of eighty-six countries with a personal income tax, fifty-five reduced their top marginal tax rate during the 1985-90 period, while only two (Luxembourg and Lebanon) increased their top rate. Countries that substantially reduced their top marginal tax rates include Australia, Brazil, France, Italy, Japan, New Zealand, Sweden, and the United Kingdom" (Gwartney 2006).
15. Criticism on the policy of tax cuts
Supply-side economics based on tax cut policy has been subject of criticism. It is beyond the scope of this paper to enter such a controversy arising out of political motives more then economic ones. However, we must admit that not every tax-rate cut would result in increased tax revenues. "Revenue responses to a tax rate change will depend upon the tax system in place, the time period being considered, the ease of movement into underground activities, the level of tax rates already in place, the prevalence of legal and accounting-driven tax loopholes, and the proclivities of the productive factors. If the existing tax rate is too high - in the "prohibitive range" - then a tax-rate cut would result in increased tax revenues. The economic effect of the tax cut would outweigh the arithmetic effect of the tax cut" (Laffer 2004).
On the other hand, it is also very obvious that at a very high rate ‘when people are prohibited from reaping much of what they sow, they will sow more sparingly. Thus, when marginal tax rates rise, some people, those with working spouses for example, will opt out of the labor force. Others will decide to take more vacation time, retire earlier, or forgo overtime opportunities. Still others will decide to forgo promising but risky business opportunities. These reductions in productive effort shrink the effective supply of resources and thereby retard output. High marginal tax rates also encourage tax shelter investments and other forms of tax avoidance" (Gwartney 2006).
Critics of the supply-side notion disagree with the notion that tax cuts can lead to higher tax revenues. But the modern version of Ibn Khaldun's theory, is far from discredited. Most of the economists recognize its potential validity, with empirical studies suggesting that tax revenues and tax rates begin to move inversely in the range of a 70 percent tax rate. Also, recent debates over tax rates have brought a greater awareness of how public policy can affect private economic incentives. In a world where national borders are becoming less important, governments must keep tax rates relatively low or face the loss of investment, jobs, and tax revenues to other countries.
16. Concluding remarks
As it is clear from the preceding pages, the thrust of this paper has been to investigate the relevance of Ibn Khaldun's theory of taxation. Having been deeply involved in public life, his theory of taxation, therefore, reflects a pragmatic orientation. Dynamic as he was, he presented a dynamic theory of government expenditures and taxation. In the opinion of many scholars Ibn Khaldun's theory of taxation is scientific in its own right and consequently it can be employed in a discursively meaningful way as a scientific component in economic theory. It is thoroughly realistic and empirical in nature and prescribes a perspective which is bound to reality and experience as verified by supply-side economists.
Lacoste (1984, p. 2) has rightly said: "Exploring the thought of Ibn Khaldun does not mean straying in medieval orientalism, plunging into the distant past of an exotic country or complacently entering into a seemingly academic debate. … It is, rather, a means of furthering an analysis of the underlying causes of the most serious of contemporary problems". No doubt it has great relevance today in matter of taxation and governmental expenditure. "Only Ibn Khaldun is so close to our contemporary concerns, and his work is undoubtedly of much greater interest than that of any other early historian" (ibid. p.6). "The extraordinary thing about Ibn Khaldun is that he raised many of the questions that modern (social scientists) are asking and tried to answer them by analysing economic, social and political structures" (Ibid).
To Ibn Khaldun, a government budget may be surplus, balance, or deficit depending on the level of development and its composition of expenditure. Accordingly tax rates would be low, medium or excessive. It is the nature of government spending and its policy of taxation that determine whether it is passing through the period of formation, prosperity and stability, or depression and decay.
Ibn Khaldun pointed out various principles of taxation, such as equity and efficiency, justice and neutrality, ability to pay, economy, benefit and convenience, attributed to Adam Smith, Multiplier effect of government spending, incidence of taxation, in addition to a number of fundamental economic theories. In view of this, Boulakia (1971 p. 1117) was perfectly right to raise the question: "Should we retire the fatherhood of these economic concepts from the authors to whom they are attributed in our histories of thought?" Indeed, Ibn Khaldun was far ahead of his time in economic thinking. To Spengler (1964, p. 305), "had his [Ibn Khaldun's] economic analysis not been so submerged in his more sociological analysis, it is possible that economic inquiry might have been carried forward effectively in the Muslim world, at least in the absence of oppressive governmental or ecclesiastical action." In the opinion of this author, Ibn Khaldun was born in a declining phase of Muslim culture and intellectual atmosphere. He could not find among the successive generation a capable follower who could improve upon his ideas and develop them further. Otherwise, he would not have been so casually mentioned in the history of economic thought and analysis. It took six centuries for his ideas to resurface in economic discipline, though much to be desired.
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* Dr. Islahi is Professor in the Islamic Economics Research Center King Abdulaziz University, Jeddah, KSA.
 The phrase is borrowed from Spengler (1964, p. 292).
 About a century before Ibn Khaldun, Ibn Taymiyah (1263-1328) also advised the taxing authority to be just in tax imposition even when the tax was an illegal one. He used interesting term "justice in injustice' (al-‘adl fi 'l-zulm) to express the idea. He gave the reason: "People might accept if a thing was wrongfully taken from them (but taken) equally (from all). But they would not accept it if some of them were exempted" (Ibn Taymiyah 1963, vol. 30, pp. 340-41).
 Supply-side economics, often conflated with trickle down economics, was popularized in the 1970s by Robert Mundell, Arthur Laffer, and Jude Wanniski. The term was coined by Wanniski in 1975. In 1978 Jude Wanniski published The Way the World Works in which he laid out the central thesis of supply-side economics and detailed the failure of high tax-rate, "progressive" income tax systems and U.S. monetary policy under Keynesians in the 1970s. For more information, read James D. Gwartney, Supply-Side Economics, in The Concise Encyclopedia of Economics. The Liberty Fund, 2002 and [Wikipedia], Supply-side economics (both articles retrieved 20.03.2010).
 According to Arthur Laffer, "the story of how the Laffer Curve got its name begins with a 1978 article by Jude Wanniski in The Public Interest entitled, "Taxes, Revenues, and the `Laffer Curve". (Wanniski, 1978.) As recounted by Wanniski (associate editor of The Wall Street Journal at the time), in December 1974, he had dinner with me (then professor at the University of Chicago), Donald Rumsfeld (Chief of Staff to President Gerald Ford), and Dick Cheney (Rumsfeld's deputy and my former classmate at Yale) at the Two Continents Restaurant at the Washington Hotel in Washington, D.C. While discussing President Ford's "WIN" (Whip Inflation Now) proposal for tax increases, I supposedly grabbed my napkin and a pen and sketched a curve on the napkin illustrating the trade-off between tax rates and tax revenues. Wanniski named the trade-off "The Laffer Curve" (Laffer, 2004).
* Dr. Islahi is Professor in the Islamic Economics Research Center King Abdulaziz University, Jeddah, KSA.
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by: Abdul Azim Islahi, Fri 26 March, 2010