Policy #5: Do You Pay More For Coffee Than The Rich Pay In Tax?

Taxes should be taken from those who have benefited the most economically from the society, i.e. the wealthy. Consequently, taxes should be based on one's asset, like the zakat or the productive yield of the land, like the kharaj. Even head taxes (i.e. jizya) should be graduated taking into account the person's wealth. Conversely, there should be no income or sales taxes.

'No taxation without representation'  was the rallying cry of the American Revolutionaries against their British imperialist masters. The ability for this phrase to incite rebellion speaks to the deep resentment a populace can have towards unjust taxation policies. 

The reality today is, however, that the taxation system in the US is one that even the rich feel is unfair to the middle and poor classes. For example, Warren Buffet famously remarked that his secretary paid a higher rate of tax than he did

So how do we get to a fair taxation system? 

Why is taxing income wrong? 

Activists often call for the rich to pay higher income taxes. A good summary of this rationale can be found in the justification for the Alternative Minimum Tax (AMT), which this Bloomberg article puts as follows:

"The AMT was introduced to taxpayers in 1970 as a way to prevent high-earning households from winnowing down or zeroing out their federal income-tax bills. The tax works by taking away personal and dependent exemptions, as well as various itemized deductions, including those for state and local taxes. Other deductions are capped. It’s triggered by almost two dozen factors, including losses, depreciation, stock options and exemptions for children."

It is intuitive for most that the rich should pay a higher amount of tax. Simply put: they have more money to spare. Furthermore, asking the poor to shoulder a greater burden of the tax load can only occur in a society where the powerful are able to exploit the weak. However, the question is how should be this done? Should there be higher income taxes or should assets be taxed instead? 

As our parents told us, it's not how much you earn but how much you save.

Savings is the excess income that's accumulated as one has more than enough income to cover their annual expenses. This makes assets an excellent base to determine an individual's ability to pay because it means they have more than they need. 

This concept of looking at assets as the basis for levying taxes emanates from the zakat, which is one of the 5 pillars of Islam. Prophet Muhammad (saw) said:

” And inform them that Allah has mandated upon them a Sadaqa (charity) from their money which is taken from their rich and given back to the poor.” [Bukhari]

This mandatory charity is the zakat where as voluntary charity is known as sadaqa. 

The 2.5% rate is derived from the saying of Aisha (ra) who said that Prophet Muhammad (saw) "[U]sed to take from every 20 Dinars and more a half of a Dinar, and from 40 Dinars a whole Dinar" [ibn Majah]. Consequently, zakat is calculated as 2.5% (i.e. 0.5/20 or 1/40) of one's unused assets that have been sitting around for a year. The rule for a year is derived from the following hadith:

“Whoever receives money is not obliged to pay Zakat for it until a year has passed over it”. [Tirmidhi]

Zakat is not collected from people who have less than the nisab, i.e. the minimum amount of wealth. Prophet Muhammd (saw) said: 

“It is neither nothing less than 20 Mithqal of gold, nor nothing less than 200 silver Dirhams as Sadaqa” [Abu Obeid]

In terms of weights, this works out to be 85 grams of gold ($3,388.95 US) or 595 grams of silver ($316.98 US). In today's context where fiat currency is used, if a Muslim's wealth exceeds the latter/lower amount then they must pay zakat on all of their savings/wealth.  

How much zakat would the rich pay? 

I thought it would be an interesting thought experiment to see how much zakat the rich would pay and contrast that to the current taxation system. 

Ironically, the billionaire Warren Buffet penned this NYT op-ed, that gives us some of the necessary data to help run this experiment. In the article, he gives insights into the amount of income and taxes the 400 wealthiest Americans earn and pay respectively: 

Income of the uber-rich:                   $90,900,000,000
Income tax rate                                                     21.5%
Total taxes paid                                $19,543,500,000

However, to understand how much how much zakat these people would pay, I had to go this Forbes article to understand the asset base of this group of people (I used the 2008 figure cited in the article to be consistent). The amount of Zakat they would pay would be as follows:

Assets of the uber-rich:                   $1,570,000,000,000
Zakat rate                                                                   2.5%
Total zakat due                                    $39,250,000,000

Under Zakat approach, the rich would pay about 200% more than they do under the current system.

Continuing with this thought experiment we can also ask: what is the ratio of the taxes they pay to their total wealth?  

If you take the amount of tax currently paid as a proportion of their assets, we find that rich paid about 1.24% of their asset in taxes. To put this into perspective, this would be like spending $124 if you had saved $10,000. 

This is where we get to the coffee.

The average American spends about $1000 year on coffee which works out to be 2.0% of the median household wealth of $51,017 - exceeding the 1.2% figure noted above.So to answer the question at the outset: yes the rich pay less tax - proportionally to their wealth - then the average American pays for coffee.  

How much Zakat would the regular person pay? 

But we can't stop here.

To understand the distributive effects of zakat, it is important to contrast it to the taxes/income of a less wealthy person. Let's say a 'regular person' hypothetically has $10,000 in assets and earns $30,000 a year (click on this link to see where I got the tax rate from):

Income of the regular person:                        $30,000
Effective income tax rate                                      13.4%
Total taxes paid                                                  $4,036

In contrast, the amount of Zakat the regular person would pay would be as follows:

Assets of the regular person:                             $10,000
Zakat rate                                                                     2.5%
Total zakat due                                                         $250

Using the same proportionally test we did for the rich, under the income tax system, the proportion of taxes of the regular person to their assets is over 40%; i.e. 4,036/10,000.  

Why did I use 10,000 as the number for the regular person?

The reason is that the Economic Policy Institute (EPI) uses it as a cut off to determine if someone is classified as "low net worth". They found in 2010 that 35.1% of Americans did not even have $10,000; 22.5% of them either had zero or less. 

Under Zakat, the regular person would be paying just 6% (250/4,036) of what they are paying right now.

What this illustrates, is how assets - not income - is much a better gauge of the person's ability to pay.   Sales taxes are regressive for the same reasons; i.e. if an American with no wealth even pays a dollar in sales tax it isn't fair. 

Before I close, I wanted to note the following caveats:

  • Is Capitalist wealth real wealth? As we've discussed previously, many of the ways that the rich get richer in Capitalism would not be allowed in Islam. For example, the American economy generates $1.3 trillion in interest. This avenue of wealth would be completely prohibited in Islam. However, the idea behind this post (and the blog more broadly) is to assess the Rough Order of Magnitude (ROM) of how the Islamic Economic policies will impact the society to have a fairer distribution of wealth.

  • Zakat must be used in specific ways: Unlike the Kharaj (land tax), the State can only use it for the 8 categories specified in the following verse: "Verily the Sadaqat are (only) for the poor, needy, those employed upon it, those whose hearts are to be reconciled, slaves, debtors, those in the way of Allah and the wayfarers” [TMQ 9:60]". For a deeper dive into the 8 categories, refer to this article (scroll down to the section entitled "Who receives the zakah?").

  • Commonly owned resources can be used to assist with public expenditures: The other unique feature of Islamic economics is a category of resources categorized as "commonly owned" - such as energy resources and minerals. These resources are administered by the State on behalf of the society. Such wealth can be used to address things of public benefits, such as schools, roads, hospitals, etc. This will be the topic of future posts in sha Allah.

  • The rich get to keep 97.5% of their wealth and that's fine: Although the rich would pay 200% more than they do now, they still keep 97.5% of their wealth. In Islam, there is no problem being rich but they must pay their fair share.

Click here for the next post where we look at how much Zakat billionaires, like Trump and Buffet would pay as well as look at the implications of zakah. We may be surprised as to who will actually pay more in zakat.