Debt, Zakah and Optimal Taxation in Islamic Economy

This paper theoretically examines the role of zakat in income re-distribution in Islamic economics. While the government in the capitalist society issues debt like T-bills and government bonds in the financial markets to make trades among generations possible, this paper illustrates, theoretically, how constructing zakat funds in a certain manner can take the role of issuing debt in the market economy. The model also sets the functional form of the optimal tax rate that the government must set in order to achieve Pareto optimality. The importance of the paper is in proving how Islamic economics can converge to Pareto optimality by its nature without government debt in the financial market, while providing the optimal tax rate for that economy.