DOMESTIC BORROWING IN THE OTTOMAN ERA
MURAT CIZAKCA
In today’s world of complex economies and increasing demands for funding for various activities, including education, health, defence, development and infrastructure, domestic borrowing by governments has become an important tool for raising money for the treasury. Punitive taxation is no longer in fashion.
In Islamic economies, the institutions of Zakat, Ushr and other forms of taxation should be applicable, but very often these are collected in a haphazard way and do not form part of the government revenues as such. Research and development of Zakat as a potential funding tool for state coffers – of course only to be used along the guidelines stipulated by Islamic law – is long overdue and imperative if Islamic economics is to make sense to ordinary Muslims. However, in the meantime, other means must be found.
Domestic borrowing by governments has a long history, not only in Western society but also in Muslim societies, such as the one in the Ottoman Khalifat.
In the face of government budgetary deficits, most states have at one time or another had to resort to domestic borrowing. But domestic borrowing in history differed from modern methods of interna l borrowing in on e important aspect: whereas in the latter, private individuals lend their own savings to the state by purchasing government bonds, in history, lending private savings directly to the government was a relatively complicated procedure, developed over many years.
Origins of Tax-Farming
Domestic borrowing in history basically took the form of tax-farming, the origins of which can be traced back to the classical world of Greece and Rome. Th e medieval Islamic world also utilised tax-farming in their financial dealings.
Before we go into the details of these historical systems, however, it would be appropriate to quote the historian Sir John Hicks, who has provided us with what is, arguably, the best explanation for the rise in tax-farming:
“If there is one thing about kings, it is that more often than not they were hard up. The underlying cause for this was, in my opinion, a rather chronic lack of tax revenue. The tax base was narrow, collection was inefficient, (falling on those whose liability was easy to assess and letting others escape) and because it was inefficient, it was also inequitable.
“Worse still, from the monarch’s point of view, was the fact that increases in revenue were not smooth and gradual; rather they proceeded by fits and starts. Inevitably there would be emergencies such as wars where the king would be forced into borrowing, which forced the question of from whom was it to be borrowed and how was the sum to be repaid?
“If the King’s tax revenue was insufficient in the first place, then he could only be regarded with caution by potential lenders. An unsecured loan on the estate would be in the same class as unsecured loans to private persons with no credit – very risky lending. However, there were solutions to this dilemma. If unsecured borrowing was difficult then how about secured borrowing? Here it is important to distinguish between the two kinds of borrowing.
“The first kind, borrowing against a mortgage, in which the security remains in the hands of the debtor, did not provide much incentive to the lender, for if the debtor defaulted, it was still necessary to go to court to enforce the claim, and it is not clear that this was any easier than with an unsecured loan. The position is somewhat different if the lender has control of the collateral, which of course puts him in a stronger position.
“Thus, it was possible to have recourse to what was to all intents and purposes the pawn shop. The asset that may be pawned could be the royal estates, but it may – and often did – take fewer tangible forms, such as the right to collect certain taxes. There is not much difference between pawning an asset, with little prospect of redemption, and outright sale, and in this way, borrowing against a tax-farm developed into selling tax-farms.”
During the Ottoman period, tax-farming remained a prime source of income for the state, tax resources were maintained as state property and the right to collect taxes from them was sold in public auctions to the highest bidder. This highest bidder became the tax-farmer who gave over to the state the amount bid in the auction. In this way, domestic borrowing became a reality for the state. In return, the tax-farmer was authorised to tax the source for a certain period.
The tax-farmer was thus a true entrepreneur; if the total amount of taxes exceeded what he paid to the state and his expenses in collecting the tax, then he enjoyed a profit. The system was known in medieval Egypt as Daman and Qabala, in Mughul India as Ijara and in the areas under Ottoman control as Iltizam, Malikane and Esham. It is not accidental that three different names have been mentioned in the Ottoman case. They indicate a long evolution.
Ottoman Tax – Farming
Moving now to the way in which the tax-farmer raised money which he paid to the state at auctions; the basic financial instrument used by the Ottoman tax-farmers for fund mobilisation was Islamic partnerships (with a provider of capital), mainly the Mudaraba and Inan, also known as Musharaka. These partnerships were combined with a system of sureties, or Kefalet. The provider of the capital, the Rab al-Maal, not only provided capital to the tax-farmer, he also stood surety for him vis-a-vis the state. The surety was particularly important when the tax-farmer paid the promised amount to the state in instalments.
Since the Rab al-Maal’s liability was limited to the amount that he contributed to the partnership, his Kefalet also covered this amount and the state made him responsible only for the capital he provided. But if an Inan partnership with joint obligation was signed between the two partners, then the state could demand repayment from each partner proportional to his share. Failure to fulfil this obligation to the state could lead to the imprisonment of all the partners. The Iltizam partnerships were generally small, comprising of two or three partners at the most.
Problems of the System
The Iltizam system had the following shortcomings. First, the tenure of the tax-farmer was unreliable. If, after winning the tax-farm in an auction, another tax-farmer emerged and promised to pay a higher amount to the state, the tax-farm would be passed over to him before the original farmer’s tenure had matured. Consequently, when a tax-farmer was assigned a farm, he tried to raise the maximum amount of revenue in the shortest possible time, which led to excessive exploitation of the tax source.
Another shortcoming of the system emerged as a result of the tax-farmers paying their debts in instalments. This was inevitable as there were not many tax farmers who could afford to pay the sums they promised in advance. But the instalments were slow to accumulate and the situation became particularly serious when the state was facing a national emergency, for example, a threat from outside. Finally, the system could raise only relatively modest sums, because the tax collection was delegated for only a limited period.
Notwithstanding these disadvantages, the system worked reasonably well during the golden age of the Ottoman period, but when they began after the 17th century to suffer military defeats, a crisis in public sector borrowing developed.
Financial Crises Led to New System
These financial crises assumed the form of huge budget deficits which reached staggering proportions during the wars of 1683-1699 to drive the Ottomans from Europe. Needing urgent revenue, the state introduced the Malikane system. The basic characteristic of this system was that the tax source was now farmed out on a lifetime basis. In return for the right to collect taxes for a lifetime, the tax-farmer paid the state a lump sum called Muaccele, as well as regular annuities called Maal. In this way the state was provided with both emergency cash and regular revenue.
The system worked by the state determining the minimum amount that it would accept for a tax-farm; the sum required would then be advertised to potential bidders, who would register with the treasury the amount that they would be willing to pay, and the highest bidder would be declared the Malikaneci, or the tax-farmer. The Malikane was not transferable, meaning that when the owner died, he could not bequeath the tax-farm to his descendants.
Advantages of the Malikane System
Another feature of the Malikane system was that it lessened the risk of default for the state. Failure to pay would mean confiscation of the tax-farm, and loss of the original lump sum. Also, the state was protected from economic fluctuations, since the tax-farmer bought the farm for life to deal with economic fluctuations.
The problem of investing in the Malikane being a risky affair for tax-farmers was solved by the devise of sub-tax-farming. The Malikanecis became basically absentee landlords, and the task of managing the tax-farms was left to an agent who was chosen by the official farmer at an auction. Into this situation came the Sarraf, who helped the Malikaneci succeed in the initial auction as well as choose the agent. Thus, four different agents were involved in the system: the Sarrafs, the treasury, the Malikanecis and the agent. Naturally, each one claimed a portion of the tax revenue generated, and the states share usually came to a mere 25 per cent.
Despite the limited income from the tax-farms, this system proved to be a huge success, as not only were the needs of the state met, and the budget deficits overcome, but a surplus was achieved. There is no doubt that the drastically improved state finances played a major role in ensuring the survival of the Ottoman system. However, this system was to change with the resounding defeat of the Ottoman government in 1775 at the hands of the Russians.
The Search for New Solutions
As a result of their defeat, the Ottoman government was forced to sign the Treaty of Kaynarca. One of the conditions of the treaty was that the Ottoman state had to pay 7.5 million grus as war compensation. Th e payment was to be completed within three years and effected in three instalments. Thus, the Ottoman government faced the daunting task of raising a huge amount in a relatively short time. It was soon apparent that whatever its advantages in times of stability, the Malikane system was ill-equipped to raise such amounts of revenue and so the Ottoman state was forced to look for new ways to deal with its deficit.
Development of the Esham System
The solution to this daunting task came to the Ottoman government in the form of Esham, Arabic for shares.
Whereas in the Malikane system the entire revenue of a tax-farm was sold to a Malikaneci for life and the management was left to him or to his agent, under the Esham system the management was centralised and the annual profit was divided into shares, hence the term Esham.
Under the new system, if a tax-farm generated a net profit of 15,000 grus, this profit could be divided into a number of shares, for example, 100 shares, which might represent an annual profit of 150 grus. Esham was simply the sale of this annual profit, in cash, for a lump sum payment which retained its name of Muaccele. Assuming that each share was sold for live times its estimated annual profit, i.e., 750 grus, any person who paid this amount could buy a share.
In this way, the owner of a single share would be paid 150 grus annually for as long as he lived. If he lived for more than five years, he would begin to make a profit, and the state would begin to lose. This provided an element of risk for both the shareholder and the state. It was this uncertainty which eliminated any possibility of Riba.
As for the state’s gain, without Esham, the state would have received its normal 15,000 grus revenue each year But, by selling shares to 100 investors and getting from each 750 grus, the state received 75,000 grus instead of 15,000. If purchaser of Esham died soon afterwards, the state made a further profit, as it repossessed the share and re-sold it for a further 750 grus.
One of the most successful Esham tax-farms was the tobacco customs of Istanbul, which was also one of the first to be established. This tax-farm had been sold as a Malikane but then, owing to the enormous revenue it generated, it was taken over by the state and organised as an Esham. Annual profit was 400,000 grus and this was divided into 160 shares. Each share was to yield 2,500 grus annual profit to its owner. These shares were sold for 12,500 grus each, yielding to the state a total revenue of two million grus.
Successful Mobilisation of Funds
To ensure saleability, the shares were divided into ever smaller parts. As a result, the number of shareholders increased substantially. Thus, the Esham system, unlike the Malikane system, was no longer dominated by the military class and was successful in mobilising the savings of the public who had responded enthusiastically to these developments; 75 per cent of the shares were sold off within the first four months and 90 per cent within the year. As other tax-farms were incorporated into the Esham system, the number of owners increased accordingly. By the year 1800, there were over 4,500 share owners. Meanwhile, the average Muaccele paid by a shareholder was declining; in the year 1800 the average paid was half of that paid in 1759.
The growth in the public’s participation in the Esham system, although beneficial in the short-term, eventually led to its demise. The most obvious advantage of the system was that by mobilising the savings of the public, the state succeeded in collecting huge amounts of revenue in a relatively short time.
Bureaucratic Failure to Meet Demands of the System
The state’s bureaucracy was unable to cope with such rapid expansion of the Esham system and increasingly failed to accurately monitor the deaths of the shareholders. Consequently, it often ended up paying the annual profit shares long after they ceased to be due.
Worse still, the change from registered shares to bearers’ shares allowed for shares to be easily bought and sold. Unlike under the Malikane system, where all the shares were registered and issued to specific individuals, when a person bought an Esham, he merely bought a paper stating the amount paid, the Muaccele, and the annual rate of return, with no information about the purchaser
It was only when the shareholder paid in his Muaccele to the cashier of the finance ministry and was issued with an invoice which he took to the Berat office, that he was given a statement – a Berat – to the effect that the share was his property. But during war, the Berat office, together with all the offices of the finance ministry, moved to the front. Consequently, it was not possible to issue Berats to the purchasers who continued to buy shares during the war, and shares without the accompanying Berats began to circulate. This allowed purchasers to avoid taxes such as the Kasr-i-yed tax, which was charged upon the sale of a share to another person.
Legalisation of Bearers’ Shares
In addition to this, the state, coming increasingly under pressure to pay its debts to the Sarrafs, offered them shares in lieu of cash. The Sarrafs accepted the shares only on the condition that they would be issued without the Berats. When the state was forced to accept, bearers’ shares became legal.
The legalisation of the bearers’ shares had two major consequences for the Esham system. First, the state was deprived of the chance to repossess the shares upon the death of the purchaser. Second, and more importantly, as far as the Islamic law was concerned, Riba could no longer be avoided. The uncertainty that was dependent on the life span of a purchaser was rendered meaningless as the sale or transfer of a share to a third person became a matter of routine.
The legalization of the bearers’ shares had two major consequences for the Esham system. First, the state was deprived of the chance to repossess the shares upon the death of the purchaser. Second, and more importantly, as far as the Islamic law was concerned, Riba could no longer be avoided. The uncertainty that was dependent on the life span of a purchaser was rendered meaningless as the sale or transfer of a share to a third person became a matter of routine.
Edited By Asma Siddiqi
Institute Of Islamic Banking And Insurance London
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