Inequality of income distribution is one of the economic problems in Indonesia. Every regency or city in Indonesia are have this problem. One of the cities in Indonesia that has high level of Inequality is Yogyakarta City. According data from BPS (Badan Pusat Statistik / Statistic Center Institution), the rate of income inequality in Yogyakarta city which indicated by gini ratio has increased for the last 5 years. Therefore, an instrument is needed to overcome the problem. Islam actually offers zakat instrument in order to reduce inequality of income distribution. Moreover, Islamic instrument may improve the welfare of the mustahik. This research aims at finding out how effective the productive zakat distributed by Baznas Yogyakarta can reduce inequality of income distribution and improving the welfare of the mustahik. The sampling technique used in this research was saturated sampling, in which the total number of the sample is as many as the total number of the population, which is 71 persons. In order to find out the level inequality of income distribution, the measurement was used Lorenz curve, coefficient index ratio and world bank criteria. To figure out the level of mustahik’s welfare, Indeks Kesejahteraan Puskas (Puskas Welfare Index) was used. The result shows that the productive zakat distribution done by Baznas Yogyakarta is able to reduce the inequality between the mustahik. It is indicated by the area of the Lorenz curve which is narrowing down, in other words it is getting closer to the equality line after zakat distribution. For the gini coefficient which was initially at 0,37, it decreases into 0,30. For the income proportion out of 40% low-income people, there is an increase from 16,65 % to 21,36 %. The productive zakat distribution done by Baznas Yogyakarta has been able to improve the welfare of the mustahik. It is indicated from the IKP increase from 0,53 to 0,74.