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Forget fairness, here’s why taxing the rich benefits us all

It's time to soak the rich, many people say. What isn't always so clear is why.

In outlining a proposal this past weekend to raise taxes on wealthy Americans, President Barack Obama positioned it in populist rhetoric as a way to aid a sagging middle-class.

Oxfam, for its part, argued that bringing the ultra-rich to heel is a simple matter of fairness. In a report published Monday, the poverty-fighting charity predicted the top 1 per cent of the global population will soon own more than half of the world's wealth.

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Both Mr. Obama and Oxfam make good points and their desire to tap the world's wealthiest citizens may signal that a more equitable system lies just ahead. Far more likely, though, is that it will merely result in endless debates about what does and doesn't constitute justice.

As you might expect, the rich aren't lining up to be taxed and many argue they deserve their good fortune.

They have a reasonable point. A significant portion of the 1 per cent are entrepreneurs and CEOs who didn't inherit great wealth, but amassed it by playing within the rules, and delivering products and services that consumers want. You don't have to be ultra-rich to believe such behaviour should be encouraged, not penalized. "Raising taxes on people that are successful is not going to make people that are struggling more successful," Florida Senator Marco Rubio said.

Rather than get caught up in these endless arguments about rights and wrongs, it's time to look at the matter more clinically. The best reason to tax the rich is that it offers a way to spark economic growth.

In its simplest form, the logic goes like this: Middle-class and working-class households tend to consume nearly all of what they earn. The ultra-rich don't, because even conspicuous consumers eventually run out of things to buy.

As a result, the increasing wealth of the world's richest families has a strong tendency to push down the level of demand for goods and services in the global economy. At the same time, it pushes up the level of savings, resulting in a glut of loanable funds. This results in a sluggish economy where interest rates remain stubbornly low – much as we see today.

But if government taxes some of the richest people's money, and hands it to less affluent households, consumption is likely to increase, spurring economic expansion. This would seem to be a better deal for everyone – even the ultra rich, who are likely to benefit disproportionately from the improved growth.

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Variants of this notion have been explored by economists such as Atif Mian of Princeton University and Amir Sufi of the University of Chicago. They warn of the dangerous outlook for a world "where a higher share of income goes to the wealthiest households who spend very little of it."

In similar fashion, Larry Summers, the former U.S. Treasury secretary, has cautioned that increasing income inequality may play a role in encouraging "secular stagnation" – the tendency of the economy to remain stuck in a weak state for a long time. He notes, too, that policies that encourage economic growth, like free trade, are only going to be politically feasible if voters perceive the benefits to be distributed across a wide range of people, not just a few.

Their viewpoints should help frame the debate on taxing the rich. It's not a matter of populism or morality, but a matter of enlightened self interest for all of us. Even the 1 per cent.

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