HK a poor lead for Sarkozy to follow on transaction taxes
French President Nicolas Sarkozy is out to hit financiers where it hurts most: in their pockets. At the weekend he said France would unilaterally impose a 0.1 per cent tax on equity and derivatives transactions from August.
Sarkozy is hoping other European countries will follow suit, leading to the introduction of a European-wide tax on financial market transactions designed to deter speculation and repair government finances. 'What we want to do is provoke a shock, to set an example,' he said.
In Hong Kong, bankers and officials are rubbing their hands at the prospect, believing the proposed levy will drive business to tax-free financial centres outside Europe.
That's a huge paradox, because Hong Kong provides one of the few pieces of evidence that a financial transactions tax may actually be effective at reducing market volatility and raising revenue.
Also known as a Tobin tax, after the late US economist James Tobin, or a Robin Hood tax, after the English folk hero who stole from the rich to give to the poor, a tax on financial transactions is hardly a new idea. British economist John Maynard Keynes proposed one in the 1930s on the grounds that it would throw sand in the wheels of international markets, helping to prevent the formation of bubbles.
Tobin himself suggested a tax on foreign exchange deals in the 1970s as a means to reduce currency volatility. And in the 1990s the United Nations came up with a similar proposition, intended to fund development projects in poor countries.
Since the 2008 financial crisis, the idea has come back into vogue as a way to rein in markets, with economists as prominent as Nobel laureate Joseph Stiglitz, as well as a clutch of European politicians coming out in favour of the idea.
Yet evidence a new tax would either reduce speculation or raise significant revenue is thin on the ground. One of the few convincing examples comes from Hong Kong, which imposes a 0.1 per cent stamp duty - the level proposed by Sarkozy - on all sales and purchases of Hong Kong-listed shares.
There is no evidence the duty has harmed the development of Hong Kong's stock market, where turnover has climbed eight-fold over the last 10 years.
But Hong Kong's stamp duty has been effective at deterring high frequency algorithm-driven traders from dealing on the city's stock market, a factor which may have protected it from the sort of 'flash crash' experienced by US stocks in May 2010, when major market indices plunged by up to 9 per cent in a matter of minutes.
What's more, stamp duty on stock transactions has proved a powerful revenue generator for the Hong Kong government, providing almost 10 per cent of its operating revenue over recent years.
Yet Hong Kong, with its captive share market may be a poor example to cite. There is plenty of evidence from elsewhere that a transaction tax may do more harm than good.
In 1984 the Swedish government imposed a 0.5 per cent tax on share deals in the belief that speculation was destabilising the economy and exacerbating income inequality. Over the next few years 50 per cent of all trading in Swedish equities, and almost all trading in their biggest stocks, migrated to London. Revenue from the new tax collapsed and it was scrapped in 1991.
Similarly, the New York state government doubled its transaction tax following the 1929 crash, a move blamed by researchers for leading to lower volumes and wider bid-ask spreads while doing nothing to reduce volatility.
The trouble is that transaction taxes tend to have the biggest impact on market-makers; the liquidity providers who deal in high volumes for low expected returns. As a result, imposing or raising tax levels tends to reduce liquidity, and may even increase volatility.
Worse, Sarkozy's tax is unlikely to raise much revenue. Trading in over-the-counter products like derivatives will simply shift to jurisdictions like Hong Kong where they are not taxed, and dealing in listed products like shares may well dwindle as it did in Sweden.
Far from helping to plug government deficits as Sarkozy hopes, a transaction tax could prove ruinously expensive. Accountants Ernst & Young reckon a Europe-wide tax could cost more than Euro100 billion (HK$1.02 trillion) a year in lost revenue.
None of these concerns is likely to bother Sarkozy much. His pledge to impose a transaction tax is a naked bid to gain popularity through a bit of banker-bashing ahead of France's presidential election in April.
Yet there must have been a time when these considerations weighed more heavily on him. France's own 0.3 per cent tax on share deals was only abolished at the beginning of 2008 - one of the first things Sarkozy's government did after assuming office the year before.