Arguments for keeping Hong Kong's stamp duty fail close scrutiny
Much of the concern among those defending the status quo focuses on high-frequency traders, but the city has safeguards to address their fears
A newspaper column calling for a cut in tax would normally get an enthusiastic reception.
So although I wasn't surprised by the volume of readers' e-mail messages that flowed in after Monitor suggested a couple of weeks ago that Hong Kong should scrap its stamp duty on share trading, I was gobsmacked by the vehemence of their criticism.
In a nutshell, Monitor argued that the city's 0.2 per cent per round trip tax on trading significantly raises transaction costs. As a result, liquidity on the Hong Kong stock exchange is shallow (see the chart), increasing the cost of capital for companies and eroding the returns earned by ordinary investors.
The government certainly doesn't need the revenues. Last year, stamp duties on shares raised just HK$20 billion, while the government ran a budget surplus of HK$65 billion.
So Monitor argued that both ordinary investors and the government itself, as the largest shareholder in Hong Kong Exchanges and Clearing, would benefit if the stamp duty were abolished.
The critics - and there were lots - divided into three camps.
A few complained that I was aiming at the wrong target. Hong Kong's 0.2 per cent stamp duty was only a minor expense compared to local brokerage commissions, they argued. Those are what I should be denouncing.
Them, I can only advise to get a new broker. These days, retail investors can easily strike agreements to pay no more than 0.1 per cent in commission on each side of a trade, and often less. As a result, stamp duty typically makes up a greater proportion of trading costs than brokerage charges.
The second group worried that scrapping the stamp duty would attract high-frequency traders to Hong Kong.
Variously, they complained that high-frequency traders were speculators rather than investors, that they contributed nothing to the market, that the liquidity they contributed disappeared when volatility surged, that they caused volatility to surge further, and that they ripped off retail investors by executing at better prices. Clearly, some of these objections are contradictory.
Yes, high-frequency traders are speculators, but by definition so is any one who buys in the hope of making capital gains. Investors buy for the dividend income.
However, there can be no doubt that high-frequency trading provides large amounts of liquidity. And liquidity reduces the price impact when institutions like pension funds and insurance companies execute large trades, to the benefit of ordinary investors.
If that liquidity sometimes evaporates, its occasional absence is no reason to argue it should never have been there in the first place.
As for the charge that high-frequency trading exaggerates volatility, the evidence of recent studies is mixed. In any case, Hong Kong operates circuit breakers that prevent the sort of wild price swings the critics fear.
Next, the accusation that high-frequency trading disadvantages ordinary investors by executing at better prices might apply in the United States, where algorithm traders arbitrage between vast numbers of different execution venues.
But by law, Hong Kong has only one stock exchange, which means at any time there is just one price, whether for big investors or small.
As a result, there is little cause for Hong Kong investors to fear high-frequency traders, but good reasons to welcome them.
Finally, the critics who wrote that there is nothing original about the idea that stamp duties serve no useful purpose but just damage the market are absolutely right. The governor of the Banque de France made the same argument just this week.
But an argument doesn't have to be new to be valid, and this one stands: Hong Kong's stamp duty on shares does more harm than good and should be scrapped.