It’s not often that Hong Kong’s laissez-faire government finds itself aligned with Bernie Sanders.

But the self-described democratic socialist may well applaud the Asian financial hub’s surprise decision on Wednesday, Feb 24, to raise its tax on stock trades for the first time since 1993.

The stamp-duty increase, which contributed a sell-off in Hong Kong’s US$7.6 trillion ($10 trilliion) market and sent shares of the city’s exchange operator down the most in five years, shows that even one of the world’s most capitalist-friendly governments is under growing pressure to target financiers and wealthy investors as it tries to address worsening inequality.

In the US, a growing cohort of Democrats including Sanders have pushed for a financial transaction tax, to the dismay of Wall Street. Both stock markets have boomed over the past year even as the economies tanked and unemployment rates soared.

“Raising the stamp duty could be the least-opposed choice politically,” said Ramon Yuen, finance and economic policy spokesperson for Hong Kong’s opposition Democratic Party.

Hong Kong’s levy on buying and selling shares will increase to 0.13% from 0.10%, Finance Secretary Paul Chan announced when delivering the city’s annual budget on Feb 24. The change will take effect from the start of August and raise an additional HK$12 billion ($2 billion) a year, local media including Apple Daily reported, citing unidentified people.

That is unlikely to move the needle much for a city with HK$903 billion in fiscal reserves, but may help Hong Kong leaders fend off critics who have said it is not doing enough to address the wealth gap. The government also reduced an income tax deduction that’s been in place since at least 2014 in another hit for the better off.

Hong Kong’s benchmark Hang Seng Index lost 3% on Feb 24, the most among Asian equity gauges. Hong Kong Exchanges & Clearing, the world’s biggest exchange operator by market value, plunged 8.8% despite announcing a record profit for 2020. The shares fell a further 1.7% on Thursday, Feb 25.

Calvin Tai, the exchange’s interim chief executive officer, said in an earnings call that the bourse was not consulted by the government on the stamp-duty decision. For Hong Kong policy makers who want to boost revenue without hurting already weak consumption, the stock market is a juicy target. The value of equities in the city soared by about US$1 trillion last year as a wave of Chinese companies listed new shares. Mainland-based funds have poured record amounts of cash into Hong Kong stocks in 2021, helping send the Hang Seng index to an almost three-year high this month.

It is unclear what role Chinese leaders played in the stamp-duty decision or in the broader budget. But Beijing has taken a more hands-on approach in the city in the wake of 2019’s pro-democracy protests, whether through imposing national security laws, allowing the disqualification of lawmakers not seen as patriotic or planning to overhaul the way Hong Kong handles its elections. The 2019 protests were often attributed by pro-Beijing figures to yawning wealth disparities in the city of 7.5 million.

Hong Kong’s government outlined plans in the budget to spend HK$150 billion to bolster the economy after two years of recession. The financial secretary is also looking to narrow the deficit from a record of about HK$260 billion in the current year to March to HK$101.6 billion.

The stamp-duty increase may deal a near-term blow to trading activity in Hong Kong, but the impact is unlikely to last, said KC Chan, an adjunct professor of finance at Hong Kong University of Science and Technology and former treasury official. Some other governments impose higher taxes on purchasing equities. In the UK, investors pay stamp duty of 0.5% every time they buy a stock.

“Increasing the friction costs of trading doesn’t change the fundamental value of companies,” said Nick Bird, chief investment officer of Hong Kong-based quant hedge fund firm OQ Funds Management. “The market has overreacted to the small increase in stamp duty.”

But the risk for Hong Kong is that the move hurts efforts to revive the city’s reputation as Asia’s premier financial hub. While Hong Kong has seen a flood of IPOs and record trading activity in recent months, it faces intense competition from rivals in Shanghai, Shenzhen and Singapore, not to mention New York.

One Hong Kong-based trader, who was not authorised to be named discussing internal matters, said clients had been lobbying the government for a tax cut. They considered that far more likely than an increase, speculating that Hong Kong wanted to attract more high-frequency trading because it significantly increases turnover.

Citigroup analysts predict the stamp-duty hike will raise the total cost of trading by as much as 15%, if average broker fees and the bid-ask spread remain unchanged. Quantitative funds that drive as much as one-fifth of daily turnover will be hardest hit because of how often they trade, the analysts wrote in a Feb 24 note.

“The industry is strongly dissatisfied,” Christopher Cheung, chief executive officer of Christfund Securities and a lawmaker who represents brokerages in Hong Kong, told reporters on the same day.

One concern among market participants is that more stamp-duty hikes may be in the offing, according to Shujin Chen, an analyst at Jefferies Financial Group.

“It is a warning sign,” Chen wrote in a report. “Stamp duty rate has been used as a means to adjust the stock market in mainland China, so there is concern it may be the same for Hong Kong in future.” — Bloomberg

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