How will the US tax policy affect the US dollar?

For it turns out that not only are lower taxes on domestic residents wending their way through Congress as part of President Trump’s Big Beautiful Bill (BBB), but there are also potentially higher taxes on non-US entities that invest in the US. Steven Barrow, Head of Standard Bank G10 Strategy said both would hit the US dollar.

In terms of domestic taxes, the focus is on the extension of the personal tax cuts that were enacted back in 2017, but are due to expire at the end of this year. Unsurprisingly, the Administration trumpets these cuts as a key component of its drive to push growth up to 3%, or more. For, if strong growth can be achieved, all this angst about a 100% -plus debt-to-GDP ratio will go away because increases in the denominator (GDP) will keep the ratio in check.

However, there is a big problem here. It is that this is not a tax cut; it is legislation that avoids a hike in taxes from next year. Unless consumers had been saving huge amounts of cash to meet these higher taxes from next year, which we very much doubt, the tax cut won’t stimulate demand at all. Instead, growth will be the same and the deficit bigger.

Two things that, in Steven Barrow’s view, are likely to weigh on the US dollar, not lift it. When it comes to taxes on foreign entities there’s been a lot of talk recently about one provision of the BBB, the Section 889 provision that gives the Administration the right to levy higher taxes on non-US individuals and firms if their country of origin is deemed to have ‘unfair’ taxes on the US. These unfair taxes include the Digital Service Tax that many countries have in place to try to prevent large US tech companies from muscling in on local markets. And it also includes the signatories to the OECD pillar 2 provision that seeks a minimum global tax – which the US has opposed. Many countries have digital taxes or are Pillar 2 sign-ups with a particular focus on the EU; a notable adversary when it comes to the Trump administration.

“At this stage we don’t know whether this provision will remain a part of the BBB, or whether the BBB will be passed by the House, to allow Trump to sign it into law. We might also wonder whether this capacity to retaliate against other countries would ever be used. For it seems clear that many supporters of the bill see it as a threat that can be made but without much chance that it will actually be used”, said Steven Barrow.

Indeed, the provision envisages that the tax rate on the investments of these individuals and firms in the US will start at a low 5% rate and then escalate in increments to a maximum of 20% - unless foreign governments scrap their Digital Services Taxes or pull out of Pillar 2. Hence, the tax is clearly set up to be a threat, rather than an increase that foreign governments cannot avoid. This being said, in the pre-Trump era, we might have expected such threats to stay as threats, and never be actioned. But we cannot say this about the Trump administration.

For instance, in his first term Trump labelled China as a currency manipulator in an apparent fit of pique by ignoring the rules surrounding the naming of currency transgressors in a way that had not seen before. Hence it is very possible that Trump could action the sort of tax hike on foreign entities that’s contained in the current BBB. Does this offer up another reason to be bearish for the US dollar?

Steven Barrow said it would seem hard to see it any other way. In fact, with tariffs under threat from the Court of International Trade ruling, it may be the case that the Administration has to raise revenue, improve competitiveness and punish foreign countries in other ways. A tax hike on foreign entities under the BBB fits this bill but its very enactment would clearly raise more concerns about the ‘safety’ of investments in the US and so undermine the US dollar.

In addition, many might fear that another route to punish foreign countries and lift US competitiveness, like tariffs, is to try to pull the US dollar down directly. Of course, that’s not happened so far and it might not. But it may not be necessary as these ‘indirect’ measures to lower the US dollar, such as poor fiscal discipline, tariffs and a foreign tax hike under the BBB seem to be doing the job admirably.