Devil in the detail as Trump's 'revenge tax' playing with fire

A key provision of the president's 'big, beautiful' tax bill is worrying traders

US president Donald Trump speaking on the South Lawn of the White House this week. Under sweeping tax reforms announced by Mr Trump, US Congress would empower his administration to impose tax hikes on foreign residents and companies that do business in the US. Picture: AP Photo/Alex Brandon

It has been billed as US president Donald Trump’s ‘revenge tax’: a provision in his 'big, beautiful bill' granting power to retaliate against countries that impose special digital service taxes on large US technology companies like Amazon and Alphabet.

Under the sweeping tax reforms announced by Mr Trump last month, the US Congress would empower his administration to impose tax hikes on foreign residents and companies that do business in the US. The US Constitution gives Congress, not the president, the power to decide on taxes and spending.

Section 899 would allow the US Treasury Department to label foreign tech taxes "unfair" and place the country in question on a list of "discriminatory foreign countries." Some other foreign taxes also would be subject to scrutiny. Once on the list, a country's individuals and its companies that operate in the US could face stiffer tax rates that could increase each year, up to 20 percentage points.

The US House of Representatives has approved the tax and spending bill that includes the possibility of imposing a progressive tax burden of up to 20% on foreign investors' passive income, such as dividends and royalties. Section 899 now rests with the US Senate. 

According to law firm Davis Polk, nations that could be considered "discriminatory foreign countries" include many that are part of the European Union, as well as India, Brazil, Australia, and the UK.

"If foreign countries want to come in the United States and tax US businesses, then those foreign-based businesses ought to be taxed as well," said Representative Ron Estes, a Kansas Republican who helped craft the provision.

Some 17 countries in Europe and others around the world impose or have announced such taxes on US tech products like Meta's Instagram. 

Mr Trump has been pressing foreign countries to lower barriers to US commerce. The Section 899 provision could raise $116bn (€101bn) over the next decade, according to the US Joint Committee on Taxation. But some experts warned that an unintended consequence of retaliatory taxes could be less foreign investment in the US.

"We see this legislation as creating the scope for the US administration to transform a trade war into a capital war if it so wishes," George Saravelos, head of FX research at Deutsche Bank, said in a note, adding the new tax could have an adverse impact on demand for US Treasuries.

If passed by the Senate, the rising tax rate on foreigners' investments would come at a time global investors have started to question so-called "US exceptionalism": its unique ability to outperform other financial markets, due to a growing fiscal deficit and a new trade policy based on tariffs.

The US currency is down roughly 8% this year against a basket of other major currencies and is on track for its worst year since 2017.

Last week, the dollar got some respite, rising 0.3% after trade talks with the EU got back on track and a US trade court blocked the bulk of Mr Trump's tariffs on the grounds that he overstepped his authority. An appeals court reinstated the duties a day later, and Trump's administration said it had other avenues to implement them if it loses in court, but many analysts said it showed there were still checks in place on the president's power.

Fiscal worries have also given rise to a broad "sell America" theme that has seen dollar assets from stocks to US Treasury bonds dropping in recent months.

Those concerns come into sharp focus as the Senate starts considering the administration's tax cut and spending bill, estimated to add $3.8tn (€3.3tn) to the federal government's $36.2tn (€31.7tn) in debt over the next decade.

The fate of section 899 of the bill could be crucial, according to Barclays analysts. "S899 would give the US free rein to tax companies and investors from countries deemed to have 'unfair foreign taxes' (and) could be seen as a tax on the US capital account at a time when investor nervousness towards US assets has grown," they said in a research report.

International companies with subsidiaries in the US, which employ 8.4m workers, fear the higher tax burden could make it more difficult to operate in the world's biggest economy. In a recent statement, the Global Business Alliance, which represents foreign companies in the US, said a tax hike would threaten investments in the country.

Financial services firm Brown Brothers Harriman (BBH) said in a recent note the new tax rate was "playing with fire".

"It would deter foreign investment in US assets at a time when the country faces increasing reliance on foreign capital to finance its ballooning debt," said Elias Haddad, BBH's senior markets strategist. "Clearly, this is not good for the dollar."

Reuters