Insights

Published 09 June 2025 on the AFR

The Trump administration is playing a dangerous hand, assuming that foreign investors and corporations have no choice but to remain in US markets.

Benjamin Franklin famously said, “In this world nothing can be said to be certain, except death and taxes.” But recent events have reminded us that there is no certainty in taxes – and that’s creating serious consequences for long-term asset allocation.

Buried in US President Donald Trump’s proposed “big beautiful bill” is Section 899, which proposes several changes to the US tax code. It targets countries such as Australia, which are judged to apply extraterritorial or discriminatory taxes, with new withholding taxes on US-sourced dividends, royalties and potentially some types of interest income.

For Australian superannuation funds, insurers and global investors, that could translate to higher tax bills and growing uncertainty around the future of US investments.

Foreign investors currently hold $US31.4 trillion ($48.4 trillion) in long-term US assets – including $US19 trillion in equities, $US7 trillion in Treasuries and $US5 trillion in credit. These holdings peaked in November 2024 at $US32.2 trillion. While flows remain strong, even a modest reallocation could send ripples across global markets.

Despite the scope of the change, the US Treasury estimates Section 899 will raise just $US116 billion over 10 years – or 0.04 per cent of GDP. But that doesn’t mean the impact is immaterial, given investors’ large potential exposure.

For large asset owners, like superannuation funds, the uncertainty, including of future changes applied retrospectively and compliance burden, may be more significant than the headline tax cost.

Australia, along with much of Europe, the UK, Canada, Japan and South Korea, is expected to be captured as a “discriminatory” country due to its digital services tax. For Australian super funds, this raises two risks: a higher tax burden on US investments and the loss of tax credits back home, reducing returns.

Market reaction has been relatively muted. Since the increased attention around Section 899 in late May, the S&P 500 has barely moved. That could reflect investor confidence that the rule will be watered down or that there’s no viable alternative to US markets.

Both assumptions are risky.

Some see Trump’s “big beautiful bill” as a stimulus that will lift corporate profits and boost equity returns. Others assume the backlash will soften the legislation’s eventual form (TACOs anyone?)

The Trump administration is playing a dangerous hand, assuming that foreign investors and corporations have no choice but to remain in US markets. In the short term, the TINA (there is no alternative) argument probably holds. However, over the longer term, the uncertainty premium around US assets becomes harder to ignore.

As George Saravelos, head of FX research at Deutsche Bank, stated in a recent note, the trade war is morphing into a capital war. If the US changes tax burdens on foreign investors, they could also reduce tax receipts in countries such as Australia, where investors can claim a credit against taxes already paid.

Hard to ignore

Higher taxes in the US and the risk of further retaliatory taxes may reduce incentives to invest, and force funds to reflect that in their strategic allocations. So far, most of the conversation has focused on the US implications of capital exit – weaker US dollar, higher Treasury yield and lower US equities. But the more important question may be: where does it go?

A logical response to the heightened tax and policy risk would be for funds to reduce their exposure to US assets, even for funds that are not directly impacted. Australian investors hold $US634 billion in US equities, $US41 billion in US corporates, and $US70 billion in Treasuries/agencies. Even small changes will be significant.

Offshore markets, from Japan and Europe to South Korea, face the same challenges. But home bias still dominates. Domestically, any reallocation is likely to focus on private markets. Superannuation funds already hold a quarter of all listed equities in Australia, and some have already said they’ve reached their limit. But competition for private assets is rising, particularly as banks also turn their focus to this space.

Superannuation funds hold nearly one-third of all bank debt securities and almost 30 per cent of bank equity, and it is growing. This situation is unsustainable. Not only are there financial stability considerations due to linkages between banks and super, but also bigger questions around whether superannuation should continue subsidising the cost of capital of our banking system.

Trump-induced uncertainty is forcing more capital back to Australia. But unless we broaden the investible universe, that capital will pile up in already crowded assets – inflating risks without creating real growth.

Author: Pete Robinson, Head of Investment Strategy at Challenger Investment.