Satellite retrievals of information about the Earth’s surface are widely used to monitor global terrestrial photosynthesis and primary production and to examine the ecological impacts of droughts. Methods for estimating photosynthesis from space commonly combine information on vegetation greenness, incoming radiation, temperature and atmospheric demand for water (vapour-pressure deficit), but do not account for the direct effects of low soil moisture. They instead rely on vapour-pressure deficit as a proxy for dryness, despite widespread evidence that soil moisture deficits have a direct impact on vegetation, independent of vapour-pressure deficit. Here, we use a globally distributed measurement network to assess the effect of soil moisture on photosynthesis, and identify a common bias in an ensemble of satellite-based estimates of photosynthesis that is governed by the magnitude of soil moisture effects on photosynthetic light-use efficiency. We develop methods to account for the influence of soil moisture and estimate that soil moisture effects reduce global annual photosynthesis by ~15%, increase interannual variability by more than 100% across 25% of the global vegetated land surface, and amplify the impacts of extreme events on primary production. These results demonstrate the importance of soil moisture effects for monitoring carbon-cycle variability and drought impacts on vegetation productivity from space.