How Big Is Obama's 28% Limitation on Itemized Deductions?

September 21, 2011

I wanted to follow up on my last post about Obama's proposal to limit the value of itemized deductions to 28%, even if one pays a higher tax rate. A lot of people have written in to ask, "How big a tax increase is this, and how does it compare to the expiration of the Bush tax cuts for high income earners?"

The answer: It depends. I've done a relatively simple analysis* looking at a few example high-income taxpayers. I use 2012 tax brackets because that's the latest year that we can know for sure what they'll be, even though these proposals likely wouldn't be in effect until 2013 at the earliest. I look at tax bills under two scenarios: existing (current year) tax policies, and Obama's proposal to let the Bush tax cuts expire for high-income taxpayers (above $200K for single filers and $250K for married filers), combined with his proposal to limit the benefit of itemized deductions to 28%. While I make some simplifying assumptions, these numbers should help to give an idea of the rough magnitude of the proposed policy changes:

Sample Tax Return #1

AGI: $240K, Filing Status: Married, No Children, Itemized Deductions: $43,200

Filing Status

Married

Kids

0

AGI

$240,000

Itemized Deductions

$43,200

Tax Under Current Policy

$40,755

Effective Tax Rate under Current Policy

17%

Tax Under Obama Plan

$40,908

Effective Tax Rate under Obama Plan

17%

Tax Increase From Expiration of Bush Tax Cuts for High Income Earners

$0

Tax Increase From 28% Limitation on Itemized Deductions

$153

Total Tax Increase

$153

Sample Tax Return #2

AGI: $500K, Filing Status: Single, No Children, Itemized Deductions: $90,000

Filing Status

Single

Kids

0

AGI

$500,000

Itemized Deductions

$90,000

Tax Under Current Policy

$118,931

Effective Tax Rate under Current Policy

24%

Tax Under Obama Plan

$139,153

Effective Tax Rate under Obama Plan

28%

Tax Increase From Expiration of Bush Tax Cuts for High Income Earners

$11,487

Tax Increase From 28% Limitation on Itemized Deductions

$8,735

Total Tax Increase

$20,222

Sample Tax Return #3

AGI: $1M, Filing Status: Married, Two Children, Itemized Deductions: $180,000

Filing Status

Married

Kids

2

AGI

$1,000,000

Itemized Deductions

$180,000

Tax Under Current Policy

$250,820

Effective Tax Rate under Current Policy

25%

Tax Under Obama Plan

$306,133

Effective Tax Rate under Obama Plan

31%

Tax Increase From Expiration of Bush Tax Cuts for High Income Earners

$38,389

Tax Increase From 28% Limitation on Itemized Deductions

$16,925

Total Tax Increase

$55,314

Sample Tax Return #4

AGI: $10M, Filing Status: Single, No Children, Itemized Deductions: $1,800,000

Filing Status

Single

Kids

0

AGI

$10,000,000

Itemized Deductions

$1,800,000

Tax Under Current Policy

$2,845,431

Effective Tax Rate under Current Policy

28%

Tax Under Obama Plan

$3,502,153

Effective Tax Rate under Obama Plan

35%

Tax Increase From Expiration of Bush Tax Cuts for High Income Earners

$482,687

Tax Increase From 28% Limitation on Itemized Deductions

$174,035

Total Tax Increase

$656,722

*I assume all income is wage income (and not dividends or capital gains, which is not entirely realistic.) We also ignore the AMT entirely. In the Obama plan, we assume the Bush tax cuts expire for upper-income taxpayers by increasing marginal tax rates to Clinton-era levels for income above $200K for singles and $250K for married filers, as well as the return of PEP and Pease limitations with higher phaseout thresholds.

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