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

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

Sample Tax Return #2

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

Sample Tax Return #3

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

Sample Tax Return #4

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

*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.