A Hidden Tax Increase: The Pease Limitation
October 20, 2014
High earners saw a hidden tax increase last year, says Kyle Pomerleau, economist at the Tax Foundation. Taxpayers are allowed to make various itemized deductions, reducing their tax bill. But for higher earners, those deductions are limited.
A tax provision known as the "Pease limitation" reduces the value of itemized deductions for taxpayers earning a certain amount of money. For every dollar that an individual earns in taxable income over $254,200 (or for every dollar that a married couple earns above $305,050), the limitation reduces the value of the taxpayer's deductions by 3 percent. Pomerleau gives the example of a Michigan taxpayer:
- A taxpayer with $500,000 in taxable income would face a 39.6 percent top marginal income tax rate at the federal level and a 4.25 percent top tax rate at the state level.
- Before he pays his federal taxes, he can deduct the amount of income taxes he paid to Michigan from his federal tax bill, which would reduce his rate to 37.92 percent.
- However, the Pease provision reduces the value of that deduction by 3 percent. In so doing, it raises the amount of income that he is forced to pay federal taxes on, increasing his marginal tax rate by 1.18 percent.
Pomerleau says that to call the provision a "limitation on itemized deductions" is misleading; it should not be called a "limitation," rather a surtax on high-income earners. He argues the limitation should be repealed. If lawmakers want to increase the marginal tax rate, they should do so directly rather than by reducing the value of itemized deductions.
Source: Kyle Pomerleau, "The Pease Limitation on Itemized Deductions Is Really a Surtax," Tax Foundation, October 16, 2014.
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