I have the same problem as well. Following klkenney's advice worked for me as well: as soon as I turned off iTunes Match in iTunes, then clicked "Sync" on the phone settings page (I had the phone already plugged in; when I turned iTunes Match on the phone settings page still reported over-capacity) the thermometer guages again showed as accurate.
Note: with iTunes Matche turned on, music was downconverted to 128kbps. I could verify this by clicking the disclosure triangle on the sidebar for my iPhone, then clicking "Music". While things were syncing over, everything said the source iTunes bitrate (ex, 320kbps or 256kbps), but as soon as a song was copied over to the phone it said 128kbps across the board. Looking at the phone itself, the Settings > General > Usage tab confirmed that I had much less on the device in music than iTunes was reporting.
The problem was not that things didn't get downconverted. The problems are:
1. The iTunes guage misreports the Music contribution
2. The Sync process only downconverts and copies over as much music as it thinks will fit, which is based 100% on the size of the music files on the computer, not on the device.
Both of these IMHO indicate a poor software design which should be fixed. The guage and the sync calculation should start from a direct report from the device regarding how much space is being taken up by certain items, then add in the space it thinks will be needed for the additional items and subtract the space it thinks will be saved by removing items. Doing things this way wouldn't completely fix the bug (because iTunes would still overestimate the size needed for any added tracks), but would alleviate it significantly.
This fundamental design flaw also explains the behavior I was seeing with my old 5G iPod, which would "think" that much less (about 0.1GB) would fit on than would actually fit on the device. Given that I was maxing out the space on that old iPod, this bug in estimation was painful there as well.