Loading the player...

What is 'Discretionary Income'

Discretionary income is the amount of an individual's income that is left for spending, investing or saving after paying taxes and paying for personal necessities, such as food, shelter and clothing. Discretionary income includes money spent on luxury items, vacations, and nonessential goods and services. Because discretionary income is the first to shrink amid a job loss or pay reduction, businesses that sell discretionary goods tend to suffer the most during economic downturns and recessions.

BREAKING DOWN 'Discretionary Income'

Discretionary spending is an important part of a healthy economy. People only spend money on things like travel, movies and consumer electronics if they have the funds to do so. Some people use credit cards to purchase discretionary goods, but increasing personal debt is not the same as having discretionary income.

Discretionary Income vs. Disposable Income

Discretionary income and disposable income are terms often used interchangeably, but they refer to different types of income. Discretionary income is derived from disposable income, which equals gross income minus taxes. Disposable income, in other words, is a person's take-home pay used to meet both essential and nonessential expenses.

Discretionary income is what is left over from disposable income after the income-earner pays for rent/mortgage, transportation, food, utilities, insurance and other essential costs. For most consumers, discretionary income gets depleted first when a pay cut happens. For example, if a person makes $4,000 per month after taxes and has $2,000 in essential costs, he has $2,000 in monthly discretionary income. If his paycheck gets cut to $3,000 per month, he can still meet his essential costs but only has $1,000 left over in discretionary income.

Discretionary Income and the Economy

Discretionary income is an important marker of economic health. Economists use it, along with disposable income, to derive other important economic ratios, such as the marginal propensity to consume (MPC), marginal propensity to save (MPS) and consumer leverage ratios.

In 2005, in the midst of a debt-fueled economic bubble, the U.S. personal savings rate went negative for four consecutive months. After paying for necessary expenses out of disposable income, the average consumer spent all his discretionary income and then some, using credit cards and other debt instruments to make additional discretionary purchases beyond what he could afford.

Aggregate discretionary income levels for an economy fluctuate over time, typically in line with business cycle activity. When economic output is strong, as measured by the gross domestic product (GDP) or another gross measure, discretionary income levels tend to be high as well. If inflation occurs in the price of life's necessities, then discretionary income falls, assuming that wages and taxes remain relatively constant.

RELATED TERMS
  1. Autonomous Consumption

    The minimum level of consumption that would still exist even ...
  2. Income

    Money that an individual or business receives in exchange for ...
  3. Business Income

    Any income that is realized as a result of business activity. ...
  4. Savings Rate

    The amount of money, expressed as a percentage or ratio, that ...
  5. Average Propensity To Save

    The average propensity to save (APS) is an economic term that ...
  6. After-Tax Income

    The amount of money that an individual or company has left over ...
Related Articles
  1. Investing

    What is Discretionary Income?

    Discretionary income is an economic term referring to income left over after a person pays taxes and living expenses.
  2. Insights

    Disposable Income

    Disposable income is the money a person has left over after all taxes have been paid. Other deductions that may affect the amount of disposable income are employment deductions for things like ...
  3. Trading

    2017 Could Be the Year for Consumer Discretionary Stocks

    Bullish chart patterns on the charts of consumer discretionary assets suggest that higher prices could be in the cards for 2017.
  4. Investing

    Which Consumer-Related ETFs Should Investors Buy? (XLY, XLP)

    Analyze the fundamental performance and valuation of XLY and XLP to determine why XLY has grown faster. Find out which ETF is a better buy.
  5. Investing

    5 Best Dividend-Paying Consumer Discretionary ETFs (RTH, RCD)

    Discover the five best dividend-paying consumer discretionary ETFs, which is one of the best-performing sectors in the market since 2013.
  6. Insights

    Calculating the Consumption Function

    The consumption function shows the level of consumer spending as it relates to disposable income.
  7. Financial Advisor

    Consumer Discretionary Vs. Consumer Staples in 2016

    Learn why understanding the seasonal tendencies of consumer discretionary and consumer staple sectors will help improve investors' portfolio performance.
  8. Personal Finance

    All About Income

    Income is the money you or a business earns by providing goods or services, or through investments.
  9. Financial Advisor

    How Much Control Should You Give Your Financial Advisor?

    Discretionary account or non-discretionary? How to tell which is best for you.
  10. Managing Wealth

    Increase Your Disposable Income

    Here are four quick and easy ways to up your spending money.
RELATED FAQS
  1. How do I know how much of my income should be discretionary?

    Understand the difference between discretionary income and disposable income. Learn how much of a person's income should ... Read Answer >>
  2. Why do economists think it is important to track discretionary income?

    Learn about the importance of discretionary income to economists, particularly for economists who emphasize consumer spending ... Read Answer >>
  3. What is the difference between disposable income and discretionary income?

    Learn about disposable and discretionary income, including why these measures are important, the main difference between ... Read Answer >>
  4. What is the difference between residual income and savings?

    Discover the differences between various forms of income and their functions, including residual, disposable and discretionary ... Read Answer >>
  5. What impact does disposable income have on the stock market?

    Learn what disposable income is and what it means for average consumers. Understand the impact that disposable income has ... Read Answer >>
Trading Center