Individuals and businesses earn income—money for providing goods or services or by investing capital in assets like individual retirement accounts (IRAs). Other sources of income include pensions or Social Security. This income may be used to fund day-to-day expenditures and necessities or to spend on things people want rather than need.
Income can be divided into two different categories: disposable and discretionary income. These are two different measures used to analyze the amount of consumer spending. Both are key economic indicators used to gauge the health of an economy. So how do they differ?
- Disposable income is the net income available to invest, save, or spend after deducting income taxes.
- Disposable income is calculated by subtracting income taxes from income.
- Discretionary income is what a household or individual has to invest, save, or spend after taxes and necessities are paid.
- Examples of necessities include the cost of housing, food, clothing, utilities, and transportation.
- Both disposable and discretionary income are similar, except disposable income does not account for necessities.
Disposable income is one of the economic indicators used to analyze the state of the economy. It is the amount of net income a household or individual has available to invest, save, or spend after income taxes. Disposable income is calculated by subtracting income taxes from income. For most people who receive a paycheck, disposable income is the net amount they receive in their check.
For example, suppose a household has an income of $250,000 and it pays a 37% tax rate. The disposable income of the household is $157,500—that is, $250,000 - ($250,000 x 0.37). Thus, the household has $157,500 to spend on necessities, luxuries, savings, and investments.
On the other hand, discretionary income is the amount of income a household or individual has to invest, save, or spend after taxes and necessities are paid. Discretionary income is what people use to pay for entertainment, luxury items, vacations, and recreation.
Discretionary income is derived from disposable income and therefore there are many similarities between the two income types. But there is one key difference: Disposable income does not take necessities into account. Necessities a household or individual may have are rent, clothing, food, bill payments, goods and services, and other typical expenses.
For example, suppose an individual has an income of $100,000 and pays an income tax rate of 35%. The individual has transportation, rent, insurance, food, clothing, and other necessities totaling $35,000 a year. Their discretionary income is $30,000 or the amount left after subtracting taxes and necessities. This is calculated as $100,000 - ($100,000 x 0.35) - $35,000 for the year.
Disposable income is higher than discretionary income within the same household because expenses of necessary items are not removed from the disposable income. Both measures can be used to project the amount of consumer spending. However, either measure must also take into account the willingness of people to make purchases.
Disposable Income Per Capita
Disposable income is a key metric monitored by financial analysts and government officials because it provides a useful gauge for the overall health of a country's economy. Disposable income is what economists use to monitor how much households are spending and saving. The data helps economists analyze and make predictions about the ability of consumers to make purchases, pay for living expenses, and save for the future.
The Organisation for Economic Co-operation and Development (OECD) compiles economic data for 37 nations, tracking and reporting the household disposable income per capita. Per capita income is a common measurement used by economists and refers to the amount of money earned per person in a region or nation.
Not surprisingly, the United States ranks at the top of the wealthiest countries with the highest disposable income per capita. Other countries that rank in the top ten with high disposable incomes per capita include Luxembourg, Switzerland, Germany, and Australia.
As of 2018, the United States had an average household disposable income of $50,292 per capita.
Peter J. Creedon, CFP®, ChFC®, CLU®
Crystal Brook Advisors, New York, NY
The terms disposable and discretionary income are sometimes used interchangeably, but there is a big difference in terminology to people that work in the financial, banking, or economic worlds.
Very simply, disposable income is money you have after taking out/paying your taxes. Discretionary income is money that is left over after paying your taxes and other living expenses (rent, mortgage, food, heat, electric, clothing, etc). Discretionary income is based and derived on your disposable income.