What Is Disposable Income?
Disposable income, also known as disposable personal income (DPI), is the amount of money that households have available for spending and saving after income taxes have been accounted for. Disposable personal income is often monitored as one of the many key economic indicators used to gauge the overall state of the economy.
DPI=Personal Income−Personal Income Taxes
Understanding Disposable Income
Disposable income is an important measure of household financial resources. For example, consider a family with a household income of $100,000, and the family has an effective income tax rate of 25% (versus marginal tax rate). This household's disposable income would then be $75,000 ($100,000 – $25,000). Economists use DPI as a starting point to gauge households' rates of savings and spending.
Statistical Uses of Disposable Income
Many useful statistical measures and economic indicators derive from disposable income. For example, economists use disposable income as a starting point to calculate metrics such as discretionary income, personal savings rates, marginal propensity to consume (MPC), and marginal propensity to save (MPS).
Disposable income minus all payments for necessities (mortgage, health insurance, food, transportation) equals discretionary income. This portion of disposable income can be spent on what the income earner chooses or, alternatively, it can be saved. Discretionary income is the first to shrink amid a job loss, pay reduction, or economic downturn. As such, businesses that sell discretionary goods tend to suffer the most during recessions and are watched closely by economists for signs of both recession and recovery.
The personal savings rate is the percentage of disposable income that goes into savings for retirement or use at a later date. Marginal propensity to consume represents the percentage of each additional dollar of disposable income that gets spent, while marginal propensity to save denotes the percentage that gets saved.
For several months in 2005, the average personal savings rate dipped into negative territory for the first time since 1933. This means that in 2005, Americans were spending all of their disposable income each month and then tapping into savings or debt for further spending.
Disposable Income for Wage Garnishment
The federal government uses a slightly different method to calculate disposable income for wage garnishment purposes. Sometimes, the government garnishes an income earner's wages for payment of back taxes or delinquent child support. It uses disposable income as a starting point to determine how much to seize from the earner's paycheck. As of 2019, the amount garnished may not exceed 25% of a person's disposable income or the amount by which a person's weekly income exceeds 30 times the federal minimum wage, whichever is less.
In addition to income taxes, the government subtracts health insurance premiums and involuntary retirement plan contributions from gross income when calculating disposable income for wage garnishment purposes. Returning to the above example, if the family described pays $10,000 per year in health insurance premiums and is required to contribute $5,000 to a retirement plan, the household's disposable income for wage garnishment purposes shrinks from $75,000 to $60,000.