Disposable and discretionary income are measurement tools used to analyze the spending capacity of households and individuals. Both are used as important economic indicators and they are easily confused with each other because each measures income following deductions that impact the value of that income.
Disposable Income Defined
Disposable income is the simple measurement of how much money individuals or households possess to save or spend once taxes have been deducted from personal income, creating an after-tax income tool. In fact, the simple calculation is income minus taxes, according to Investopedia. Disposable income shows how much money someone has to spend on all of life's necessities and luxuries, or to save, invest or disperse in some other manner once the tax obligation is fulfilled.
Discretionary Income Defined
Discretionary income takes a few steps further than disposable income in examining an individual or household's financial status. In addition to removing taxes from your income, discretionary income also removes the money you will need to spend on necessary living expenses, such as food, housing and clothing. What remains is discretionary income, which measures a household's available money for spending on goods and services that are not essential, such as a vacation or luxury items.
Disposable income tends to be higher than discretionary income because it does not remove as many expenses from income. Inflation has a much larger impact on discretionary income than on disposable income because discretionary income depends heavily on the cost of goods and services. As those prices rise with inflation, it cuts into household discretionary income.
Economists utilize disposable income to set the average household rates of spending and saving, according to Investopedia. Neither can fully project spending habits because actual spending also depends on how willing people are to go into personal debt to make purchases, whether it's basic goods and services or non-essential ones. Discretionary income is a critical measurement for gauging the ranks of the middle class, according to "The Economist." Part of being in the middle class is having enough discretionary income to make non-essential purchases and not be limited to essential items.
- Investopedia: Disposable Income
- Investopedia: Discretionary Income
- "The Economist"; Burgeoning Bourgeoisie; February 2009
- Business Dictionary: Disposable Income
- "Bloomberg BusinessWeek"; Real Disposable Income: Bad News for Democrats?; Mike Dorning; June 2010
- Bloomberg: Faster Inflation Causes "Trade Down" to McDonald's, Wal-Mart
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