What Is Disposable Income?
Disposable income represents the amount of money that individuals or households can spend or save after deductions for federal, state, and local taxes as well as other mandatory charges. Economists closely track this figure as a key indicator of economic strength. It includes both essential and discretionary spending.
Key Takeaways
- Disposable income is the money left after all forms of tax deductions.
- Discretionary income is what remains after all essential costs are covered.
- Economists use these metrics to understand saving, spending, and borrowing trends among consumers.
Formula and Calculation of Disposable Income
To compute disposable income:
Disposable Income = Total Income - Taxes - Mandatory Deductions
Total income encompasses all gross wages earned, adjusted for factors that might reduce this total (e.g., returns or refunds). Taxes and other non-negotiable deductions are then subtracted.
Understanding Disposable Income
Disposable income is the remaining amount after tax payments. This leftover sum is used to meet living expenses like food and rent and can also be reserved for discretionary items, leisure, or investments. Economic health is significantly influenced by disposable income.
It affects consumer spending, business revenues, and savings and investment behavior. It’s the base for various economic measures like discretionary income, personal savings rates, marginal propensity to consume (MPC), and marginal propensity to save (MPS).
Special Considerations
For wage garnishment purposes, the federal government uses a variant method to calculate disposable income, determining what portion of wages can be seized for back taxes or overdue child support. Deductions include retirement plan contributions from gross income for these calculations.
How to Use Disposable Income
Unlike taxes, expenditure of disposable income is highly flexible. Let’s explore some categories where this income is usually allocated:
Discretionary Income
Discretionary income is what’s left after accounting for all necessary expenses, including mortgage/rent, health insurance, food, and transportation. Typically, it is the first to be reduced during financial constraints like job loss or recession, impacting industries selling luxury or non-essential items the most.
Personal Savings Rate
This rate shows the percentage of disposable income channeled into savings. Low savings rates indicate that a higher portion of income is spent immediately.
Marginal Propensity
The marginal propensity to consume is the fraction of each additional disposable income dollar spent right away, while the marginal propensity to save is the share that gets saved. Both tend to increase as incomes rise.
Importance of Disposable Income
Disposable income is vital for both personal financial health and the overall economy. Here’s why:
- Financial Flexibility: Enables better management of expenses, emergencies, and future goals.
- Higher Living Standards: Allows access to better goods, services, leisure activities, and cultural engagements.
- Economic Growth: Drives consumer spending, which is crucial for economic expansion and job creation.
- Savings and Investments: Facilitates building long-term assets and financial security.
- Tax Revenues: Higher disposable income generally means more tax revenues for public services.
Interpreting Disposable Income
Month-to-month changes in disposable personal income are tracked by the Bureau of Economic Analysis (BEA) for economic trend analysis. For example, increases suggest that households have more to spend or save, fueling economic activities.
Calculation Examples
To calculate your disposable income:
- Determine your gross income (total earnings before deductions).
- Subtract all taxes owed.
- The result is your disposable income.
FAQs
Is Disposable Income Net or Gross?
Disposable income is a net figure, post-tax.
Is Disposable Income Taxable?
By definition, it is post-tax income.
What Is the Average Disposable Income in the U.S.?
In 2023, this figure was $60,326 per capita, highlighting disparities in earning across different segments of the population.
Proportion of Saved Disposable Income?
Known as the average propensity to save (APS)—it’s the part of disposable income that goes into savings.
Bottom Line
Disposable income plays a crucial role in personal finance and economic growth. It covers basic living expenses and caters to discretionary spending, driving consumer demand, business profitability, and job creation.
Related Terms: discretionary income, gross income, net income, savings rate.
References
- U.S. Department of Labor. “Fact Sheet #30: The Federal Wage Garnishment Law, Consumer Credit Protection Act’s Title III (CCPA)”.
- Bureau of Economic Analysis. “Personal Saving Rate”.
- U.S. Government Accountability Office. “Fiscal Stewardship and Defense Transformation”.
- Bureau of Economic Analysis. “Personal Income and Outlays, February 2024”.
- Federal Reserve Bank of St. Louis. “Real Disposable Personal Income”.
- United States Department of Agriculture. “Total Food Budget Share Increased from 9.4 Percent of Disposable Income to 10.3% in 2021”.
- St. Louis Fed. “Disposable Personal Income Per Capita”.
- Organisation for Economic Co-operation and Development. “OECD Better Life Index - United States”.
