Disposable IncomeIncluding Definition and Formula

Written By:
Lisa Borga

Disposable income refers to the amount of income individuals have leftover after paying federal, state, and local taxes as well as other deductions.

This income is an individual’s actual income which is available to them to spend on private consumption.

In other words, disposable income shows the spending ability of an individual, with a higher number indicating a greater ability to spend.

Disposable income can be calculated for individuals, households, or a nation as a whole.

The resulting measurement can provide an indication of the economic health of individuals and entire economies.

Disposable Income Explained

Disposable income, also known as disposable personal income or net pay, is the amount of income remaining after all mandatory deductions are made.

This is equivalent to all earnings, including unemployment benefits and capital income, minus all mandatory government payments such as federal, state, and local taxes, unemployment insurance, garnishments, and mandatory health insurance premiums.

Disposable income shows how capable an individual or household is of paying for necessary expenses and luxuries.

How much disposable income is available to an individual will have a considerable impact on their spending decisions.

When disposable income is low, a greater proportion is likely to be spent on necessities, and when it is high, more is likely to be spent on luxuries and saving for greater financial security.

As more disposable income becomes available in an economy, consumer spending will increase, and the market will, in turn, strengthen.

In addition, the greater the amount that consumers save, the more banks are willing and able to provide loans to individuals and businesses.

This helps financial sectors to grow, in turn helping entire economies to prosper.

As a result, the level of disposable income in an economy serves as an important indicator of its health.

Essential Points

• Disposable income is the amount that an individual has available to spend once all mandatory payments to a government, including all taxes, are made.
• Economists pay close attention to the disposable income of a country’s residents in addition to consumer spending, which is heavily dependent upon disposable income.
• A higher national disposable income means that its population has a greater ability to spend and save.
• Disposable income should not be confused with discretionary income, which is another measurement of an individual’s available income. Unlike disposable income, this measurement is the amount of income left to a person after taxes and all essential expenses such as food and utilities.

Similar Metrics

Disposable Income can be used to compute other similar metrics, such as the marginal propensity to consume, personal savings rates, and the marginal propensity to save.

Marginal Propensity to Consume

The marginal propensity to consume is the increase in spending that occurs as a result of an increase in income.

It is calculated by dividing the change in consumption by the change in income.

Personal Saving Rates

The personal saving rate is the percentage of income that is saved for retirement, education, or other purposes.

Marginal Propensity to Save

The marginal propensity to save is the proportion of an individual’s increase in income that they will save instead of spend.

It is found by dividing the change in savings by the change in income.

This is studied to see people’s propensity to save in certain economic situations.

Formula for Calculating Disposable Income

Disposable personal income is found by subtracting any federal, state, or local taxes from gross annual income.

The formula is as follows:

Disposable Personal Income = Personal Income – Current Taxes on Income

This formula gives the net pay of an individual earner.

Example

Here is an example of how to calculate disposable personal income.

Sally earns $110,000 in annual gross income as a nurse practitioner.

She pays a 15% federal tax on the income and a 5% state tax.

The net pay is computed as follows.

Disposable Personal Income = Personal Income – Current Taxes on Income.

Disposable Personal Income = $110,000 – [($110,000 x .15) + ($110,000 x .05)]

Disposable Personal Income = $110,000 – $22,000 = $88,000

Sally has a disposable income of $88,000 to spend on goods and services.

Disposable Income vs. Discretionary Income

Disposable income, or net pay, is the income remaining from an individual’s salary, wages, unemployment benefits, or capital income after taxes.

An individual can use this income to meet their needs.

Discretionary income is a part of disposable income.

It is obtained by subtracting the cost of necessities, such as rent or food, from disposable income.

Discretionary income can be used to save or spend on whatever the individual wants.

Final Thoughts

Analysts frequently look at disposable income when trying to determine the health of an economy.

One way in which disposable income affects the health of the economy is that it determines the amount of money a person has to save or spend.

If disposable income is high, people have a lot of money available for saving or spending, which is one sign of a healthy economy.