Discretionary income is the money an individual or household has left for spending after basic needs are met. It is not the same as disposable income, which is an individual's net income after taxes, but rather a component of disposable income. The formal definition of discretionary income is disposable income minus savings and expenditures for essential livings costs such as for clothing, food, and housing. These expenditures (excluding savings) are sometimes known as nondiscretionary expenditures or fixed consumption. Disposable income, in turn, is all personal income (gross income) less taxes and other payments to the government.
High levels of discretionary income in an economy usually signal prosperity and a high standard of living, as it is a measure of personal economic activity beyond subsistence. Thus, in periods of economic expansion, aggregate discretionary income tends to rise slightly, and conversely in times of general decline discretionary income tends to fall. In the United States, discretionary income has proven resilient during economic downturns, and thus the upward and downward fluctuations have not been very dramatic.
Because many consumer products and services offered in an industrial economy aren't needed for subsistence, businesses that sell such products have a strong interest in the trends and demographics of a nation's (or region's) discretionary income. Such information is required for forecasting potential market growth as well as for directing marketing efforts toward qualified segments of the population.
One problem that plagues studies of discretionary income is how to define it precisely. The concept is seemingly simple—money left after basic needs are met—yet where is the line between "basic" or "essential" spending and discretionary spending? The conventional definition holds, for example, that spending on food is nondiscretionary. But what if most of an individual's food spending occurs at expensive restaurants?
The traditional definition of discretionary income allows for three categories of essential spending: food, apparel, and housing. Ignoring for the moment the potential for optional or luxury spending in each of those categories, this leaves a number of common expenditures that seem essential by almost any standard, notably in areas such as health care, education, and transportation costs.
To get around such hair-splitting, another definition of discretionary income is the income left after all expenses needed to maintain one's present standard of living. This, too, can be problematic when higher income households are considered: if the present standard of living includes many luxuries, it would seem that this definition lumps many discretionary purchases into its calculation of what is essential. One notable study that used this definition was published by the U.S. Census Bureau during the 1980s; when compared with estimates from other sources, it appeared to significantly underestimate the number of households with discretionary income.
Probably the broadest consensus on definitions is for variations on the traditional formula of disposable income minus basic spending.
Total U.S. discretionary income as of 1997 was estimated at $930 billion, or roughly 15 percent of gross personal income in the United States. According to an analysis of the Consumer Expenditure Survey, a widely used gauge of consumer finances published by the U.S. Bureau of Labor Statistics, as of 1997 the average U.S. household had discretionary income of approximately $8,800. (The survey does not calculate discretionary income itself, but provides details on various kinds of consumer income and spending for others to interpret.) This figure is based on the average after-tax household income minus the average expenditures for food, housing, utilities, apparel, health care, and transportation. Small allowances were also made for what may be considered discretionary apparel and transportation spending. Other definitions of essential spending would yield different estimates. Traditional definitions of discretionary income, for example, may consider health care and transportation costs as discretionary, resulting in a higher reported level of discretionary income. Analysts who use the stricter definition arrived at 1997 estimates of $10,000-$ 12,000 in discretionary income per household.
Based on data from the U.S. Census Bureau, approximately two-thirds of U.S. households appear to have some discretionary income leftover after fixed consumption. A minority of the population—predominantly high-income households—control the majority of discretionary income. The top 5 percent alone, according to 1997 data from the Census Bureau, brought in more than one-fifth of all household income (gross income), and the upper 20 percent of households were responsible for half of all income. Income distribution is also stratified by age—not surprisingly, older people tend to have more. Persons age 45 and above control more than half of all discretionary income in the United States, even though this group represents about 46 percent of the adult population. Conversely, households headed by individuals under age 25 control less than 3 percent of U.S. discretionary income. Education is another predictor of discretionary income, as persons with more formal education tend to have more discretionary income.
Many consumer-oriented businesses depend on consumers having discretionary income, and most benefit from it. Obvious examples of industries dependent on discretionary income are those marketing entertainment, luxury goods, or other nonessential goods and services. But it is discretionary income that keeps sales of many household items such as kitchen appliances, stereo equipment, and personal computers buoyant.
Realistically, even people on very tight incomes spend money at movie theaters, buy new televisions, and indulge in other "luxuries"; discretionary income is by no means a have/have not proposition. However, many marketers are interested in reaching segments of the population that are widely and consistently able (and, of course, willing) to purchase their products or services. They use the demographics of discretionary income to help target their marketing. To take an obvious example, a kitchen appliance manufacturer would probably not find it worth its while to target consumers under age 25, since members of this group tend to have little discretionary income and are unlikely to own any of their own appliances in the first place. Rather, knowing that older people and homeowners without children tend to have the highest discretionary income, the manufacturer's marketing team would be more likely to target members of these groups.
Exter, Thomas G., and Cheryl Russell. The Official Guide to American Incomes: The Demographics of Who Does and Who Doesn't Have Money, With a Special Supplement on Discretionary Income. 2nd ed. Ithaca, NY: New Strategist Publications, 1996.
Francese, Peter K., and John Rogers. "Big Spenders.' American Demographics, August 1997.
U.S. Bureau of Labor Statistics. "Average Annual Expenditures and Characteristics of All Consumer Units." Consumer Expenditure Survey. Washington, 1997. Available from www.bls.gov .