Disposable income is among the most important economic terms, as it is a great indicator on the health of the nation’s economy. This type of income refers to the net amount a person or a firm receives after direct taxes have been subtracted. It shows the amount the individual or the business is able to spend and save. The formula used for calculating disposable income looks like this:
Income received – direct tax deductions = disposable income
As it is typically used in the individual context, it is commonly referred to as disposable personal income or DPI.
What income is included?
The income included in the calculation includes the following earns and gains:
Any income from an economic activity such as wages
Profits of self-employed
Income from property such as dividends, interest and rents
Social benefits such as unemployment benefits, retirement pensions and other family allowances
Social transfers, such as education, received either free or at discounted prices
What deductions apply?
In order to calculate the disposable income, direct taxes need to be taken off from the income received. The most typical direct tax is income tax. Disposable income can also be affected by other deductions. These could include employment deductions, such as health insurance payments.
Disposable income is perhaps easier to understand through an example.
Person A’s salary is $80,000 per year. The country’s income tax means person A has to pay 35% in tax, which would be $28,000 of the salary. This means person A’s disposable income is $52,000.
Using disposable income to monitor the economy
Economic analysis often looks at disposable income in terms of household disposable income. Household disposable income refers to the total amount of money the household earns in a year after taxes and other deductions. Economists use the term in order to monitor how much households are spending money, as well as saving money. Monitoring disposable income levels is an important tool in policy-making. Knowing the disposable income of households will help economists understand the following:
The ability of consumers to make purchases
The ability to pay for living expenses
The ability to save for the future
Disposable income should not be confused with discretionary income, which is calculated by taking living expenses off from disposable income. Living expenses refer to the essential expenditure, such as food, clothing, and rent or mortgage payments.
For instance, if person A’s disposable income is $52,000 and living expenses are $30,000, the discretionary income for person A is $22,000.
Recent Developments in global disposable income
There are large differences in national household disposable incomes. The overall trend in recent years has been an increase in disposable income, as incomes have steadily increased. On average, the OECD nations have annual household disposable income of $25,908 per capita. Despite the general improvement in living standards, inequality has also increased in recent years. This has led to unequal income distribution and large differences in disposable income. In OEDC countries, the average disposable income for the top 20% of the population stood at around $54,313 per year while the bottom 20% had a disposable income of $8,496.