Discretionary Income (Encyclopedia of Small Business)
Discretionary income is the amount of income consumers have left over after paying their necessary expenses, such as food, rent or mortgage payments, utilities, and insurance. A similar concept is disposable income, which is the amount of income consumers have left over after paying their taxes. Disposable income is then used to pay necessary expenses. Many consumers do not spend all of their disposable income; instead, they may save or invest some of it. The amount that remains can be spent on luxuries, as opposed to necessities, at the consumers' discretion, and so is known as discretionary income. It is important to note that what qualifies as discretionary income may vary for different individuals and different income levels, as well as over time. For example, a color television set may be a discretionary purchase for a lower-income family, but it may be considered a necessity by a wealthy senior citizen.
The U.S. Bureau of Labor Statistics and the U.S. Census Bureau collaborate to publish ongoing studies of discretionary income and consumer spending. Census Bureau statisticians rank a number of American households according to age, size, and geographic area of residence. They then track the income levels of these households as well as their level of spending in various expense categories, including necessities (such as food, housing, clothing, transportation, and health care) as well as luxuries (such as alcohol, tobacco, entertainment, and education). These studies are used to determine how much money a household typically needs to maintain its standard of living. Many private firms in the country undertake their own studies of discretionary income, but their analyses are also based on the publicly available (online as well as on CD-ROM) census data.
Knowing the pertinent facts about discretionary income is of vital importance to both business and government. Companies are interested in discretionary income levels of consumers in various geographic areas, age brackets, and socioeconomic backgrounds because consumers with larger amounts are more likely to spend their money on the goods and services they provide. The statistics also provide information about consumer spending habits that can be useful in targeting marketing campaigns. Although the data alone cannot predict how a certain consumer will choose to spend his or her discretionary income, it can provide useful information to help marketers make sound planning decisions.
Discretionary incomes of people in certain age groups are of particular value to business and marketing specialists. For example, those over the age of 50 have half of the total amount of discretionary income in their control, making the 50-plus age category the wealthiest group in the nation. This group also corners three-quarters of the bank deposits in the nation, and accounts for 80 percent of all savings accounts. In short, the "over 50s" have enormous financial clout. Similarly, teenage and young adult consumers have considerable sums of discretionary incomend are thus highly valued by companiesecause they are more likely to have their living costs absorbed by other individuals (typically parents) and they are less likely to be in a position where they have to devote resources to support a family.
Niemira, Michael P. "Discretionary Income Growth Booms: The Underpinning for Consumption." Chain Store Age Executive with Shopping Center Age. May 1998.
Russell, Cheryl. The Official Guide to American Incomes: A Comprehensive Look at How Much Americans Have to Spend: With a Special Section on Discretionary Income. New Strategist Publications and Consulting, 1993.
Woodard, Kathy L. "Boomers Lead Boom in Home Re-modeling." Business First-Columbus. April 21, 2000.
Discretionary Income (Encyclopedia of Business)
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 simpleoney left after basic needs are metet 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 populationredominantly high-income householdsontrol 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 ageot 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.