That Extra Money: A Primer on Discretionary Income

Do you ever wonder why some people can keep up with the latest fashion trends or treat their family to dinner out, while others are more focused on just getting by? A big part of that difference comes down to something called discretionary income. In this blog post, we’ll cover:

• What discretionary income is
• Why discretionary income matters to the economy
• How much discretionary income U.S. households have

What Is Discretionary Income?

Households make a certain amount of money each month. What do they do with that money? First, they must pay for the really important expenses, which could include rent or mortgage, groceries, utilities like electricity and water, insurance, car payments and taxes.

These items are called nondiscretionary expenses—things you pretty much have to pay for. After all those essential bills are taken care of, the money that is left over is called discretionary income. It’s money you can spend at your discretion—you’re free to use it as you like, on what you want rather than strictly need.

Now, some people might think they need to have the latest fashion, but to economists that purchase still comes from discretionary income. Some other examples of discretionary spending include paying for movies, travel, private school tuition or tickets to a sporting event. Of course, you can also save or invest your discretionary income. Yet, as you’ll see later in this post, many low- and moderate-income families don’t have money left over after paying for the essentials.

Why Does Discretionary Income Matter for the Overall Economy?

The amount of discretionary income people have can have a big impact on the overall health of the economy. Here’s what discretionary income does:

• Fuels spending and investment: Discretionary income reflects people’s spending power. When they have increased discretionary income, they can spend on the extra things they want. They may also choose to invest, providing capital for businesses.
• Drives business growth and impacts jobs: When businesses see more spending from households, they may decide to invest in their business by expanding or opening new locations and by creating new products. They may also want to hire more workers to keep up with demand.
• Reflects economic health: When the economy is doing well, people may see their incomes rise, leading to more discretionary income. During economic downturns, people might lose their jobs or see their incomes stagnate, leaving them with less money for nonessential spending.
• Influences government revenue: An increase in household spending can mean an increase in sales taxes. Businesses that are doing well may also pay more in taxes.

Discretionary spending can create more opportunities and help the overall economy grow.

How Much Discretionary Income Do Households Have?

How much discretionary income households have is a bit of a tricky question to answer because it varies greatly depending on the household’s situation: income, cost of living and spending habits. For example, a single person with a moderate-paying job who shares housing and utility costs with a roommate and bikes to work might have a relatively high amount of discretionary income. On the other hand, a higher-income couple in an expensive city with two kids in child care might have relatively little discretionary income after covering their necessary expenses.

Though situations can vary, gross income, or income before any taxes or necessary expenses, and total spending do tend to be related. In 2023, households in the top quintile by income (the 81st to 100th percentile) averaged $150,000 in expenditures, while those in the bottom quintile (first to 20th percentile) averaged $34,000, as you can see in the graphic.

The Lowest-Earning 40% Had Little or No Discretionary Income

SOURCES: Consumer Expenditure Surveys, U.S. Bureau of Labor Statistics, September 2024, and authors’ calculations.

NOTES: Essential categories include food at home, housing, transportation, health care, and personal insurance and pensions. Discretionary income is calculated as the difference between income after taxes and essential spending. Values have been rounded to the nearest thousand.

As you can see in the table below, the highest earners had the most discretionary income after their essential spending, while the lowest-earning 40% either spent more on these items than they earned or had very little money left over after paying for essentials. In other words, these low- and moderate-income households spent all or nearly all their pre-tax income on necessities.There are different ways to compute discretionary income. This blog post makes the distinction between essential and nonessential expenditures. Another recent blog post does not make this distinction and has an estimate of 50% of households not having discretionary income.

The Big Picture

Discretionary income is the money people have for extras, but it’s more than that. It’s also vital for economic activity, driving business growth and job creation. Yet, many households have relatively little or no money left over after essential expenditures. If the households with relatively more discretionary income pull back on spending, it can have an outsized impact on the economy. By understanding what discretionary income is and how it changes, we can get a better grasp of how it shapes our economy and the financial well-being of individuals and families.

Note

1. There are different ways to compute discretionary income. This blog post makes the distinction between essential and nonessential expenditures. Another recent blog post does not make this distinction and has an estimate of 50% of households not having discretionary income.