Discretionary income is the money that remains for spending (or saving or reducing debt) after a household has paid all the necessary costs of living a middle-class lifestyle. Many businesses depend on discretionary dollars for sales and profits.
The $13,179 in discretionary income available to the average household in 2009 was 2 percent less than in 2007, after adjusting for inflation. The decline is not surprising. What is surprising is that the decline was not greater or more widespread. In fact, many households saw their discretionary income rise between 2007 and 2009. The households with growing discretionary incomes include those headed by people aged 25 to 44, households with incomes between $40,000 and $150,000, blacks and Hispanics, households in the Midwest, and householders with no more than a high school degree. How could discretionary income increase for these typically struggling households in the midst of the Great Recession?
The households with growing discretionary incomes are the ones that have succeeded in cutting their spending on necessities the most.
To understand why discretionary income increased for some households requires familiarity with two terms: disposable income or take-home pay, and nondiscretionary--or necessary--spending. Disposable income is the income households bring home after taxes and mandatory payroll deductions for retirement plans. Disposable income fell pretty much across the board between 2007 and 2009, after adjusting for inflation. But--and this is the important point--many households cut their spending on necessities even more than their incomes fell. The households that succeeded in cutting their necessary spending the most were the ones that saw their discretionary income rise, since discretionary income is what's left over after subtracting necessary spending from disposable income.
Let's look at an example. Households headed by 35-to-44-year-olds cut their annual spending on necessities by $2,696 between 2007 and 2009, after adjusting for inflation. This cut was far greater than the $1,657 decline in their disposable income during those years. Consequently, their discretionary income grew by $1,038 to $16,811. How did these households succeed in cutting their spending on necessities so sharply? One of the most important factors was the decline in homeownership. The homeownership rate of 35-to-44-year-olds fell from 68 to 65 percent between 2007 and 2009. Consequently, the age group managed to cut its annual spending on housing by 4 percent during those years, after adjusting for inflation. Most of the households that experienced an increase in discretionary income between 2007 and 2009 saw their homeownership rate fall. By becoming or remaining renters rather than homeowners, they succeeded in cutting their spending on the single biggest item in the household budget--housing.
An increase in discretionary income is not necessarily good news for businesses that sell discretionary items. Just because some households had more discretionary income in 2009 than in 2007 does not mean they spent those extra dollars. That's the point: they did not spend the money. Regardless of the demographics, most households slashed their discretionary spending and their necessary spending between 2007 and 2009, after adjusting for inflation. Householders aged 35 to 44 cut their discretionary spending by 8 percent during those years--a $982 cut. Many households are using their "fun" money to pay down debt, which explains why the economic recovery is no fun at all.
Source: American Incomes: Demographics of Who Has Money, available as a PDF download with links to Excel spreadsheets for each data table
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