Disposable Income is that income which is available to the individual after deducting the taxes from the income. It is that income which is left for expenditure/spending and savings.
The income that enters into a household is subjected to many taxes and for that reason, Disposable Income is calculated.
It is because of the disposable income that the economic and cost of living can be calculated. It serves as an indicator of the standard of living in any economy.
To arrive at Disposable Income, the formula is:
Disposable Income (DI) = Total Income (TI) – Taxes Paid (TP)
From the disposable income, one can also find the Marginal Propensity to Consume of any household or economy. It highly depends on the total income of the household. If there are any variations in the income the disposable income and marginal propensity to consume also changes.
For example, if the monthly earning of a family is Rs. 100,000/- and the taxes are 35,000 then the Disposable Income is:
DI = Total Income - Taxes Paid
Therefore 100,000 – 35,000 = 65,000
The Disposable Income is Rs. 65,000/- for that household which is available for spending and savings.
It should be noted that the disposable income should be positive so that the positivity is maintained. If the Disposable Income is negative it means that there are debts and overdrafts done. This situation should always be avoided. For a household, it can be revived but for an economy, once the country goes in debt it becomes very difficult to earn surplus then. Therefore the taxes should be defined such that there are chances for the people to spend and save as well.
If the majority of their income goes in taxes it will lead to s deficit situation and people will start borrowing either from banks or from financial institutions. These debts then become very difficult to repay.
Thus the tax policy makers should always keep the marginal propensity to consume in mind and then make policies that are according to the power of the citizens to pay.
Too high and too taxes will make no benefit for the economy. It should be a win-win situation where the economy also earns and the individual also has the power to spend and save as well.
Thus Disposable Income plays a vital role in the development of any economy and serves as an indicator of the standard of living in any country.