Inequality and income mobility: the case of targeted and universal interventions in India

Income interventions with pro-poor targeting is a common fiscal policy around the world. However their distributional effects on consumption and savings are not well understood. Motivated by the Mahatma Gandhi National Rural Employment Guarantee Act (MGNREGA), we use longitudinal data on income and consumption of Indian households to estimate distributional effects of such interventions in a model with endogenous consumption and savings distribution, where households face uninsured income risks. In the model, a standard scheme of interventions that consistently targets low-income cohorts, has small distributional impacts on targeted and non-targeted cohorts alike. In contrast, a fiscally-equivalent scheme that changes the expected income profile of the targeted households in the same initial cohort irrespective of their future incomes, generates larger effects by changing income mobility for both the targeted and non-targeted cohorts. This mobility-based channel generates consumption responses even though the magnitude of the shock is lesser for the initially targeted cohort, as it more than offsets the effect from permanent income shock. Quantitatively, such an intervention in the order of 0.6 percent of output, approximating the Indian scenario, increases consumption share of the targeted cohort by nearly 2.5 percent, five times as large as the effect of standard interventions. The distributional effects are similar to those arising from a counterfactual policy of universal basic income.