The Effects of Fossil-Fuel Subsidy Reform: A review of modelling and empirical studies

Reforming subsidies to fossil fuels is a challenging prospect for many governments. To help policy-makers better appreciate the trade-offs between economic, environmental and social impacts, various organizations have analyzed fossil-fuel subsidies and their effects, often with the aid of complex economic models.

Measuring the impacts of subsidy reform is a critical step in determining under what conditions the net effect of subsidy removal is positive and what supporting measures need to be undertaken to ensure that negative effects are minimized. This study reviews the literature on fossil-fuel subsidy reform, focusing in particular on six major studies that have been undertaken since the early 1990s.

Largely because of differences in the scope, method and years analyzed, the studies reviewed here are not directly comparable. Nevertheless, some broad conclusions can still be drawn.

From an economic perspective, all six studies found that fossil-fuel subsidy reform would result in aggregate increases in gross domestic product (GDP) in both OECD and non-OECD countries, with expected increases ranging from 0.1 per cent in total by 2010 to 0.7 per cent per year to 2050. All six studies concluded that the reform of fossil-fuel subsidies would reduce CO2 emissions, sometimes substantially. Because the models relied on price gap subsidy values as inputs (often forming a lower-bound for actual subsidies in an economy), actual reductions in GHG emissions could be even higher.  The expected social impacts of reform could be mitigated through re-targeting some of the saved subsidy expenditure towards social programs.

Recommended future actions on subsidy modelling include extending assessments to producer subsidies, more countries, and to incorporate a broader set of social impacts.  Methodological changes in the modelling efforts, such as consistency in how geographic regions are defined, or standardized outputs (e.g., presenting social impacts by income quintile; or subsidies in dollars/year), would greatly enhance the ability to contrast and compare model results.

Despite the fact that further research can and should be undertaken, the analysis in this paper strongly supports the conclusion that there are significant environmental and economic benefits that would result from the reform of fossil-fuel subsidies. Fossil-fuel subsidy reform should be considered as a key element of a larger overall package for global climate-change mitigation. On this basis, there is a mounting body of evidence that policy-makers should not wait to begin the reform process.